Why Pennsylvania might be the only game in town
By Anne M Porter -- Purchasing, 7/16/1998
While some power marketers have all but abandoned the so-called competitive electricity markets in California and Massachusetts, they're signing up in droves to do business in Pennsylvania when the state opens its power markets to competition at the start of next year. "Right now," says Alex Galatic, power supply coordinator for Pittsburgh-based startup Strategic Energy Limited (SEL), "Pennsylvania is the only viable market in the U.S."Dr. William Huss, senior vice president of Xenergy in Burlington, Mass., observes that--unlike California and Massachusetts--Pennsylvania has structured its electricity market so that new entrants can hope to make money while offering prices that are competitive with offerings from incumbent utilities. In states such as California, marketers may be actively courting large industrial or commercial clients, but experts agree that, in so doing, these firms are either purchasing market share or selling a low-margin product at a loss in order to establish lucrative service relationships.
Huss says Pennsylvania differs also by providing customers with clear incentives to shop for their power. "In Pennsylvania," he notes, "people will have to shop if they want to obtain the maximum savings." The same is not true for other states. In both California and Massachusetts, Huss notes, legislators began with goals of delivering standard rate reductions (10%) to most consumers, giving them little incentive to shop around. As many see it, these were the political carrots offered by utilities in return for unfettered recovery of their stranded investments (investments that had been considered prudent under the regulated regime but which are expected to go largely unrecovered when the utility is forced to compete with lower-cost power generation suppliers).
How Pennsylvania differs
The essential market-making mechanism in Pennsylvania is a "shopping" or "generation" credit. The credit represents the supply portion of an unbundled utility bill--the amount remaining after the utility subtracts its charges for transmission, distribution, ancillary services, and stranded costs. Theoretically, customers will save money by finding suppliers willing to sell electrons at prices below the generation credit amount.
Utilities' stranded cost assessments were the key in Pennsylvania to creating sufficiently-sized generation credits, say the experts. Sandra Barber, energy supply manager for the National Energy Team (NET) (an unregulated affiliate of Philadelphia's peco Energy that provides energy procurement services to multi-site clients across the country) remarks that, "Unlike California and Massachusetts, Pennsylvania did not allow for full recovery of the utilities' claimed stranded costs." Huss elaborates: "In Pennsylvania," he says, "the pa-puc has simply taken a different definition of stranded costs than the utilities."
Galatic points out also that restructuring legislation in Pennsylvania sets a nine-year period for utility stranded cost recovery compared to just four years in California. He says that by extending the recovery period, Pennsylvania effectively reduced the stranded cost portion of the bill which had the effect of raising the shopping credit. By opting for a longer recovery period, Galatic says Pennsylvania is taking a tradeoff as overall price levels are expected to plunge once stranded costs are paid off. "In Pennsylvania," he says, "the transition to full competition will occur over a longer period than in California, but when stranded cost charges go away, Pennsylvania will have a mature market, populated with experienced suppliers."
Secrets of success
pa-puc chairman John Quain attributes success in Pennsylvania to the way in which the state has approached its restructuring. "The law in Pennsylvania was drafted by a collaborative process involving all the different interests--utilities, marketing companies, residential consumers, industrial companies, independent power producers, and environmental groups."
What is more, Quain points out that the consensus legislation left much of the fine-tuning to be managed on a utility-by-utility basis. "Pennsylvania is unique," Quain says, "in that we have some of the lowest-cost power and some of the highest-cost power in the U.S. We came to the conclusion very early that we couldn't have a one-size-fits-all law."
Legislation in Pennsylvania called for each utility to present a restructuring plan to the pa-puc. Early actions quickly threatened to move the process into court, but Quain says, "We got all the parties together and decided it would be far better to work out a compromise than to litigate matters." Surprisingly, Quain says, this negotiating process yielded innovations that "added value for everyone." One example: The chance for new entrants to bid on becoming "provider of last resort" or default provider for consumers who choose not to choose a supplier.
"In Pennsylvania," says the NET's Barber, "there was a very progressive PUC panel and staff. They listened to not only incumbent utilities but industrial user groups, consumer advocates, marketers, and environmentalists in order to negotiate fair settlements. There was give and take by all parties."
Galatic, and many others, credit former pa-puc commissioner John Hanger for spearheading the PUC's effort to negotiate downward the amount of stranded costs that utilities would collect from customers. (The Pennsylvania governor's recent failure to reappoint Hanger was widely criticized as a capitulation to anti-competitive interests). However, Quain says that, with one exception, the voting record at the pa-puc shows "plenty of support on this agency for obtaining lower power rates and preserving reliability in a way that is fair to the stockholders at incumbent utilities and to new market entrants."
A trial run
Barber of the NET suggests that Pennsylvania's highly successful pilot may be another secret to its success in delivering a competitive market. The pilot, she says, provided an incentive to participate by guaranteeing a 10%-13% discount off the electric distribution company (EDC) charge for all classes of customers while establishing a generation credit that allowed customers to obtain electricity supply at 5%-20% below the credit. As a result, "the pilot was oversubscribed and the pa-puc and EDCs had an opportunity to work out a lot of the kinks in the transition to competition." Huss--whose organization has been conducting structured research on various pilot programs around the nation--attributes the success of Pennsylvania's pilot to a number of factors:
* Scale. The pilot was offered to 250,000 customers.
* Scope. The pilot covered all customer classes (residential, commercial, and industrial) and encompassed several major cities.
* Education and publicity. Roughly one million people signed up for 250,000 slots.
Says Quain: "The pilot taught us a lot. It told us that a great number of people were interested in customer choice. It told us that the action of the General Assembly was correct and that savings were achievable."
A caveat
The Pennsylvania model is being hailed as a great leap forward for power market restructuring, but the state still has some hurdles to clear. So far, it has settled only one utility restructuring deal--that with peco Energy of Philadelphia. Final restructuring orders (similar to peco's) have been issued for most of the remaining utilities, but as Quain puts it: "These companies are not through thinking [about settling]. They're looking at their legal options."
While peco is the only utility to have finalized its restructuring order, the NET's Barber says "it is widely believed that the phase in and enrollment parameters will be the same or similar for other utilities." There will be differences in rate unbundling, but looking at the significant increase in the market generation credits from 1998 to 1999 (as illustrated in the table) and based on where commodity costs are today, Barber says that "Customers can expect to see substantial savings in addition to the guaranteed discounts."
A Pennsylvania restructuring model
Pilot phase
Description 11/97-12/98 1999 2000
Eligible load 5% 66% 100%
Guaranteed EDC discounts 10%-13% 8% 6%
Mkt generation credits (2.85) (4.46) (4.47)
(system avg)
Transmission/distribution -- 2.98 2.98
Stranded cost recovery -- 1.72 1.92
(Charges shown in cents/kWh)
SOURCE: THE NATIONAL ENERGY TEAM, PHILADELPHIA, 1998
Although peco Energy is the only Pennsylvania utility to have its final restructured rates approved by the pa-puc, phase-in and enrollment parameters have been created which could become the model for other states. It is likely, however, that there will be differences in rate unbundling (i.e., market generation or shopping credits, transmission and distribution charges, stranded cost recovery, etc.) across other states.
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