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Market Share in Generation: The Impact of Retail Competition on Investor-Owned Utilities

Fortnightly Magazine - July 1 1998

THE ROAD TO RETAIL COMPETITION IS A LONG ONE. HAVING realized that, utility management has quelled its initial panic and has begun to concentrate on longer-term objectives. For instance, how much market share am I likely to lose during competition's early stages? And what prices can I charge to various customer classes without incurring a loss in market share?

The answer could affect decisions about future load, asset divestiture and competitive strategies.

Quantitative measurement of future load in a competitive world relies on methods that capture customer sensitivity to changing prices. %n1%n Estimates of the price elasticity of demand, defined as the percentage change in demand for electric power caused by a given percentage change in the price of power, can be used to formulate generation market share. The problem might be characterized in this way: How much market share would the incumbent utility lose to competition if it should continue to charge regulated rates while competitors were free to enter and drive prices down toward the variable cost of producing electricity?

We know, for example, that even under regulated rates customers still have some ability to substitute for energy purchased from their electric provider. For instance, customers could always choose to cut their electricity consumption if prices rise. (This ability to curtail consumption is reflected in studies that estimate negative demand elasticities for electric power. %n2%n) Yet while customers have never been completely at the mercy of the incumbent provider, it is indisputable that their choices will expand dramatically under retail competition.

This widening of choices will transform historical relation- ships between electricity use and price. Thus, we analyze three possible scenarios: (1) no competitive alternatives (historic franchise regulation); (2) moderate customer choice, as exists today in a few dual-served territories; (3) full retail competition, which has been approximated using evidence from highly analogous industries that have already undergone a monopoly-to-competition transformation. By analyzing all three cases, the increase in customer responsiveness as a function of acceptable substitutes is explained.

Scenario #1

No Competition: Small Losses

The "no competitive alternatives" case is based on actual information from Niagara Mohawk Power Corp. %n3%n NiMo's data for tariffs and customer load by rate class along with information about the economy and weather patterns were used to produce a load forecast. The demand elasticities were drawn from this exercise. The estimates were similar to elasticity estimates published elsewhere. %n4%n For example, the NiMo data produces estimated elasticities for residential customers of about -0.25. In other words, for every 10-percent change in electricity prices, the change in electricity used was -2.5 percent. Similarly, the estimated demand elasticity for commercial customers was also about -0.2, while the estimated demand elasticities for industrial customers were just greater than -0.3. The estimates for NiMo's customer price sensitivity were combined with results from previously published studies to suggest a "lower bound" for market share losses due to retail competition. These findings appear in Table 1.

The predicted changes in market share provide a picture of modest price sensitivity in a regulated environment where customers do not have an option