Judge Cudahy and the Idiocy of Electric Deregulation

Judge Richard D. Cudahy, Judge for the Seventh Circuit Court of Appeals, [Chicago; covers Illinois, Indiana & Wisconsin] which court is known for its excellently-written, often hilarious, opinions, (e.g. Lust v. Sealy Matress) is the first and only knowledgeable person that I know of, to write unflinchingly about the idiocy of electric deregulation.

Earlier in his amazing career he was a commissioner on the Wisconsin Public Service Commission. He knows whereof he writes.




[excerpts]
Copyright (c) 1998 Yale J. on Reg.
Yale University
Summer, 1998
15 Yale J. on Reg. 427

Commentary: The Folklore of Deregulation (with Apologies to Thurman Arnold)
Richard D. Cudahy

And it celebrates the army of middlemen sustained by the folklore of deregulation--
marketers, publicists, advertisers, and the like--a new class dedicated to reinventing
venerable industries as savvy competitors.

We will see that certain endeavors--e.g., the unbundling of functions, the stranding of
costs, the passionate search for mergers, and the pervasive drumbeat of advertising--are
the indispensable ingredients of deregulation. Moreover, we will see that the process of
deregulation itself is legitimized by an army of consultants, marketers, middlemen, and
media people that give shape and meaning to the folklore of deregulation
But gone is obeisance to the idea of universal service--that everyone, wherever
located, should get adequate service at a fair price. This would be achievable only under
regulation, of course. With competition, the megalopolis is frequently and cheaply served
while the small city may have fewer flights than the space shuttle but at comparable
prices.

The ISO is one of the mythic heroes of deregulation, beholden to no one and capable
in theory of monumental feats of coordination and dispatch...

In fact, the bilateral traders accused the Poolco advocates of fabricating nonexistent
transmission problems and of introducing an unnecessary ISO to engage in, of all things,
regulation. The bilateral folks only wanted free trade betw

Retail wheeling is an arrangement devoutly sought after by large industrial
users of power. Those with an uncritical commitment to the market believe that the worst threat to their goals is any kind of slowdown [*435] that would allow the forces of regulation to
regroup and counterattack. Perhaps this perception is correct, and retail wheeling is like
the flag raised by the Marines on Iwo Jima to signal their final victory and discourage

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counterattacks. But symbolism aside and with a view to grim reality, the rush to judgment
may be premature. The decisive importance of faith and folklore in energy matters is illustrated by the stark contrast between the treatment of natural gas twenty years ago and today. Twenty years ago natural gas was generally believed to be a precious resource in short supply. It was to be reserved by regulatory fiat for its highest use--home heating. It was
emphatically not to be used for electric generation, for heating swimming pools, or for
burning in gas logs. Now the supply of natural gas is generally believed to be
inexhaustible, with no threat of inflated prices. As an environmentally friendly
hydrocarbon, there can be no higher and better use for gas than for industrial applications
and for electric generation. By using it in combined cycle turbine generators, we have a
low-capital-cost source of power, which cancels out economies of scale in generation and
voids any argument that electricity is a natural monopoly. Thus, instead of being subject
to legislative extinction as a generation source, natural gas is to be elevated by free
market competition to a new place of honor. There has been a radical shift in natural
[*436] gas's place in the folklore, reflecting once again the manic-depressive bent of
energy thinking. As we have seen, the folklore of deregulation is imbedded in all the various schemes for competition. But that folklore is perhaps most striking in the people, activities, and
buzzwords that accompany sort. Unbundling and stranded costs are exotic features of the
process, and mergers are commonplace. All are rich ingredients these proposals.
Deregulation is a magnet for middlemen and consultants, as well as for advertising
people of every of the folklore of deregulation.

A. Middlemen, Media, and Consultants

The folklore of deregulation is part of the powerful myth of the market, with the trader
as high priest and trading as the liturgy. Again, this is perhaps best illustrated by
developments in electric power. In its early years, the electric power business was
dominated by engineers and scientists. The initial problems of the industry raised
predominantly scientific and engineering issues--e.g., [*437] whether direct or
alternating current worked best. There were also early rate problems, mostly addressed by
engineers. After the engineers came the lawyers, who were presumed to know how to
deal with government regulation, when regulation came to be a bigger concern than
which way the current flowed. If there were any cracks in the phalanx of lawyers, they
were filled by the throngs of economists pouring into a land of opportunity. The
economists temporarily eclipsed the lawyers by shrewdly inventing deregulation, thereby
depriving the lawyers of their stock in trade.

With the advent of deregulation came a whole new breed of industry figures. This was
a crowd extraordinarily comfortable in an atmosphere redolent of new angles and new
dollars. These were the marketers, traders, and brokers that composed the emerging class
empowered by the new regime of competition in an unregulated marketplace. In sober
truth, the battle cry of deregulation was not, "Eliminate the middleman!" Rather,

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middlemen--individual and corporate--were coming out of the woodwork. The pecking
order of the new regime seemed to put those who arranged trades and made deals or who
followed futures quotations ahead of those who merely knew how to power up a gas
turbine or how to get on the good side of a utility commissioner. The less one dirtied
one's hands with wires and poles, or even rate schedules, the faster one rose, with
marketers in the lead. This new prominence of the trader is a bit like a move from mere
wheat farming to trading in wheat futures on the Chicago Board of Trade. How do you
get them back on the farm, once they've seen the wheat pit? In the folklore of
deregulation, the marketer and the trader are the leading players. In the new regime, if one needs power, one merely e-mails a marketer who has gobs of electricity in his, her, or its portfolio. Everything seems ethereal because it is virtual electricity that exists only as a blip on a computer screen and will never give one a shock. One imagines that somewhere there have to be real power plants and real transmission lines and real electricity, but one doesn't really know this for sure. All one deals with are virtual megawatts, emerging from virtual power stations onto virtual transmission lines for delivery to virtual customers, from whom payment will be received. But note this carefully: The payment is not virtual--it is in real dollars. Reality has retreated to the money part of the system.

The widespread existence of power marketers with only a computer, a fax, and a
cellular telephone lends verity to the idea that electric power has joined the yen and the
ringgit as a staple of exchange and speculation, and that the new elite of the electric
world are traders, brokers, and marketers--middlemen. To those steeped in the culture of
capitalism there is something reassuring about this. Certainly it is more modern and
enlightened to entrust the fate of the nation to traders, who understand and obey the
Invisible Hand, than to follow the lawyers into the snake pit of government regulation. In
the folklore of deregulation, the [*438] prime article of faith is the terminal ineptitude
of government. Any government is conclusively deemed part of the problem and not part
of the solution.

The better one is able to put the trading process into sophisticated garb, the better one
seems to evoke the beating heart of capitalism. Thus, the development of futures and
options or, better yet, options on futures for megawatts of electric power provides an
exhilaration that mere megawatts cannot match. In the public relations version, these
derivatives are useful for hedging and therefore contribute to the efficient management of
the power system. But we sophisticates know better. We know that these vehicles
occasionally prove useful, as in Orange County, to the informed speculator or even to the
uninformed gambler. Also of consequence is the business that these derivatives will
generate for brokerage houses and for commodity brokers, as well as for the exchanges
on which they are traded. A reform and restructuring of electric power is hardly of note
unless it provides new and exciting products for the trading floor--something to put pork
bellies in the shade.

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The deregulation of electric power has therefore generated an impressive growth of
employment opportunities for brokers, traders, and marketers. This will more than make
up for all the linemen, electricians, and clerks laid off in the interest of efficiency.
Perhaps these unfortunates can be retrained to be useful around a trading pit. But the need
for brokers, traders, and marketers is only the beginning of the employment opportunities
springing from deregulation. Some of the most impressive of these opportunities are in
the realm of education. No one can keep track of all the seminars, conferences, courses,
colloquia, encounters, round table discussions, brown bag lunches, and apres-ski
discourses offered in the name of preparation for the New World of Deregulation. The
revenues generated by these educational efforts seem to dwarf the combined take of all
the formerly regulated industries put together. And all these industries have their own
educational programs, at times with inter-industry insights, like using power lines for
computer talk.

Many of the members of the faculties of these various courses are consultants hopeful
of finding work with one or more of the programs' students, who are company managers.
So there is a delightful reciprocity about things. It is generally true that brochures
announcing these programs proclaim the advent of deregulation as a turning point in
history roughly on a par with the discovery of America. Nonetheless, however expansive
these interpretations, there is nothing to obscure the bottom line that "the 'd' in
deregulation is for 'dollars'." I am still waiting to hear any suggestion that the new
competitive regime might have a downside. If the advent of deregulation is like any other
novelty, however, at some point there will be a reactive flood of complaints, warnings,
and bomb threats demanding the immediate end of deregulatory activity and a return to
what the sender will call sanity. [*439] Rivaling the rash of educational conferences heralding the arrival of deregulation is the deluge of new newsletters, books, and periodicals dealing in hyperbolic terms with one facet or another of a deregulated industry. These publications have a seemingly inexhaustible supply of arguably newsworthy events with which to fill their pages. Now this is not news as riveting as Monica Lewinsky or Princess Di, and it may even be thin
gruel for a dentist's waiting room. But at least the definition of "newsworthy event" is far
from confining. It includes, of course, every official action of every state utility
commission and of every relevant federal agency. But this is only the beginning. Afterdinner
speeches of the commissioners may contain important clues to impending
developments in state X or in the nation. This sort of interpretation calls for virtuosity on
the part of the newsletter author in the art of "reading the tea leaves." This is a talent for
sensing, in an apparently unambiguous declaration, a hint that just the opposite may be in
store. For example, if a regulator proclaims dramatically how ardent his or her agency has
been in furthering deregulation and waves a bunch of papers to prove it, it may really be a
signal that a huge batch of onerous new regulations is about to be issued.
The need for inside information is particularly pressing at a time when industries are
being restructured to prepare them for competition. The reason for this is that everyone is
in favor of deregulation, and it becomes increasingly important to tell those that are really

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for competition from those who merely fear that a negative stance will jeopardize their
consulting contracts. There are few in industry, government, or academia who have gone
on record as opposing deregulation. Even the managements of the highest cost and most
inefficient regulated utilities declare that they are delighted to be stripped of their
monopoly. They like to give the impression that their newly proclaimed desire to trash
their monopolistic past and to seek entrepreneurial opportunity really was hidden in their
secret hearts all along. And no politician has been rash enough to suggest that
competition will be bad for the consumer and for the environment, even though his past
campaigns have always been generously supported by utilities with a monopoly
franchise. It is therefore important for the purveyors of inside information to be able to
report not only what is said publicly but also with whom the speaker had lunch before the
talk, or with whom he shot grouse in Scotland, not to mention miscellaneous pillow talk.
There is also a heart-warming rapport among, first, publications following industry
news; second, conferences and seminars at which the speakers make news; and, third,
consultants seeking to make a name for themselves as deregulation gurus. This
combination can work beautifully, with a newsletter sponsoring a conference, at which a
consultant can speak and have his views reported in the newsletter, wherein they will be
read by numerous potential clients. A government official seeking lucrative employment
in private industry can be a useful addition to this mix. [*440]

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B. Advertising
Further, it is certainly not a revelation that deregulation has brought unimaginable
prosperity to people in advertising. We will soon be listening to electricity commercials.
Along this line, ads plugging as exceptionally reliable an "Old Faithful" brand of electric
power (filmed in Yellowstone Park, of course) are probably not far off. We can also look
forward to "green" promotions, where fly fishermen and Smokey the Bear will be
featured in 30 second spots recommending current generated by windmills or flowing
from a solar panel. Negative ads may showcase a mushroom cloud floating up from an
errant nuclear generator. We have as a model, of course, the virtually unintelligible television pitches of long distance telephone companies. One features ten minutes of free calling a day to American Samoa, while another explains a new procedure for making
.
C. Unbundling, Stranded Costs, and Mergers

Three issues that have been the subjects of many conferences and seminars, and which
arise in many deregulatory contexts, are the questions of unbundling, stranded costs, and
mergers. A short word on unbundling will suffice. It is not the forced separation of lovers
wrapped in intimate embrace; it is the forced separation, in the interest of competition, of
utility functions and services formerly wrapped in anticompetitive embrace.
Stranded costs refer to all the most harebrained mistakes made by regulated utilities,
which had duly received regulatory blessing, but which in the new order are condemned
to oblivion by competition. In the electric power industry, very [*441] expensive
nuclear plants are prominent on the list of stranded assets. The burial costs of such illstarred
undertakings are high, and there have been various plans for their payment by
some category of hapless customers. Unless the customers can be forced to pay, the
utilities may be driven into bankruptcy. It is therefore not surprising that many of these
monopolies asked nothing of the plans stripping them of their franchises except that their
stranded costs--the "funeral expenses" of their stranded assets--be somehow paid by their
customers. This position is not noble, but it is surely practical. Some of the most
apparently fanatical deregulators have adopted a mirror-image stance: Regulated
monopoly must be destroyed root and branch, but, almost incidentally (wink and nod),
the customers should pick up the tab for stranded costs. In fact, this is the new
"deregulatory compact."

Another favorite subject of conferences and of economists' theorizing is industry
concentration, mergers, and the like. As industries deregulate, their constituent companies
rush into one another's arms, forming ever more gigantic firms to compete in a much
friendlier market. These surges of corporate love at first sight give rise to the aphorism
(duly noted in the folklore): "Nothing is certain about deregulation except the mergers
that follow." Mergers are accomplished in the name of efficiency and perhaps (though
certainly sub silentio) in the hope of some easing of competitive pressures. The efforts of

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the antitrust authorities to halt or slow this process are ineffectual in the face of the wild
corporate lusts unleashed by deregulation. More and more, competition in the formerly
regulated industries is carried on by a handful of behemoths of international dimensions.
And, to complicate the picture, the competitive myth that everyone covets his neighbor's
business is being tested in, for example, the telephone industry, where the anticipated
rush of long distance companies to enter local service has been notably subdued.
In the electric power industry, Herculean efforts are being made to sustain competition
against merger, vertical integration, and other hazards. Power companies vertically
disintegrate by selling off their power stations to eliminate cozy relations between
generators and distributors in their regional market and to put rival generators on a level
playing field. In line with this thinking, plants in New England are being sold to faraway
California owners and, in another transaction, to an even more distant French concern.
These deals are supposed to make sense competitively because the new owners have no
distribution or other assets in New England with which to play footsie. As in other
matters governed by the folklore of deregulation, the theoretical effectiveness of
competition is the one and only factor considered. Whether the infrastructure belongs in
foreign hands or even in absentee ownership is not a question any informed person would
ask. Whether New England regulators will have the same leverage over distant owners is
also not a permissible question. In the olden days, the only international relationships
among utilities involved First World ownership of Third World facilities--and these
arrangements frequently ended [*442] unhappily for both parties to the bargain. Now,
on the other hand, U.S. concerns own things in Britain (and elsewhere), and British
companies own things in the U.S. (and elsewhere). So far the French electric system is
not in play because it is still government-owned and, France being French, may stay that
way. International crossownership may be put to the test if electricity demand should
slacken and foreign owners seek to reduce or abandon service--pulling the infrastructure
out from under, so to speak.

Conclusion

Deregulation is a wondrous process, driven by the belief that competition is all. One of
the truly remarkable things about deregulation is its strong appeal to both the Right and
the Left. There may be some observers in the center who do not wildly applaud
deregulation, but nothing is heard from them as the plaudits come in from both ends of
the political spectrum. Conservatives love deregulation because it gets rid of the
government. Liberals seem to love it because it spells the end of hated monopolies.
Deregulation legislation is often sponsored by a vociferous liberal in partnership with a
doughty conservative. <=9> n8 In fact, judging by the debate on deregulation, it is hard
to believe that traditional regulated industries like AT&T ever had any friends. Rather,
these industries seem so cowed by the volume of demands by the Right and Left that they
be stripped of their monopoly, that they have accepted their fates, literally renounced
their regulated past, lit a candle to deregulation and its folklore, and adopted the fanatical
faith common among converts.

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Competition is undoubtedly something, but whether it is all remains to be seen. It is
certainly a prod to efficiency and, no doubt, to innovation; but whether it can live up to
its folklore as a paradise of unlimited choice among ever-cheaper, yet always reliable,
basic services may raise nagging questions. Possibly, in some circumstances, the oldfashioned
obligation to serve may even be missed. The true believers would, of course,
be scandalized that one could entertain such a thought. In any event, whether
deregulation is a sea change or only a nudge of right rudder, it has certainly called forth a
wild abundance of musings by experts and by those aspiring to be experts. They have
launched a torrent of writings and speeches and regulations and orders and policy
statements that rival catalogues and credit card offers as a burden on the mails.
Developments in deregulation have actually appeared in front page banner headlines!
That has almost succeeded in making regulated and formerly regulated industries
exciting. At least that is the fragile reed on which this Commentary rests.

FOOTNOTES:
n1 See generally Applications of Microwave Communications, Inc., 18 F.C.C.2d 953
(1969).
n2 Back in 1973, I heard John deButts, then Chairman of the old AT&T, make a speech
at a convention of state regulators in Seattle. See John D. deButts, The Time Is Now for
the Communications Industry: Address Before the Eighty-Fifth Annual Convention of the
National Association of Regulatory Utility Commissioners, 1973 Nat'l Ass'n Reg. Util.
Commissioners Proc. 285. To an audience packed with AT&T vice presidents, he
declared that his company had fought to retain its monopoly status, but, now that
competition had been ordained, AT&T was going to compete with the best of them. See
id. at 287. Judging by its role as a defendant in a pack of antitrust suits, AT&T did
compete in a muscular way and without excessive restraint until it mutated from
regulated monopoly to telephonic free spirit.
n3 Applications of Microwave Communications, Inc., 18 F.C.C.2d at 978.
n4 Id. at 971.
n5 David Boies, Deregulation in Practice, 55 Antitrust L.J. 185, 189 (1986)
(commenting on Alfred E. Kahn, The Theory and Application of Regulation, 55 Antitrust
L.J. 177, 178-84 (1986)).
n6 Now apparently to be joined by a fourth--a Northwest-Continental combination.
n7 Abundant Power from Atom Seen, N.Y. Times, Sept. 17, 1954, at 5 (quoting Lewis
L. Strauss, Address at the Twentieth Anniversary of the National Association of Science
Writers (Sept. 16, 1954)). Mr. Strauss was the chairman of the Atomic Energy
Commission. See id.

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n8 See, e.g., The Transition to Electric Competition Act, S. 1401, 105th Cong. (1997)
(Dale Bumpers (D.-Arkansas), Slade Gorton (D.-Washington)).