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Converging Markets: The First Real Electric/Gas Merger

Fortnightly Magazine - October 1 1996

vertical monopoly, the utility functions as sole power supplier to its franchise customers (em in effect procuring the power it supplies customers from itself. In a sense, the vertically integrated utility internalizes the wholesale market as power passes invisibly from the utility as power producer to the utility as power

supplier. Rate regulation enables the utility to set the phantom wholesale power price at a level that generally provides it with a reasonable return, even if achieving a reasonable return requires it to charge a price far above the free-market wholesale price.

Where the gas-supply function takes place on the open market, the electric supply function lies buried in the fabric of the electric utility's vertical integration. There is no explicit wholesale transaction between the utility as producer and the utility as supplier, which enables the utility to control the pseudo-wholesale transaction and its phantom price.

The risk for the electric utility lies in the

disparity between its phantom wholesale price and the free-market wholesale price that would exist if customers were free to choose their power supplier. To the extent that the phantom price lies above the market price, competition poses a risk for electric utilities that never touches a gas distributor. This distinction provides an incentive for electric utilities to delay competition to keep their phantom wholesale price high as long as possible.

Advantage, Gas

Gas LDCs enjoy several advantages over electric utilities in positioning themselves for competition in energy services. First, gas LDCs are farther along the path in implementing competition. Large customers are now free to choose their gas supplier, and gas LDCs are in the process of extending this freedom to the smallest customers. By contrast, electric utilities are just beginning their first experiments with freedom of customer choice. Moreover, freedom of choice will probably not reach any appreciable number of electric customers on a permanent basis before 1998. Accordingly, gas LDCs will have more experience in dealing with the freedom of customer choice for a number of years to come.

Second, gas LDCs have incentive to implement competition; most electric utilities have incentive to resist it. This is particularly important organizationally. The incentive that gas companies have to foster competition will permeate their strategies and accelerate the cultural change required to compete effectively. Conversely, the incentive that electric companies have to frustrate competition will slow the development of strategies and organizational change.

As customer choice becomes the driver in gas and electric markets, gas and electric companies or their successors will find themselves competing head-to-head in an energy services market that involves both gas and electric services. With more experience and greater incentive to engage in competition, gas companies will find themselves in a better initial position than electric companies. t

Charles M. Studness is a contributing editor of PUBLIC UTILITIES FORTNIGHTLY. Dr. Studness has a PhD in economics from Columbia University, and specializes in economics and financial research on electric utilities.

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