BILL ANALYSIS 1
1
SENATE ENERGY, UTILITIES AND COMMUNICATIONS COMMITTEE
DEBRA BOWEN, CHAIRWOMAN
AB 2958 - Wright Hearing Date:
June 25, 2002 A
As Amended: May 6, 2002 FISCAL B
2
9
5
8
DESCRIPTION
Current law requires telephone rates to be just and reasonable.
Current law provides that it is the policy of the state to
promote lower prices, broader consumer choice, and avoidance of
anti-competitive conduct.
This bill states legislative intent to maintain the progress
created by the California Public Utilities Commission's (CPUC)
new regulatory framework (NRF) for telecommunications companies.
This bill finds that telecommunications companies regulated
under NRF require certainty with respect to its provisions.
This bill requires the CPUC to suspend any price cap index,
productivity factor, and sharing mechanism until January 1, 2007
for SBC and Verizon.
BACKGROUND
Federal and state laws and policies have consistently tried to
transform telecommunications monopolies into competitive
markets. This started with the market for telephone sets in the
early 1980's, moved to long distance telephone service in the
mid-80's, then to short distance telephone service in the late
80's, and finally to local telephone service in the mid-90's.
As the markets became competitive, regulation changed.
Telephone sets, once only obtainable through the AT&T monopoly
at regulated prices, can be purchased virtually anywhere. Long
and short distance service can be purchased from hundreds of
companies. Local telephone service is now starting to become
competitive, based upon very recent decisions at the state and
federal level.
NRF, or New Regulatory Framework, is the now outdated name for
the regulatory structure for the larger local telephone
companies. It was created by the CPUC in 1989 to replace the
long-standing process of setting telephone rates equal to the
cost of serving those customers, plus a fair profit for the
telephone company. Under NRF, rates charged were indexed
annually - increased by the rate of inflation and decreased by a
"productivity factor" aimed at reflecting gains from
technological innovation occurring in telecommunications
markets. Because of moderate inflation, this index actually
reduced prices every year it was in effect. Initially, NRF
applied to only the two largest local telephone companies, SBC
and Verizon (then Pacific Bell and GTE California).
Subsequently, NRF was applied to the next two largest local
telephone companies, Citizens Communications and Roseville
Telephone Company (RTC).
In 1989, SBC's and Verizon's prices were set so they would earn
a rate of return of 11.5%. If they did well, because they ran
the company efficiently, sold more products, or got lucky and
the economy heated up, they could earn up to 13% and keep all
the profits. Any profits between 13% and 16.5% were split 50/50
with ratepayers. Any profits exceeding 16.5% were kept by
ratepayers.
Over time, the CPUC altered the NRF, tinkering with the index
and the sharing formula. By 1998, the latest completed NRF
review, the CPUC suspended profit sharing and continued the
practice of eliminating any indexing of prices.
The CPUC is currently considering whether to revise the NRF, as
it has done three times in the past. According to a staff
audit, SBC understated its earnings by $2 billion between 1997
and 1999, failing to share profits with ratepayers as the NRF
required it to do. If this finding is sustained by the CPUC,
SBC will be required to return over $350 million to its
customers, potentially triggering other changes to the existing
NRF structure.
COMMENTS
1)Ongoing CPUC Proceeding . The CPUC reviews the NRF structure
every three years. Reviews in 1992, 1995, and 1998 led to
changes being made in the sharing or indexing mechanisms. The
CPUC is now in the middle of its latest NRF review for SBC and
Verizon, and is hoping to complete the review by the end of
this year. Among the issues in this review are whether the
CPUC should reinstate a price-cap index and profit sharing
mechanism, the very issues addressed in this bill.
This bill decides the issues for the CPUC in favor of freezing
the existing order in place until at least January 1, 2007,
thus preventing the CPUC from reinstating a price cap index or
a profit sharing mechanism irrespective of what the CPUC
discovers in its analysis.
The Legislature long ago gave the CPUC clear policy direction
that telecommunications rates must be "just and reasonable,"
then left it to the CPUC to create the mechanism(s) needed to
meet that policy. For decades, the CPUC met the Legislature's
policy goals through traditional rate of return regulation.
In response to the changing telecommunications market place
the CPUC replaced that old regulatory scheme with the NRF.
The Legislature never codified the NRF, nor changed its
structure, opting instead to leave complex rate making issues
to the CPUC as long as the commission adhered to the goal of
ensure consumers only paid rates that were just and
reasonable. By codifying the current version of the NRF just
as the CPUC is in the midst of considering changes to the
policy, this bill may reduce the CPUC's ability to meet the
overall policy goal of protecting consumers against unjust and
unreasonable local telephone rates.
2)The CPUC's 1998 Revisions To NRF . Apart from the question of
whether the Legislature should impose its judgement over that
of the CPUC is the question of whether freezing in place the
current terms of the NRF is sound public policy.
The 1998 CPUC decision that created the current NRF structure
(D.98-10-026), which this bill freezes in place, discusses the
CPUC's rationale for establishing that structure. The CPUC
suspended, instead of eliminating, the price indexing
mechanism because "price cap regulation is still needed in the
transition to a fully competitive market" (Page 15).
In hearings on that decision, some parties argued the price
indexing mechanism was needed to avoid a "war chest" that
could be used to gain unfair competitive advantage through
cross subsidization. The CPUC noted there was no reason to
believe that war chests were accumulating and that "rates of
return in 1996 and 1997 do not show an accumulating war
chest." If cross-subsidies were found, the CPUC noted it
would "eliminate any improper cross-subsidies" (Page 18).
With regard to suspending the profit sharing mechanism, the
CPUC said "we only suspend, but do not eliminate, sharing
because some small risks remain that market power problems
will materialize, that competition will not evolve as
expected, or that rates of return will become truly
unreasonable" (Page 37). Furthermore, the CPUC noted "should
rates of return become truly unreasonable, we will consider
reinstating all aspects of sharing" (Page 36).
Four years after the CPUC's NRF revisions, it appears that
many of the things the commission was concerned would develop
to the detriment of ratepayers have indeed developed.
Competition has come, at best, in fits and starts, and if the
staff audit of SBC's results is accurate, consumers are paying
rates that are too high, allowing incumbent providers like SBC
and Verizon to build their own war chests. Consequently,
using the yardsticks established by the CPUC in its 1998
decision, it's difficult to conclude that the existing NRF
structure should remain frozen in place through 2006.
3)Competition . It's clear the CPUC was being cautious in its
effort to deregulate SBC and Verizon, concerned that
competition would not materialize or that rates of return
would get too high. Looking back on that 1998 decision, those
concerns appear to be well founded, especially when looking at
the evolution of competitive markets. That 1998 decision was
made in the wake of Congress passing the Telecommunications
Act of 1996, which promised competition and lower rates for
local telephone service. Companies like SBC and Verizon were
required to lease parts of their networks to competitors. As
an inducement, once they had made their networks available and
competitors had surfaced in the marketplace, they would be
permitted to offer long-distance service within their service
areas.
The passage of the Act was met with great enthusiasm.
Hundreds of new companies sprung up, all hoping to take
advantage of the newly opened markets. Companies like Covad,
PSINet, and Northpoint Communications provided competitive,
high speed telephone access by leasing facilities from the
Regional Bell Operating Companies (RBOCs). Other companies,
like Winstar Communications, Williams Communications Company
and Global Crossing, installed their own facilities to try and
compete. Yet despite unprecedented access to investment
capital, the one thing all of these companies have in common
is they've all filed for bankruptcy.
The competitive burst that followed the passage of the Act has
bust. A May article in the Wall Street Journal notes that in
1998, the number of RBOC competitors had risen from about a
dozen in 1996 to over 150 in 1998 and nearly hit 400 in 1999.
In 2001, the figure declined to less than 100 and is surely
lower today. Even the three largest long-distance
competitors, household names all, are in trouble what with
Sprint having to sell its lucrative Yellow Pages business and
its debt rated at just above junk bond level, WorldCom (MCI)
under SEC investigation and its stock having lost 80% of its
value this year, and AT&T debt downgraded to just two levels
above junk bond level.
More evidence of the lack of competition comes from the CPUC
recently released competition report, The Status of
Telecommunications Competition in California (June 5, 2002),
which this committee heard testimony on during a June 10, 2002
hearing. That report found that 95% of telephone lines are
controlled by SBC, Verizon, and the other incumbent telephone
companies as of June 2001. (The number is slightly higher for
residential lines and lower for business lines.) This finding
is corroborated by data from the Federal Communications
Commission, which found that competitors provide about 7% of
the lines.
4)Bill Implications . The NRF is intended to represent a
balanced application of regulatory tools which leads to just
and reasonable rates. This bill takes away the CPUC's
flexibility to utilize the profit sharing and price indexing
tools to meets its statutory obligation of assuring that
prices are just and reasonable. Since the NRF was established
in 1989, the CPUC has continued to tinker with the balance in
the NRF by adjusting profit sharing levels, price indexes, and
permanent rate adjustments, all in response to changing market
conditions.
This bill has one of two implications. The first is that it's
intended to substitute for the CPUC's judgement on whether
existing rates are fair and reasonable. This could be
inferred from the intent language in the bill which speaks to
"maintaining the progress created by the commission's NRF" and
the findings about the need for certainty about the provisions
of the NRF. By locking the 1998 version of NRF in place
through 2006, this bill appears to make adherence to a
particular regulatory structure (NRF, which has been altered
three times to reflect changing market conditions since 1989)
more important than adherence to the CPUC's overall statutory
charge of protecting ratepayers (which is to ensure ratepayers
are charged no more than just and reasonable rates).
The second, alternative implication is that the bill is solely
intended to restrict the CPUC's use of the profit sharing and
price indexing tools but not its ability to ensure prices are
just and reasonable. If that's the case, then the CPUC will
have to find some other mechanism to meet that larger
statutory mandate. In that sense, the bill paradoxically
moves the CPUC back to traditional rate of return regulation,
as that's the one known mechanism that can produce fair and
reasonable rates. Perhaps some alternative mechanism can be
found, but that of course is what the NRF represented.
5)Picking Winners . Supporters of this bill assert that freezing
the current NRF in place creates strong incentives to invest.
Objective data supporting this analysis is hard to come by,
though several highly touted infrastructure initiatives
designed to deploy advanced technologies throughout California
have been shelved or curtailed.
In a tightly regulated, non-competitive world, regulators may
choose to increase the allowed return of the regulated
companies to encourage those companies to invest in necessary
infrastructure. However, providing incumbent telephone
companies with strong incentives to invest in a world where
competitors are also trying to enter only skews the
competitive marketplace. While the possibility of high
returns for the incumbent regulated company will, of course,
create an incentive to invest, it will also tip the playing
field against competitors. The extra incentive for incumbents
to invest will drive out competitors that won't want to
compete in a biased game. Striking the right balance which
encourages healthy competition is a tricky task, and one which
is extremely difficult to find in an instrument as blunt as
this bill.
Clearly investment will go where returns are best, but
remember that the revenues that make returns high come from
telephone customers. To the extent that investment is
attracted by the highest returns, customers may be paying too
much. Consider the recent short-lived boom in electric
powerplant investments, which resulted from the high prices
customers paid for electricity.
ASSEMBLY VOTES
Assembly Floor (66-1)
Assembly Appropriations Committee (21-0)
Assembly Utilities and Commerce Committee
(15-0)
POSITIONS
Sponsor:
Author
Support:
Boys & Girls Club of Venice
California Alliance For Consumer Protection
California Association of Urban League Executives
California Chamber of Commerce
California Coalition of Consumers
California Hispanic Chambers of Commerce
California Labor and Telecommunications Coalition
California Labor Federation
California Manufacturers and Technology Association
California Small Business Association
California Telephone Association
Citizens Telecommunications Company of California, Inc.
City of Lomita
Communications Workers of America
Communities in Schools of South Bay, Inc.
Compton Chamber of Commerce
Congress of California Seniors
Consumers First
Greater Sacramento Urban League
Hermosa Beach Chamber of Commerce and Visitors Bureau
Intel Corporation
Kerman Telephone Company
League of United Latin American Citizens - District 7
Los Angeles County Federal of Labor, AFL-CIO
Los Angeles Urban League
National Association of Women Business Owners
Roseville Chamber of Commerce
Santa Clara University School of Law
South Bay Latino Chamber of Commerce
Torrance Area Chamber of Commerce
Verizon
Westside Council of Chambers of Commerce
203 individuals
Oppose:
AARP California
California Association of Competitive Telecommunications
Companies
California Internet Service Providers Association
California Public Utilities Commission
Consumer Federation of America
Consumers Union
Office of Ratepayer Advocates
Pac-West Telecomm, Inc.
The Utility Reform Network
XO California, Inc.
148 individuals
Randy Chinn
AB 2958 Analysis
Hearing Date: June 25, 2002