America enjoys some of the most reliable and affordable electricity in the world. But have you ever wondered how today's electricity system, with its "on-demand" power, got its start?
You would probably guess that any discussion about the early use of electricity would have to include Thomas Alva Edison, and you'd be right. Although knowledge of electricity dates back to the ancient Greeks, it wasn't until Edison's pioneering work with electricity in the late 19th century that we were able to harness electricity in a useful way. Edison's invention of the incandescent light bulb in 1879 revolutionized our way of life and we have him to thank for today's electric innovations.
Invention of the Light Bulb
On October 21, 1879, Edison created his now famous incandescent light bulb, which burned for 40 hours. During 1880, Edison continued work to refine his light bulb. He also began exploring ideas for an equally important invention: a way to generate and transmit the electricity his light bulb would need. A practical and reliable electricity supply was essential if the light bulb was ever to become a practical appliance for homes and businesses.
Edison's Pearl Street Station
By the end of 1880, Edison had formed the Edison Electric Illuminating Company to build central station electric generating plants in New York City. The first central power plant, Pearl Street Station in lower Manhattan, began generating electricity on September 4, 1882. Pearl Street had one generator and it produced power for 800 electric light bulbs. Within 14 months, Pearl Street Station had 508 subscribers and 12,732 bulbs.
With the success of Pearl Street Station, Edison created the Edison Company for Isolated Lighting. This company was formed in May 1883 to build and sell electric power stations, like Pearl Street Station, to towns and cities throughout the United States.
AC vs. DC
Edison's method for generating and transmitting electricity was called direct current, or low voltage. George Westinghouse, a consolidator of his time, built Westinghouse Electric by purchasing other inventor's patents, including the polyphase alternating current (AC) system invented by Nikola Tesla.
In an alternating current system, transformers were used to step up, or increase the voltage that left the power plant. This enabled the electricity to travel over long-distance wires. When the electricity reached its destination, another transformer would then step down, or decrease the voltage so that power could be used in homes and factories.
Edison's direct current system was unable to use transformers. With Edison's system, the voltage dropped as it traveled further and further from the generator. To overcome this disadvantage, power plants would have to be built close to the power use—a costly solution.
Soon, the Westinghouse alternating current system—rather than Edison's more expensive, higher-maintenance, and less efficient direct current system—began to get most of the orders. Another advantage with the alternating system soon became apparent. By allowing central stations to serve wider markets, the AC system also encouraged utilities to build larger stations, which then benefited from economies of scale and lowered their operating costs.
In 1893, the Westinghouse AC system was chosen to move electric power from Niagara Falls to Buffalo. Shortly after that, the Westinghouse AC "universal" system became the new standard for transmitting electricity. Now, one generating station could transmit power relatively cheaply over a wide service area.
Emergence of An Electric Utility Industry Structure
Early electric companies were somewhat inefficient and redundant in the services they provided. Separate companies provided electricity for different needs such as street illumination, industrial power, residential lighting, and street car service. They frequently operated under nonexclusive franchises, often in competition with one another. Companies used different equipment, voltages, and frequencies, so their systems were not compatible.
In order to operate, the companies had to acquire franchise rights from the local municipality. Franchise territories differed greatly, from a single block to the entire city. The franchise process kept the industry fragmented and inefficient. It was not unusual for franchises to be granted on the basis of bribes and payoffs to city officials. The issuance of numerous short-term franchises created an uncertain, chaotic operating environment.
It was during these early years that entrepreneurs like Samuel Insull, who had worked with Edison, gave his attention to utility operations and began to shape and define important economic concepts which still govern modern utility planning and pricing.
Emerging Financial Framework
Early leaders recognized that electric companies suffered from high fixed costs as a result of the heavy investment needed to finance central generating plants and distribution systems. At the same time, their operating- or variable-costs were relatively low. Insull understood that with more customers on a system, more revenue was generated, spreading out fixed costs. He reduced prices and aggressively marketed to attract more customers. Many companies gave away light bulbs and electric irons to encourage electricity use. The difficulty was in establishing an appropriate price for electricity.
The development of the demand meter made it possible for Insull to more accurately price his commodity. The demand meter measured a customer's electric demand, or the "share" of fixed cost required for usage, as well as the actual energy for kilowatt-hours used. Insull set the price of electricity to cover both of these costs: fixed (demand) and operating (energy or variable). Fixed costs reflect the fixed amount of investment that must be paid, regardless of output, and include power plant construction and equipment. Variable costs are those which vary with the level of electrical output and include fuel expenses.
Early analyses showed that the more time a plant was in use, the higher the profit, with a lower average kilowatt-hour cost to the customer. Since electricity cannot be stored, the trick was to find the right mix of customers to utilize the plant for as much of the day as possible. For example, in order to maximize plants to their fullest, one might take into account the early morning and late afternoon streetcar load, an evening residential lighting load, and a business and industrial load between the two streetcar peak loads. Insull realized that the same three loads could be served by one plant instead of three different plants which were then being used.
In addition to load diversity, it was discovered that there was a way of increasing efficiency through economies of scale. One large, centrally-located power station could be operated more cheaply than numerous isolated small generating units. Thus, the formation of the industry was heavily influenced by the inherent advantage of serving many customers, the desirability of load diversity, and building to achieve economies of scale. Today, with the advent of natural gas and some renewable energy plants, smaller units can again be cost-effective, especially to meet unusually high demand.
The Evolution of the Natural Monopoly and the Advent of Regulation
Utilities frequently found that it was difficult to maintain investor confidence and attract adequate capital. This was attributable to both the dubious franchise process, which made operation of the utility over the long term an uncertain prospect, and the low returns investors received. Early industry leaders began to think that if the franchise granting process and the rates charged by utilities were overseen by a nonpartisan state agency instead of a city council, financing might be easier and cheaper to obtain.
In 1898, in an address before the National Electric Light Association (the forerunner of Edison Electric Institute), Samuel Insull proposed that electric companies be regulated by state agencies which would establish rates and set service standards. The idea became increasingly appealing to shareholder-owned companies in the face of public enthusiasm for the growth of municipal electric systems. Privately-owned companies surmised that the public might be more supportive if their companies were regulated so that customer interest would be protected. By 1916, 33 states had regulatory agencies. Early regulation of the industry proved beneficial to both the electric companies and their customers, who got reliable, reasonably priced service without the uncertainties caused by duplicate services and inefficient operations.
Forms of Ownership
Private investor funds fueled the earliest electric power production and distribution facilities. This tradition has continued to today, with shareholder-owned electric companies providing approximately 70 percent of all power generated in the United States by electric utilities. Shareholder-owned electric companies are owned by millions of small investors, either directly or indirectly, through other investments such as life insurance policies, retirement funds, and mutual funds.
- Shareholder-Owned Electric Companies
Sell power at retail rates to several different classes of customers and at wholesale rates (for resale) to state and local government-owned utilities, public utility districts, and rural electric cooperatives. While most electricity is provided by shareholder-owned electric utilities, other entities that function as electric utilities include: municipally-owned systems, federally-owned systems, and rural electric cooperatives.
- Municipally-Owned Electric Utilities
Owned by the city or municipality in which they operate and are financed through municipal bonds. They are self-regulated. Approximately 11 percent of the nation's power needs are met by about 2,000 municipally-owned systems.
- Federally-Owned Utilities
Agencies of the federal government involved in the generation and/or transmission of electricity, most of which is sold at wholesale prices to local government-owned and cooperatively-owned utilities and to shareholder-owned companies. These government agencies are the Army Corps of Engineers and the Bureau of Reclamation, which generate electricity at federally-owned hydroelectric projects. There are five power marketing agencies that sell this relatively low-cost power on a preferential basis to local government-owned and cooperatively-owned utilities. In addition, the Tennessee Valley Authority produces and transmits electricity in the Tennessee Valley region.
- Electric Cooperatives
In 1936, the Rural Electrification Administration was created to provide low-interest loans to expand electric service to rural areas. Electric cooperatives were and can still be formed by groups of rural area residents. There are approximately 1,000 cooperatives in the United States. Most are distribution cooperatives that purchase power from federally owned and/or shareholder-owned utilities, but about 60 of them are generation and transmission cooperatives that provide wholesale power to their member distribution cooperatives.