The telecommunications and electric power industries are fundamental to the sustained growth of the U.S. economy. Power is critical to the physical economy, while telecom is critical to the virtual economy.
Communications and computing are increasingly dependent on reliable and high-quality power, while the efficient and reliable distribution of power is increasingly dependent on communications and computing. This creates a virtuous cycle of innovation and the potential for strong industry growth for decades to come. Evolving the regulatory environment to foster such growth is essential, and both industries are in critical need of change in this regard.
The FCC’s recent proposal to allow for internet "fast lanes" has once again catalyzed debate over the extent of regulation required to ensure open and non-discriminatory broadband access while incentivizing continued innovation in internet services. Since the Telecommunications Act of 1996, the internet has become virtually ubiquitous in its accessibility, but also acutely reliant on an oligopoly of broadband service providers.
Similarly, albeit much more quietly, discussions of regulatory change within the electric utility sector have been occurring throughout the country. Such discussions have been sparked by the realization that the traditional electric utility revenue model, and associated investment incentives that have served the industry well since the 1930s, are becoming stressed by customer adoption of distributed generation, the increasing severity and frequency of storm-induced power outages, and the apparent diversification of customer demand for electricity.
The response to internet fast lanes has been markedly one-sided. The principle of net neutrality has overwhelming public support, and rightly so, considering the highly consolidated set of internet service providers, coupled with their increasing vertical integration across the spaces of content generation, distribution and broadband access. Under the Telecom Act of 1996, such entities are free to operate without rules that ensure open and non-discriminatory broadband access to the internet, posing a fundamental threat to the continued innovation and growth of internet services.
In contrast, since Congress passed the Public Utility Holding Company Act in 1935, electric power distribution has been subject to regulation by state utility commissions to ensure open, non-discriminatory access at reasonable rates -- the prototypical example of a common carrier service. However, such regulation now threatens the long-term sustainability of the industry in the face of customer adoption of distributed generation and energy efficiency measures, which, under the current structure, result in loss of volumetric sales to distribution operators.
Fewer customers paying into the system, coupled with what essentially is a cost-plus utility revenue model, results in the necessity of imposing rate increases to cover the fixed costs of maintaining and operating the grid. In turn, that incentivizes customers to further adopt distributed generation or energy-efficiency measures. Some have termed phenomenon the “utility death spiral.”
Each sector is in need of structural change, but they are starting from opposite ends of the regulatory spectrum. Electric power is subject to common carrier requirements but lacking in demand-driven innovation; internet services exhibit plenty of innovation, but without rules for ensuring open and non-discriminatory broadband access to those services. There is an opportunity for each industry to evolve to a similar regulatory model, one that is based upon a tiered services structure consisting of basic service, subject to common-carrier regulation, and differentiated services, subject to competitive market forces.
The telecom case: Applying common carrier principles to broadband service
The Telecommunications Act of 1996, the first major regulatory change since the Communications Act of 1934, created a clear distinction between telecommunication providers and information service providers, legally absolving the latter from common carrier requirements. It is particularly worth noting that broadband service providers that happen to leverage their own telecommunications infrastructure are categorized as information service providers under this act. In classifying service providers in this way, the architects of deregulation were simultaneously visionary and unknowingly myopic. By absolving information service providers of common carrier requirements, customer demand and competition were allowed to drive rapid market evolution without reliance on regulatory clairvoyance, creating the ubiquitous internet we rely on today.
However, by categorizing service providers based upon the highest level service they offer, irrespective of other lower level services they may internally rely on or independently offer, a subtle but powerful financial incentive was created for telecommunications providers to vertically integrate information services into their offering in order to extricate themselves from common carrier regulations. Indeed, despite the original intentions of the 1996 Telecom Act to foster competition among local exchange providers, industry consolidation has rendered at best into the form of regional duopolies in wired broadband access. Worse yet, vertical integration occurred across multiple internet and content services spaces.
A particularly pathological example of this is Comcast’s majority stake in NBC Universal and Comcast Sports Ventures’ ownership of the Philadelphia Flyers. The fact that these industry behemoths are unconstrained in their delivery of broadband access services understandably forms the crux of the debate on net neutrality.
Most can agree that a consumer’s ability to access any content, independent of its source (subject to certain obvious legal constraints), is absolutely essential to the sustainable growth of internet services. And let’s be clear: it is innovation in internet services that we should endeavor to incentivize. Broadband service is merely the means of accessing internet services, and thus it now plays a supporting, albeit still important role in the ecosystem.
Broadband access has become what plain old telephone service is: a basic service. The deregulation that was once beneficial to the proliferation of broadband access now threatens to undermine society’s basic need for unfettered and fair access to information. Allowing so-called internet fast lanes only exacerbates this threat, explicitly allowing for commercial discrimination among consumers or producers of content. ISPs that double as content generators and distributors already have a fundamental financial advantage over third-party content providers owing to their vertical integration, but allowing them to differentially price service based upon prioritized forwarding of packets within their networks only amplifies this advantage and strengthens their oligopoly.
For these reasons, it seems wholly imprudent for the FCC to allow for internet fast lanes, and indeed entirely contradictory to its previous Open Internet Order of 2010, which called for three net neutrality principles to be applied to broadband access: transparency, no blocking, and no unreasonable discrimination. Unfortunately, two of these three principles were vacated by the D.C. Court of Appeals in Verizon vs. FCC earlier this year, leaving only transparency as a guiding principle.
The legal basis for the decision was the classification of broadband providers under Title I of the Communications Act of 1934, alleviating them of common carrier requirements. Consequently, net neutrality proponents have reactively suggested reclassifying broadband providers under Title II of the Act, thereby reapplying common carrier requirements. Some have termed this the nuclear option, and indeed it is: broadband providers now offer far more than just broadband access, and subjecting all such services to common carrier requirements is undoubtedly counter to fostering innovation.
Rather, the right approach is to reclassify just broadband access as a telecommunications service, irrespective of whether its corresponding provider also offers higher-level services. Undoubtedly, there are legal complexities involved in implementing this (and the authors are not attorneys), but regulatory structure should be derived from fundamental principles rather than being constrained by legal mechanics.
A path forward in electric power: Allowing tiered retail power services
Over the last decade, electric distribution has experienced both demand- and supply-side disruptions of increasing intensity, including customer adoption of distributed generation and/or energy-efficiency measures, demand for more reliable service in storm-prone areas, and adoption of electric vehicles. All three trends adversely impact the utility rate-of-return revenue model.
Customer adoption of distributed generation and energy efficiency measures decreases a utility’s volumetric sales, and results in fixed costs being asymmetrically socialized across all other customers, potentially raising rates at high levels of penetration. Net energy metering exacerbates this problem by valuing distributed resources above wholesale (and in many cases at or above retail) rates, whether or not energy demand warrants it.
Areas that are burdened by frequent storm-induced outages require higher levels of investment to maintain similar reliability metrics, again socializing such costs over the entire ratepayer base, raising rates for everyone.
Customer adoption of electric vehicles, though a new source of utility revenue, creates peak demands that utilities have not had to contend with before, requiring them to increase the capacity of the grid, even if it is used for only a relatively short period of time.
Fundamentally, the volumetric sales model of the utility, socialization of costs across all ratepayers, and increasing disparity between peak and average demands all point to the need to consider changes in rate design. However, it is imperative that customers whose usage patterns have not changed should continue to be able to access electric power reliably and at reasonable rates -- and these customers represent the vast majority of the customer base today. In contrast, the growing minority of customers whose use of the grid is changing or whose demand is evolving should be able to access a suite of differentiated power services with corresponding price and performance determined by market forces rather than regulatory clairvoyance.
This tiered services approach resembles that of the Telecom Act of 1996: basic power service is akin to telecommunications service and differentiated power services are akin to information services. However, let us take a lesson from the telecom sector and define common carrier requirements on a per-service basis rather than on a per-service-provider basis, lest the electric power industry be faced with the legal conundrum the FCC currently is.
The FCC and FERC should talk
It is time to reapply common carrier principles to broadband internet access. Without doing so, we place the future growth of internet services at grave risk. Demand- and supply-side disruptions in electric power now warrant consideration of a tiered retail services model, similar to that created under the Telecom Act of 1996.
Let us not forget, however, that the differentiated services of today will become the basic services of tomorrow, and the regulatory architecture we adopt must accommodate this type of service evolution. In order to maintain America’s leadership in the telecom and energy economies into the next century, the FCC and FERC should compare notes, as they could gain tremendous insight from each other on how progressive regulation can simultaneously provide universal access and foster market-driven services innovation.
***
Naimish Patel is the CEO of Gridco Systems; Hemant Taneja is a managing director at General Catalyst Partners.