In our recent issue brief, Geoffrey Manne, Kristian Stout, and I considered the antitrust economics of state-owned enterprises—specifically the local power companies (LPCs) that are government-owned under the authority of the Tennessee Valley Authority (TVA).
While we noted that electricity cooperatives (co-ops) do not receive antitrust immunities and could therefore be subject to antitrust enforcement, we didn’t spend much time considering the economics of co-ops. This is important, because electricity co-ops themselves own a large number of poles and attaching to those poles at reasonable rates will be important to effectuate congressional intent to deploy broadband quickly in the rural areas those co-ops generally serve.
According to the National Rural Electric Cooperative Association, the trade association for rural electricity co-ops:
- Co-ops serve 56% of the U.S. landmass and 88% of the nation’s counties, including 93% of the 353 persistent poverty counties.
- They account for roughly 13% of all electricity sold in the United States.
- More than 90% of electric co-ops serve territories where the average household income is below the national average. One in six co-op consumer-members live at or below the poverty line.
- Cooperatives serve an average of eight consumer-members per-mile of electric line, but this average masks the extremely low-density population of many co-ops. If the handful of large co-ops near cities were removed, the average would be lower.
- More than 100 electric cooperatives provide broadband service and more than 200 co-ops are exploring the option and conducting feasibility studies to do so.
There are some important differences between electric co-ops and investor-owned power companies. Most importantly, co-ops are owned by their consumers. Economics helps explain why this form of organization could be pro-competitive in some situations, but the history of rural electricity co-ops (RECs) suggests that government support and corporate rules particular to co-ops are the main reasons that we continue to rely on co-ops to distribute electricity in rural areas of the United States. As a result, RECs—especially those that distribute electricity generated and transmitted by the TVA—have incentives more like those of state-owned enterprises (SEOs) than private firms.
In other words, RECs also have the incentive and ability to act anticompetitively—e.g., by refusing to deal with private broadband providers who wish to attach to the poles they own. Consequently, antitrust enforcement and Federal Communications Commission (FCC) oversight through Section 224 authority are necessary to ensure RECs do not abuse their market power over poles in order to promote broadband deployment in rural areas.
Economics of Co-ops: Why Do We Have So Many RECs?
The classic law & economics examination of firms’ choice of business organization comes from Henry Hansmann, in his book The Ownership of Enterprise. He explained that the choice of ownership for any firm is driven by costs. The form that is chosen by a particular firm is that which “minimizes the total costs of transactions between the firm and all of its patrons.” These costs include both transaction costs with those patrons who are not owners, and the costs of ownership, such as monitoring and controlling the firm.
Hansmann argued that the form of consumer-owned co-ops predominates in the distribution of electricity in rural areas because it is a response to the threat of natural monopoly, where high barriers to entry and startup costs suggest that one firm is likely to dominate. This is particularly true in geographic areas with low population density, because the costs of building out infrastructure is extremely high per individual consumer. As such, consumers would likely be subject “to serious price exploitation if they were to rely on market contracting with an investor-owned firm.” Thus, the choice is among rate regulation of an investor-owned utility, municipal ownership, or consumer ownership through a co-op.
Hansmann argued that consumer co-ops best align “the firm’s interests with those of its consumers” because they have lower overall costs than other forms of ownership in rural areas. This is because electricity is a “highly homogeneous [commodity] with few important quality variables that affect different users differently.” Moreover, relatively stable farm and nonfarm residential households account for the overwhelming majority of the membership and demand for electricity in rural areas, “creating a dominant group of patrons with relatively homogenous interests.”
As a result, the costs of monitoring and controlling these natural monopolies are relatively lower for the consumers as owners than they would be as citizens overseeing a public utility commission in charge of regulating an investor-owned utility, or a board in charge of a municipally owned utility.
On the other hand, the history of RECs suggests that their formation and persistence may be more due to government intervention than as a market response to consumer demand. As Hansmann himself recognized, RECs received significant public subsidies in the form of below-market loans from the Rural Electrification Administration (REA), though he argues that these loans were not significant subsidies for the first 15 years); exemption from federal corporate income tax; and preferential access to power generated by the TVA. On top of that, the REA essentially organized many co-ops in their early days.
Nonetheless, Hansmann argues:
These subsidies have undoubtedly been important in encouraging the formation and growth of cooperative utilities, and therefore the great proliferation of rural electric cooperatives does not provide an unbiased test of the viability of the cooperative form. Evidently, however, the federal subsidies have not been critical to the success of cooperatives in the electric power industry. Even before the federal programs were enacted, there already existed forty-six rural electric cooperatives operating in thirteen different states. Also, as already noted, there was no net interest subsidy to the cooperatives for the first fifteen years of the REA. And in its early years, the REA also offered low-interest loans to investor-owned utilities that wished to extend service into rural areas, but found little interest in these loans among the latter firms.
In an excellent 2018 law-review article, however, Randall S. Thomas, Debra C. Jeter, & Harwell Wells systematically detail the great lengths to which the REA went to organize co-ops in rural areas. The authors convincingly argue that the co-op model was not adopted as a market response, but primarily due to the REA’s organizational efforts and the subsidies bestowed upon them.
Even if RECs were a market response to natural monopoly in rural areas at the time of their adoption, that does not mean that they would necessarily continue to be the most economically efficient model. At a given point of time, economies of scale and high costs of entry may mean that the market can only support one firm (i.e., natural monopoly). But over the last 80-90 years, underlying conditions that may have made co-ops the most efficient model may have changed. As we argued in a 2021 white paper:
[I]n any given market at a given time, there is likely some optimal number of firms that maximizes social welfare. That optimal number—which is sometimes just one and is never the maximum possible—is subject to change, as technological shocks affect the dominant paradigms controlling the market. The optimal number of firms also varies with the strength of scale economies, such that consumers may benefit from an increase in concentration if economies of scale are strong enough… And it is important to remember that the market process itself is not static. When factors change—whether a change in demographics or population density, or other exogenous shocks that change the cost of deployment—there will be corresponding changes in available profit opportunities. Thus, while there is a hypothetical equilibrium for each market—the point at which the entry of a new competitor could reduce consumer welfare—it is best to leave entry determinations to the market process.
In fact, as Thomas, Jeter, & Wells go on to argue, rules particular to the co-op model make it nearly impossible to change the form of ownership through merger or acquisition. These rules—adopted as part of the model acts promoted by the REA—prevent what the great Henry Manne called “the market for corporate control” that would otherwise discipline co-op managers.
As has been noted by even the strongest supporters of the co-op model—and seemingly undermining Hansmann’s assessment that consumer-ownership is the most effective form of organization for these entities—RECs suffer from a lack of oversight by consumer-owners, with very few ever showing up to even vote for their board of directors:
This lack of oversight from the ownership means that the board of directors can engage in all kinds of abuses, as detailed extensively by Thomas, Jeter, & Wells.
Without sufficient incentives for oversight by consumer-owners or a functioning market for corporate control, there is no basis to conclude that RECs remain the best business model for distributing electricity. Their ubiquity is more due to the REA’s organizational efforts and ongoing government benefits—in the form of subsidies, tax exemptions, and preferences from the TVA—than market demand.
Antitrust Economics of RECs and Pole Attachments
Due to the privileged position enjoyed by RECs, particularly those that distribute electricity from the TVA, they have a unique ability and incentive to act anticompetitively toward broadband providers that want to attach to the poles they own.
Much like municipally owned electricity distributors, RECs are not motivated solely by profit maximization. RECs also have similar advantages, like access to eminent domain, below-market loans, tax exemptions, and the ability to cross-subsidize entry into a new market (like broadband) from its dominant position in electricity distribution.
On the other hand, unlike municipally owned electricity distributors, RECs can go out of business, and thus must earn sufficient revenues to remain a going concern. This means that the incentives for RECs to act anticompetitively are at least as strong as those of investor-owned firms, and may be even as strong as those of state-owned enterprises. This is especially notable, when so many RECs either have entered or are planning to enter the broadband market.
In such cases, there are strong incentives for RECs to refuse to deal with private broadband providers that are trying to deploy in—and introduce competition to—their rural areas. As Sen. Mike Lee’s (R-Utah) recent letter to the U.S. Justice Department suggests, many of these co-ops have done exactly that:
- Delaying or refusing to negotiate pole-attachment agreements with competitive broadband-service providers, including when the TVA LPC provides broadband service (itself or through a joint venture agreement) or is interested in doing so;
- Initially refusing to negotiate pole-attachment agreements that would enable competitive broadband-service providers to obtain permits in sufficient time to meet federal grant deadlines;
- Refusing to review pole-attachment applications on a scale or at the pace necessary to complete broadband projects in a timeframe required by federal grant programs;
- Refusing to follow the standard industry practice of approving a contractor to process pole-access applications in a timely manner when the utility’s staff is insufficient to do the work, even when the broadband-service provider is willing to pay the entire bill for the contractor; and
- Refusing to process pole-attachment applications at all, and failing to respond to provider outreach regarding the processing of applications for months on end.
The economic logic that drives a limited duty to deal under antitrust law is that enforced sharing rarely makes sense because it reduces the incentives to build infrastructure. But creating new rural infrastructure (like poles) is cost-prohibitive—at least, without the same subsidies, eminent-domain power, and other advantages that RECs have historically enjoyed. Thus, RECs may rightfully have a duty to deal with broadband providers on a reasonable and nondiscriminatory basis.
Moreover, many RECs receive little oversight from rate regulators when it comes to pole attachments. And when they do, like those RECs that distribute electricity from the TVA, the formula allows for much higher rates than the FCC would allow. As a result, pole costs are much higher for broadband companies dealing with poles owned by co-ops and municipalities that are not subject to the FCC’s authority.
Conclusion
If congressional intent to build out broadband networks to rural areas is to be fulfilled, RECs should not be allowed to thwart it by abusing the pole-attachment process. The good news is that there appears to be no applicable immunities for RECs that would prevent antitrust action against them. A limited duty to deal on a reasonable and nondiscriminatory basis makes sense. Bringing poles owned by co-ops under FCC Section 224 authority is another potential solution if the goal is to prioritize deploying broadband to unserved rural areas quickly.