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The Downfall of Deregulation

The Downfall of Deregulation

California’s grand experiment into electric utility deregulation, which is supposed to bring full competition and lower electricity prices to California homes and businesses, has gotten off to slow and rocky start. Beset by a three-month delay, wary customers, caution among energy retailers, and inherent short-term barriers to full competition, deregulation is looking less like the much-ballyhooed plunge into an open market and more like a slow evolutionary change.
“People have been lowering their expectations about what deregulation is going to bring in the short term.” said Arthur O’Donnell, editor and associate publisher of California Energy Market, a newsletter that tracks the state’s electric power industry. “Most companies are waiting on the sidelines to see how it will unfold,” he said. “Those that were more aggressive are now taking a step back.”

Compounding the uncertainty came word in December of computer problems on the new electricity trading market known as the Power Exchange. The complex computer system needed to run the market arrived only three weeks before the scheduled Jan. 1 start date and had trouble linking up with computers on the Independent System Operator, which was set up to ensure that all businesses and residents get the power they need.

State officials were forced to delay the start date of deregulation three months, to March 31.

This week, officials with the Power Exchange and ISO were scheduled to update Public Utility Commission officials on the status of the computer systems. Even before word of the computer problems, there were signs that deregulation of California’s $20 billion electric power industry wasn’t going to debut with a bang. While PUC figures show that 15,000 companies and 11,000 residents had signed up with different power providers in November and December, that’s only a fraction of the estimated 700,000 companies and 10 million residential customers served by the state’s three investor-owned utilities – Southern California Edison Co., San Diego Gas amp; Electric Co. and Pacific Gas amp; Electric Co.

As was the case with deregulation of the telephone market in the mid-’80s there is a lot of confusion among consumers and businesses about the new world of power deregulation. “Utility bills used to be very simple and somewhat predictable for companies,” said Danielle Seitz, an analyst with UBS Securities in New York. “Now, there will be uncertainty in pricing, so companies will have to keep close track of power prices. And the billing system will be far more complex,” she said.

Ironically, business electricity price comparison call today the biggest impact so far has been on the one sector not covered in the early phases of deregulation: municipal utilities. The Los Angeles Department of Water and Power last fall announced it would lay off 2,000 of its 7,000 employees to trim down its cost structure and prepare to compete against leaner power providers. The utility must also pay down nearly $4 billion in debt. After months of bargaining with employee unions, the L.A. City Council last week approved a $346 million buyout and severance package, looking to induce many of the workers to take early retirement.

Smaller layoffs either have occurred or are expected at other municipal utilities, including those in Burbank and Glendale. The deregulation process does not require participation of municipal utilities. But as a practical matter, they will be forced to take part or risk seeing their big, profitable customers locate facilities outside their jurisdiction. State lawmakers gave the municipal utilities until Jan. 1, 2001 to decide what to do. In Los Angeles, the City Council will have the final say over whether to deregulate.

Outside of the job cuts at the DWP and other local municipal utilities, the impact of deregulation has yet to be seen. Officials with the PUC, which is charged with implementing deregulation, defend the slow launch. “The fact is, we are the trailblazing state in this area and we really didn’t know what was going to happen,” said PUC Commissioner Gregory Conlon. “Frankly, I would expect most people will want to wait to see the cash price on the Power Exchange before deciding whether or not to switch”

But others point to a deeper reason for the reluctance to climb on board: the imposition of a “competitive transition charge,” or CTC, on all ratepayers for the first four years of deregulation. This fee will be collected by Edison, SDG E; and PG E; and be used to pay off nearly $30 billion of investments they made in costly alternative and out-of-state power contracts in the 1970s and 1980s.

While the charge was a key inducement for the investor-owned utilities to go along with deregulation as the law was being crafted two years ago, it is likely to have the effect of lessening the savings for companies desiring to switch power providers. That’s because only about 40 percent of a typical power bill will be for the electricity itself; the remaining 60 percent will include transmission, distribution and metering charges, as well as the CTC.

“The magnitude of the cost savings now will not be all that great, wherever you get your power from; it’s only a small portion of the bill,” said Brian Youngberg, an analyst with Duff amp; Phelps Credit Rating. “The true competition kicks in after 2002.” Also, the CTC is a variable charge: it will be inversely related to the spot price of power on the electricity trading market, known as the Power Exchange.

These factors have a ripple effect on some of the outside providers that have been eyeing the California market. In order to make it worthwhile for companies to switch from their current providers, these utilities must offer power at rates at or near 10 percent below the rate that the three in-state utilities would get on the electricity trading market. But selling power at such low rates could cut deeply into operating margins, Youngberg said.

Portland, Ore.-based PacifiCorp, for example, had stepped up operations in California last year to go after power customers. But last fall, the company pulled back, choosing instead to focus on selling power wholesale to other power providers. “The main reason we pulled out was because the CTC prevents the true power savings from being passed on to the customer,” said PacifiCorp spokeswoman Jan Mitchell. Another outside provider – Houston-based Enron Corp. – has made a major entry into the California market as part of a push to become the nation’s largest energy provider.

Enron is in the midst of a $10 million to $20 million marketing campaign that included mailers sent to 2.5 million residential customers and small businesses throughout the state. However, even Enron, which has successfully pried open markets in the Northeast, may be forced to scale back. “Since California is the first state to go with deregulation on such a massive scale, it has symbolic importance to us,” Enron spokesman Gary Foster said. “But there is no margin at all for us right now; this is totally a loss-leader.” The unregulated power retailing arms of the state’s three investor-owned utilities – Edison Source, PG E; Energy Services and Energy Pacific – have also been busy getting their operations up and running, Particularly in flux is Energy Pacific, which is a joint venture of San Diego-based Enova Corp. (parent of San Diego Gas amp; Electric Co.) and L.A,-based Pacific Enterprises (parent of the Southern California Gas Co.). Enova and Pacific Enterprises announced plans to merge in October 1996; regulatory, approvals are still pending.

The most active participants in the new system so far are large energy users, like Los Angeles-based Ralphs Grocery Co. – which signed up last fall with Los Angeles-based New Energy Ventures – and San Francisco-based Pacific Bell, which signed up with Enron. These companies face multimillion-dollar utility bills; even a 5 percent savings on the power portion can amount to half a million dollars or more. Also, “the large companies are savvy and know how to navigate the system. Many of them already have on board full-time energy buyerst” Foster said. But small businesses (those corner grocery stores, small professional offices and other firms that use less than 20 kilowatts of power in any given hour) and homeowners have little inducement to change because they have already received an automatic 10 percent rate cut, effective with their January bills.

Despite all these hurdles, no one is saying electric power deregulation is doomed in California. “There may be some bumps in the road, and we are definitely in a bump right now, but in the end, we should get to a fully deregulated marketplace,” said Douglas Kline, spokesman for San Diego-based Enova Corp.

Terms of Deregulation:

The utility business is filled with jargon. Here is a glossary to help decode the language.

• California Alternate Rates for Energy (CARE): A program of lower electric rates for those with limited incomes.
• California Public Utilities Commission (CPUC): The agency that regulates the electricity utility industry and is overseeing the industry’s changes.
• Competition Transition Charge (CTC): A regrouping of some generation-related costs that long has been part of electric bills in California.
• Electric Service Provider (ESP): The company or organization that provides electricity from a variety of generation sources.
• Generation: The actual creation of electricity.
• Public Purpose Program Charge: A charge Californians pay for social and environmental programs.
• Slamming: The switching of a customer’s electric service provider without the customer’s knowledge or consent.
• Transmission: The conveying of electricity from generation sources to local distribution wires.
• Utility Distribution Company: The new name for the local utility company.