inroadsmicrocenter

February13,2000REVISEDDISCUSSIONDRAFTWHYDOWENEEDELECTRICITYRETAILERSORCANYOUGETITCHEAPERWHOLESALEPaulL.
Joskow1MIT"It'sasintobuyretail"AttributedtoWoodyAllenABSTRACTTheopportunitiesforretailelectricitycompetitiontoprovidenewvalue-addedservicestoretailelectricityconsumersarediscussed.
Thephysicalattributesofelectricitysupplymakemanyofthetraditional"convenienceservices"providedbyretailersinotherindustriesirrelevantinelectricity.
Inaddition,theseattributesprovidealow-costwayforelectricityconsumerstobuydirectlyinthewholesalemarket.
Inthisway,retailconsumerscanreceivethecommoditypricerelatedbenefitsofcompetitivegenerationmarketswithoutincurringlargeincreasesinadvertising,promotionandcustomerservicecosts.
Electricdistributioncompanies(UDCs)caneasilyprovideaBasicElectricityService(BES)thatmakesitpossibleforallconsumerstobuycommodityelectricityincompetitivewholesaleelectricitymarketsatthespotmarketprice.
TheavailabilityofBESisespeciallyimportantforresidentialandsmallcommercialcustomersforwhomfewnewretailvalue-addedservicesareevident.
BESalsoprovidesanexcellentcompetitivebenchmarkagainstwhichconsumerscancomparethevalueaddedassociatedwithcompetitivesupplyoffersfromcompetingElectricityServiceProviders(ESPs),helpstoprotectresidentialandsmallcommercialcustomersfromexploitationbyESPs,andmitigateswastefulexpendituresonmarketingandpromotionbyrent-seekingESPsthatwillincreaseprices.
TheavailabilityofBEShelpstochannelESPcompetitiveeffortstowardprovidingvalueaddedservicessuchasrealtimemeteringandcontrol,energymanagementcontracts,riskhedgingandforwardcontracting,greenpowerandotherservices.
ThisisthestrategythatthemostsuccessfulESPsarepursuing.
Asuccessfulretailcompetitionprogramcanhaveadditionalsocialbenefitsbyhelpingtoimprovetheperformanceofwholesalemarkets.
However,effortstousecreamy"shoppingcredits"tosubsidizeESPsaremisguided,raisingbothefficiencyandequityconcerns.
Thesuccessofretailcompetitionshouldbejudgedbythenewvalueaddedservicesitbringstothesystem,notbythenumberofcustomerswhoswitchtoESPsfromBESandsimilardefaultservices.
RegulatorswhofocusonretailswitchingstatisticsandwhoaresubsidizingcustomerswitchingarelikelytobemakingresidentialconsumersworseoffthantheywouldbeifBEShadbeenmadeavailabletothembytheirUDC.
1DepartmentofEconomics,SloanSchoolofManagement,andCenterforEnergyandEnvironmentalPolicyResearchatMIT.
IwouldliketothankCarlBlumstein,RogerBohn,SeverinBorenstein,TheresaFlaim,BillHogan,FredKahn,RickShapiro,andFrankWolakforcommentsonanearlierdraft.
IamgratefultotheMITCenterforEnergyandEnvironmentalPolicyResearchforfinancialsupport.
2TABLEOFCONTENTSPageINTRODUCTIONANDSUMMARY1WHATDORETAILERSDOINOTHERINDUSTRIES9PHYSICALATTRIBUTESOFELECTRICITYANDIMPLICATIONSFORRETAILING14HOWCANELECTRICITYRETAILERSPROVIDEVALUEADDED17BENCHMARKPRICES24CURRENTUDCRETAILINGCOSTS29STIMULATINGCOMPETITIONTOPROVIDEVALUE-ADDEDSERVICES38THEPENNSYLVANIASHOPPINGCREDITAPPROACH:ARIPOFFFORRESIDENTIALCUSTOMERS45RETAILCUSTOMERSWITCHINGBEHAVIOR49SHOULDWESUBSIDIZEESPs55CONCLUSIONS56February13,2000REVISEDDISCUSSIONDRAFTWHYDOWENEEDELECTRICITYRETAILERSORCANYOUGETITCHEAPERWHOLESALEPaulL.
Joskow1MIT"It'sasintobuyretail"AttributedtoWoodyAllenINTRODUCTIONANDSUMMARYAgreatdealofthepopulardiscussionofelectricitysectorrestructuring,competitionandregulatoryreformhasfocusedonproviding"customerchoice"forallretailconsumers---small,mediumorlarge.
Customerchoiceprogramsseparatethedistributionofelectricity,whichremainsaregulatedmonopoly,2fromthefinancialarrangementsforacquiringelectricgenerationservicesincompetitivewholesalemarketsandresellingtheseservicestoend-useretailconsumers.
3Utilitydistributioncompanies(UDCs)providethefirstservice.
Independentunregulatedelectricityretailers(ElectricityServiceProvidersorESPs)providethesecondenergysupplyservice,relyingontheUDC'sdistributionfacilitiestophysicallydelivertheelectricity.
ESPsneedownnophysicalelectricityproductionordistributionfacilities.
ESPsareprimarilyfinancialintermediarieswhichacquireelectricityinthe1DepartmentofEconomics,SloanSchoolofManagement,andCenterforEnergyandEnvironmentalPolicyResearchatMIT.
IwouldliketothankCarlBlumstein,RogerBohn,SeverinBorenstein,TheresaFlaim,BillHogan,FredKahn,RickShapiro,andFrankWolakforcommentsonanearlierdraft.
IamgratefultotheMITCenterforEnergyandEnvironmentalPolicyResearchforfinancialsupport.
2Electricitydiffersfromtelecommunicationsandrelatedinformationservicesinthisregard.
Withcurrenttechnology,itisnotexpectedthat"facilitybased"distributionservicecompetitorswillevolveinthesamewayascable,wireless,satelliteandoverbuildcompetitionisemergingfordeliveryoftelephone,dataandvideoservicestoend-usecustomers.
3Itshouldgowithoutsayingthatareasonablywellfunctioningcompetitivewholesalemarketisapreconditionforcreatingawellfunctioningcompetitiveretailmarket.
Stateswhichintroduceretailcompetitionwithoutfirstcreatingthenecessarysupportingcompetitivewholesalemarketinstitutionsare2competitivewholesalemarketandresellitatretailtoresidentialcommercialandindustrialconsumers.
ESPsmayprovidetheirownmetering,billingandcustomercareservicestoservetheirretailsupplycustomers,mayrelyontheUDCtoprovidesomeoralloftheseservices,orcanoutsourcesomeoftheseservicestothirdparties.
CustomerswhodonotswitchtoanESPcangenerallycontinuetobesuppliedwithelectricenergybytheUDC---viaadefaultorstandardofferserviceoption---basedonaregulatedprice.
RegulatorstravelfromconferencetoconferencewiththeirchartsdepictinghowmanyESPshavebeenlicensedintheirstatesandhowmanycustomershaveswitchedtoanESP.
Theywringtheirhandswhenthedataindicatethatthenumberofcustomers,especiallyresidentialandsmallcommercialcustomers,switchingtoESPsissmallerthantheyhadhopedandwhentheyobservemanyESPswithdrawingfromthemarketsoonaftertheyhaveenteredbecausetheyfinditdifficulttomakeaprofit.
ThebasicproblemthatmanyESPsfaceisthattheycan'tprofitablycompetewiththestandardofferordefaultservicethatcontinuestobeavailabletocustomersfromtheirlocalUDC.
Thisappearstobeanespeciallydifficultchallengeforservingresidentialandsmallcommercialcustomers.
4Atthesametime,manyregulatorsarecommittedtoprotectingthesesmallconsumersfromexploitationbyESPstryingtotakeadvantageofthewidespreadconfusionaboutelectricitycompetition,poorinformationaboutmarketvaluesandcompetitiveoptionsavailable,andgenerallyhightransactionsandswitchingcosts.
TheseprotectionstaketheformofregulatedUDCdefaultserviceoptions,informationprovisionprogramsandregulations,andminimumservicestandardsforESPsESPsareincreasinglypressingregulatorstofindwaystoputmore"retailmargin"intothesystem---thedifferencebetweentheretailpricechargedforgenerationservicebytheUDCtoboundtorunintoseriousproblems.
4Forexample,inCaliforniaabout25%ofthelargeindustrialloadhadswitchedtoanESPduringthefirstyearofcustomerchoicedespitenospecialprovisionstocreate"retailmargin"forESPs.
However,less3customerswhodonotswitchtoanESPandthecompetitivewholesalemarketpriceofelectricgenerationservicesthatbothESPsandtheUDCacquireinregionalwholesalepowermarkets.
ESPsarguethatthestandardofferordefaultservicepricesofferedbytheUDCmustbesignificantlyhigherthanitnowissothatESPscanattractcustomersbyofferingthemlowerpricesthantheycanobtainfromstandardofferordefaultserviceandstillearnenoughtocovertheirmarketing,advertising,promotion,baddebtandanybillingandmeteringcoststheyhavechosentoincur.
Somestateshaveprovidedcreamy"shoppingcredits"forconsumerswhochooseESPsinordertoprovidesucharetailmargintothem.
TheseshoppingcreditseffectivelyincreasetheregulatedpricethatconsumerswhodonotchooseanESPmustpaytolevelsabovethewholesalecommoditycostofelectricityandprovideanopportunityforESPstoattractcustomersbyofferingdiscountseveniftheUDCcontinuestoprovidemetering,billingandothercustomerservicesonbehalfoftheESP.
Atthesametime,someastutepolicymakershaverecognizedthatelectricityconsumerscangetmanyofthebenefitsofcompetitivegenerationmarketsinasimpleandstraightforwardmannerbybuyingdirectlyinthecompetitivewholesalemarket,withoutincurringadditionalmarketing,promotionandadvertisingcosts.
Givingconsumersdirectaccesstothewholesalemarketalsomitigatesconcernsaboutabusivesalespractices,customerripoffs,andtheneedforburdensomeconsumerprotectionregulations.
Thisleadstoanobviousquestion.
Ifcustomerscan"getitcheaperatwholesale,"whatvalueaddeddoelectricityretailersbringtothetableonceacompetitivewholesalemarketiscreatedandconsumersgivenaccesstobuyelectricitythereCompetitiveretailingentailssubstantialincreasesinoverallmarketing,advertisingandpromotionexpensesintheelectricitysector.
UDCs'costsintheseareasarenaturallyquitelow;electricitysupplyhasneverbeenanadvertising/promotionintensivebusiness.
Accordingly,ESPsmustbringsomevaluedaddedtothesystemtomaketheiractivitiesthan1.
5%oftheresidentialloadhasswitchedtoanESPduringthesametimeperiod.
4beneficialfromasocietalperspective.
Moreimportantly,whatarethecostsandbenefitsofvariousregulatoryinitiativesdesignedtogiveESPsmore"retailmargin"tohelpthemtoprosper5ThepopularfocusonretailcompetitioninelectricityhasbeenmotivatedbytheviewthatallowingretailcustomerstochoosetheirretailsupplierfromamongmanycompetingESPsistheonlywaythatsmallresidentialandcommercialconsumerscanandwillbenefitfromelectricitycompetition.
Thisviewinturnreflectsconcerns(realorimagined)thatsmallercustomershavenotbenefitedgreatlyfromtheintroductionofcompetitioninsectorsliketelecommunicationsandnaturalgassupplywhichhavegonethroughindustrytransformationssimilartowhatisnowtakingplaceinelectricity.
Thisviewreflects,inpart,thefailuretounderstandthephysicalaspectsofelectricitysupplyanddeliveryandtheopportunitiesthesephysicalattributescreateforgivingcustomerstheopportunitytobuydirectlyinthewholesalemarketwithlowtransactionscosts.
Infact,thereisasimpleandlow-costwaytoensurethatelectricityconsumersgettheprice-relatedbenefitsofcompetitionamonggenerationsuppliers.
ThephysicalattributesoftheproductionanddeliveryofelectricitymakesitveryeasytogiveallretailelectricityconsumerstheequivalentofdirectaccesstothewholesalespotmarketforelectricityandprovidesanaturalbenchmarkthatconsumerscanusetocompareoffersfromESPs.
ABasicElectricityService(BES)optionprovidedbytheUDCthatallowsretailcustomerstobuydirectlyinthewholesalemarketshouldbethebenchmarkagainstwhichthesocialbenefitsofretailcompetitionandthebestmechanismstorealizethesebenefitsshouldbejudged.
Thatis,successfulretailcompetitionshouldprovidevalue-addedservicestoconsumersoverandabovewhatcantheycanrealizeinasimpleandinexpensivewaythroughdirectaccesstothewholesalemarket.
Thisishowretailerssucceedinotherindustries.
Itistheseretailvalue-addedservicesthatshouldsupporttheretailingcostsrequiredtoprovidetheseadditionalretailservices.
Ifaretailercannotprovidevalueaddedoverandabovewhata5Seeforexample,AlfredE.
Kahn"BribingCustomerstoLeaveandCallingit'Competition',"The5consumercanrealizebybuyingatwholesalethentheretailershouldnotexpecttosucceed.
Noretailvalueadded,noretailmargin!
Moreover,successofretailcompetitionshouldbemeasuredbythevalued-addedservicesitbringstothesystemnotbythefractionofcustomerswhodecidetobuyatretailratherthanatwholesale.
Inthisframework,theprimarysocialvalueincreasingroleofESPsistoprovideenhancedcustomerserviceswhichprovidevalueaddedtoconsumersoverandabovewhatconsumersrealizebypurchasingatwholesalethroughtheUDC.
6Theseservicesincludeenhancedmeteringandcontroltechnologies,priceandconsumptionhedgecontracts,totalenergymanagementservices,bundlingofagas,electric,telephoneservice,7andotherinnovativeservicesthatESPscancreateandendeavortoconvinceconsumerstopurchase.
ESPsmustthenrecovertheirretailingcoststhroughthehigherpricesthatconsumersarewillingtopayforthesevalue-addedservices.
Moreover,consumersareprotectedfromunscrupulousretailersandexcessiveretailmarkupsbyhavingatransparentcompetitivewholesalemarketpurchaseoptionagainstwhichretailsuppliersmustcompeteandagainstwhichconsumerscaneasilyevaluatecompetingoffers.
Thisreducestheconsumerprotectionchallengesthathaveburdenedstateregulators.
ItshouldnotbesurprisingthatESPswouldbeopposedtoallowingUDCstoofferthistypeofbasicno-frillsBEStoretailcustomers.
ItprovidesahighlytransparentbenchmarkagainstwhichESPsElectricityJournal,May,1999,pages88–90.
6AsIwilldiscussinmoredetailbelow,thereareotherpotentialsocialbenefitsassociatedwiththedevelopmentofanactiveretailmarketservedbycompetingESPs.
IfESPsofferrealtimepricingoptionsthatallowconsumerstoadjusttheirconsumptiontorapidlychangingelectricitypricestheycanhelptomitigatemarketperformanceproblemsthatarisewhenwholesalesuppliesarescarceandthereisnodemandelasticityinthewholesalespotmarket.
Inaddition,participationinthewholesalemarketsbymultipleESPbuyerswithvaryingdemandpatterns,contractualobligations,andriskpreferencescanincreasewholesalemarketliquidityandimprovewholesalemarketperformancewithforwardcontracting.
7Forexample,checkouthttp://www.
essential.
com/.
Alsocomparethequalityoftheinformationprovidedregardingpricesandservicesonthissitetowhatisavailableathttp://www.
utility.
com/.
6mustcompete.
Moreimportantly,theonlywaythatanESPcancompeteeffectivelywithBESserviceistooffervalueaddedservices---overandabovecommodityservicesavailabledirectlyinwholesalespotmarkets----forwhichconsumersarewillingtopayahigherprice.
Thatprice,inturn,mustbehighenoughtocovertheirmarketing,promotion,procurement,andcapitalcosts.
Ontheotherhand,ESPswouldraisesomelegitimateobjectionstoBESasIhavedescribeditsofar.
TherearecostsoverandabovethecostsofwholesalepowerthataUDCincurswhenitprovidesBES.
Thesecostsincludecustomerservicecosts,billingcosts,baddebtcosts,meterreadingcosts,procurementexpenses,advertising,etc.
SomeofthesecostsarepotentiallyavoidablewhenanESPattractscustomersfromtheUDCwhileotherstheUDCmustcontinuetoincurtomeetitsserviceobligations.
HowmuchoftheseretailcostsareavoidablewhencustomerschoosetobeservedbyanESPdepends,inpart,onwhatretailservicesESPsprovide(e.
g.
meteringandbillingservices)andwhatresidualcustomerserviceobligationsareretainedbytheUDC.
ESPsmaybeabletooffertheseretailservicesmoreeconomicallythancantheUDC.
Thus,the"retailmargin"issueisinseparablefromissuesassociatedwiththeunbundlingofspecificretailingservicesthatareopentocompetitionfromESPs,thepricingoftheseservices,andtheremainingserviceobligationsoftheUDC.
Thereclearlyarepotentialopportunitiesforelectricityretailerstoprovidevalue-addedservicestoretailconsumers,especiallyforlargercommercialandindustrialcustomers.
Indeed,ESPshavebeenmostsuccessfulinattractingtheselargercustomerseveninthefaceofdefaultservicepricesthatreflectonlywholesalemarketpricesforelectricity.
However,theopportunitiesforESPstoaddrealvalue(net),theexpectationswehaveforthebehaviorandperformanceofelectricityretailing,andthepublicpoliciesthataffecthowESPscompeteforretailcustomers,mustbeviewedfromtheperspectiveofthepeculiarattributesofthesupplyanddistributionofelectricitythatmakedirectaccesstothewholesalemarketveryeasy.
Thevalue-addedopportunitiesarelikelytodependheavilyonthevolumeand7patternsofthecustomer'selectricityconsumption,howthecustomeruseselectricitytoprovideend-useservices,andopportunitiestoprovidevaluetocustomersbybundlingcommodityelectricitysaleswithotherservices----e.
g.
totalenergymanagementservices.
Therearelikelytobesignificantdifferencesinvalue-addedopportunitiesbetweenresidential,smallcommercial,largecommercialandindustrialconsumersbecauseofdifferencesinthequantitiesofelectricitytheyconsume,howtheyusethatelectricity,andtotalenergymanagementopportunities.
Therearealsolikelytobesignificantdifferencesamongthesegroupsintheopportunitiesforconsumerexploitationandtheassociatedneedforconsumerprotectioninitiatives.
ItissometimesarguedthatsubsidiesforESPsarejustifiedbecausethisisan"infantindustry"thatneedshelpingettinggoing.
SomeevenpointtothePURPAexperienceasdemonstratinghowsupra-competitivepaymentsforelectricityproducedbyQualifyingFacilities(QFs)hashelpedtostimulatethedevelopmentonanindependentpowersector.
Onemustbesuspiciousofinfantindustryarguments.
Industriesthathavegrownand(sometimes)prosperedbasedonsubsidiesrationalizedasnecessarytopromoteanewindustryoftenremain"infants"fordecades.
Temporarysubsidiesbecomedifficulttowithdraw.
ManyoftheESPsarenotpoorcapital-starvedinfantsbutratherareaffiliatesoflargecorporationswithsubstantialresources.
PURPAhascosttheU.
S.
tensofbillionsofdollarsinexcessivecosts.
WeshouldatleasttrytofindalesscostlywaytoprovideESPsofferingrealvalue-addedserviceswithareasonableeconomicenvironmentinwhichtocompete.
AmorerespectableargumentforprovidingsubsidiestoencouragethedevelopmentofESPsisthatESPs,asagroup,canhelptoimprovetheperformanceofwholesaleelectricitymarkets.
Thepotentialbeneficialimpactsofacompetitiveretail-ESPmarketontheperformanceofwholesalemarketsincludeincreasedliquidityinspotandforwardmarkets,demandmanagementinresponsetospotmarketpricemovementstomitigatemarketpowerproblemswhencapacityisscarceanddemand8isotherwiseveryinelastic,andcontractingtoinsureagainstpricespikes.
Thesocialvalueoftheseimprovementsinwholesalemarketperformancecannotbefullycapturedthroughordinarymarketprocesses.
Accordingly,sometypeofsubsidymaybejustifiedinordertoacceleratetheevolutionofretailloadsservedbyESPs.
Beforeanysuchsubsidiesshouldbeprovided,however,thewholesalemarketperformanceproblemstheyaredesignedtoremedyshouldbefullyunderstood,themagnitudeoftheseperformanceproblemsassessed,andanysubsidiesshouldbetargetedatstimulatingESPinitiativesthatremedythewholesalemarketperformanceproblemsatissue.
Thepurposeofthispaperistomakesomesenseoftheseissuesandtoidentifyandevaluatepolicyoptions.
Myfocushereisonretailcompetitionasitrelatestoresidentialandsmallcommercialcustomers.
Iwillarguethatduringatransitionperiod,theUDCshouldofferresidentialandsmallcommercialcustomersaBESoptionthatgivesthemdefactodirectaccesstothecompetitivewholesalemarket.
ThisoptionwouldincludecreditsforretailservicecoststhattheUDCavoidswhencustomersareservedbyESPs.
Intheshortrun,theopportunitiesforprovidingvalue-addedservicestothebulkofthesecustomersissmallwhiletheopportunitiesforincreasingthecoststhesecustomerspayforelectricityloomlarge.
Inaddition,ratedesignchangesarenecessarytoproperlyreflectretailservicecostsinprevailingratedesignsinordertoavoidcreamskimmingandredliningofcertaingroupsofresidentialandsmallcommercialcustomers.
TheBESoptionstrikesagoodbalancebetweenthepromotionofefficientretailcompetitionandconsumerprotectionforsmallercustomers.
Forlargercustomers,thepresentopportunitiesformeaningfulvalueaddedservicesappeartobemuchgreaterthanforsmallcustomers,directretailingcostsareamuchsmallercomponentoftotalsupplycosts,theopportunitiesforcustomerconfusionandexploitationofmuchlessconcern,andESPsarealreadymakingsignificantinroadsintothesesectors,eveninstateswheretheyfeelthattheeconomicincentivesarenotasfavorableastheywouldlike.
Thus,thereislittlereasonwhytheUDCshouldofferthelarge9customersaregulatedBESserviceoptionatall.
Forthelargecustomers,theUDCshouldcontinuetoofferregulated"wires"services,associatedcustomersupportservices,andcontinuetocollectfundstocoverstrandedcostsandvarious"publicbenefits"fundsastheydonow.
RetailelectricitysupplyservicesprovidedbyESPs,includingutilityaffiliates,canbederegulatedoncecompetitivewholesalemarketshavebeencreated.
8Suchapolicywillchannelretailcompetitiontowardthedevelopmentofrealvalueaddedservicesforcustomers,limitwastefulexpendituresonadvertisingandpromotion,providetimetorebalanceregulatedpriceschedulessothattheybetterreflectcostscausality,andprotectsmallerconsumersfromexploitationbyprovidingasimplebenchmarkagainstwhichtheycancomparecompetingoffers.
WHATDORETAILERSDOINOTHERINDUSTRIESInotherindustries,retailersexistandprosperbecausetheyaddvalue(realorimaginedandIwillnotdistinguishherebetweenthetwo)towhatconsumerswouldreceiveiftheypurchaseddirectlyinthewholesalemarket.
Retailerscanaddvalueinmanydifferentwaysdependingonthenatureofthespecificgoodsandservicestheysupplyandtheevolutionofretailservicetechnology.
Theprimarywaysinwhichretailerstypicallyaddvalueare:a.
Byestablishingconvenientlocationsatwhichproductsaresold,bykeepingtheretailoutletsopenatconvenienttimesofdayanddaysoftheweek,andbyprovidingotherservicesthatofferconsumersamoreconvenientwaytoshop.
Convenientlocationsallowconsumerstoconserveontransportationcosts.
Convenienthoursofoperationallowconsumerstoallocatebetterthescarcetimethattheyhaveavailableforshopping.
Theplethoraof"conveniencestores"and"24-hourstores"whichsellasubsetoftheproductsavailablein8WithappropriatecostandbehaviorseparationsoftheUDC'sregulateddistributionandcompetitive10full-linesupermarketsaregoodexamplesofhowconvenientlocationsandhoursofoperationappealtoconsumers.
Conveniencefood+storestypicallychargehigherpricesthandofull-linesupermarkets,buttheyarerightaroundthecornerandarealwaysopen.
InternetsellerslikeAmazon.
comorBuy.
comprovideamoreconvenientwayforconsumerstoshopfromtheirhomesandbusinesses.
Retailgasolinestationsprovideconvenientlocations,arrangefortransportationofthefuelfromthewholesaleterminal,areopenatconvenienttimes,maintainaninventoryofgasolineintheirtanks,stockfuelwithdifferentoctaneratings,providecredit,etc.
Thedifferencebetweentheretailpriceofgasoline(taxesaside)andthewholesalepriceofgasolineistheretailmarginthatretailgasstationsrelyontopayforthecostsofprovidingtheseservices.
b.
Bysellingawiderangeofcomplementaryproductsandmaintainingextensiveinventoriesofseveralbrandsofeachproductinasingleconvenientlocation.
Byofferingafulllineofsubstituteandcomplementaryproductsatthesamelocation,retailersreduceconsumersearchcosts,facilitatecomparisonsofbrandsfrombothapriceandqualityperspective,andmakeitpossibleforaconsumertogettheproductshewantsinstantly.
Adeepinventoryofproductsreduces"stockout"costs.
FoodsupermarketsprovidethistypeofretailvalueaddedasdodepartmentstoreslikeBloomingdalesorFilenes.
Mallsprovideawayforavarietyofretailoutletstocollocatetofurtherreduceconsumersearchcosts.
c.
Byprovidingpoint-of-saleservicetoconsumers.
Therearemanyproductsforwhichconsumersdesireinformationandassistanceinchoosingthebestproducttomatchtheirretailingfunctions.
11preferencesbeforetheymakeafinalpurchasechoice.
Thispre-saleinformationcanbeprovidedbyretailemployees.
Thevalueofpre-saleinformationvariesfromproducttoproductandfromconsumertoconsumer.
AfullservicepersonalcomputersuperstorelikeCompUSAorMicroCenterprovidesthistypeofpoint-of-saleservice(aswellastheotherconvenienceservicesnotedabove)andappealstomanyconsumerswhoknowlittleaboutcomputers,softwareandperipherals.
Computermavenswhoknowwhattheywantanddonotneedfurtherassistancecanpurchaseinsteaddirectlyfromthemanufacturer,forexampleusingtheDell,GatewayorSonywebsites.
Alternatively,computersandperipheralscanbepurchasedfromoneofthemysteriousvirtualretailoutletslocatedinBrooklyn(andelsewhere)thathaveadsintheSundaynewspaperspaperofferingamazingsavings($call$)andan800numbertocalltoplaceyourorder.
Ineithercase,aknowledgeableconsumercansavesomemoneybybuyingatanoutletthatprovideslittleornopoint-of-saleservicecomparedtowhatshewouldpayatthefullserviceoutlet.
9d.
Byprovidingpost-saleserviceandreturnprivileges.
Forsomeproducts,consumersmayneedpost-saleassistancetomakeeffectiveuseoftheproductortodealwithdefectsthatarediscoveredwhentheproductisfirstused.
Someretailersprovidethiskindofservice,butothersdonot(trygettingsuchservicefromthemysteriouscomputeroutletinBrooklyn).
Insomecasesconsumersmaydecide,onreflection,thattheydonotreallywanttheproductandseektoreturnitforcashorcredit.
Forexample,Toys-R-Ushasanexcellentreputationfortakingtoysbackevenmonthsaftertheyhavebeenpurchased.
Thiskindofservicecanbequite9Fullserviceretailoutletsoftenmustconfronta"freerider"problem.
Customerscomeintogetinformationaboutaproductandthengohomeandcallthe800numberofthevirtualretailoutletinBrooklyntobuytheproduct.
Thetorturedhistoryofantitrustpolicygoverningso-calledverticalrestraints,12costly,however.
10e.
Bypassingalongthebenefitsofanywholesalemarketbuyingpowerthataretailermightpossessintheformoflowerretailprices.
Largeretailerswhichcanbuyinvolumecanoftennegotiatelowerpriceswithwholesalesuppliers,incurloweraveragetransactionscosts,andcanpasssomeoftheirlowerwholesalecostsontoretailconsumers.
Wal-Marthasareputationforbeingatoughbargainerwithitssuppliers.
Costcoconcentratesitswholesalepurchasesinarestrictedsetofproductstogetbetterdealstopassalongtoconsumersandchangestheproductsithasavailableinitsstorescontinuouslyasitfollowstheopportunitiestogetproductsatlowerpricesinthewholesalemarket.
11f.
Bydevelopinginnovativeretailingtechnologiesthatreduceretailingcostsandallowretailerstopassthesavingsalongtoconsumers.
RetailmarginsarelowerintheU.
S.
thantheyareinalmostanyotherOECDcountry.
Moreover,weareinthemidstofaretailingtechnologyrevolutionthatisplacingevenmorepressureonretailmargins.
Evenifaninnovativeretailercannotprovidebetterservice,itmaybeabletoreduceretailingcostsandretailmarginssignificantlybyadoptingmoreefficientretailingtechnologies.
Sectorsinwhichretailmarginsareparticularlyhigharenaturaltargetsofopportunityforretailerswhocandevelopanddeploymoreefficientretailingtechnologiesandpasstheretailcostsavingsalongtoconsumersinthesuchasresalepricemaintenance,reflectsconflictsbetweenfull-serviceandno-frillsserviceretailers.
10Toys-R-Ushasanotherattractiveservice.
Theywillputthetoystogetherforyou,butforanextrafee.
Ihavealwaysfoundthefeetobeveryreasonablecomparedwiththealternativeofassemblingthetoysmyself.
11Costcoalsoreducescostsbyincreasingtheminimumsizeofretailpurchases.
Costcoisnottheplacetogoifyouwantahalf-poundoffrozenshrimp.
ButifyouwanttenormorepoundsofshrimpCostcowillofferyouagoodprice.
13formoflowerprices.
ThisisoneofthepromisesofInternetretailing,thoughformanyinternetretailersthecostsofadvertisingandpromotionarebecominganincreasingchallenge.
g.
Bydevelopingareputationforprovidingaccurateinformationaboutproductqualityanddeliveringonpromisesaboutproductattributesandpost-saleservicemadetoconsumers.
Manyconsumersplacesomevalueondealingwitharetailerwhotheycantrust.
Thisisespeciallytruewhentheproductstheyarepurchasingareofparticularlyhighvalue,wherebuyingfromadisreputableretailermaybeespeciallycostly,and/orwherecustomerswitchingandsearchcostsarehighrelativetothecostoftheproduct.
Developingandcapitalizingonareputationforprovidinghighqualityserviceisanincreasingchallengeforretailersasthepopulationbecomesmoremobile,retailpurchaseoptionsexpand,andadvertisingprovidesmoremisinformationthaninformation.
Retailersmixandmatchtheprovisionofthesedifferenttypesofvalue-addedservicesinmanydifferentwaysastheytrytoappealtoconsumerswithdiversepreferences,searchcosts,andinformationacquisitionandprocessingcosts.
Theactivitiesofretailersaswellasthecostandmagnitudeofthevalueaddedtheybringtotheeconomyvarieswidelyfromindustrytoindustrydependingoneachindustry'sattributes.
Thenatureandcostsofretailingservicesalsovaryovertimeasconsumerpreferenceschange,searchandinformationcostschange,andnewtechnologiesfordeliveringretailservicesaredeployed.
Largecommercialandindustrialcustomerstypicallybuygoodsandservicesthroughdifferentretailchannels,ordirectlyfrommanufacturers,thandoindividualsandsmallbusinesscustomers.
Severalthingsareclear,however.
Wehaveseenenormousinnovationsinretailinggenerallyinthelastfewyears.
Theseinnovationshavemadeitsignificantlymoreconvenientfor14consumerstoshopforgoodsandservices.
Thetrendinretailingaroundtheworldhasbeentosqueezeretailmarginsandtoreducethenumberoflevelsinthesaleschain,sothatretailconsumerscanget"closer"tothewholesalemarket.
12Successfulretailersmustprovidevalueaddedtoconsumersoverandabovethevaluethattheygetiftheybuyatwholesaleoratalesscostlyretailoutlet.
Thisistheonlywaythatretailerscancollectaretailmargintocovertheiradvertising,promotion,inventory,credit,rent,display,sales,andoverheadcosts.
Noincrementalvalueadded,noincrementalretailmargin!
PHYSICALATTRIBUTESOFELECTRICITYANDIMPLICATIONSFORRETAILINGElectricityhasanumberofpeculiarattributesthatarerelevantforunderstandingwhereretailvalueaddedislikelytobefoundandwhereitisnot:a.
Theavailabilityofconvenientlocations,convenientshoppingtimes,adeepproductinventory,awiderangeofbrandsavailableunderoneroof,post-saleserviceandreturnprivilegeshavefewnaturalanalogieswithregardtothesupplyofretailcommodityelectricity.
Thereisgenerallynodirectphysicalrelationshipbetweenaspecificgeneratingsourceandaspecificretailcustomerorgroupofretailcustomers.
Theelectricityproducedbyageneratorgoesintothepoolofelectronsandconsumersandconsumerstakeelectricityoutofthepoolofelectrons.
Theproductgetsdeliveredtoeveryone'sdoorbytheUDCandisautomaticallyavailableeverysecondovertheUDC'sdistributionwiresregardlessofwhichESParetailcustomerhaschosentorepresenther.
ElectricitycannotbeeconomicallystoredbytheESP.
Youcan'treturnit.
Thereliabilityofservicedependsonthestateofthenetworkandsupply12OfficesupplysuperstoreslikeStaplesandOfficeDepotinitiallyfocusedonprovided"largecustomerdiscounts"tosmallbusinesses.
Internet-basedsalesbycompanieslikeDellallowindividualsandsmallbusinessestobuydirectlyfromthemanufacturerasonlylargecompanieshadpreviouslybeenabletodo.
15anddemandconditionsinthewholesalemarketnotontheindividualretailersupplyingaparticularcustomer.
Whenageneratorfailstosupplythecustomersofaretailerwhohascontractedwiththatgenerator,ortheretailerrunsofftoBrazilwithoutpayingitsbills,theretailcustomercontinuestogetelectricityfromthenetworkaslongasthecustomerpaysherbills.
InalloftheorganizedwholesalemarketsintheU.
S.
,theretailerwhosegenerationsupplierhasfailedtosupplyelectronstothesystemtomatchitscontractualobligationsnowsimplyowesthenetworkoperator,whichcontinuouslybalancesphysicalsupplyanddemandinthesystem,animbalancepayment.
Theretailercanthentrytogetthemoneybackfromthegeneratorsthatbreachedtheirsupplyagreements.
ThebottomlineisthatanESPusingthepublicdistributionandtransmissionnetworkonlytobuyandresellwholesalepowercannotprovideindividualcustomerswithmoreconvenientdeliverylocationsorchangethebasicreliabilityofthedeliveryofelectricitytothecustomer.
Regardlessoftheretailerchosenbyacustomer,theelectricitygetsdeliveredonthesamewiresanddrawsfromthesamepoolofelectronswiththesamereliability.
13Thus,thenatureofamonopolydistributionandtransmissionnetworksharplyconstrainstheabilityofelectricityretailerstodosomeofthemostimportantthingsthatretailersinotherindustriesnormallyexisttodo.
14b.
Retailingcommodityelectricityperse(i.
e.
ignoringmetering,variousbehindthemeter13AsIwilldiscusspresently,customerspecificreliabilityandpowerqualityenhancementsgenerallyrequireinvestmentsonthecustomer-sideofthemeter.
Thisisanimportantvalue-addedservicethatESPscananddoprovidetocustomers.
14Thiscanbecontrastedwithwhatisevolvingintelecommunicationsandinformationserviceswheretherearecompetinglocal"facility-based"serviceproviders.
Thedevelopmentofcompetingwireline,wirelessandsatellitedeliverysystemhasbeenaccompaniesbymanyproductinnovationsthatareintegratedintothelocaldeliveryfacilitiesthemselves.
16services,andothercomplementaryservicesforthemoment)involvesprimarilyasetoffinancialrelationshipsratherthanphysicalproductionanddeliveryobligations.
ESPsdonothavetoownanyphysicalelectricityproduction,transmissionordistributionassetstobeinbusiness.
Theycanbuyelectricityforresaleinthewholesalemarketanddonotneedtoownoroperateanygeneratingplants.
Theyarenot"facility-basedcompetitors"inphysicaldistributionortransmission.
TheseservicesareacquiredfromtheUDC.
AnESPneednotevenhavethecapabilitytoreadameterorrenderabillundercurrentarrangementsbutcantypicallyrelyontheUDCtodobothontheESP'sbehalf.
AsfarascommodityelectricityprovidedoverthepublicnetworkisconcernedESPsareprimarilyfinancialintermediariesbetweenwholesalegenerationsupplymarketinstitutionsandtheretailconsumer.
c.
Atthepresenttime,thewaythatretailconsumptionofelectricityismeasuredfor99%oftheconsumersispoorlymatchedtothewayelectricityistradedinthewholesalemarket.
Wholesaleelectricitypricesandquantitiesvaryatleastfromhourtohourandcanvarymorefrequently.
Thevariationsinwholesalemarketpricesoverthecourseofamonthcanbeafactorof100ormore.
Electricityconsumedat2PMonahotSeptemberdaymaybe$500/Mwhandatmidnightonly$25/Mwh.
Butvirtuallyallretailelectricityconsumptionismeasuredonamonthlyorsemi-monthlybasis.
HowthencanweorganizethesystemtoproperlychargearetailcustomerwhohashisairconditioneronfullblastonahotSeptemberdaydifferentlyfromtheconsumerwhowasonvacationinCanadathatdayHowdoyoumatchuparetailer'sretailsupplyobligationswithitsretailcustomers'consumptionfromthesystemTheanswertothesequestionsisthatyoucan'twithoutinstallingmeteringequipmentthatmatchesretailusewiththecontemporaneouswholesalemarketprices.
17Promotingcustomerchoiceforallretailcustomerswithoutrequiringmoresophisticatedmeteringhasmadeitnecessarytorelyoncostlyandhighlyimperfectloadprofilingsystems.
Loadprofilingtakesthemonthlyconsumptiononthemeter---e.
g.
1000kWh---andtransformitintohourlyconsumptionbasedontheconsumptionpatternsofasampleof"similar"consumerswhoareplacedonhourlyintervalmeters.
Thisislikeasupermarketchargingforacartofgroceriesbasedontheaveragecostperpoundofgroceriesinasampleofshoppingcartsthatpassedthroughthecashier'sdeskratherthanbasedontheindividualitemsinthecart.
HOWCANELECTRICITYRETAILERSPROVIDEVALUEADDEDGiventhesepeculiarattributesofelectricitysupply,wherearetheretailvalue-addedopportunitieslikelytolieintheelectricitysectorPopulardiscussionsofelectricityretailingtendtofocuson"headtohead"pricecompetitionwiththeUDC'sbasicelectricityservicebyretailerswhosimplybuycommodityelectricityatwholesaleandresellitatretail.
Whiletheremaybesomerealvalue-addedopportunitiesassociatedwiththistypeofretailing,Iwillargueinthenextsectionthattheseopportunitiesarelikelytobesmall,especiallyforresidentialandsmallcommercialconsumers.
Moreover,ifbuyingelectricityinthewholesalemarketandthensimplyresellingitatretailistheprimarywaythatESPsenvisionengaginginretailcompetition,thereislittlesocialvalueassociatedwithitand,indeed,retailcompetitionmaybesociallycostlyasaconsequenceofincreasesinaggregatemarketing,advertising,promotion,billing,settlementandtransactionscostsassociatedwithretailcompetition.
Retailcompetitionbeingsadditionalcostsintothesystem.
Weshouldexpectasuccessfulretailserviceprogramtoprovideconsumerbenefitsthatexceedthesecosts.
IfretailcompetitionistobesociallybeneficialcomparedtoBES(allowingretailcustomerstobuydirectlyinthewholesalemarket)itmustfocusonabroadersetofretail-valuedaddedopportunitiesthansimplybuyingandreselling18wholesalecommodityelectricity.
Letmediscussthemajorpotentialareaswhereopportunitiesforretailvalueaddedservicesarelikelytolieinelectricity.
a.
Reducingthecostsofretailingelectricity.
ThemoststraightforwardwaythatESPsmightprovidevalueaddedissimplybydeployinglesscostlytechnologiesforsupplyingthoseaspectsofretailcustomerservice(e.
g.
metering,billing,customerservice)thatareopeneduptocompetitionandwhichpresentlysupportbasicelectricityservicenowprovidedbyUDCs.
Thesavingsinretailingcostscouldthenbepassedalongtoconsumersintheformoflowerrates.
Internetretailerslikewww.
utility.
comandwww.
essential.
comhopetousetheirinternetplatformstoreducemarketingandbillingcosts.
Theopportunitiesforretailcompetitiontoreduceretailingcostsoveralldependsuponanumberoffactors.
Thesefactorsinclude:whichretailservicesareopeneduptocompetition;thenatureofresidualUDCobligationstoprovidecustomerservicesotherthanpure"wiresservices";themagnitudeoftheUDCretailingcoststhatareavoidedwhencustomerschooseESPs;thewayinwhichUDCretailservicecostsarepresentlyreflectedinretailratedesigns;thecoststhatretailersincurtoprovidecustomerservices.
Thesefactorsalsodeterminehowmuch"retailmargin"shouldbeincludedintheBESbenchmarkserviceoutlinedearlieragainstwhichESPscancompeteandalsowhethercompetitionactuallyincreasessocialvalueaddedormerelyexploitsimperfectionsinthewayregulatorshaveallocatedcostsinprevailingratedesigns.
b.
Superiorwholesalepowerprocurement:IfanESPcanbuywholesaleelectricityatalowerpricethanthepricesprevailingintheorganizedwholesalemarketitcanattractcustomersfromtheBESofferedbytheUDCbyofferingtosellelectricitytothembelowthe"generallyavailable"wholesalemarketprice.
Forexample,anESPmaybeabletoachievelowercostsuppliesbystrikingbilateral19forwardcontractswithgenerators.
ThecontractscansupportpricehedgeswiththeESP'scustomersandcanbeusedbygeneratorswhosecurethesecontractualcommitmentstosecurelowercostfinancing.
c.
Installationofmoresophisticatedmeteringandcontroltechnology.
Clearly,animportantpotentialwayforretailerstoaddvaluewouldtodeploymoresophisticatedmeteringandcontroltechnologytoallowcustomerstoseethevariationinwholesalepricesandtorelyonESPstohelpthemtomanagetheirenergyneedsaccordingly.
Oneofthecriticalpreconditionsforretailconsumerstakingfulladvantageofcompetitivewholesaleelectricitymarketsisforthemtoseeandbeabletorespondtowidevariationsinthepricesinthewholesalemarket.
Thisrequiresmetersthatmeasureconsumptiononanhourlybasisandcommunicationsandcontrolequipmentthatallowretailcustomerstoparticipateasactivedemand-sidebiddersinthewholesalemarket.
Consumerscanthenadjusttheirconsumptionpatternstoreflecthourlypricevariationsandincreasethenetvaluetheyreceivefromconsumingelectricity.
Communicationsandcontrolequipmentthatallowsthemtoparticipateintheday-aheadandevenhour-aheadmarketwouldgiveconsumersevenmoreflexibilityinthisdimension.
Moreover,bycreatinganactivedemandsideinthewholesalemarket,theperformanceofwholesalemarketscouldimprovesignificantly.
ItparticulartheseactivitiescouldhelptomitigateperformanceproblemsthathaveemergedinCaliforniaandNewEnglandduringtightsupplysituationswhendemandhaszeropriceelasticity.
Atthepresenttime,thistypeofsophisticatedmeteringandcontrolequipmentiseconomicalonlyforlargercustomers.
Thesecostsarelikelytofallovertime,however,ascommunications,remotesensingandcontroltechnologyadvances.
Andperhapssomedaywhenweallhavefastinternetconnectionsandourrefrigeratorsandwashingmachineshaveinternetconnectionsandcontroldevices20aswell,companieslikeEssential.
comandUtility.
Comwillbeabletoprovideremotereal-timemeteringanddemandmanagementservicestoresidentialandsmallcommercialcustomers.
Thisisunlikelytoberealityformostsmallcustomersinthenearfuture,however.
c.
Hedgingmarketpriceriskforcustomers.
Ifwetakethemostbasic"buyitatwholesale"optionasbuyinginthewholesalespotmarket,theconsumerwhobuyselectricityinthewholesalemarkethastoconfrontsignificantpricevolatility.
Sincemostconsumersareriskaverse,ademandforinsuranceorpricehedgesshouldbeoutthere.
However,thedemandforpricehedgesisintimatelyrelatedtotheapplicationofmoresophisticatedmetering.
Ifacustomer'smeterisreadonlyonceamonthoronceeverytwomonthsandthecustomer'sbillisdeterminedbyrunningthesemeterreadsthroughagrouploadprofile,asignificantamountofthevariationinpricesnecessarilygetsaveragedoutthisway.
Thereisnointra-monthpricevariabilityseenbytheconsumeratallwithconventionalmonthlymetering.
Accordingly,theopportunitiesforESPstooffercustomerscontractsthathedgepricerisksisrelatedtothedeploymentofmeteringtechnologythatallowscustomerstoseethevariationsinwholesalemarketpricesandtothenevaluatewhattheyarewillingtopaytohedgethepricevolatilityinthewholesalemarket.
d.
HedgingWeatherandOtherConsumptionUncertainties:Atypicalconsumer'sdemandforelectricityvarieswithchangesinweatherpatternsasaresultoftheassociatedvariationsinthedemandforheatingandcoolingservices.
Thus,thevolatilityofacustomersbilldependsonbothpricevolatilityandweathervariability.
Moreover,extremeweatherconditionsarelikelytobepositivelycorrelatedwithprices.
Whenitisveryhot,bothelectricityconsumptionandelectricitypriceswillberelativelyhigh.
Riskaverseconsumersmayseevalueinaweather-relatedinsuranceproductsthat21mitigatebothpriceandquantityrisks.
e.
Behindthemeterapplicationsdesignedtoprovidehigherqualityservices.
Design,constructionandoperationofon-sitegeneratingfacilities,continuouspowersuppliesandequipmenttoimprovepowerqualitycancustomizepowersupplyqualityattributestobettersatisfydiverseconsumerpreferencesforsuperiorpowerqualityandreliability.
Energymanagementandenergyefficiencyinvestmentsalsofallinthesamecategory.
Ofcourse,thereisnomonopolynowonofferingtheseservices.
Herethesaleofcommodityelectricityissimplyanadd-ontothesaleofpowerqualityandsupplyreliabilityenhancingservices.
f.
Greenpower.
Someconsumershaverevealedapreferenceforbuyingtheirelectricityfromenvironmentallybenignsources.
That'safinethingandit'saservicethatshouldbeavailabletoconsumersinacompetitivemarket.
Greenpowerisnotwithoutsomepotentialproblems.
Forthereasonsalreadydiscussed,thesaleofgreenelectricityproductshasasignificantpotentialformisleadingsalestacticsbecauseonecan'tphysicallydirectonlygreenelectronstoaparticularcustomeranddistinguishthemfrombrownelectrons.
Atleastintheshortrunif"greenmarketers"don'tactuallydispatchgreengeneratorsthatwouldnototherwisebedispatchedbasedontheirstraighteconomics,everycustomerwhopurchases500kWhorgreenelectrons,necessarilyleadstoanothercustomerpurchasinganadditional500kWhofbrownelectrons.
Asaresult,detailedauditingrequirementshavebeenurgedbyenvironmentalgroupswhichlikegreenpowersold,butwantittomakearealcontributiontoreducingpollution.
g.
TotalEnergyManagement/UtilityServices:Largecommercialandindustrialcustomers,22especiallythosewithmultipleproductionandsalessitesspendconsiderableamountsofmoneyprocuringenergyandmanagingtheiruseofenergy.
Formulti-sitefirmsthistaskiscomplicatedbyhavingtodealwithmanydifferentenergysupplycompaniesoperatingunderrulesandregulationsthatvaryfromstatetostate.
Thesecustomerssometimeshavecostlyinternalenergyprocurementandmanagementdepartments.
Consumersinthissituationhaveexpressedadesirefor"onestopshopping"fortheirenergyneeds(electric,gas,oilsuppliedaroundthecountry)andareinterestedinoutsourcingthemanagementoftheirenergyprocurementandutilization.
ESPscanprovidethesecustomerswithsignificantvalueaddedbyservingalloftheirenergymanagementneedsinanintegratedfashion.
Enronappearstohavefocusedonprovidingthistypeofservicetocommercialandindustrialconsumers.
15Otherservicessuchastelephoneandinternetaccesscouldbeaddedtothepackageaswell.
Thistypeofservicebundlingisalsoemergingforresidentialcustomers.
Forexample,www.
essential.
com16sellsalloftheseservicesonthesameinternetsite,bundlessomeofthemtogether,andreliesoninternetbilling.
Jointsales,marketing,billingandbundlingseveralservicestogethercanhelpESPstoexploiteconomiesofscopeandconserveonmarketing,promotion,andbillingcostsandreducetheaveragecostofretailservicesmeasured.
Thisstrategymayalsobeattractivetoretailerssothattheycandeveloprelationshipswithconsumersthatcanbeutilizedtosellthemstillotherservices.
PotentialSocialValueofARobustRetailMarket:AsIhavealreadyindicated,thereisalsopotentialsocialvalueaddedassociatedwiththedevelopmentofasuccessfulretailingsector.
Thesesocialbenefitsareaconsequenceoftherelationshipsbetweenthewholesalemarketandtheretailmarket.
IthasbecomeclearfromtheexperienceinCalifornia,NewEngland,andotherareasofthecountrythattheperformanceofwholesalemarketsisunderminedbytheabsenceofanactivedemand15"EnronDoesDealwithPinkPanther'sParent,"TheElectricityDaily,"September27,1999,page2.
23side(zerodemandelasticity)androbustforwardcontractingactivity.
Theabsenceofanyshort-rundemandelasticityandlimitedforwardcontractingaffectstheincentivesgeneratorshavetowithholdsuppliestodriveuppricesduringtightsupplysituations.
Bysuccessfullysellingconsumersprice-sensitiveenergycontractsandcontractingforwardforsuppliestomeettheirobligationstoretailconsumers,ESPs'wholesalemarketactivitiescouldreducewholesalemarketpricevolatilityandhelptomitigatewholesalemarketpowerproblems,especiallyduringtightsupplysituations.
However,shortrunpriceresponsivenesscanonlybestimulatedforthosecustomerswhocanactuallyseetheday-aheadandrealtimepricesandhavethemetering,communicationsandcontrolequipmentthatmakesitpossibleforthemtorespondtoit.
Moreover,theincentivetopayforpricehedgingserviceswillbereducedifcustomersdonothavehourlyintervalmeterssincemonthlyaveragingwillhidetheunderlyingpricevolatility.
Atthepresenttime,thegreatestopportunitiesforsuccessfullymarketingthesetypesofservicesliewithlargercustomersforwhomthebenefitsofloadmanagement,intermsoflowerelectricitybills,canpayforthenecessarymetering,communications,andloadcontrolcosts.
AnotherwaythatESPscanhaveapositiveimpactonwholesalemarketsisbyincreasingthenumberanddiversityofbuyersinthesemarkets.
AtthepresenttimeUDCsaretheprimarybuyersinwholesalemarkets.
WhileinmanyregionsoftheU.
S.
therearealargenumberofUDC'sonthebuyingside,includingmunicipalandcooperativedistributioncompanies,expandingthenumberanddiversityofpurchasingactivitycanincreasemarketliquidityandincreaseopportunitiesforgeneratorstolayoffrisksinthemarketatcompetitiveprices.
Thedramaticgrowthinwholesalemarketingactivityoverthelastthreeyears,combinedwithgenerationdivestitureandthegrowingportfoliosofindustrialandlargecommercialloadsturningtoESPssuggeststhatwearealreadyonapathtomitigatingremainingmarketliquidityproblemsinthoseregionsofthecountrythathaveadoptedretailcompetitionprograms.
16Seealsohttp://www.
telenergy.
comandhttp://www.
enermetrix.
com/.
24Extendingpoliciestotherestofthecountrywhichatleastfunctionallyunbundleallgenerationfromdistribution,settlestrandedcostissues,andrequireallgenerationsuppliestobesoldatmarket-basedrates,willnecessarilybringmoreUDCs(asbuyersfortheirretailloads)andmoregenerators(assellers)intothewholesalemarketandwillhavethegreatestpositiveeffectsonincreasingmarketliquidity.
BENCHMARKPRICESMostofthevaluedaddedopportunitiesthatIhavejustdiscussedrepresentadditionalservices,overandabovetheservicesthatIhaveincludedinthebenchmarkbasicelectricservice(BES)thatgivesretailconsumersdirectaccesstothewholesalemarket.
Thecostsofprovidingtheseservices,iftheyareofsufficientvaluetocustomers,shouldberecoveredfromhigherpricesthatretailerscanchargefortheseenhancedservices.
Thatis,retailerswillhavetolooktocustomer'swillingnesstopayhigherpricesforenhancedservicesasthesourceoftheretailmargintheyneedtocovertheadditionalcostsofprovidingtheseservices.
Nevertheless,sincemuchofthecurrentdiscussionofretailcompetition,especiallyforsmallresidentialandcommercialconsumers,seemstofocusonESPssimplybuyingwholesalecommodityelectricityandresellingitatretail,andcompetingagainsttheUDC'sstandardofferordefaultservicebasedsolelyonprice,itisusefultodevelopasetofbenchmarkpricesandcoststoprovideaframeworkfordiscussingthepotentialsocialvalueaddedthatESPsbringtothesystemifresellingcommodityelectricityistheirprimaryactivity.
TheprimarygoalofelectricityrestructuringintheU.
S.
istocreateasystemthat,attheveryleast,wouldyieldlowerpricesforconsumerscomparedtothepricestheywouldhavepaidiftheoldparadigmhadcontinued,holdingservicequalityandreliabilityconstant.
17Thehopeisthatcompetition17Thishasnotbeenthegoalofelectricityrestructuringinallcountries.
Inmanydevelopingcountries25willbringbothlowercostsandpricesfor"plainoldelectricityservice"aswellasinnovativeenhancementstotheservicesavailabletoelectricityconsumersforwhichconsumerswouldbewillingtopaysomethingextra.
Intheabsenceofretailcompetition,theregulatedretailpricespaidbyretailcustomersforutilitiesthathavegonethroughrestructuring,hadtheirstrandedcostsvalued,andparticipateinanorganizedcompetitivewholesalemarket,canbebrokendownintoseveralcomponents,someofwhichhaveorcanbeunbundledandopeneduptocompetition:BenchmarkRegulatedRetailRateTheregulatedbundledretailrate(PT)ofatypicallyverticallyintegratedutilityhasseveralmajorcostcomponents:PT=Gw+Sg+T&D+DSM+RT=AveragetotalUDCbundledprice/kWhWhere:Gw:MarketvalueofgenerationservicesbasedonwholesalemarketpricesSg:StrandedgenerationcostsT&D:Transmissionanddistributioncosts,includingancillaryservicescostssuppliedbythenetworkoperatorRT:Totalretailservicecosts(metering,billing,customercare,energyprocurement,etc.
)RT=Rm+Rcelectricitypricesweretoolow,thequalityofservicewaspoor,andthesectorwasunabletoattractinvestmenttobalancesupplyanddemandefficiently.
TheseproblemshavenotbeenthemotivationforelectricityrestructuringintheU.
S.
26Rm:RetailcustomerservicecostsforservicestheUDCisobligatedtoprovideRc:AvoidableretailcustomerservicecostsforUDCservicesopeneduptocompetitionandprovidedbyESPsDSM:Chargesforenergyefficiencyandother"publicbenefit"(e.
g.
low-income)programsForfuturereference,theaverageU.
S.
IOUBundledRetailPrice/kWhin1997forthestandardbroadcustomerclasseswas:AllCustomers:7.
1cents/kWhResidential:8.
9cents/kWhCommercial:7.
8cents/kWhIndustrial:4.
7cents/kWhInmostofthefollowingdiscussionIwillassumethatthestrandedgenerationcost(Sg)andthepublicbenefit(DSM)componentsoftheutility'scostshavebeendefinedbyregulatorsandarenon-bypassable.
Inaddition,Iwillassumethatapolicydecisionhasbeenmadetomakecustomers'responsibilityforstrandedcostrecoveryindependentofwhetherthecustomerchoosestobesuppliedbyanESPorcontinuestogetbasicelectricityservicefromtheUDC.
Californiaandsomeotherstateshaveadoptedthisprinciple.
Thetransmissionanddistributioncomponent(T&D)ofUDCratesisassumedtoberegulatedandtobenon-bypassableaswell.
18Thewholesalegenerationcostcomponent(Gw)isbasedonthemeteredconsumptionofeachcustomer,loadprofilingprotocolsin18Irecognizethattherearesomeinterestingdistributionbypassissues,butIdonotplantodiscusstheminthispaper.
27effect,andthespotmarketpricesforgenerationservicesacquiredinthewholesalemarket.
Retailservicescosts(RT=Rm+Rc)reflectthetotalcostsofmetering,billing,baddebts,customerservices,powerprocurementandanyadvertisingcoststhatarepresentlyrecognizedasbeingallowablecostsforratemakingpurposes.
ThedivisionofRTintocomponentsRmandRcdependsonregulatorypoliciesIwilldiscusspresently.
WecannowconstructtwodifferentconceptualizationsofBasicElectricService(BES)thatgivesUDCtocustomerswhodonotchooseanESPdirectaccesstothewholesalemarket:1.
Basicelectricityservicewithoutunbundlingofanyretailcustomerservices:19DistributionServiceCharge:Pd=Sg+T&D+DSM+Rm+RcBasicElectricityServiceCharge:Pbg=GwAcustomerselectinganESPcontinuestopayPdtotheUDCandpaystheESPforthegenerationserviceitprovides.
TheESPisresponsibleforimbalancesinthewholesalemarketandcontinuestorelyontheUDCtodometeringandbillingfortheESP.
19Thiscouldalsobeviewedasthepricestructurethatwouldprevailincaseswheresomecustomerservicesareopeneduptocompetitionandunbundled,butwhereESPshavetheoptionofnotsupplyingsubstitutecustomerservicesandcontinuingtorelyontheUDCtoprovidethem.
282.
BasicelectricityservicewithunbundlingofcertaincustomerservicesthatESPsmustprovidetothecustomerstheyserve.
20DistributionServiceCharge:Pdu=Sg+T&D+DSM+RmBasicElectricityServiceCharge:Pbgu=Gw+RcThedivisionoftotalretailingcosts(RT)intoafraction(Rm)thattheUDC,continuestorecoverfromallcustomersandafraction(Rc)thatcanbedisplacedbyanESPprovidingsubstitutecustomerservicesforthosesuppliedbytheUDCdependsonwhatservicestheUDCisobligatedtocontinuetooffertosupplytosomeoralldistributioncustomers,whichservicesareopeneduptocompetition,andhowanyretailtransitioncostsaretobehandled.
Rcthenrepresentsthe"retailmargin"thatanESPhasavailabletoittoprovidetheequivalentofBESprovidedbytheUDCwithoutincreasingthetotalpricethataretailcustomerwouldhavetopayasaresultofretailcompetition.
IfanESPiscompetingtosupplytheequivalentofBESitmustcoveritsownretailingcostsandprovideanydiscounttoattractconsumersoutofthismarginunlessitcanconvinceconsumerstopaymoreforwhattheywouldotherwisegetfromtheUDCatalowerpriceorprovidethemwithvalueaddedservicestosupportahigherretailmargin.
CURRENTUDCRETAILSERVICECOSTSInordertoevaluatethepotentialopportunitiesforESPstocompeteprimarilyonthebasisofprovidingmoreefficientretailingservicesandofferinglowerpricestoreflecttheseefficiencies,itisuseful20TotheextentthattheUDCisrequiredtostandreadytosupply"competitive"customerservicestoESPsrequestingthem,theeffectwillbetoincreaseRm.
Moreover,ifESPscanrelyontheUDCasabackstoptoprovideanyretailingservicestheESPchoosesnottoprovide,therecouldbeseriousadverseselectionproblemssinceESPswouldhaveanincentivetochoosetoprovidemeteringandbillingservicestothosecustomerstowhomitischeaptoprovidetheseservicesandtoleanontheUDCtosupplytheseservicestocustomerswhoareexpensivetoserve.
HowimportantthisadverseselectionproblemwillbewilldependonexactlyhowretailingcostsareunbundledandthedetailsoftheUDC'sobligationtoserve.
29togetasenseforthemagnitudeoftheretailingcoststhatareembeddedinregulatedUDCprices.
Thisisnotsoeasytodosinceretailratesarenottypicallybrokendowninawaythatidentifiesaseparatepriceforretailingservice.
However,itispossibletogobacktotheFERCForm1datatodeveloproughestimatesofthetotalcostsincurredbyaUDCisprovidingretailcustomerservicesofthetypesdiscussedabove(RT).
IhavemadeasetofestimatesofthetotalembeddedcostsofprovidingretailserviceusingreadilyavailableFERCForm1datafor1996.
21IhaveincludedinretailingcostsallO&Mcostslistedinthefollowingcategories:meterreading,metermaintenance,customeraccountsexpenses(includingbaddebts),customerserviceandinformationexpenses,andsalesexpenses,includingadvertising.
Ihavealsodevelopedcapitalcarrycosts(depreciation,interest,returnonequityandtaxes)formetersandgeneralplant,includingalargefractionofITfacilities.
TherangeofestimatesisreportedinanumberofdifferentwaysinTable1.
TheestimatedaveragecostofallretailingservicesRTvariesbetween2.
7millsperkWhand3.
8millsperkWh,between$5.
80and$8.
25percustomerpermonth,andamountstobetween3.
3%and4.
7%oftotalretailrevenue.
22ThelowernumberincludesallidentifiableO&Mcosts(includingbaddebts)andthehighernumberincludesthecapitalcarryingcostsof21IhavereliedprimarilyontheEnergyInformationAdministration'sFinancialStatisticsofMajorU.
S.
Investor-OwnedUtilities,"thelatestversionofwhichavailablewhenImadethesecalculationshaddatafor1996.
22Thisamountstobetween$6.
3billionand$8.
9billionintheaggregate.
It'snotpeanuts.
30TABLE1AVERAGEEMBEDDEDRETAILINGCOSTSPerKwh:0.
27-0.
38cents/KwhPercustomer:$5.
80-$8.
25permonthRetailingCostsIncluded:Meterreading,metermaintenance,metercarryingcharges,billingcosts,baddebts,customerservices,advertisingandpromotion,A&Gallocation.
CalculatedfromdatareportedinFinancialStatisticsofMajorU.
S.
Investor-OwnedUtilities(1996),U.
S.
DepartmentofEnergy,EnergyInformationAdministration.
31meters23andagoodchunkofgeneralplant.
24SomeofthesecostsarelikelytocontinuetobeincurredbytheUDCevenifallretailcustomersareservedbyESPs(Rm).
SomeofthesecostsmaybeavoidableasretailcustomersmovetoESPs(Rc).
TheseestimatesindicatethattotalretailingcostsincurredbyUDCsare,onaverage,relativelysmall.
Evenifweassume,contrarytofact,thatalloftheretailservicecoststhatIhaveidentifiedarepotentiallyavoidableasretailcustomersturntoESPsandthatESPscansupplytheseservicesata25%lowercost,thepotentialreductionintheaveragecustomer'sbillwouldbelessthan1%orabout$2permonthbyswitchingtoanESPthatpassedalongallofthecostsavings.
Moreover,therearegoodreasonstobelievethataggregatecustomerservicecostsmayactuallyincreaseascustomersshifttoESPs.
ESPsnecessarilyincuradvertisingandpromotioncoststoattractcustomersandtoestablishabrandname.
Historically,therehasbeenlittleadvertising,promotionandmarketingcostsintheretailcoststructuresofmostutilities.
25Undertheoldregulatedmonopolyparadigm,consumerswhoneededelectricityforlights,appliancesandequipment,knewwheretoturntobuyit(nochoice!
).
Mostutilitieswererestrictedinadvertisingtopromoteelectricityuse.
Withcompetitiveretailing,advertising,marketingandpromotioncostsassociatedwithelectricitysuppliesarelikelytoincreasesignificantlyasESPscompetetoattractcustomers.
26Otherthingsequal,thisincreaseinandvertisingandpromotion23ThecarryingcostsformetersareprobablyanoverestimatesincecustomermetersandmetersatsubstationsandotherpointsonthenetworkdonotappeartobeseparatedinthesesummaryForm1data.
24Severalcommentatorshavesuggestedthatmyestimatesarehigh,thoughtheordersofmagnitudearecorrect.
TheestimatesmaybehighbecausesomeofthecoststhatIcapturedfromtheFERCForm1data(e.
g.
certainmetermaintenanceandcarryingcosts)maybemoreproperlycharacterizedasdistributionortransmissionratherthanretailservicecostsbecausetheyreflectcostsofmeteringflowsonthedistributionandtransmissionsystems.
Inaddition,evenaUDCwhichprovidesonly"wires"servicewillstillincurcustomerservicecoststorespondtorequeststoconnect,disconnectandchangethelevelofservice,toprovidegeneralinformationtoconsumers,torespondtooutagesandpowerqualityproblems,andtointerfacewithESPs.
25Utilityadvertisingexpensesamountedtolessthat0.
5%oftheretailservicecostestimatesthatIpreviouslyprovidedandtotalsalescostsamountedtoabout5%oftotalretailservicecosts.
26Withcurrenttechnology,meterreadingforresidentialandsmallcommercialcustomersmaybe32costsnecessarilymeansthatretailerswillrequireahighermargin,overandabovethecompetitivewholesalemarketcostofcommodityelectricity,thanisnowembeddedinautility'scoststructure,tomakeaprofitiftheyoffernoothervalueaddedservices.
UnlessESPscanreduceothercomponentsofretailingcosts(e.
g.
lowermeterreading,billing,andcustomerserviceoperatingcosts)orsellothervalueaddedservices,theonlywayforthemtocovertheincreasedadvertisingandmarketcoststheybringtothesystemisforretailelectricitypricestoincreasecomparedtoBES.
ThecompetitiveenvironmentfacingESPs,theopportunitiesforESPstoprovidenetvalueadded,andtheoverallsocietaleffectsofretailcompetitiondependsnotonlyontheaveragelevelofUDCretailingcostsandthecoststhatretailerswouldincurforcomparableservices,butalsoonthedistributionofretailingcostsamongcustomerswithdifferentutilizationanddemographiccharacteristics.
Customersvarywidelyinthequantityofelectricitythattheyconsumeandthecostsofprovidingthemwithcustomerservices.
Accordingly,discussionsofelectricityretailingandretailingcoststhatfocusonlyonaverages,ashasmydiscussionsofar,canbemisleading.
Therearetworelevantdimensionstothedistributionofretailservicecosts.
Thefirstdimensionreflectscostcausality.
HowdoretailingcostsvaryastheattributesofthecustomersservedvariesTheseconddimensionreflectsregulatorycostaccountingprocedures.
HowareUDCretailingcostsallocatedacrosscustomerclasses(inter-classallocations)andinratestructureswithincustomerclassesFromthecostcausalityperspective,retailservicecostsarelikelytobedrivenmorebythenumberofcustomersservedbytheUDCandindividualcustomercredithistoriesthanbythequantityofelectricityconsumedbyindividualcustomers.
Retailservicecostsaredrivenbythecostsofreadingmeters,creatingandmailingbills,respondingtorequeststoinitiateorterminateservice,respondingtoespeciallydifficulttoaccomplisheconomicallybyESPsifmanydifferentcompaniesarereadingmetersforasmallfractionofthecustomersinanygivenneighborhood.
Themeterreadernowhastowalkordrivebyalotofhouseswhosemetersshedoesnotread.
33billinginquiries,followingupwithcustomerswhosebillsaredelinquent,andbaddebtcosts.
Manyofthesecostsareunlikelytovarymuchwiththequantityofelectricityconsumedbyindividualcustomers.
Theretailservicecostsforaresidentialcustomer(likeme)whoconsumesabout1,200kWh/monthareunlikelytobethreetimesasgreatastheretailingcostsforaresidentialcustomerwhoconsumes450kWh/month.
Toafirstapproximation,theretailingcostsforthesetwocustomersareprobablyaboutthesame.
Indeed,totheextentthattheaveragelow-usecustomerhasalowerincome,ismorelikelytohavecreditproblems,andchangesresidencesmorefrequently,theretailservicecostsforalow-usecustomermayactuallybelarger(inabsoluteamount)thantheretailingcostsforacustomerlikemewhopayshisbillsontimeeverymonth,hasnotmovedin20years,andhasnevercalledtheUDC'scallcenterexcepttoreportanoutage.
Ifratemakingproceduresfollowcostcausalityprinciples,thenalargefractionofretailservicecostsshouldbeallocatedequallyacrosscustomersandonlysmallfractionallocatedbasedonutilization(demandandkWh)andrelatedcustomercharacteristics.
Itisextremelydifficulttodeterminehowretailingcostshavebeenfactoredintoretailratedesignsandwhichcostallocationrulesareappliedindifferentstates.
Myguessisthatlittlethoughthasbeengiventotheseissuesinthepastbecausethecostsinvolvedarerelativelysmallandtherewasnocompetitiontoexploitgapsbetweenaccountingcostsallocationsandthetrueeconomiccostofsupplyingretailingservicestodifferenttypesofcustomers.
Therearetwoissueshere.
Oneistheregulatoryallocationofcostsbetweencustomerclasses.
ThesecondistheregulatoryallocationofthesecostswithincustomerclassesbetweencustomerchargesthatdonotvarywithkW/kWhusageandusage-relatedcustomerchargesthatvarywithacustomer'speakdemandandkWhconsumption.
34TABLE2ALTERNATIVERETAILINGCOSTALLOCATIONMETHODSPerKwhAllocationAverageEmbeddedRCSCost/MonthResidential:$2.
25-$3.
20/monthCommercial$15.
30-$21.
75/monthIndustrial$407.
50-$578.
70/month70%Customer/AverageEmbeddedRCSCost/Month30%perkWhAllocationResidential$4.
75-$6.
73/monthCommercial$8.
66-$12.
30/monthIndustrial$126.
33-$179.
38RetailingCostsIncluded:Meterreading,metermaintenance,metercarryingcharges,billingcosts,baddebts,customerservices,advertisingandpromotion,A&Gallocation.
35Table2displaystherangesfortheaverageannualtotal"retailservicebill"forresidential,commercialandindustrialcustomersbasedondifferentinterclassretailservicecostallocationassumptions.
ThefirstallocationruleallocatesallretailingcostsonaperkWhbasis.
Thesecondallocatesallcosts70%onapercustomerbasisand30%onakWhbasis.
ItisevidentfromTable2thattheretailservicecostsattributedtodifferenttypesofcustomersincurrentratesvarieswidelydependingontheregulatorycostallocationruleutilized.
Usingamid-rangeestimatefortotalretailservicecosts,averagesimulatedresidentialcustomerretailservicebills(includingbothavoidableandfixedRCScosts)varyfrom$2.
25to$6.
73permonth,averagecommercialcustomers'retailservicebillsfrom$8.
66to$21.
75permonth,andaverageindustrialcustomers'retailservicebillsvaryfrom$126.
33to$578.
70permonth,dependingonthecostallocationmethodused.
Additionalvariancewouldbeintroducedthemoreintra-classretailservicecostsareallocatedonaperkWhbasisratherthanonapercustomerbasis.
Forexample,manystatesimplicitlysubsidizelow-usecustomersbysettingthemonthlycustomerchargeataverylowlevelthatisunlikelytorecoverallofthefixedcostsassociatedwithbeingacustomer.
Fixedcustomercostsincludebothsomefractionoftheseretailservicecostsaswellascostsassociatedwiththe"customerspecific"portionsofthedistributionsystem.
Ifthemonthlycustomerchargeissetatalevelbelowthefixedcustomercostthentheresidualisbeingrecovered(shifted)inperkWhcharges.
Clearly,theallocationofretailcustomerservicecoststocustomerclassesandwithincustomerclasseshasimportantpotentialimplicationsfortheretailmarginpotentiallyavailabletoESPsservingdifferenttypesofcustomers.
Forexample,ifcostcausalityimpliesanallocationsuchasthe70/30allocationutilizedinTable2,aregulatoryallocationproceduresthat,instead,allocatesretailingcostsbasedonkWhutilizationcouldcreatesignificantdistortionsaffectingtheattractivenessofdifferenttypesofcustomerstoESPs.
Inthiscase,smallresidentialandcommercialcustomersarelikelytorepresent36relativelyunattractivesalesopportunitiestoESPs,sincetheretailingcostsallocatedtothemwhentheytakeBESfromtheUDC,andtheassociatedretailmarginsthatanESPwouldhavetolivewithifitattractedsuchcustomers,arebelowthetruecostofsupplyingthesesmallcustomerswithretailservice.
Ontheotherhand,commercialandindustrialcustomerswithhighconsumptionlevelsmaylookmuchmoreattractivetoESPspurelyonretailcost-savingsgrounds.
Indeed,anESPdoesn'tevenhavetobeamoreefficientsupplierofretailingservicesthantheUDCinthiscaseforlargecustomerstobeattractivetothembecausetheallocationofretailingcostsintheirUDCratesfarexceedswhatitactuallycoststheUDCtoprovidethemwithretailservices.
Ifretailratedesignsdonotreflectcostcausalityandretailservicecostsareallocatedinsteadbasedoncustomer-specificdemandandkWhcharges,retailcompetitioncanleadtothefollowingeffects:(a)retailingeffortswillfocusonrelativelyhighusecustomerswithgoodcreditrecords;(b)asthesecustomersshifttoESPstheretailservicerevenuesproducedbytheremainingUDCBEScustomerswillnotcovertheirretailingcostssincethecostsavingsassociatedwithcustomerswhodoswitcharelessthantherevenueslostwhentheyswitch;(c)retailingcostsreflectedintheUDCchargesfortheremainingBEScustomerswilltendtoriseasmoreoftheretailcostsareallocated(properly)tothem;and(d)totalretailingcostsmayincreaseasESPsspendsignificantsumstocompeteaggressivelytoattractlargecustomerswithgoodcreditrecordsbecauseregulatorycostallocationruleshavecreatedanartificialretailmarginforthesecustomersthatfarexceedsthetruecosttheUDCincurstoprovidethemwithretailservice.
Ifonebelievesthatasignificantbenefitofretailcompetition---comparedtothebenchmarkBESdescribedearlier---istoberealizedfromdrivingthecostsofprovidingretailservicedown,thenitisimportanttoensurethatifandwhenretailservicecostsareunbundleditisdonesoinawaythatproperlyreflectscostcausality.
Thisislikelytorequireincreasingnon-usagesensitivecustomercharges37forresidentialandsmallcommercialcustomersanddecreasingutilizationchargesfordistributionservicesbyanequivalentaggregateamount.
TheseconsiderationsleadmetoconcludethatifallESPsdoistoacquireelectronsinacompetitivewholesalespotmarketandthensimplyresellthemtoretailcustomerswithamarginaddedtothewholesalerprice,thereisnotlikelytobemuchconsumervalueaddedincompetitiveretailingofelectricity.
Indeed,ifretailelectricitycompetitionfocusesonlyoneffectivelyprovidingunregulatedBES,intheabsenceofthecontinuedavailabilityofaregulatedUDCsuppliedBES,thecompetitiveequilibriumforresidentialandsmallcommercialconsumerscouldeasilybecharacterizedbyhigheroverallretailservicecostsandhigherpricesforresidentialconsumers.
Thecasefor,andtheevaluationoftheperformanceofretailcompetition,shouldfocusmoreontheabilityofacompetitiveretailingsystemtoprovidesomeoralloftheotherdimensionsofvalueaddedthatIdiscussedabove.
WewanttoencourageretailcompetitioniftheESPsthatarecompetingareabletoprovidevalueaddedservicestoconsumersthatarenotreadilyavailabletodaythroughadirectaccesswholesaletariffofferedbytheUDC.
Thatis,wemustdistinguishbetweenthebenefitsofwholesalegenerationmarketcompetition,whichcanbepassedalongtoconsumersinacheapstraightforwardmannerasdiscussedabove,andtheincrementalbenefitsofretailmarketcompetition.
Intheend,whetherthereisaviablemarketforthesevalue-addedservices,andwhatshareoftheUDC'sretailcustomerswithaccesstoBESswitchtoanESPfromBES,shoulddependonwhetherornotESPscanfindcustomerswillingtopayenoughtocoverthecostsofprovidingthesevalueaddedservices.
IffewcustomersswitchitdoesnotnecessarilyimplyeitherthatretailconsumersarenotgettingthebenefitsofcompetitionorthatunreasonableimpedimentsrestricttheexpansionofESPmarketshares.
ThelowswitchingratescouldsimplymeanthatESPshavebeenunsuccessfulinfindingvalueaddedservicesthatmakesitattractiveforconsumerstobuyatretailratherthanatwholesale.
The38waytoevaluatethesuccessofretailcompetitionisnottolookatthenumberofcustomerswhoswitch,oratESPmarketshares,butatthevalueaddedservicesbeingofferedbyESPstovariouscustomergroupsandtheircosts.
Sincemanyofthevalue-addedservicesthatIhavediscussedareverydifficultandcostlytoprovidetosmallresidentialandcommercialcustomers,itshouldnotbesurprisingthatretailerswillfinditdifficulttocompeteagainstBESthatoffersconsumersdirectaccesstothewholesalemarketbyprovidingstandardofferordefaultserviceoptionsthatreflectwholesalemarketpricesforelectricity.
TheproblemisnotthatBESis"toocheap"butthattheESPshavenotfoundvalueaddedservicestosellthatareattractivetocustomers.
STIMULATINGRETAILCOMPETITIONTOPROVIDEVALUE-ADDEDSERVICESTORETAILCONSUMERSTheseconsiderationsleadmetothefollowingpreliminaryconclusionsaboutretailcompetition,asitrelatestoresidentialandsmallcommercialcustomers:(a)atthepresenttimeretailcompetitionisunlikelytoprovidemuchvalueaddedoveraBESoptionthatgivesthesecustomersdirectaccesstothewholesalemarket;(b)retailcompetitionmayactuallyleadtohigherretailingcostsandhigherpricesoverall;(c)simplisticunbundlingofretailingcosts(e.
g.
inkWhcharges)canstimulatecreamskimmingandotheradverseselectionproblems;and(d)unbundlingretailingservicesandtheircostsinawaythatdoesnotleadtosuchadverseselectionproblemsislikelytorequiresignificantraterebalancingthatwillincreasepricesforconsumerswhouserelativelysmallquantitiesofelectricityandrequiretheadoptionofstandardcommercialpracticesforcustomerswhopaytheirbillslateorarecreditrisks.
Inlightoftheseconclusions,Ibelievethatelectricityretailcompetitionpolicyforresidentialandsmallcommercialconsumersshouldpursuetwoprimarygoals:(a)provideacheap,simplewayforresidentialandsmallcommercialcustomerstobuydirectlyinthewholesalemarketthroughtheUDC's39passivepassthroughofwholesalespotmarketcostsforatransitionperiod;(b)createaneconomicenvironmentthatharnessesthepowerofcompetitiveretailingtoprovidevalueaddedservicesofthetypeIhavediscussed(orothersESPsmaydevelop);and(c)ensurethattheallocationofanyUDCretailservicecoststhatareunbundledtofacecompetitionfromESPsreflectcostcausalityinordertomitigatecream-skimming,adverseselection,andassociatedwasteandinequities.
Ifoneacceptstheseconclusionsandpolicygoals,itcouldrationallyleadtothepolicyconclusionthattheappropriatestrategyisnottoopenuptheresidentialandsmallcommercialmarkettocompetingretailsuppliersatallatthistime.
Thecostsofloadprofiling,increasedsettlementcomplicationsandcosts,thedifficultiesofreallocatingretailservicecosts,andavarietyofpotentialconsumerprotectionproblemsmaysimplymakeretailcompetitionforthesecustomersacostincreasingandvalue-reducingproposition.
Instead,residentialandsmallcommercialcustomerswouldeffectivelybegiventheopportunitytobuyelectricityinthewholesalemarketatthecompetitivewholesalemarket.
ThiscouldbeaccomplishedbyofferingresidentialandsmallcommercialcustomerswhatIreferredtoearlierasBasicElectricityServicewithoutunbundlingofanyretailcustomerservicecosts(RCS),andwithouttheoptionofbeingservedbyanESP.
Theunbundledrateswouldtakethefollowingform:BESWithoutRCSUnbundlingDistributionServiceCharge:Pd=Sg+T&D+DSM+Rm+RcBasicElectricityServiceCharge:Pbg=GwResidentialandsmallcommercialcustomerswouldgetthefullbenefitsofwholesalemarketcompetitionthroughtheirdirectaccesstoelectricityatthewholesalemarketprice(Gw).
Thisservicecouldbe40enhancedbyproviding,forexample,optionstobuyportfoliosofgreenpoweratapremiumprice(Gwg)determinedbycompetitivebiddingbywholesalesuppliersorbythepricesinorganizedmarketsthatincludedgreenpoweroptions,suchasthemarketoperatedbytheAutomatedPowerExchangeinCalifornia(e.
g.
Gwg>Gw).
ThisappearstobetheapproachthatOregonistakingforresidentialcustomers.
27Astimegoesonandtheretailmarketforlargercommercialandindustrialcustomersmatures,therestrictionsonretailcompetitionastheyapplytosmallercustomercanberelaxedasretailcompetition,consumerinformation,andtheavailabilityofvalueaddedservicesdevelopsfurther.
Thatis,atafuturetimewhenresidentialandsmallcommercialcustomerscanbenefitfromthe"trickledown"opportunitiesthatmaybeavailablefromamatureretailmarketinvolvinglargercustomers.
Whilethiswouldseemtometobeaverysensiblepolicy,ithassomepotentialproblems.
28First,asapracticalmatterit'stoolatetowithdrawthe"customerchoice"optionfromsmallretailcustomersinthosejurisdictionswhichhavealreadyembracedit.
Second,andmoreimportantly,itcouldbearguedthatthispolicypresumesthatwecanpredictwithareasonabledegreeofcertaintywhereretailvalueaddedcanbecreatedandwhereitcan'tbecreatedasaconsequenceofretailcompetitionandtheinnovationsbroughttotheworldbyESPs.
29WhileIthinkthatmyconclusionsinthisregardarelikelytoprovetobecorrect,Icannotbesureofthem.
Oneoftheprimarybenefitsofcompetitionisthatitunleashescompetitorstotrytodevelopandmarketinnovateproductsandservices.
Aslongastherisksandrewardsofpursuingsuchinnovativeideasarenotdistortedbyregulation,throughratestructuresthatdepartfromcostcausalityprinciples,weshouldwanttogiveESPsachancetoshowwhattheycandoandgivethemanopportunitytocompete,innovateand27OregonSenateBill1149,June29,1999.
28Nevertheless,ImustcommendpolicymakersinOregonforhavingtheintelligencetoseethroughalloftherhetoricaboutretailcompetitionandthecouragetoresistenormouspoliticalpressuretoembraceitforallcustomers,toarriveataretailcompetitionpolicythatdepartsfromwhatistrendy.
29Actually,thisisaweakargumentsinceasvalueaddedopportunitiesbegintoemerge,Oregon's41providethevalue-addedservicesthatdon'tappeartobeparticularlyabundantforresidentialandsmallcommercialcustomers.
Forbothreasons,itseemstomethattheadoptionofapolicythatallowsESPstoserveallretailcustomers,removespotentialregulatorydistortionstoretailcompetition,andchannelsESPscompetitiveenergiestowardincreasingvalueaddedisthebestwaytoproceed.
WeshouldnotprejudgewhetherESPswillbesuccessfulinmarketingvalue-addedservicesandweshouldnotbesurprisedifthepaceatwhichresidentialcustomersswitchtoESPsisslow.
WhatwouldsuchapolicylooklikeUDCswouldofferavariantofwhatIhavecalledBESwithunbundledtariffs,separatinggenerationandothercompetitiveservicesfromdistribution,transmission,strandedcost,unavoidableretailservicecostsandothermandateddistributioncompanyservices.
Retailingcosts,bothavoidableandunavoidable,wouldbeproperlyallocatedbetweencustomer-relatedandutilization-relatedcharges.
Thatis,allcustomerswouldhaveaccesstoavariantofthesecondBEStariffdiscussedearlier.
Itwouldhavethefollowingbasicstructure:BESwithRCSUnbundlingBasedonAvoidedCostsDistributionServiceBill:Rd=Fd+Frm+(Sg+T&D+DSM)*qBasicElectricityServiceBill:Rbgu=Frc+(Gw+rc)*qWhere:Fd=non-usagesensitivecustomerdistribution("wires")servicechargeFrm=non-usagesensitivecustomerchargeforunavoidableretailingcostsSg=strandedgenerationcostcharge(assumedtobeutilization-related)restrictionsonretailcompetitioncouldberemoved.
42T&D=utilizationrelatedT&DpriceDSM=energyefficiencyandother"publicbenefits"chargesFrc=Non-usagesensitivecustomerchargeforavoidableretailingcostsGw=wholesalegenerationserviceschargebasedontransparentwholesalemarketprices(includinglosses)rc=utilization-relatedchargeforavoidableretailingcostsThisBasicElectricityServiceoptionreflectsadollarfordollarpass-throughofthetransparentspotmarketpricesrecordedinwholesalepowermarketsplusaregulatedpricefor"competitive"(i.
e.
avoidable)retailingcosts.
ThelatterreflectstheUDC'sretailingcoststhatareallocatedbasedoncostcausalityprinciplesbetweennon-usagesensitivecustomerandutilizationcharges.
Basically,thedistributionutilityoffersconsumersasimplestrawtothewholesalemarketwithnobellsandwhistlesandconsumersareassuredoftheopportunitytobuyatwholesale.
Forexample,inCaliforniathewholesalemarketpricecomponentwouldbethepricesforenergyinthePXandISO;inNewEngland,NewYorkandthePJMregionitwouldbepricesforenergyinthespotwholesalemarketsrunbytheirrespectiveISOs.
TheavoidableretailingcostsandtheirallocationbetweencustomerandkWhchargesaredeterminedbyregulators.
BESalsoservesasthedefaultserviceforcustomersabandonedbytheirretailersorwhocan'tfindaretailertotakeonthefinancialresponsibilitiesassociatedwithsupplyingthemwithgenerationservice.
Thedistributionutilitieswouldnotbeallowedtoofferanyvalueaddedservices(hedging,specialmetering,jointsalesofmultipleproducts,etc.
)throughtheutilityitself,thoughtheycouldbeofferedthroughanunregulatedaffiliate.
30Consumerswhovaluethoseserviceswould30Obviously,accompaniedbyreasonableaffiliaterulesthatguardagainstcross-subsidizationofunregulatedservicesfromrevenuesearnedfromregulatedserviceswhosepricesarebasedonaccountingcostsandabusiveself-dealing.
OneaffiliaterulethatIobjecttoisnotallowingaretailertousetheutility's43havetoturntoESPs.
Whenacustomerchoosesacompetitiveretailerthatoffersvalueaddedservices,thebasicgenerationservicechargecomponentdisappearfromthebillandtheretailertakesoverresponsibilityforpayingfortheelectronsthatpassthroughtothecustomerandforanycustomerserviceswhosecostsareincludedinFrcandrcwhicharenolongerbeingobtainedfromtheutility.
AcriticalcomponentofthisstrategymustbeaclearregulatoryspecificationofthoseretailservicefunctionsthattheUDCwillbeexpectedtocontinuetoprovideandthoseretailservicefunctionsthatwouldbeopeneduptocompetition.
TherespectiveobligationsofESPsandtheUDCmustbedefined.
Similarly,theretailservicecoststhatareproperlyassociatedwiththecompetitiveservicesmustbecarefullydistinguishedfromretailingcoststhatreflectcontinuingobligationsoftheUDC.
Thecompetitiveretailservicecosts,inturn,mustbereflectedoncustomerbillsinawaythatreflectsthecausalrelationshipsbetweencostsandcustomerservices.
ThiswillalmostcertainlyleadtothebulkofthesecostsbeingallocatedthroughcustomerchargesratherthanthroughdemandandkWhcharges.
ThedirectandindirectcostsofresidentialandsmallcommercialcustomersgroupswhomaybeexpectedtorepresentcreditrisksmustbeidentifiedandhandledinawaythatdoesnotinviteESPstoserveonlythecustomerswhodonotrepresentcreditrisksanddonotrequirealotofcustomerservice.
Thiswillrequireuniformconnectionanddisconnectionpolicies,uniformpoliciesonbillingforlatepayment,mayrequireaspecialfundtoprovidemoneytocompensateESPsortheUDCforservingcustomergroupswhoarelikelytobeperceivedashavingpoorpaymentrecordsorrequiringdirectpublicassistance.
Thisapproachhasseveralattractivefeatures.
First,itcreatesanenvironmentwherethereisatransparentwholesalemarketpriceagainstwhichconsumerscancompareoffersfromcompetingnamewhenitmarkets.
Ithinkthatsucharulegetsitbackwards.
IwanttoknowwhichcompanyliesbehindtheESPandIthinkthatESPsshouldberequiredtorevealwhotheirparentisbyreferencetoitscommonlyusedname.
Customersshouldbeinformedthattheyhavenoobligationtotakeservicesfrom44retailers.
Second,itforcescompetitiveretailerstofocusonaddingrealvaluetowhatconsumerscangetbysimplybuyinginthewholesalemarket.
Third,ithelpstoprotectconsumersfrombeingassignedtoretailerswhomayultimatelyexploitinformationandtransactionscoststotheirdisadvantage.
Fourth,consumersgetthebenefitsofcompetitionbyhavingtheopportunityeffectivelytobuyinorganizedcompetitivewholesaleenergymarketsreflectingthe"nofrills"lowcost"directwholesaleaccess"thatadistributioncompanycansoeasilyprovidewithoutincurringanysignificantincrementalcosts.
Fifth,itwillhelptomitigate(butprobablynotfullymitigate)inefficientandinequitableadverseselectionproblemsdrivenbydifferencesbetweenregulatorycostallocationsandcostcausality.
Thisbasicapproachtoretailcompetitionforresidentialandsmallcommercialcustomershassomeadditionalimplications.
First,onecannotjudgethesuccessofelectricityrestructuringandcompetitionbylookingattheshareofretailcustomerswhohaveswitchedtoESPs.
IdonotexpectanenormousfractionoftheresidentialandsmallcommercialcustomerstoswitchunderthispolicyuntilESPsfigureouthowtoproviderealvalueaddedrelativetobuyingelectricityatwholesalethroughtheUDC.
Thelackofswitchingdoesnotmeanthatcustomersarenotbenefitingfromcompetition.
Theygetallofthebenefitsofwholesalecompetition.
Second,oneshouldevaluatethesuccessofretailcompetitionbyexaminingthenatureofthevalueaddedservicesthatESPsareprovidingtothecustomersthattheydoattract.
ItissurprisinghowlittleregulatorsandESPstalkaboutthevalueaddedopportunitiestheyareofferingtoresidentialandsmallcommercialcustomers.
IdonotanticipatethattheavailabilityofaBESofthisformfromtheUDCforresidentialandsmallcommercialconsumerswouldbepermanent.
Iseeitasmechanismtoassureasmoothtransitiontoaretailcompetitionenvironmentthatprovidesrealvalueaddedtoallcustomers.
TheavailabilityofBEScouldbewithdrawngraduallyoveraperiodofafewyearstomatchthedevelopmentofretailtheaffiliate.
45competitionandvalueaddedservices.
Itwouldfirstbewithdrawnfromlargeindustrialcustomers,thenfrommedium-sizedcommercialcustomers,andfinallyfromresidentialcustomers.
AstheavailabilityofBESiswithdrawnfromacustomerclass,retailsupplycharges(obviouslyexceptT&D,strandedcost,DSMcosts,residualcustomerserviceobligations,etc.
,thataretheresponsibilitybytheregulatedT&Dmonopoly)wouldbederegulatedforthatclass.
TheywouldeffectivelybeforcedtochooseanESPorremainwiththeutility(oranaffiliate),butfacepricesregulatedonlybycompetition.
Inareasofthecountrywithwelldevelopedwholesalemarkets,thetransitioncouldbeaccomplishedoverathreetofiveyearperiod.
THEPENNSYLVANIASHOPPINGCREDITAPPROACH:ARIPOFFFORRESIDENTIALCUSTOMERSTherehasbeengreatinterestamongESPs,andamongthoseregulatorswho(incorrectly)measurethesuccessoftheircompetitioninitiativesbyhowmanyretailcustomershaveswitchedtoESPs,inthe"shoppingcredit"approachadoptedfirstbyPennsylvaniaandmorerecentlybyNewJersey.
Basically,regulatedUDCretailratesinPennsylvanianowincludecomponentsreflectingT&Dcosts(includingretailingcosts),strandedcostsanda"shoppingcredit.
"WhenanESPattractsaretailcustomer,thecustomerreceivesa"shoppingcredit"onherbillforeachkWhthatisnowsuppliedbytheESPratherthantheUDC.
Theshoppingcreditswereconsciouslysetatalevelthatexceeds,insomecasesbyalargeamount,thewholesalemarketpriceoftheelectricitythatthecustomerpurchases.
Thedifferencebetweentheshoppingcreditandthewholesalemarketpriceofelectricitythenbecomesa"retailmargin"thattheESPcanusetooffercustomersadiscountandtocoveritsretailingcosts.
ThesizeofthecreditwasdeterminedbytheregulatorsinPennsylvaniaandvariesfromutilitytoutility.
Forexample,in1999aPECOresidentialcustomerwouldreceiveacreditcoveringbothgenerationand46transmissioncostsequalto5.
65cents/kWhwhileaPP&Lcustomerwouldreceiveacreditonly4.
26cents/kWh.
31BothcreditsexceedthewholesalepriceofgenerationandtransmissionserviceinthePJMareainwhichbothcompaniesbuyandsellwholesalepower.
ThedifferenceinthesecreditsreflectneitherdifferencesinretailingcostsnordifferencesinwholesalepowercostswhichareeffectivelythesamesincebothcompaniesareinPJMandcanbuyinPJM'swholesalemarkets.
Indeed,theonlyrationaleforthedifferencesinshoppingcreditsacrosscompaniescanbethatitreflectsdifferencesinstrandedcosts,notretailingcosts,betweenthem.
Basically,customersthatchooseanESPeffectivelygetadiscountonthestrandedcostpaymentstheymaketotheirUDC,whilecustomerswhodonotswitchtoanESPeffectivelymakealargerstrandedcostpayment.
Toseethis,wemustlookatthebasicarithmeticofregulatedelectricitypricesdiscussedearlier.
Theregulatedbundledelectricitypriceforautilitythathasgonethroughrestructuringhasseveralcomponents.
Restatingthem:PT=Gw+Sg+T&D+DSM+RT=averageUDCbundledprice/kWhWherethecomponentsofthechargesareasbefore:Gw:GenerationservicesbasedonwholesalemarketpricesSg:StrandedgenerationcostsT&D:Transmissionanddistributioncosts,includingancillaryservicescostssuppliedbythenetworkoperatorDSM:Energyefficiencyandother"publicbenefits"chargesRT:Totalretailservicecosts31Includesbothgeneration-relatedcostsandtransmission-relatedcoststhatESPsareobligatedtopay47Rm:RetailcustomerservicecoststheUDCisobligatedtoprovideRc:AvoidableretailcustomerservicecostsforUDCservicesopeneduptocompetitionRT=Rm+RcAtthepresenttime,32undertheshoppingcreditapproachwhenacustomerswitchestoanESP,thenetchargesthatitpaystheUDCaregivenby:Pudc=(Gw+Sg–SC)+T&D+DSM+RT=UDCcharges/kWhforESPcustomerWhereSCistheshoppingcreditwhichinturnisgreaterthanGw.
Howcanashoppingcreditbesetabovethewholesalemarketpriceofelectricity(SC>Gw)when,asinPennsylvania,retailingcostshavenotyetbeenunbundled33First,thestrandedcostchargeSgcouldhavebeensetatalevelbelowtheutility'sactualstrandedcostsandtherest(ormorethantherest)includedintheshoppingcredit.
Alternatively,thestrandedcostchargemightbeanaccuratemeasureofstrandedcosts,butthetotalregulatedratePThasnotbeenreducedsufficientlytoreflectboththepropervaluationofstrandedcostsandthevalueofelectricityinthewholesalemarket.
Thatis,thetotalbundledregulatedratethathasbeenmadeavailabletoallcustomersisgreaterthantheregulatedratethatcouldhavebeenmadeavailabletoallcustomers,whileallowingtheutilitytofullyrecoveritscosts,includingitsstrandedgenerationcosts.
Thisdifferenceisreflectedinthe"abovemarket"portionoftheshoppingcredit.
Inthefirstcase,theutilitymakesupforsome,all,ormorethanallofitsactualstrandedcostsfromcustomerswhodonotswitch.
ThemorecustomerswhoswitchtheunderthePJMrulesforloadservingentities.
32AsIunderstandit,theUDC'sretailingcostswillbeunbundledaswellinthefuture.
33AsIhavealreadyindicated,UDCretailingcostsarenothighenoughtojustifyacreditofthismagnitude48lesstheutilityeffectivelycollectsinstrandedcostchargesandviceversa.
Inthesecondcase,theutilityrecoversmorethanitsactualstrandedcostsfromthosecustomerswhodonotswitchsincethebundledprice(includingchargeforfullrecoveryofstrandedcosts)hasbeenartificiallyinflatedanddoesnotfullyreflectedthewholesalemarketvalueofelectricity.
34Inbothcases,customerswhodonotswitchpaymoreoftheutility'sstrandedcoststhandocustomerswhoswitch.
Inthesecondcase,allcustomersmayenduppayingmorethantheywouldhaveifmyproposedBasicElectricityService,whichgivesdirectaccesstothewholesalemarkettoallcustomersandallowsthemtobuyatthewholesalemarketprice,hadbeenadopted.
Whateverthesourceoftheshoppingcredit,theeffectisthesame.
IfanESPcanbuywholesalepowerandtransmissionserviceinPJMfor4.
0cents/kWhandcansellagainstacreditof5.
6cents/kWhwhenitsnaresaPECOcustomer,theESPgets1.
6cent/kWhofmargintoplaywith.
Forexample,theESPcouldofferthecustomeran0.
8cents/kWhdiscountandkeep0.
8cents/kWhtocoveritsretailingcosts.
Thisisanobrainerforacustomerwhounderstandswhat'sgoingon.
Togetthecredit,allacustomereffectivelyhastoagreetodoistochangethenameoftheenergysupplycompanyonherbill.
NorealvalueaddedservicesneedtobeprovidedbytheESPtothecustomer.
Notsurprisingly,theareasofPennsylvaniawithhighshoppingcredits,likePhiladelphia,haveattractedalotofESPactivityandarelativelylargefractionoftheresidentialcustomershaveswitchedtoESPs.
TheopportunitiesforretailersinPP&L'sareaaremuchlessattractivebecausetheshoppingcreditissmaller.
(moreonthisbelow)Obviously,theshoppingcreditapproachisagooddealforretailersandagooddealforcustomerswhoswitchcomparedtothosewhodon'tswitchsincetheypresumablycanshareintheeveniftheywereunbundled.
34Ifthereisanongoingtrue-upofstrandedcostrecovery,therewouldnotbeexcessivecompensationtotheUDC.
Thecustomerswhodonotswitchwouldstillpayalargershareofthestrandedcoststhan49marginthePennsylvaniaPUChasleftonthetable.
35Butthecreditisanarbitrarynumberthatisbasedneitheronmarketvaluesnoronretailingcosts.
Iteffectivelysimplygivescustomerswhoswitchadiscountontheirstrandedcostobligations.
IfPennsylvaniahadadoptedtheBESapproachthatIoutlinedearlier,theywouldhavefirstarrivedatastrandedcostchargewhichallcustomerswouldpay,whetherornottheyswitched,andthengivenallcustomersthebenefitofthecompetitivewholesalemarketpricesavailableinPJM.
Retailcustomerswhodon'thavethewittoswitch,orforonereasonorotherarenotattractivetargetsformarketers,wouldnotendupdefactopayingalargerfractionofthehostutility'sstrandedcostsastheydounderthe"shoppingcredit"approach.
RETAILCUSTOMERSWITCHINGBEHAVIORItshouldcomeasnosurprisethatinstateswhereregulatorshaveusedcreamyshoppingcreditstoinducecustomerstoswitchtoESPs,morecustomershaveinfactswitchedtotakeadvantageofthestrandedcostdiscountopportunitythatregulatorshavebuiltintotheUDC'sregulatedrates.
Tables3,4,and5comparethepenetrationofESPsforthreestates:Pennsylvania,whichpioneeredthelavishshoppingcreditapproach,CaliforniawhicheffectivelygivesUDCcustomersdirectaccesstothewholesalemarketprice(adjustedfordistributionlosses)andprovidesretailerswithamodestRCScreditbasedonavoidedcosts,andMassachusettswhich,untilveryrecently,providedUDCcustomerswithunbundled"standardoffer"generationserviceatalevelatorslightlybelowthewholesalemarketprice(adjustedfordistributionlosses).
36comparablecustomerswhodoswitch,however.
35HowgoodadealitisforanycustomerinPennsylvaniadependsonthemagnitudeoftheseparatestrandedcostchargethatallcustomerspayandwhetherittookintoaccounttheabove-marketgenerationservicerevenuesthatthePennsylvaniautilitiescontinuetoreceivefromthosecustomerswhodon'tswitch.
Sinceinmanycasesgeneratingplantswereevaluatedadministrativelyratherthanthroughamarketprocessitishardtoknowhowfairthedealisoverall.
36RespondingtopressurefromESPs,MassachusettsrecentlyraisedthestandardofferforBostonEdison50to4.
5cents/kWh,whichisabovetheprevailingwholesalemarketpriceinNewEngland.
However,atthesametimeitreducedBostonEdison'sstrandedcostchargetokeeptheoverallUDCpriceatthesamelevel.
TotheextentthatthisleadstomorecustomersswitchingtoESPs,thiswillextendthenumberofyearsintothefutureduringwhichBostonEdisonwillcontinuetorecoveritsstrandedcosts.
"PowerCostMaySparkCompetition,"BostonGlobe,January7,2000,pageD1.
51TABLE3CUSTOMERSSWITCHINGTOESPsINPENNSYLVANIAPERCENTAGEOFLOADSERVEDBYESPsAsOf1/7/2000(Choicestarted1/1/99)1999UDCRESIDENTIALCOMMERCIALINDUSTRIALRESIDENTIALSHOPPINGCREDITPECO17.
5%39.
15%58.
7%5.
65/kWhPP&L2.
833.
342.
14.
26/kWhGPUENERGY6.
758.
267.
34.
53/kWhDUQUESNE13.
641.
313.
44.
75/kWhALLEGHENY1.
520.
121.
1N/AN/A:ComparablenumbersarenotavailablesincetransmissionchargesaretreateddifferentlyforAllegheny.
However,thecomparableshoppingcreditforAlleghenyislikelytobelowerthanthosereportedfortheotherutilities.
Source:PennsylvaniaOfficeofConsumerAdvocate52TABLE4RETAILCUSTOMERSWITCHINGTOESPsINCALIFORNIAAsofDecember15,1999(Retailchoicestarted4/1/98)%ofDemand%ofCustomersRESIDENTIAL2.
0%1.
7%COMMERCIAL500kW32.
0%20.
1%Source:CaliforniaPublicUtilitiesCommission,DirectAccessReports,December1999.
53TABLE5RETAILCUSTOMERSWITCHINGTOESPsINMASSACHUSETTSAsofNovember1999(Retailchoicestarted4/1/98)%ofRetailSalesResidential:0.
17%SmallCommercial:1.
69%MediumCommercial:5.
0%LargeCommercial:20.
7%Source:DivisionofEnergyResources,CommonwealthofMassachusetts,November,1999.
54ItisevidentfromthedatainthesetablesthatcustomersinPennsylvaniahavegenerallytakenmuchgreateradvantageoftheopportunitytoreducetheirratesbygivingtheirbusinesstoESPsthanhavecustomersinCaliforniaandMassachusetts.
37AndthereissomeevidencethatmoreresidentialcustomershaveswitchedinUDCareasinPennsylvaniawiththelargershoppingcredits.
However,thisdoesnotimplythatresidentialcustomersarebetteroffthantheywouldbeifthePennsylvaniaregulatorshadrequiredUDCstoofferallresidentialcustomersdirectaccesstothewholesalemarketwithaBESoptionofthetypeIdescribedabove.
Clearlytheresidentialcustomerswhohavenotswitched,thevastmajorityofresidentialcustomers,arenotbetteroffwithshoppingcreditsthantheywouldhavebeenwithBES.
Theyarepayingbothstrandedcostchargesandagenerationservicepricethatisinexcessofitswholesalemarketvalue.
NorarethecustomerswhohaveswitchedlikelytobebetteroffthantheywouldhavebeenwithBES.
InPhiladelphia,forexample,thediscountofthetotalUDCdefaultrateofferedbythemostsuccessfulESPisonlyabout0.
5cents/kWh,whileBESwouldofferandiscountofroughly1.
2cents/kWh.
Theonlyrealvalueaddedservicesthatappeartobeofferedtoresidentialcustomersare"greenpower"products.
ThekindofrealtimemeteringandcontrolservicethatwouldhelptoimprovewholesalemarketperformanceisnotamajorsalesthemeforESPsalestoresidentialandsmallcommercialcustomers.
ItisalsoworthnotingthatinPennsylvania,largercustomershavebeenabletotakemuchgreateradvantageofretailcompetitionthanhavesmallercustomers,despitethelargeresidentialshoppingcreditsinsomeareas.
Moreover,inCaliforniaandMassachusetts,wherethedefaultandstandardofferservicehasprovidelittleifanymarginoverthewholesaleprice,ESPshavestillbeenabletoattractalargefractionofthelargestcustomers.
ThissuggeststhatESPscananddoofferlarge37IthasbeensuggestedtomethatanotherreasonwhytherehasbeensomuchswitchinginPennsylvaniaisthatutilityretailingaffiliatesfacefewerrestrictionsthaninCaliforniaandMassachusettsandareattractingalargeshareoftheswitchingcustomers.
55customersvalue-addedservicesinadditiontoprovidingthemwithcommodityelectricitytheyacquireinthewholesalemarket.
SHOULDSUBSIDIESBEOFFEREDTOHELPESPsTOATTRACTRETAILCUSTOMERSSomeregulatorshaverecognizedthecreamyshoppingcreditsforwhattheyreallyare,butjustifythemasnecessarytostimulatethedevelopmentofavibrantretailingsector.
Oneargumentisthatthisisaninfantindustrythatneedstobeencouragednowwiththeexpectationthatitwillyieldsignificantbenefitsinthelongrunwhenitmatures.
AtleastoneregulatorhasevenpointedtothePURPAexperienceasdemonstratinghowsupra-competitivepaymentsforelectricityproducedbyQFshashelpedtostimulatethedevelopmentofanindependentpowersector.
Onemustbesuspiciousofinfantindustryarguments.
Industriesthathavegrownand(sometimes)prosperedbasedonsubsidiesrationalizedasnecessarytopromoteanewindustryoftenremain"infants"fordecades.
Temporarysubsidiesbecomedifficulttowithdraw.
ManyofthosewhohaveenteredtheESPbusinessarenot"infants"starvedforcapital,butareaffiliatesoflargecorporationswithenormousfinancialresources.
PURPAhascosttheU.
S.
tensofbillionsofdollarsinexcessivecosts.
Thisisnotanexperiencethatweshouldbeproudtorepeat.
AsIhavediscussed,however,theremaybesignificantsocialvalueassociatedwiththepotentialforasuccessfulretailmarkettoimprovetheperformanceofwholesalemarkets.
Thissocialvaluemaybedifficulttocapturebymarketparticipantsinstandardmarkettransactions.
Accordingly,theremaybeajustificationforpublicsubsidiestostimulatethedevelopmentofretailsalesarrangementsthatcontributetothemitigationofwholesalemarketperformanceproblems.
However,ifthisistherationaleforsubsidizingESPsthenitisimportantforpolicymakerstoclearlyarticulatethisrationale.
Moreimportantly,anysubsidiesshouldbetargetedtostimulateESPstodothekindsofthingsthatwillhelpto56improvewholesalemarketperformance.
Forexample,subsidiesmightbelimitedtosupportforrealtimemeteringandcommunicationsequipmenttocreatemoredemandelasticityinwholesalemarkets.
Generalsubsidiesarelikelyonlytostimulatealotofcustomerchurn,wastefuladvertisingandpromotionalexpenditures,andinequitabledistributionsofstrandedcostresponsibility,withoutmitigatingwholesalemarketperformanceproblems.
CONCLUSIONTherhetoricabout"customerchoice"and"retailcompetition"asitappliestoresidentialandsmallcommercialcustomershasbornelittlerelationshiptotheobservablevalueaddedthatESPsarebringingtothesecustomers.
Thephysicalattributesofelectricityproduction,distributionandmeteringprovideasimpleandinexpensivemethodtobringasignificantfractionofthebenefitsofelectricitycompetitiontoallcustomersbygivingthemdirectaccesstothewholesalemarket.
Themaxim"Icangetitcheaperforyouatwholesale"canbeapplieddirectlytoelectricity.
Atthesametime,thesesamephysicalattributesmakeitverychallengingforretailerstoprovidesignificantvalueaddedtoresidentialandsmallcommercialcustomerscomparedtothevaluetheyreceivebygettingsimplecheapdirectaccesstothewholesalemarket.
ESPsshouldbegivenafairopportunitytocompetetoattractretailelectricitycustomersbyofferingtoprovidethemwithrealvalueaddedservices.
However,theyshouldbecompetingagainstabenchmarkdefinedbythecostsofprovidingcustomerswithdirectaccesstothewholesalemarket.
AnyretailingcoststhatareunbundledmustreflectacarefulspecificationoftherespectiveserviceobligationsofUDCsandESPs,cost-causalityrelationships,anddistinguishbetweenavoidableandunavoidablecostsrequiredtomeetUDCserviceobligations.
Regulatorsmustbeonguardagainstcreamskimmingandredliningasitrelates,inparticular,tosmallercustomerswithbelowaveragecreditrecordswhoESPsmayseektoavoid,especiallyifregulatedratesdonotfullyreflect57retailservicecostcausality.
ThesuccessofanyretailcompetitionprogramshouldbejudgedbythevalueaddeditprovidestoconsumersoverandabovethebasicwholesaleelectricityservicethatIhavedescribed,notbythefractionofretailcustomerswhohaveswitchedtoESPs.
Overtime,IexpectthoseESPswhohavebeensuccessfulindevelopingandsellingvalue-addedservicestolargercustomerswillsucceedinapplyingtheirskillstosmallerandsmallercustomers.
Futuredevelopmentsincommunications,computation,controlandmeteringtechnologywillsomedaybringthesevalueaddedserviceswithinreachofmanymorecustomers.
Inthemeantime,BESprovidedbyUDCswillmakeitpossibletotakeadvantageoftheopportunitytoprovideallcustomerswithlow-costdirectaccesstothewholesalemarkettoconveytothemthebenefitsofgenerationservicepricecompetitionandtochannelthecompetitiveenergiesofESPstowarddevelopingandmarketingvalueaddedservices,notjustbringingnewadvertising,marketing,andpromotionexpensesintothesystem.