Stop Whining about Pepco (because it’s your fault)

by William Yeatman on July 9, 2012

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Pepco has been getting a bum rap for its supposedly poor response to recent power outages. To be sure, I sympathize with anyone bereft of climate control for prolonged periods during a Mid-Atlantic summer, but this sticky situation is not the utility’s fault. If Pepco customers seek someone to blame, they should look in the mirror.

The cause of the controversial power outages was a rare “land hurricane” storm, which felled trees into power lines. Pepco’s critics claim that those trees shouldn’t have been there to begin with. In particular, they allege that Pepco for years has neglected its responsibilities to manage tree growth adjacent to its electricity distribution system. Pepco’s motive, according to the scapegoat-seekers, was to minimize costs, and thereby fatten its bottom line.

There are two big problems with this tidy narrative.

First, while it’s true that Pepco had every incentive to suppress expenditures on tree clearing, this is precisely what Maryland’s elected officials intended.

Allow me to explain. About 100 years ago, Progressive Party local politicians convinced themselves that electric utilities invariably consolidate into predatory “natural” monopolies. These progressives came to this conclusion despite the fact that electric utilities were competing furiously at the time in many municipalities. The ironic progressive solution to natural monopolies was…(wait for it)….a government-granted monopoly. In exchange for a state-certified monopoly “franchise” over a given service territory, utilities allowed state officials to set electricity rates. Thus, the electric industry for a century has operated under the thumb of the state. Not coincidentally, the electric industry hasn’t advanced technologically since the Progressive Era.

All 50 States eventually adopted this progressive arrangement. Moreover, they all adopted identical rate-setting mechanisms. Here’s how it works: For capital expenditures, like power plants or electric transformers, utilities are awarded a rate of return (i.e., a state-dictated profit), in addition to reimbursement of the original investment. For operations and maintenance (O&M) costs, however, state officials have taken a more jaundiced eye. Invariably, rate-setting for O&M costs are contentious—much more so than rate-setting procedures for capital costs. This is because O&M costs are much more ambiguous than large capital outlays, so there is more grey area over which to dispute. It’s easier for state regulators to object to O&M costs, and thereby “save” ratepayers money (and appease political masters), then it is for them to dispute capital costs.

So what does any rational utility do? It skimps on O&M costs, like tree clearing. Pepco shouldn’t be blamed for acting rationally in the face of Maryland’s backwards compensation system. To put it another way, don’t hate the player, hate the game. Or, better yet, change the game, by freeing the electricity market from the chains of socialism.

In response to the words above, many might ask: If all utilities have the same silly incentives, then how do you explain Pepco’s especially poor performance for reliability? The answer is to be found in the unique demographics of Pepco’s customer base, which is the second reason that Pepco’s critics are wrong.

Pepco’s biggest service territory is in Montgomery County, Maryland, which is one of the wealthiest regions in the country. It’s also exceptionally woody. Guess what rich people hate? Utilities cutting down trees in their neighborhoods, that’s what. Accordingly, Pepco operates under more stringent tree-trimming guidelines in Montgomery County than do utilities in neighboring service areas. According to the Washington Examiner, Pepco is allowed to cut trees within 10 feet of a power line. In Virginia, Dominion Power can trim trees within 15 feet of a power line. In fact, the utility actively has been lobbying the Transportation Infrastructure, Energy, and Environment Committee of the Montgomery County Council for expanded tree-cutting prerogatives.

Instead of corporate malfeasance, the true causes of Pepco’s crummy record on reliability are: (1) the Progressive-era incentive structure for utilities and (2) not-in-my-backyard-ism in one of the country’s richest counties. Both of these factors are derivative of Pepco’s customers, not its boardroom.

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