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Fortnightly Magazine - July 1 1995

T.R. Standish's letter ("NUGs Take the Cake," May 1, 1995) in response to our article ("How State Regulators Should Handle Retail Wheeling," Feb. 15, 1995) reflects the views of those who believe that the full benefits of competition in the electric power industry do not require retail competition. Mr. Standish, in fact, believes that retail competition is bad and not inevitable. We would like to address several of his points:

Reasonable people can certainly debate the inevitability of retail competition. But unlike Mr. Standish, we feel that competition in the electric power industry will penetrate the retail sector. Once competition begins in an industry, it quickly spreads to all facets. We have seen this in the telecommunications and the natural gas industries; there is no reason to believe it will not happen in the electric power industry. We feel that as competition develops in the electric power industry the distinction between wholesale and retail wheeling will increasingly become blurred. The retail seller will face increasing competition from "bargain" sellers, and will, in turn, pressure the retail utility to tailor its services to the individual needs of customers (em which, in essence, is what retail competition is all about.

E We agree that small (core) customers should not suffer from retail competition. In fact, we believe that if retail competition is to be socially desirable, all customers should have the opportunity to benefit. We disagree with Mr. Standish and others that retail competition is merely a ploy of industrial customers to shift costs to other customers. Clearly, industrial customers will benefit from retail competition. We believe that retail competition will enhance pressures to improve the overall economic performance of the electric power industry.

I We agree that nonutility generators (NUGs) will prefer to sell their power directly to retail customers. These customers will benefit as long as NUG prices are below the utility's embedded generation costs. NUGs will prefer selling power to retail customers when the price these customers are willing to pay exceeds the local utility's avoided cost. Such incentives are, after all, consistent with the operation of competitive markets.

There can be a problem, however, if the local utility is unable to lower its price in response to competitive forces, leading to what economists call "uneconomic bypass" (em where the purchaser makes a rational decision to buy from a higher-cost, but lower-priced, power producer. Assume, for example, that a utility's embedded rate equals 7 cents per kilowatt-hour (›/Kwh), its marginal cost equals 4›/Kwh, and the NUG's marginal cost and price each equal 5›/Kwh. In this scenario, the customer would buy from the NUG even though the utility has the lower marginal cost. Although pricing flexibility would largely avoid this problem, the utility would find its revenues and profit margins decreased. We strongly suspect that Mr. Standish would not object to pricing flexibility, but would oppose having to reduce costs or having utility shareholders shoulder the lost revenues.

I We cannot dispute Mr. Standish's comment that many utilities have paid excessively for power from qualifying facilities (QFs). Mr. Standish is incorrect, however,