The Deregulation of Electricity

“Retail Wheeling”
NASPO Research Subcommittee
John T. Houlihan, Chairman

Background: The Energy Policy Act of 1992 and the Federal Energy Regulatory Commission (FERC) open access transmission orders issued in 1996 will make significant changes in the way we purchase electricity at the retail level. The deregulation of electricity and the impact on the future purchase of electricity is a topic that was assigned to the Research Committee for study. I was asked to chair a subcommittee to conduct research on the subject. We started by searching the INTERNET and found almost more information than we could grasp. We also found that the information was changing almost on a daily basis since most of the states are very active in studying the impact of deregulating the purchase of electricity and are developing the policy and statutes that will be necessary when the industry is fully deregulated. At this point, we decided that rather than writing a “white paper” it would be better to locate some of the best INTERNET sites and make them easily available through the NASPO home page. Included with this paper is a summary of the information available on INTERNET and information on the electric industry and the changes that will occur because of deregulation. Some of the deregulation information and issues are:

The early electric power system in the United States consisted primarily of separate electric companies that provided power to local communities. Our system today, although greatly expanded from the earlier system, still provides most retail users with electricity through a local distribution system company (LDS). The LDS purchases the electricity from a power plant or wholesaler, transmits it over long distance power transmission lines to the LDS system, moves it to the retail meter and bills the customer monthly. Some communities receive their electricity from a cooperative or a municipal generating and distribution system. All utility rates are approved by a local regulatory commission since the LDS has a monopoly on providing electricity to the community.

The Federal Power Act required that no public utility shall “make or grant any undue preference or advantage to any person or subject any person to any undue preference or disadvantage,” with respect to the transmission of electric energy in interstate commerce or the sale for resale of electric energy in interstate commerce. The FERC used this authority to open up the long distance transmission lines to all wholesale customers and allowed these customers to select the generating plant to provide electricity to their retail customers. Although the price charged by the transmission line and distribution companies will continue to be regulated since they are a monopoly, the generating plant prices will be based on competition with other power generating plants. Retail customers will be able to select their wholesale supplier on a competitive basis rather than be required to use their LDS. This retail competition is also called “retail wheeling”.

Some of the issues that are being addressed by the states are:

Stranded Costs: These are the cost of assets that exceed the amount that can be recovered through the asset’s sale. For example, if some years ago a utility company was encouraged to build a nuclear power plant by the regulatory authorities with the agreement that they could recover the cost by charging it off to their captive customers over a 20 or 30-year period and if, under retail wheeling, these customers select a different generation source, the utility cannot recover their costs. Some municipalities have a similar problem if they have issued long term bonds and invested heavily in capital equipment to provide electricity and the municipal customers decide to buy their power from another source.
Taxes: How do states tax electricity that is produced outside the state boundaries? Will state and local taxes make the state’s power plants unable to compete with other state power plants?

Stranded Benefits: These are public interest programs and goals which could be compromised or abandoned by a restructured electric industry. These potential “stranded benefits” might include: environmental protection, fuel diversity, energy efficiency, low-income ratepayer assistance and other types of socially beneficial programs.

There are many other issues that must be resolved before individual states allow the deregulation of the electric industry. States that are moving quickly to deregulate electricity are generally states that presently have a high cost of electric power. There is some concern in states that have a low cost of power that deregulation will increase their cost of power as the industries in high cost states compete for the cheaper power. Using the old law of supply and demand, this increased competition for a limited amount of low cost electricity may drive up the prices in the low cost states.

Deregulation will be more beneficial to large users of electricity than small (residential) users. The large user will be able to take advantage of volume and long term contracts to drive the price down. In order to purchase electricity on a competitive basis the purchaser must have an extensive understanding of how and when the facility uses energy. Some of the information that will be required is: documentation of a 12-month history of utility bills; identification of all energy using equipment; understanding of the facility operation relative to the use of electricity; identification of loads that can be curtailed; an understanding of the local electric distribution operation; identification of other users that could provide purchasing partnership for volume discounts.

The purchase of electricity in a deregulated environment will be a challenge to the purchasing professional and the facility managers. It will be an opportunity to significantly reduce the cost of energy to state agencies.

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