Exchanging One Form of Regulation for Another: Part Deux

March 28, 2012
Arizona Investment Council
Gary Yaquinto

Earlier this week I attended the Arizona Energy Conference (also noticed as an Open Meeting by the Arizona Corporation Commission), where I gave a speech on retail access in Arizona. Here's what I said:

Let me begin by stating that for retail access to move forward on a large and ubiquitous scale in Arizona, legislators, regulators, utility companies and consumers have a very large, complicated and expensive task ahead.

And, at the end of the day, should the ACC authorize retail access, regulators will need to expand regulations over power markets, not lessen them. Why? Because electricity is an essential, critical and life saving service, with few substitutes. And it will fall on the ACC to make sure the lights stay on – for everyone.

And, ACC Commissioners must face the prospect that rates for some customers could be higher, not lower, under competition. That's a conclusion reached in at least 3 independent studies performed by different groups, ABBACUS, APPA, and TCAP.

If anyone thinks that moving to competition in electricity means a free and open market, devoid of government interference, they are sorely mistaken.

While some form of retail competition has been implemented with varying degrees of success in about half the states -- consistently, the biggest winners of retail access have been large customers – large retailers with large power needs like Wal-Mart and other large commercial and industrial customers – basically, those customers that posses the savvy and the ability to shop for their power needs and can buy in huge quantities. It has also benefited competitive providers and energy traders, like Constellation Energy that have new markets into which they can sell electricity. Those classes of customers with smaller power needs and are the most expensive to serve – like residential customers have not -- and will not -- benefit as much, if at all.

We've heard testimonials from competitive providers – like those that sell to residential customers in states like Texas – that their residential customers are happy. I personally haven't heard consistently positive reviews about competitive choice from those residential customers themselves, but their providers are understandably eager to sing the praise of customer choice.

We do know that the competitive states – Pennsylvania is a great example – have spent hundreds of millions of dollars in efforts to educate residential customers and prepare markets for competition. Even at that, less than 20 percent of residential customers in Pennsylvania have switched to a competitive provider. On the other hand, the percentage of commercial and industrial customers switching to competitors in Pennsylvania is three times as great as residential.

In Houston, residential customers are literally bombarded with choice, with 255 energy products offered by 37 providers. All I can say is that the Texas PUC must have one heck-of-an education program to guide seniors and other customers through that Marketing Maze. We're talking about power, not ice cream. Even Baskin Robbins stops at 31 flavors -- and for good reason!

On the flip side, a handful of states – states where electricity prices are relatively low – have specifically considered, but said no thanks to retail access. They include states like Colorado, North Carolina and Wisconsin.

A few other states have started down the path of retail access only to come to the conclusion that it might not produce the intended results after all, and have suspended efforts to move to retail access – Arizona falls into this category. Certainly, the 2000-2001 deregulation meltdown in neighboring California had much to do with putting on the brakes here. During this period of retail access in California, customers were hit with rolling black-outs and wholesale electricity prices that jumped well over ten-fold, literally overnight.

Now, we're told that the problems that plagued California's deregulation effort provided valuable lessons about deregulation for the rest of us – a California situation, so we're told, can't happen again.

And, I generally agree – we have learned – with competition, we need proper price signals to bring more supply to market and curb demand when necessary – otherwise the market won't work. And, a dysfunctional market like the one California created in the late 1990s, forced one incumbent utility into bankruptcy and the near-bankruptcy of another. It gave that state yet another black eye.

From the California debacle, we now have better antennae for warnings about bad market behavior, like market manipulation. We also have better enforcement practices in place to stop it before it does excessive damage. In Texas, it's the Public Utilities Commission that polices market manipulation. For most other competitive states, bad behavior by energy traders is policed by FERC.

As a matter of fact, just a few weeks ago, FERC entered into a settlement agreement with Constellation Energy, where Constellation agreed to pay a penalty of $135 million and restitution to customers of an additional $110 million for market power manipulation in the Northeast.

It is ironic that in moving to competition, federal and state regulators have actually added more layers of regulations on an already heavily regulated industry, not less. So, the market is anything but free – and it can never be free, given: (1) the essential nature of the product and (2) the critical importance of safety and reliability in delivering it to consumers.

So, now large customers and competitive power providers are back – knocking on the doors of the legislature and ACC to open up Arizona to competitors. Some of these proponents claim that Arizona already has the structure in place and with a few tweaks to the ACC's competitive rules, which have been essentially idle now for over a decade and originally modeled after California's ill-conceived rules, they can launch competitive operations in Arizona and bring benefits of provider choice, lower rates, cleaner energy, etc. to customers.

That is what you will hear from them.

I respectfully disagree with that simplistic view.

Opening up Arizona's electricity market will be complicated. That is not to say it cannot be accomplished. But, it would require integrating new requirements – read here more regulation – adopted by the ACC for renewables, energy efficiency and resource planning into a competitive environment.

It would require incumbent utility companies to restructure billing systems and other IT systems that have been mothballed and are now dated from Arizona's earlier attempt at retail access. The first time around, these changes and systems cost companies and ratepayers some $100 million.

It would require regulators to implement provider of last resort requirements to ensure all customers have a supplier of power.

It would require regulators to implement rules for allowing customers who are dissatisfied with a competitive provider to return to the provider of last resort and to recognize the risks and costs utilities bear in providing POLR service.

What happens – down the road – when the natural gas bubble bursts yet again and gas prices jump? And customers want to return to the incumbent or POLR, who have now designed their systems around a competitive model. What obligations do they have to serve these returning customers and at what cost? These are all details that regulators must work out – not when it becomes a crisis, but on the front-end.

Opening the market to competition would require policymakers to implement new regulations to establish an independent system operator and to provide enforcement of new rules and regulations to police the market for market manipulation practices. Again, more important and expensive details to work out.

It would require Commissioners to consider divestiture of generation assets of the incumbent utilities yet one more time – a process which will introduce additional uncertainty and risks for investors.

It will be expensive. It will take time, money and resources to implement a competitive model that works for Arizona consumers – ALL Arizona consumers. If retail access is to move forward in Arizona – IT MUST BE DONE RIGHT – a few tweaks to outdated, outmoded rules won't suffice.

And, it must be constitutional and meet all legal requirements. The legal infirmities of the rules that were identified by the courts must be fixed. Primarily, the ACC cannot simply say that prices will be market-based without giving consideration to the utility or provider's property fair value in determining rates. That's what the Arizona Constitution requires and that is what the courts, among other things, have said must be done to move to some form of retail competition.

My conclusion that I express here today is very simple: I believe the risks and costs are great. They are great risks and costs for regulators; for incumbent providers and investors; and for the most vulnerable customers – residential consumers.

And, the benefits -- at least to these groups -- are uncertain.

Does Arizona really want to exchange one set of regulations for another, more complicated and uncertain set? We know who will benefit the most from competition. We also know which customers are most at risk and will benefit the least, if at all.

Ok. I'm almost at the end and, I'd like to end on a positive note – and here it is –

Amongst all the hubbub surrounding a move to competition, it is rarely pointed out that under our current system, Arizona residential customers today enjoy relatively low electricity rates compared with places like Texas and Pennsylvania. They also enjoy award winning customer service delivered by incumbent providers, and they can choose from a vast array of rate schedules, payment options and programs for renewable energy and energy efficiency.

In my opinion, that is reason enough to stay the current course.

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