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Fortnightly Magazine - February 15 1997

My business, the natural gas industry, stands at a crossroads. Unbundling and deregulation permeate the market. The next three years will see the end of many fixed, long-term supply and transportation service contracts (em the closing of an era.

In fact, natural gas marks perhaps the last commodity traded on a major exchange that remains captive to such long-term contracts. The demise of such contracts will add flexibility to gas pricing and supply management.

This evolution will accelerate with a host of changes in the way gas moves in wholesale markets. Open access has focused our attention on new fronts: secondary markets; front-, middle- and back-end storage on interstate pipelines; transportation switch points; imbalance workouts; short-term parking; and hubs and market centers at pipelines and local distributions companies. Improvements in information processing promise greater efficiency in matching supply and capacity with buyer and seller. All these changes will vie for attention (em remaking the local distribution company, or "LDC."

Nevertheless, even the most forward-looking LDC will face a difficult balancing act, as it attempts to keep one foot ahead of the market, with the other taking care of monopoly services that remain subject to regulation. This awkward transition creates a new type of "virtual" company (em one that owns some traditional regulatory assets, but one that deals head-on with competition by outsourcing competitive enterprises, through unregulated affiliates or unrelated third parties.

Shaking Out

Traditional relationships already have fallen by the wayside. New alliances emerge daily. Roles appear less clearly defined (em for producers, pipelines and distributors. Pipelines no longer serve as merchants. Distributors no longer provide customers merely with bundled service and a clean, dependable, abundant energy product. The evolution has promoted a wave of gas industry enterprises (em new players that already have retooled to respond to new customer-driven market dynamics.

Distributors, like my company, Southern Connecticut Gas, must now tailor products and services to individual customers. In the ideal case, the LDC will retain fixed-rate, class-specific pricing only for distribution (em the monopoly function. It will transfer other services to affiliates that offer competitive, unregulated services. Competition will force better cost controls and enhance service quality. By isolating the activities of the regulated monopoly and outsourcing others to third parties (whether or not affiliated), the business improves performance. Overall, the LDC should be able to:

• Reduce subsidies among rate classes;

• Eliminate excess costs (incurred to guarantee service as a sole supplier);

• Limit hidden taxes in utility rates;

• Widen service options (via unregulated affiliates);

• Differentiate services among customers; and

• Trim regulated costs (by outsourcing).

In spite of these opportunities, utilities can be seen responding on three different levels: Leading, following or just plain idling.

The leaders are "market driven." These companies have re-engineered to provide customized, unbundled, deregulated, and repackaged service combinations. They are interacting with regulators, legislators, customers and competitors. Quite simply, they are working to set the industry standard.

Second-level utilities are looking on cautiously (em they recognize the coming change, but are weighing options and will choose a path based on the successes or failures of others. These