When talking to industry leaders around the country, it quickly becomes clear that significant differences exist in regional approaches to restructuring. Sam Jones, COO of ERCOT (Austin, Texas, U.S.) declares that deregulation is an idea whose time has arrived, and he looks forward to an ERCOT market that continues to evolve. “We feel like deregulation here in Texas has been fairly successful. The model is working, and we've got pretty good competitive activity,” Jones says.

In the Northwest, Dick Byers, senior energy policy analyst, Washington Utilities and Transportation Commission (Olympia, Washington, U.S.) reports that in his state, a limited open market exists and the state has no plans to further restructure. He feels that prices in deregulated markets would have to fall considerably before things in his region changed. “I would not anticipate that we would see anything like [retail choice] in my career. There aren't any benefits in it for our consumers,” Byers says.

With such divergent approaches, one might expect divergent views on deregulation, but that is not so. Across the country, industry leaders share many of the same opinions.

Transition: Ugly and Long

Electricity really is unique. More service than commodity, it cannot be stored and its reliable supply is critical to the safety and health of consumers. So do not expect electric restructuring to follow the same path that deregulation took in the transportation and telecom industries — or even natural gas for that matter. But we can learn a few important lessons by studying those cases. Namely, restructuring a large industry can only be messy and it takes a long time. It is up to us to recognize that the market is suffering from growing pains, not a terminal illness.

“Whenever you have an emerging market, you will have significant failures, folks trying to take advantage of the situation, and bankruptcies. We are seeing that. That is exactly what we expect to see with such an enormous change,” says Francis Shields, managing partner for wholesale energy for Accenture (New York, New York, U.S.).

Another not-well-considered fact about deregulation is the sequence of events. No one expected FERC to issue 888 on Monday so every residential customer in the country could have choice by Friday. However, it has been 10 years, and residential choice is still limited to certain regions. This might lead some to ask if deregulation failed. Not really. It just needs more time.

“We must recognize that there is a certain sequence in deregulation and that sequence is wholesale first, then you move to industrial and commercial customers and you end with the residential customer,” Shields points out.

Residential Delay

The reason why is obvious: Wholesale is a commodity business. You sell kilowatt-hours, usually in blocks. It is clean and simple, and not that many people are involved.

“In ERCOT, wholesale competition has worked quite well because we really have equal access to the grid. The Texas wholesale rules are such that it doesn't really favor one owner over another. We've got the unbundling of the wires from the generation, which is essential for an active wholesale market,” says Jones. “We've got a third-party grid operator. In other words, there is no incentive for ERCOT to favor one participant over another. And, I think those things are essential to having a viable wholesale competition.”

It is becoming clear that retail choice cannot happen until there is at least a modest wholesale market.

Once wholesale is up and running in a region, the opportunities created by restructuring can start to trickle down to the retail level, but retail is far more complicated. “When you are selling retail services you are selling customers the experience of buying electricity, including billing, customer care — those kinds of things — and you are likely to produce products that are much more customer-oriented,” says Julie Blunden, executive director of the Alliance for Retail Choice and senior vice president of KEMA (Fairfax, Virginia, U.S.).

Large customers are the first to benefit. “If you look at the total [restructured retail] load, it is overwhelmingly the commercial, industrial and institutional customers that have switched. The residential market is weak in most places, stronger in Texas,” Blunden says.

Even in areas that have not embraced retail choice, large C&I customers are working out ways to reduce their costs. “In the state of Washington, we do not have a general regime of open access at the retail level. There are a number of industrial customers in the state who have worked out arrangements with their utilities and with our commission to get unbundled retail service. But, that is not a generally applied state policy,” Byers explains.

Retail Growing in Pockets

All this is not to say that a robust retail market lies somewhere in our distant future. “To the surprise of many people, the retail market has been dramatically growing over the last three years. We are now at very close to 50,000 MW of load [in retail choice markets],” Blunden reports. She goes on to say, “KEMA's most recent calculation showed a little over 49,000 MW, and we expect that number to hit 50,000 by the beginning of 2003. Just to put that in perspective, that is larger than the peak load of the New England ISO, the New York ISO or the California ISO.”

Further, pockets of retail success portend a rosier future. “There are anecdotes of success very early at this stage in retail. ERCOT has presented a 15% to 20% savings in their view over the regulated market, but there are international examples, such as the U.K., where they presented as much as 30% savings to their end use customers,” says Shields.

Just a Matter of Time

According to Shields, the electric power industry is about 40% along in its way to a complete restructuring, and that took 10 years. Looking at the natural gas market for comparison, we see a market with 20 years of progress.

“Over the past 10 years, we've seen enormous savings for natural gas customers, significant price transparency, significant trading and liquidity. This year, NIMEX reported the highest natural gas volumes that they've had in their history of natural gas. So we are seeing a very liquid market,” Shields says. “And, at a time when there is a shortage of natural gas, the market is responding. Markets are wonderfully self-correcting. So we see a lot of success in the wholesale market, and for C&I customers, but we have yet to see significant success, even after 20 years, with the end user in natural gas.”

Patchwork Progress

While some markets are showing signs of success, restructuring is not being embraced everywhere, most notably in those areas with traditionally low power rates. In an open market, lower cost resources are naturally redirected to areas that pay higher prices. Consumers in states with low electric rates would see their prices rise if they restructured — in effect, subsidizing the cost of power in higher priced areas. “In general, what we've found is that a good chunk of the country — significantly more than half the states in the country — have decided that the best way to provide retail service is to not restructure retail service. The best way is to continue a regulated system — essentially a vertically integrated system,” Byers says.

In other parts of the country, changing the structure of retail service offers significant benefits. In part, that is because the costs of retail service there was high to start with, so there was a significant potential benefit. “In others areas, there was a power system in place that would relatively easily accommodate that kind of competition. The tight power pools of the East, for example, are significantly different than the way in which power is generated, moved and dispatched here in the West,” Byers continues.

This regional patchwork of varying rules might be considered part of the natural restructuring process, but it is not without its downside.

A study prepared by Cambridge Energy Research Associates (CERA; Cambridge, Massachusetts, U.S.), in collaboration with Accenture, details some of the consequences.

“After a decade of deregulation, the power industry is, at best, halfway along in the transition from regulation to the marketplace. The process has now stalled, leaving us with an unintended half market-based, half regulated ‘hybrid’ structure for at least five more years,” says Jone-Lin Wang, CERA director, North American Electric Power.

The transition to open markets and the hybrid structure create both opportunity and risk. According to CERA, a number of power companies lost more than 90% of the equity value in the last two years, while other companies performed better than the stock market in general. The report concludes that it is imperative for business executives, investors and policy makers to understand the forces that created such dramatic discrepancies.

Concerning the expansion of markets, the report predicts, “Retail choice will stall for several years. No additional states are currently considering retail competition. “It is increasingly likely that many states will extend, rather than end, the restructuring transition period — with the associated price caps and rate freezes — and in doing so, rely more and more on performance-based rates for distribution services.”

Blunden's view of the near future is more hopeful. “Because Texas will have had over a year of real competition, we are actually thinking that 2004 will be a turning point for the perception of retail markets. In addition, there is a possibility the California market will re-energize. (More than 4000 MW is still served competitively in California.) On top of that, we've had several major decisions and actions taken by states in the East that changed their default service structures — New Jersey, Maryland, Massachusetts. And, we expect to see regulatory changes that will basically redesign retail market structures in Ohio, Illinois, possibly Connecticut, and potentially DC and Virginia in the next years,” Blunden says.

Shields finds hope in the improving economy, saying, “I think during the next year or two, as we get past these economically troubled times, we will see liquidity returning. We will continue to see the success in industrial and wholesale markets. I think the Energy Bill with the PUHCA (Public Utility Holding Company Act) repeal will help increase investment. We will see enormous investments on all fronts — in particular, around transmission. (Not only because of the blackout, but also because of the great need for transmission investment that we've all been aware of for many years),” says Shields.

Finally, if Texas really is leading the way, then market restructuring has a bright future. Stakeholders in ERCOT continue to look for ways to improve their market. “There are certain groups that would like to see ERCOT adopt a model with a whole lot of nodes, not just the four or five that we are used to. If it looks feasible, we will probably make the transition late in 2006.”

“As we go, we learn more about how to make the market work. I believe things will just get better and better,” Jones says.

Patricia Irwin is a freelance writer based in Sharpsburg, Maryland, and a professional engineer.