Retail power reality check

E. Russell Braziel

Altra Energy Technologies

When the Federal Energy Regulatory Commission (FERC) issued Orders 888 and 889 in 1996, many considered them the kick-off for a viable, competitive market in wholesale electric power, and they were.

But considering the orders contain 500 references to retail markets and 400 to wholesale markets, FERC also clearly expected that competitive markets for retail energy were poised and ready-just around the corner.

By July 1997, momentum seemed to be building, with industry players trumpeting customer-choice programs and glowing outlooks like-“The deregulated retail power market is bigger and more lucrative potentially than any other opportunity”-domi- nating the press.

Then, it all started to unravel, with Utilicorp Energy One and others announcing their retreats, the American Public Power Association and the National Rural Electric Cooperative Association calling for time out, and federal “date certain” legislation for retail choice unlikely.

Obviously, the lack of a federal mandate throws the lead to the states, and although several have enacted legislation, there is clearly a long process between legislation and implementation, with seemingly endless roadblocks along the way.

Competing agendas

The difficult creation of viable retail markets spawns partly from the four constituencies-incumbents, new merchants, consumers, and regulators-advancing their own agendas.

While exceptions exist, the incumbents or existing regulated utilities want stranded cost recovery; the ability to use the utility`s name as a marketing tool; rules that ensure the current utility remains the default provider; and preferential access to customer information.

In contrast, the new merchants or retail energy marketers want the ability to offer customers a savings off the utility`s bundled rates, plus make a margin; minimum barriers to entry; convenient, electronic access to information; and regulatory assurance that the incumbent utility`s merchant subsidiary plays under the same rules.

Consumers-presumably the reason for all this-are not nearly so particular and want competitive markets and customer choice only if it gives them lower prices, new services, reliability and simplicity. But, barring these, most seem perfectly happy to stay with the status quo.

Regulators too want lower prices, but they also hope to keep their state utilities healthy, maintain a sound economic environment, and above all, keep voters happy.

Faced with so many opposing viewpoints, and with no single regulatory authority to impose a gas industry-like solution, it is a wonder the retail power industry is developing at all.

Details, details

On the surface, it appears the regulatory process is producing results, with more than half the states reporting active engagement in some kind of retail unbundling initiative. However, to quote Martin Allday, former FERC chairman, “The devil is in the details.”

In this case, the details-rate structures, program rules, and operating procedures-make it difficult, if not impossible, for competitive markets to function properly.

One of the most obvious ways to discourage competition is through the rate design and cost allocation process. The following example illustrates how the economics of retail choice can be defeated by eliminating the opportunity for customers to save money by choosing an alternative supplier (see Figure 1).

Utility XYZ`s bundled residential rate is eight cents per kWh. In its retail tariff, XYZ allocates 2.5 cents as the transmission and distribution rate the customer pays to use utility assets and power delivery services. If power is available into XYZ at 3.5 cents, it appears the marketer and customer split a savings of about two cents, which represents the difference between the competitive generation cost and the utility`s generation cost embedded in its bundled rate.

However, the Competitive Transition Charge (CTC), which represents an additional 1.75 cents on the customer`s bill, poses the problem. With this charge, the customer only saves a quarter of a cent per kWh, or about 3 percent-a paltry savings that hardly justifies switching suppliers.

The rate mechanism used to achieve this result-a shopping or generation credit-ideally gives the customer a reduced bundled rate as an allowance to shop for energy.

The difference between the cost of competitive power and the shopping credit must be split between customer and marketer. Too little savings, and the customer loses interest. Too little margin, and the marketer must close shop.

If rates, do not squelch the competitive retail market, more subtle tools exist-onerous retail program rules.

For example, some programs require customers who chose different suppliers to install expensive, high-tech meters. Others limit the marketer`s source of supply to a mandatory wholesale power pool, restrict or delay access to customer load information, or charge penalties that far exceed the infractions.

Again, with similar results as with rates, operating cost and risk outstrip potential margins, and competitive suppliers withdraw because they cannot make money.

Still another way to quell competition is the creation of complex, unwieldy operating procedures. All retail programs need at least six communication and coordination functions between the transmission and distribution utility and the marketer:

1. Enrollment-how a customer signs up for an alternative supplier, how the utility is notified, and where the marketer is in the loop;

2. Load forecasting-how the marketer determines the projected load shape for the customer;

3. Scheduling from generation to load;

4. Measurement-usage information;

5. Billing; and

6. Reconciliation.

In any retail energy program, the utility and the marketer, in some fashion, share in each of these functions. What separates successful retail programs from failures is how these functions are shared.

Failures are characterized by complex processes, communication delays, inaccurate data, and bias toward the utility marketing affiliate. In successful programs, the processes are simplified, data is timely and accurate, and the same procedures apply to all market participants on an equal basis.

Even when the programs are done right, marketers still have another challenge: They must deal with the fact that procedures and protocols vary with each jurisdiction.

A few utilities have made some progress toward streamlining procedures by using the Internet as a communication tool for a variety of their retail program`s communication needs. Unfortunately, no standards exist across the country, and as we have seen before, operating and transaction costs are high, often causing competitive suppliers to withdraw because they cannot make money.

Where`s the money?

So is it possible to make money in retail power? The answer is yes, but it is a very limited yes, depending on the rates and rules in each jurisdiction. Frankly, most utility systems are not structured to allow marketers to make money today, and it will be tough, if not impossible, to make any kind of a national retail power market for the next few years.

To achieve this kind of scalability, marketers must actively participate in the regulatory, legislative and legal process to help create a viable, competitive marketplace-one utility at a time.

The other prerequisite to making money is the capable and efficient handling of all the diverse retail power operating procedures, including comprehensive market knowledge and accurate forecasting tools; cost-effective customer acquisition and superb customer service; and well designed, efficient business and accounting processes.

With the targeted market selected and the homework complete, a marketer still must pull together an information systems infrastructure that incorporates elements of wholesale-level energy transaction management with more traditional utility information technology solutions.

Some wholesale functions include scheduling, risk management, and interfaces with Independent System Operators (ISOs) and Open-Access Same-time Information System (OASIS) nodes, while retail functions can include meter data interfaces, call centers, Customer Information Systems (CIS), billing, collections, and sales force automation.

These functions, while individually important, are not as critical as the collective architecture of the overall system (see Figure 2). The system architecture must be designed to not only handle today`s business, but must be built to evolve as retail power matures.

For this, a system should have four characteristics:

1. It must be a modular system. It is very difficult to design a comprehensive retail energy marketing system as one giant application. As Bill Gates said, “Big bang projects always just leave big craters in the ground.”

2. It must be parameter driven, meaning the scheduling function for Utility A will no work for Utility B. So the system must accommodate this diversity of procedures without requiring time- consuming reprogramming.

3. The system must be scalable, functioning for a marketer with 5,000 customers today, but be able to handle millions in a few years.

4. And finally, the system must be e-commerce enabled, eliminating manual data entry processes and using the Internet`s cost-effective and simple tools for communicating information.

Just another business

The keys to success at this stage of the retail power market`s evolution are not scope and scale, but rather flexibility and keen market knowledge. The companies who make money over the next couple of years will probably be small organizations focused on narrow opportunities, or perhaps larger companies who have been able to organize themselves as a confederation of smaller teams.

In any event, these companies will be challenged by the complexity of developing the necessary information systems needed to effectively compete with incumbent utilities.

No doubt the announcements of new retail marketing organizations and alliances, all targeted toward the ultimate pot of gold at the end of the retail energy rainbow, will continue. The success of these ventures can only be gauged over the long term, and it may be some time before analysts can tell the winners from the losers. As Warren Buffet said about hedge funds and Long-Term Capital Management, but which seems appropriate for retail power, “You never know who`s swimming naked until the tide goes out.”

The winners will probably not be the companies making headlines with big ad budgets and flavor-of-the-week partnerships. Instead, the winners will most likely remain companies that buy right, keep operating costs low, provide value to their customers, and grow one customer at a time-just like any other retail business. n

Editor`s note: E. Russell Braziel is chairman of Altra Energy Technologies, a Houston-based vendor of enterprise information systems and electronic trading platforms for the energy marketing business.

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