Industry restructuring update.

• Author: Boudreaux, Greg
• Position: Electric utility industry - Industry Overview

This industry update summarizes material presented at the 1998 Regional Meeting Mini-Seminars. For additional information, contact Greg Boudreaux at (703) 907-5614 or e-mail at greg.boudreaux@nreca.org.

The electric utility industry continues to change rapidly. In recent months, it has experienced just about everything, from continuing growth in the number of states mandating retail wheeling, to the emergence of new terms like "slamming" and "cramming," to electricity selling for $7,000 a megawatt hour on the wholesale market.

One year ago, the 1997 Regional Meetings included a quote from columnist Jane Bryant Quinn:

"For some utilities, it's too late to survive. For others, there's a three year window in which to recreate themselves. For the future, 'Watch out, as marketing of electricity becomes North America's most costly and risky business.' Not a soul knows how it will all turn out."

As we look back on the past 12 months, it appears that Ms. Quinn was right. Things did get more risky, many utilities are reinventing themselves, and nobody knows how it will turn out. To help make sense of these changes, this industry update will focus on six key questions:

1. What have been the drivers of wholesale and retail competition, and how do these two concepts differ?

2. What lessons can be learned from retail wheeling activities in the states?

3. What's happening in the power marketing business, and how does that relate to the price hikes this summer in the wholesale market?

4. What strategies are being implemented by investor owned utilities?

5. What are the prospects for national restructuring legislation?

6. What are electric cooperatives doing to prepare for competition?

   WHOLESALE AND RETAIL COMPETITION

   The passage of the Energy Policy Act in 1992 heralded a new era of wholesale transmission access in the bulk power market. A few years later, the Federal Energy Regulatory Commission - FERC - issued its landmark Orders No. 888 and .889. These orders required all "public utilities" subject to FERC jurisdiction under the Federal Power Act to do three things:

1. File open access transmission tariffs

2. Implement a computer-based "Open Access Same Time Information System" ("Oasis")

3. Functionally unbundle their transmission and power marketing functions.

   The goal of functional unbundling was to create a nationwide market for the wholesale purchase and sale of electricity. Owners of transmission facilities had to open their transmission systems and provide non-discriminatory "open access" transmission. Most cooperatives aren't "public utilities" under the Federal Power Act, and not directly subject to Orders 888 and 889. However, some non-RUS borrower co-ops are subject to FERC jurisdiction, and all utilities - co-op, municipal, and IOU - are affected by the Orders' reciprocity requirement.

   This creation of wholesale competition contributed to the movement toward retail access, also known as retail wheeling. Where do we stand with retail wheeling today? Twelve months ago, in September of 1997, 13 states had approved some form of retail wheeling, either through legislation or regulation. As of September 1 this year, and as shown in Exhibit 1, 19 states have enacted restructuring legislation, or have had restructuring orders issued by the public utility commission. Over half of the U.S. population lives in states that have mandated retail wheeling. In addition, another 26 states have formal legislative or regulatory processes underway to study retail wheeling.

   There are several issues that policy makers must address when they try to restructure the industry on the retail level. One of the most important is the potential for large players, whether utilities or independent power marketers, to accumulate and exercise undue market power. A "merger mania" is sweeping the industry. The dilemma is, policymakers are advocating restructuring - what some call "deregulation" - because of a belief that competitive markets are more efficient, and will result in lower prices for consumers, but if restructuring results in greater consolidation in the industry, there will be fewer competitors, and those few are likely to grow larger, with even less competition than when we started.

   Consider the telecommunications industry. In 1996, Congress passed a sweeping telecommunications act that was supposed to revolutionize the industry and bring competition. And where are we today? At least five major telecom mergers have already been approved, and at least five more are pending. Even the Wall Street Journal is asking "where will Washington finally draw the line on consolidation?" Shouldn't policymakers now looking to apply their deregulatory theories to the electric industry pay attention to what's happened in telecom over just two years?

   Another issue driving the retail wheeling debate is the environment. Many environmental activists support restructuring because they believe retail wheeling will lead to less environmentally harmful power production.

   Environmental concerns are reflected in the new retail wheeling schemes in several ways. For example, most states and the Clinton administration would mandate a "renewables portfolio requirement." This would require that a certain percentage of power produced come from "renewable" resources, such as wind, solar, or geothermal.

   It is interesting to note that surveys show that some consumers are in favor of "green power," and would pay a premium. But there's a catch. The Clinton administration's definition of "renewable resources" excludes hydropower. While many co-ops have access to hydropower, only a few participate in other renewable energy projects. Any portfolio requirements that don't count hydro as "renewable" could be hard to meet.

   RETAIL WHEELING IN THE STATES

   Although retail wheeling has been approved in 19 states, it is currently being implemented only in a handful. The most prominent example is California. Customer choice was scheduled to begin on January 1, 1998. Because of what were called "computer programming snafus," it didn't actually begin until April 1. What happened?

   As the market opened in California, over 250 companies paid a $100 fee and registered with the state public utility commission to sell power. These included companies like New West Energy, TerraWatt, and the Green Power Connection. There was no requirement for power suppliers to post a bond, demonstrate financial stability, or show that they had power supplies to meet their contractual obligations. (According to one joke in California, you could be certified as a power supplier by "sending in two box tops and the entrance fee.")

   Houston-based Enron was a big player. It announced a marketing blitz to reach every customer in the state. News reports said it made a "bold entry into the California electricity market." The RKS Research and Consulting firm has conducted opinion polls in California every month to track the public's response to restructuring. Its initial consumer data supported Enron's strategy. RKS reported in January that "most Californians are ready to switch." More than 80% of California residents were said to be aware of electricity restructuring, and most expected "significant savings: 14% in the first year." RKS found similar attitudes in commercial and industrial customers. By a huge majority, businesses said they wanted customer choice.

   In response to these opportunities, Enron offered two weeks of free electricity and 10% rate cuts. As one strategy to reach residential consumers, Enron teamed with AMWAY to sell "electricity by Enron" through AMWAY's thousands of sales representatives.

   Not to be outdone, NU-SKIN, a beauty and skin-care products company, said that its representatives would also sell electricity.

   In addition, an Internet-based company called FutureNet developed a web-site where customers could not only choose their power supplier, but become FutureNet sales representatives. By paying a $99 application fee, anyone could become a "Power Representative," and sign up customers. By the end of January, the Federal Trade Commission successfully sued Future Net, charging it with engaging in an illegal pyramid scheme.

   As a consequence of such experiences, California changed its criteria for licensing energy suppliers. Now businesses seeking to sell power must post a $25,000 bond and show evidence of financial worthiness and technical capability. Clearly, it is good for consumers that California tightened these licensing requirements. The...