November 1999

Retail: The Halls of Montezuma

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 12/99)

In the month when Con Ed announced its proposed acquisition of Northeast Utilities, as part of its mega pipes and wires-company strategy and the American for Affordable Electricity (pro-choice) changed its ad theme to reflect progress on competition legislation, it’s timely to examine what has been learned about retail competition in those "laboratories of democracy" which have already actually begun its implementation. Not that we may expect Congressional legislation in this remarkably bipartisan year, in which Senator Murkowski in a recent introduction of legislation noted with respect to the conduct of Hearings: "If there is no consensus, we all have better things to do with our time." Rather, this is a chance to reflect upon the somewhat hyperbolic advice by the Electric Power Supply Association to legislators regarding the merits of retail deregulation; "On the other shore is a brave ‘new world’ of possibilities for your constituents, almost as valuable, perhaps, as a share of Aztec Gold."

Well maybe. But what should the objective legislator be aware of in examining the record to date. How should the legislation be structured to get the great Cortez machine running in America?

In Massachusetts, there has been no miracle. The number of shoppers who have switched vendors is 0.13% of the customer total. Residential prices have come down a penny, but that reflects the standard offers imposed on utilities. Open markets haven’t driven customers to new providers; perhaps that will change as the standard offer price creeps gently upwards over time. Rhode Island, the first state to deregulate is following a similar pattern. So too is California.

The word from Pennsylvania, at the moment, is that the model at least works, but overall competition keeps declining. There has been a movement of 450,000 customers (three times California) and there has been price competition, notably in Philadelphia. As in several states, there has been a movement to "green power" branding – this is highlighted as a retail buyer’s benefit. However, in less power/expensive regions of the State, not surprisingly, the amount of shifting has been limited. As in the other deregulated jurisdictions, commercial load shifting is outstripping the residential consumer’s exercise of choice.

One key problem in Pennsylvania has been educating consumers how to shop. While $100 million is slated to be spent over the next 4 years, and 95% of Pennsylvanians know competition exists, only 45% know how to exercise that choice. A similar problem has shaped up in New Jersey, where host utilities, not anxious to encourage change, have not distributed the most edifying of materials. Nevertheless, more marketers are seeking to enter the residential sector. Again, because standard offers are slated to decline over time anyway, the extent of savings available may seem problematic to many residential customers.

One key factor which may, over the long run, nevertheless increase the relative amount of competition in New England compared to that in Pennsylvania is that native load utilities were required to divest assets there, while they were not in Pennsylvania. The surviving utilities in Pennsylvania have begun to exercise their clout, literally coming to customers on radio spots with this message about their upstart competitors: "You made me promises, promises you knew you’d never keep". Not only that, but the switching statistics may be misleading. They fail to reveal, for example, how great a percentage of utility’s consumers have switched to the same utility’s unregulated subsidiary (Peco consumers, for example, now being served by its unregulated supplier Exelon Energy). The Consumer Advocate (!) is treating the specific figures regarding Pennsylvania’s largest single unregulated electric generator supplier as "proprietary information".

Proponents of deregulation California-style emphasize this difference as well. They avow that while state stranded cost policy has limited consumer shifting now, ultimately in the long run California will move ahead of Pennsylvania in retail competition, because California’s regulators and legislators opted to allow cost recovery of stranded costs more quickly to get it over with, while in Pennsylvania the process will be dragged out over time. The early initial Pennsylvania consumer migrations, in short, will be more than offset over time in California (whether this is true, however is problematic. One Pennsylvania Commissioner has argued that during the long wait for true market rates in California, the incumbent utilities will have several years to solidify their dominant position – and hence competition will not ultimately be as robust in California when it finally does come).

What, if anything, is to be inferred in the halls of Congress about the retail Halls of Montezeuma, where the former pipes and wires moguls have divested their assets, only to be succeeded by new supplier moguls from out of town. How well will market competition bring down prices, when part of the acquirers’ strategy necessarily is to backstop their trading capability with generating assets? More fundamentally, if retail competition is the goal, how much variation is healthy. And if it is not, what prescription for retail competition is best? The debate perhaps should not be about fixed date soft landings and states rights (out of tender concern for local regional differences) as much as cool appraisal of how parties will act, depending on economic incentives, anywhere in the country.

The other key question as to the efficacy of retail deregulation was raised by Rep. Markey (D. Mass.) with respect to the latest Barton bill, slated to be marked up just as Congress heads for home. Does it establish a structure which in addition to adequately disciplining the market also encourages innovation? Electric power innovation seems to one likely to be in four areas: web based (more transparent and efficient) energy marketing; provision of converging telecom/communication services; promotion of dispersed generation and promotion of use of cleaner technologies. As regards the answer the encouraging model is telecom deregulation – which has been a source of significant technical breakthroughs. As regards the answer, the discouraging model is telecom deregulation – the source of ever increasing multi-media agglomeration of power in fewer hands, with limited public programming benefit. Perhaps it would be helpful for Congress to reexamine the potential for consumer "Aztec gold" in the related context of telecom’s experience. Especially, is this pertinent since ultimately electricity may become just an incidental vertically integrated product of mega-utility service firms – a wire into the home, or just juice in someone else’s plug.

In the past two decades, we have deconstructed regulation in this country and are in the midst of seeing whether what we have created a modern replay of the monopolistic 19th century or a new web netted model for the 21st. In revamping retail markets, the record suggests that the three areas requiring special legislative and administrative care are:

• Prevention of backdoor re-monopolization of services;
  

• Creation of meaningful retail customer choice;
  

• Assurance that technological innovation can and will be rewarded in the marketplace.

These goals are not necessarily addressed simply by structural industry modification.

Unless attention is paid to these factors, by empirical reference to experience, Aztec Gold can turn out to be iron pyrites.

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.