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Power Markets Disconnected? How to Reconcile Retail with Wholesale

Fortnightly Magazine - September 15 1999

Market Mismatch

How does the California and PJM experience translate into policy action to jump-start competition? Here are some solutions. Some of these solutions will require extra attention by state PUCs, while some will require FERC action. Others will force the ISOs to do more to assure that competition will flourish. None should require any fundamental jurisdictional change. Yet each of these solutions will require policymakers to become more cognizant that what they do affects the viability of markets.

1. Boost Shopping Credits.

If the wholesale cost of electricity, fully loaded for line losses, capacity charges, risk management and customer acquisition and handling charges, is greater than the retail shopping credit set by state commissions, there cannot be savings nor profits. A broad-based commodity market for electricity cannot be sustained under these conditions. This situation crippled the residential market for electricity in California, delayed the retail markets in Massachusetts and Rhode Island and even hampered some markets in Pennsylvania.

The credit provided by state regulators to the consumer under the generation portion of the retail tariff must be sufficiently greater than the total cost of buying wholesale power and delivering it to a specific customer or there will be no competition. Yes, competition is about more than price and short-term savings. But without the ability to deliver savings immediately, there is little reason for the market to get started.

When setting shopping credits in retail tariffs, state regulators should err toward setting the credits higher than absolutely necessary. If saving opportunities are too small, even a small unexpected increase in the wholesale cost can kill the retail market.

Some so-called economic theorists claim that there should be no premium above current costs to encourage customers to shop for electricity. These same theorists seem willing to provide for full recovery of stranded costs and disregard the real-world friction costs of getting people to change their purchasing habits. This adherence to so-called economic purity only delays competition and its benefits while creating deregulated monopolies.

Not only is it proper and necessary to set retail credits sufficiently above the delivered wholesale cost, but it also is possible. The Pennsylvania Public Utility Commission, in the face of enormous stranded-cost claims and without passing on to customers the savings of securitization in many cases, constructed tariffs where the shopping credits produced double-digit percentage savings on total bills.

When establishing shopping credits above the wholesale cost, state regulators also must establish a true-up mechanism that adjusts stranded costs when customers do not switch. Failure to do so will produce unintended windfall profits for utilities when customers stay with the utility, and therefore encourage the creation of impediments to competition. It always is preferable to eliminate the incentive for bad behavior than to try to cure bad behavior after it has occurred.

2. Tailor Credits to Load Patterns.

Not only is the absolute difference between the wholesale cost and the retail credit important, but so are the structures of their underlying components. One comparison that must be made is between the wholesale cost of capacity and the demand component