LESSONS LEARNED TO DATE IN
FEDERAL TRADE COMMISSION
September 13, 1999
Thank you for inviting me to speak at this Public Workshop on market power and consumer protection issues involved with encouraging competition in the U. S. electric industry. As one of the first states to open its market to retail electricity competition, I want to explain to you where we stand today and what approach and structure we followed to open the retail market and allow restructuring of this $21.0 Billion retail market.
As one of the five Commissioners on the California Public Utilities Commission when we designed and issued the defining regulatory orders, I say without reservation that we wanted to allow all customers to have the ability to chose new energy service providers of electricity and to take advantage of the variable prices of electricity from season to season and from hour to hour, to reduce their energy bills and to more efficiently use energy. In addition, I believe the Commission wanted to allow creativity and innovation to flourish in the new deregulated market and most important allow acceleration of new technology to enter the market to further reduce cost and ultimately prices.
Status of California's restructuring
On March 31, 1999, the State celebrated the first year anniversary of the complete opening of the competitive electricity for all customers in all classes, served by the three major Investor Owned Utilities (IOU's) in California. This represents 25 million out of the 33 million people in the state. The electric generation sector of this market has been deregulated and, except for the nuclear plants and two coal generating plants all the generation of these three companies will be divested to new owners by this year end. This represents approximately 20,000 megawatts of electric generation or over 40 percent of the entire states electric generation capacity. The days of the vertically integrated monopoly utility is over in California for the serving of electric service.
Even though the customers' ability to choose new competitive electricity service providers has been with us for over a year, we are still in the third year of a five year transition period where all electric rates are frozen, except for the energy portion of the bill for those customers who have selected a new energy service provider. This rate freeze transition period is to allow the three IOU's to recover over $20 billion in so-called stranded assets, i.e. those assets that will not be recovered under competitive rates. The rate freeze is suppose to provide sufficient head room between the frozen rates and the actual cost the IOU's incur to provide electric service over the five year transition period to recover the stranded assets.
When this transition period ends for each of the IOU's, each customer's electricity rates will be billed each month at a energy rate agreed to by its new competitive service provider, if a customer so elects, or if not, at the average Power Exchange Price for energy provided by the electric IOU's still providing energy services to its remaining customers. San Diego G & E has already announced it expects to end its transition rate freeze in late summer of this year, almost three years earlier than allowed. I expect the other two IOU's, Pacific Gas and Electric Co. and Southern California Edison, will be able to end their transition period early also, as early as the end of the year 2000. This is the key date when all customers will see for the first time the true price signals of a deregulated electricity market. This is what we were aiming for at the beginning of the process, this is the panacea and the big enchilada that we have been striving for.
Then for the first time price signals will be available to allow supply and demand to interact as they do in most open markets. Today we have no elasticity of demand in the electricity market and this has caused serious price spikes that need to be moderated through realistic price signals of a competitive market.
To summarize where we are today compared to January 1, 1998, and where rates are expected to go in the future let us review:
As a result of electric restructuring:
This potential total reduction in rates for all three IOU's, for all rate classes combined, is expected to equal $4 to $6 billion a year. This would be equal to a 20% reduction in California's state income taxes for all citizens in the State.
The ability of customers to choose their own energy provider, to save money if they can switch their energy usage to off-peak periods, and the introduction of new technologies to the energy field will provide additional benefits and reduced prices and bills to consumers.
Status of the Number of Customers Selecting Direct Access:
After only 15 months, all signs in California show that competition is flourishing. Looking at the latest figures compiled by the Commission's Energy Division available from the Commission's web site, as of July 31, 1999:
These customers represent almost;
Of this $2-3 billion, it appears that three companies are leading in acquiring customers. These companies are: · New Energy Ventures (which has claimed that it has upwards of 40% of the direct access market),
Predictably, participation in direct access varies by group, and even between utility.
For large industrial customers for the three IOU's combined (those with a monthly demand greater than 500 kW,) 20% of the customers have switched, and these customers represent about 26% of the industrial load.
For large commercial customers, about 6% or 12,100 customers have switched, representing about 14% of the total sales to this customer class.
For the large commercial and industrial customers, the press reports and news releases show that they are saving money. I continue to hear of other announcements of companies that they have chosen an energy service provider. I believe that this includes most of the major petroleum refiners and distributors located in California.
Although the prices that these companies pay are obviously confidential, the published reports and press releases usually mention that the company will save about 5% off of their total bill. Many of these deals are increasingly "total energy" deals, where the energy service provider agrees to provide not only electricity, but also natural gas purchasing and energy conservation investments.
PG&E Energy Services, the unregulated affiliate of PG&E, for example signed a 5-year $750 million deal to manage all of Diamond Shamrock's energy needs. Diamond Shamrock is a large oil refiner and marketer.
To date, the Commission's numbers do not yet see a significant sign-up of residential, and to a lesser extent, small commercial customers. About 1% (108,500) of residential customers, and 2.9% (28,700) of small commercial customers have switched, representing about 1% of total residential load and 4% of small commercial load.
I expect that once CTC is gone or significantly reduced energy service providers will more aggressively market to residential and small commercial customers, Enron has inferred such and I expect Shell Oil and possibly other oil companies will join the fray. According to a recent study by the Commission's Office of Ratepayer Advocates, there are still several energy service providers offering service to residential customers.
One of the major success stories in the residential sector is the marketing "green power", or renewable energy. This seems to be one of the major reasons that many residential customers, including myself, have signed up for direct access. Estimates are that about one-half of the residential customers choosing direct access are choosing renewable energy. "Green marketers" are offering a variety of energy portfolios at different prices, from a 100% hydroelectric portfolio to a 100% wind portfolio. Green Mountain, one of the renewable energy providers which I have personally chosen as my energy service provider, has committed to building one new windmill for each 3,000 customers who sign up for wind energy.
I was disappointed that Enron, a major marketer, announced last year that it was withdrawing from the California market. But on the other hand a major oil company, Shell Oil, has organized a new subsidiary to ultimately get into the electric retail market in California and elsewhere.
One reason that more residential customers in California may not have switched suppliers is that they are already enjoying the advantages of competition at the wholesale level through the operation of the Power Exchange and its competitive hourly prices. It provides a daily marketplace for buyers and sellers of electricity and helps set the market clearing price. Customers remaining with the distribution utility as their default energy provider have all of their energy needs purchased by the utility from out of the Power Exchange.
POWER EXCHANGE BENEFITS
The benefits of a Power Exchange are that it aggregates the purchasing power of all customers who do not choose direct access. This allows these retail customers to receive the equivalent of the wholesale price for electricity. This ensures that these customers 1) receive the wholesale price for their energy; 2) receive the benefits of the competitive market bidding into the Power Exchange and 3) help prevent the distribution utility from favoring its own remaining generating resources if they are above market cost.
As I mentioned earlier, in addition to the Power Exchange, residential and small commercial customers have received a 10% rate reduction off of their rates as a result of the sale of approximately $7.5 billion in rate reduction bonds.
The hourly fluctuation in energy prices, both in the Power Exchange and the wholesale market, also provide an opportunity for all customers to save money by shifting their energy usage to off-peak periods, particularly when the rate freeze ends and the variable prices are clearly visible to all customers. As of January 1, 1999 energy service providers are now allowed to offer metering functions to all customers, not just the larger customers which was allowed as of January 1, 1998.
I fully expect that in the next several years we will see the cost of real-time metering technology fall significantly, perhaps as low as $100-200 and that it will be widely deployed. Companies such as CellNet, for example, have announced plans that would allow up to 80% of California's customers to be within range of CellNet's wireless metering technology.
As a result of improvements in real time metering customers will have a strong incentive to monitor their energy usage in order to take advantage of price changes in the Power Exchange. One company has announced it will provide real-time information on the Internet to provide similar services. Real-time metering will give all customers a strong financial incentive to shift their energy usage to off-peak periods where possible. I strongly urge all customers to factor these potential savings when scheduling their production runs.
Having attended the dedication ceremony of the Independent System Operator (or ISO) on March 31, 1998, I am proud of what California has accomplished. To date both the ISO and the Power Exchange have been operating and functioning.
The Wall Street Journal is now reporting the Power Exchange prices daily and , bidding volume into the Power Exchange is strong. Hourly prices are available on a day-ahead basis on the Internet at the PX's web site. We are also seeing the hourly fluctuation in energy prices between on-peak and off-peak periods. Earlier in 1998, the Power Exchange's average price was hovering at around 2.4 cents per kilowatt/hour, going as low as 1.5 cents in the evening and as high as 2.8 cents during peak periods. During the 1998 summer heat waves in California during July and August, we saw prices rise to the range of 6 to 10 cents per kilowatt hour during the peak afternoon hours, and prices for the day averaging in the 3-4 cent range.
As was widely reported in the press, the ISO also saw high prices in its replacement reserve market during peak periods. My hope is that as more out-of-state resources bid into this market, we will see these prices drop in the long-term. In the short-term, these prices send a market signal on the price of capacity, however the ISO has implemented a flexible price cap for these services.
Once PG&E and Edison end their rate freeze next year, price signals that the economists always dream about will be present in the market. The customers of all classes and sizes can take advantage of them or ignore them as they choose. The choice will be theirs.
The Power Exchange also provides for a transparent and visible market price for electricity. This latter point is critical, in that a transparent and active market is needed in order for a futures market to develop. The development of a futures market in turn, makes it easier for new power projects to be financed, since the project developers can use the futures market to limit their level of risk.
(For additional comments on the benefit of the Power Exchange, see my comments filed at the FERC on August 23, 1999, in the RTO NOPR-pages 17 to 21.)
This leads me to one of the somewhat unexpected benefits of restructuring -- new investment in power plants. The competitive market allows new entrants to build power plants in response to market demand. To date, California has had plans and/or announcements for about 10,000 megawatts, or about $5 to $7 billion, of new merchant power plants, and many other projects are expected to be announced soon. These plants will be built without any regulatory assurance of recovering their costs, and will have to recover all of their costs from the competitive marketplace. All of these plants will be powered by natural gas and will utilize the latest in combined cycle technology with heat rates as low as 6,900 BTU per kilowatt/hour. I would not be surprised if we see additional announcements of new power plant projects in the near future. The first 500MW plant received government site approval from the California Energy Commission last month and it is expected to be in operation in the year 2001.
Why did California restructure?
The main reason that California restructured was because of high electric rates. California's rates were 50% above the national average, and almost twice what they were in adjoining states such as Oregon and Washington. California believed that we had to reduce rates to remain competitive in today's global economy. At least the major customers were very dissatisfied with the high rates and the Commission's form of regulation. This customer dissatisfaction drove the Commission to do something to help the customers during this very difficult economic time of 1993 and 1994, the worst California recession since the depression. California had lost over 500,000 jobs. I was informed that at least 2 companies did not build major plants in California, about one-quarter of a billion dollars each, due to high electricity rates. I know personally that this made it much more compelling to make systemic changes to the electric industry to help remedy the dire situation for these customers. The residential customers in California's high desert, particularly Palm Springs were also very vocal about their high rates and high bills and something had to be done to address their concerns as well.
Other states with high electric rates, such as New York, Massachusetts, and Pennsylvania also restructured and expect significant price reductions.
Equally important, however, was the concept of customer choice. During our debates over restructuring, many industrial customers met with me and said: "I have a choice of supplier for natural gas, why not electricity? Why can't I have choice there as well?" Many of these customers had seen the benefits of competition in natural gas where there was a significant reduction in prices when the natural gas market was opened to competition. These customers believed that similar reductions could be achieved in electricity if they had choice.
Lessons from California's restructuring?
After working on California's restructuring, I have concluded that once you have made the commitment to "customer choice" and competition, the major issues that need to be resolved and which the Commission learned from are;
Resolution of these issues has strongly dictated how we restructured the electric industry.
Market Power Considerations:
Throughout the entire debate over electric restructuring my main concern has always been ensuring a competitive market place is accomplished and preventing the abuse of market power. The potential for market power abuse is particularly a problem in the electric industry, where almost 100 years of either regulation or government ownership has resulted in the incumbent utilities controlling almost all of the existing generation, transmission, and distribution assets within their service territory. The incumbent utilities also start out with a captive customer base of 100% of the market. It is this captive market that Direct Access will now open up to full competition.
The issue of market power has essentially driven the debate over restructuring in California in cascading steps. The first problem was one of breaking up the existing utilities' control of both generation and access to the transmission system. This is why California created the Independent System Operator (or ISO). The purpose of the ISO, is to ensure that California's transmission system is available to all market participants on an open and non-discriminatory basis. The ISO serves as the "air traffic controller" of the electric system, ensuring that all market participants have access to the system, and that the system is operated in a safe and reliable manner.
Today, the concept of an ISO, or a Regional Transmission Organization (RTO's) is being considered for use in most regions of the United States.
At the time of our restructuring, our Commission considered going even further and requiring the development of TRANSCOs. A Transco, unlike an ISO, actually owns and operates the transmission system in addition to controlling dispatch and scheduling.
At the time of our restructuring proposal, even the concept of an ISO was considered somewhat daring. However, having attended several workshops sponsored by our Federal Energy Regulatory Commission (or FERC) , I was surprised at the strong support that there seemed to be for the creation of TRANSCOs. Participants from utilities, including the Edison Electric Institute, were now advocating their creation.
Therefore, as electric restructuring evolves in California and the rest of the United States, I would not be surprised if you see the creation of TRANSCO's, as well as, the possible consolidation of ISO's, so that each ISO covers a broader geographical area.
(See additional comments in my FERC Comments in RTO NOPR filed August 23, 1999-Pages 11 thru 15.)
After deciding to open up the transmission system, the concern in California then led to the utility's control of energy procurement for their captive customers. This was a market power problem in that the existing utilities were the major purchaser of energy in the marketplace.
In California this led to the further separation of the transmission scheduling and energy procurement functions of the electric system into two separate entities--the ISO and the Power Exchange. In some other countries, such as the U.K., and other states, these functions were combined into a single entity. This is what the Commission had first proposed in its May, 1995 decision. In California, the Power Exchange performs much the same function as the "Pool" does in the United Kingdom. It provides a daily marketplace for buyers and sellers of electricity and helps set the market clearing price.
The benefits of a Power Exchange are that it aggregates the purchasing power of all customers who do not choose direct access. This allows these retail customers to receive the equivalent of the wholesale price for electricity. It also provides for a transparent and visible market price for electricity. This latter point is critical, in that a transparent and active market is needed in order for a futures market to develop. The development of a futures market in turn, makes it easier for new power projects to be financed, since the project developers can use the futures market to limit their level of risk.
Another advantage of the Power Exchange is that it provides a marketplace for the local distribution utilities to purchase energy for their default customers, those customers who do not want to purchase their energy directly. California requires that the distribution utilities purchase all of their energy needs for these default customers from the Power Exchange. This helps prevent the distribution utility from favoring its own generating resources if they are above market cost.
The creation of the ISO and the Power Exchange were designed to resolve the problem of vertical market power. Once this problem was addressed, California turned its attention to the issue of horizontal market power. Horizontal market power occurs where the incumbent utilities hold the vast majority of the existing generation assets within their service territories. When the United Kingdom restructured, for example, it sold off all of its non-nuclear generating plants to only two companies - National Power and Power Gen which I understand resulted in a market power problem. We wanted to avoid the problems faced by the United Kingdom of having too few independent electric generators.
California as well as some of the New England states, have addressed this issue through the divestiture of generation. We strongly encouraged are two largest utilities, Pacific Gas & Electric and Southern California Edison to divest themselves of at least 50% of their fossil-fueled generation within California. Both utilities have gone beyond what the Commission has asked them and San Diego Gas and Electric voluntarily agreed to divest its generation;
DIVESTITURE OF GENERATION PLANTS:
A question for all states and countries to consider if they restructure is to ensure that there is not a market power problem for generation. States should ensure that the existing level of generation and transmission ownership does not create a market power problem.
The second major issue in electric restructuring is of course stranded costs. Fortunately, this appears to be less controversial than first envisioned.
California, through state legislation, AB1890, provided our utilities with a reasonable opportunity to fully recover their stranded costs by no later than March 31, 2002. Most other states also seem to be considering providing a reasonable opportunity for full recovery. Many utilities also seem to be working out negotiated agreements with regulators and interested parties regarding stranded costs.
In order to understand the issue of stranded costs, it is important to know what they consist of.
In California about one-half of the stranded costs are associated with the above-market prices paid to Qualifying Facilities (or QFs) under the federal requirements of PURPA (the Public Utilities Regulatory Policy Act of 1978). QFs consist of renewable energy sources and co-generation projects. Although California is justifiably proud that we lead the nation in renewable energy, with over 11% of our generation capacity in renewables, this has come with a price. Many of these contracts were based on 1980's forecast of energy prices which were forecast to be as high as $100 per barrel. Today, every Californian is paying 25 cent per day in above market prices for these contracts. Fortunately, the above-market costs of these contracts will decline over time due to the way these contracts were structured (This is sometimes referred to as the "Year 11 QF cliff."
The second half of stranded costs has been California's investment in nuclear power plants. Similar to the QF contracts, these power plants were proposed to be built during the oil crises of the late 70's early 80's when it was thought that fossil fuels would be in short supply.
Some have argued that these plants were built under a "regulatory compact." They were built at a time when the utility had an obligation to serve all customers and had to plan to meet all future demand.
The Commission decided to honor the contracts with the QFs, although the Commission I believe is looking at ways to restructure these contracts and save ratepayers money.
California's answer to the issue of stranded costs associated with the nuclear plants was to accelerate the depreciation of the book value of the plant at a reduced rate of return, while putting them under a performance-based ratemaking approach for all going forward costs of their operation. If the utilities are unable to recover the fixed costs of these plants by March, 2002, the utility shareholders will be responsible for any shortfall.
California also has chosen to use the marketplace to establish stranded costs for utility-owned plant. As mentioned, California, encouraged the utilities to sell off their generating assets. Under this approach, the gain on sale from some assets can be used to offset the cost of other uneconomic assets. The sale of these plants at above book value prices has, or will allow, the other two IOU's other than San Diego G & E, to reduce rates sooner than the April 1, 2002 outside date.
The level and amount of stranded costs will obviously vary between different states and countries. In states and countries with low rates, there may be little or no stranded cost problem. In states and countries with high electric rates, stranded costs will be a problem that regulators will have to face.
In addition to "stranded costs" there are also "stranded benefits." Many people have expressed concern that in restructuring, many public purpose programs financed through rates would be jeopardized. In California, these programs include investments in energy efficiency and renewable energy, low-income ratepayer assistance and research and development.
California's restructuring program continues funding of these vital programs through a non-by passable Public Goods Charge.
California also remains committed to ensuring that competition in the energy industry is fair. Legislation passed last year has given the Commission significant power to prevent fraud and deceptive business practices by energy service providers. I believe that the Commission will be vigilant in enforcing these rules.
The final lesson that can be learned from California's restructuring concerns jurisdictional issues. In this country, the electric utility industry consists of a combination of government-owned municipal utilities and investor-owned utilities. Regulatory authority is divided between the federal government, which regulates interstate transmission and wholesale transactions, and state public utility commissions which regulate retail transactions.
In California, generation is becoming competitive, although it is FERC that now has most of the jurisdictional authority in this area. Transmission lines are also under FERC jurisdiction. Both the ISO and the Power Exchange are regulated by FERC, not the California Commission.
California retains primary jurisdiction over the distribution of electricity, and in reviewing the local distribution utilities' purchase of electricity for their captive customers who do not choose direct access. California also has the lead role in implementing public purpose programs, collecting stranded costs, and consumer education and protection.
Fortunately in California, cooperation between FERC and our state Commission has been excellent. In the past at conferences at FERC, I addressed the roles that the states and federal governments will have to play as we restructure. It will be the federal government, through FERC, that will regulate the ISO and Power Exchanges that are being created throughout the United States to promote competition at the wholesale level. It will be the states, however, that will play the critical role in establishing the ISOs and ensuring the participation of the utilities that they regulate in the ISO's.
It will also be the states, not the federal government that will bring retail competition to all customers. FERC is prohibited from ordering direct access. Only states can do this. Under almost all of the currently proposed federal restructuring bills, it is still the states that will have the authority to order direct access and retail competition. Remember without retail customers to sell to, it is very difficult for the wholesale market to grow and flourish.
As California's restructuring efforts have shown, this is where the "rubber meets the road." States will have to take the lead in retail competition. In California, as in other states and other nations, this effort requires separating rates into their unbundled components and opening up the portions of the market that are competitive i.e., generation, metering and billing for sure.
And even after direct access has been established, there will still be a strong role for states to ensure that the marketplace remains competitive. Therefore states will continue to be involved in consumer protection rules, educating consumers about their options, ensuring that the incumbent utility does not leverage its control of the distribution to favor its unregulated affiliates; and an issue I have always been focused on -- preventing abuses of market power.
In closing, my view of the California competitive electricity market is that it has been a great success to date. Customers are exercising choice of energy suppliers; the wholesale Power Exchange Prices, which will soon drive all retail energy prices, are lower than we ever expected; the stranded assets will be recovered sooner than we ever imagined; and customers will be able to observe and react to competitive variable prices and rates which I believe will allow further reductions in customer bills by both better load management and fuel switching.
California still has a ways to go to realize the VISION we, at the Commission saw, but the State is moving quicker than expected and I look for the State's average rates to be close to the national average within three years to five years.
Over half the population in the United States are in individual states that are, or soon will be, offering a competitive electricity market. I encourage their progress. Thank you, I hope my comments were helpful.