Policy Study

Integrating Municipal Utilities into a Competitive Electricity Market

Executive Summary

Electric-industry restructuring is already a reality for half the states in the nation, and more will soon follow. Given time for markets to develop, competition in generation of electric power should bring consumers more choices of electricity services and lower prices. But so far, the restructuring debate has focused on integrating private utilities into competitive markets, while paying little attention to the issue of integrating the nation’s over 2,000 municipal utilities (munis) into competitive markets. Participating in competitive markets is not easy for government-owned entities, and markets don’t function well when groups of participants play by different legal, tax, and regulatory rules.

Integrating munis into competitive electricity markets requires grappling with both public-policy challenges and management-policy challenges. The public-policy challenges begin with defining a new role for munis in the electric industry as it evolves toward competition. Munis were born in an era without competition as an alternative to poor service from private utilities. As the market becomes competitive, what role remains for munis? Part of the answer is the second public-policy challenge: munis have become an often critical source of municipal revenue; when they have to compete for customers, they can no longer be a city’s cash cow, and some cities may find that competition brings a financial crisis.

A third public-policy challenge is financial subsidies provided to munis. They get preferential access to cheap federal hydropower, do not pay federal income taxes, and can use lower-cost, tax-exempt bonds to pay for capital projects. All give munis a financial edge over private utilities that will distort a competitive market. How do we change these policies as the market moves from monopoly to competition?

The management-policy changes that munis face are no less thorny. Typical munis have much higher debt levels than private utilities. They are often managed through politicized city bodies that react slowly to change and make decisions for political rather than economic reasons. And competitive markets are a far riskier environment than monopoly-a muni that makes the wrong decisions, or is simply outsmarted by a competitor, will lose money. That is one reason why services with competitive risk are best left to private firms. If city and muni officials cannot overcome these challenges, they will likely have to answer to taxpayers for the financial costs of their failure.

Some munis are seriously working to cope with the public and management-policy challenges they face. Others are trying to avoid competition or are striving to seize upon ways to distort competition in their favor. They are striving to expand their service areas, create new munis, and launch risky commercial ventures unrelated to electricity, such as cable TV and home-security businesses. In each they are trying to earn profits, all the while professing to be nonprofit entities. Their actions seek to expand government participation in the electricity market precisely when policy is seeking to make it more competitive.

To help public officials understand the options available to them to help transition munis into a competitive market, we examine several options and provide a matrix for evaluating the merits of each option:

  • Corporatization: turning the muni into a private corporation with the city as sole shareholder;
  • Selling the Utility: an option increasing popular in the rest of the world, with a number of methods that can be tailored to a local government’s needs and goals;
  • Contracting for Operations: hiring a private firm to operate and manage the muni; and
  • Alliances: teaming up with a private partner to jointly manage the muni.

Finally, we make a series of policy recommendations for making the transition from monopoly to competition and establishing a competitive electricity market where consumers can enjoy sovereignty to choose providers and services:

  • Focus on Competition;
  • Address the Tax-exempt-debt Problem;
  • Open Access to Federal Power;
  • Put an End to Municipalization; and
  • Put an End to Commercial Ventures by Government Utilities.