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## Pricing Off the Tariff: How to Figure the Maximum Supportable Electric Rate Discount

to consider the likelihood of direct access. Suppose that the utility believes there is a 50-percent chance that retail access will be implemented by the beginning of the fifth and final year of the analysis period. Assuming that the utility analyst believes there is an equal chance that direct access will occur in any particular year, it can be shown that the cumulative probability of 50 percent implies an annual probability of 12.94 percent. %n1%n Using this information we derive the probabilities that direct access (and customer departure) occurs for each of the five years (see Figure 1).

In Figure 1, the probability values in each circle (node) show the probability that customer departure occurs at the beginning of the first year, beginning of the second year, and so on. The computed values are based on the assumption that the customer does not return to the utility supplier once he has left. The node connected to the rounded rectangle, labeled Yr. 1, shows that there is a 12.94 percent chance of customer departure in the first year. The node connected to Yr. 2 shows a 11.27 percent chance that customer departure will occur at the beginning of year two. This second-year figure is calculated as the product of the probability that the customer stays in year one (87.06 percent) times the probability that of leaving (12.94 percent) in any year. In similar fashion, the probability of customer departure at the beginning of the third year is calculated as the product of the probability that the customer stays the first two years (87.06 percent ' 87.06 percent) and the independent probability of departure (12.94 percent). Given all of these assumptions, the expected gross margins are shown on Table 1.

When Bypass Occurs

In Table 1, Column 2 shows the annual gross margin and the cumulative present value gross margin if the customer continues to take service at the current tariff rates throughout the entire five year period. Column 3 shows the gross margin impacts if the customer should opt for an alternative generation supplier at the beginning of the first year. In that case the utility would recover no gross margin contribution for any year over the five-year period.

Columns 4-7 show the gross margin if the customer opted for a nonutility supplier at the second year, third year, and so on, respectively. The row labeled "Cum PV" refers to the cumulative present value gross margin for each possible outcome, discounted at the assumed 10 percent cost of capital. The row labeled "Prob." refers to the probability of occurrence of each outcome. Since there is a 12.94-percent chance that the customer will seek an alternative supplier each year, the probability that the customer leaves at the beginning of the first year is just that.

The remaining probabilities are determined as described above. That is, each value represents the conditional probability that the customer leaves in any particular year (I), given the cumulative probability that he has remained a utility customer in year (I-1). The row labeled "Prob. Wtd." is just the simple product