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Electric Retailing: When Will I See Profits?

Deregulation Abroad: Still Reaching Its Potential
Fortnightly Magazine - June 1 2000

that in markets as far-removed as Australia, Britain, and California, the overwhelming majority of customers still prefer a fixed price for electricity, and are willing to pay a premium for being insulated from hourly price volatility.

The introduction of new pricing based on financial engineering represents a major innovation in the staid world of electric rate design. It is likely that U.S. ESPs will use price risk management to create a "second wave" of product designs, and thus extricate themselves from the "trench warfare" of pricing.

A side benefit of price risk management is that it mitigates price spikes in wholesale markets, such as those witnessed during the two past summers in the Midwest. The beneficiaries are those customers that have opted for spot pricing as well as customers that have chosen a fixed price, because lower price volatility translates into a lower "insurance premium."

Additionally, price risk management can enhance system reliability in capacity-short states such as California by introducing "demand responsiveness" in competitive electricity markets. Sen. Steve Peace has introduced a bill in the California Senate that would mandate the installation of a standard meter interface for all customers, providing access to "kyz" demand pulses. That would make it easier for marketers to offer various value-added services. 19

Down the road, one can expect to see large-scale deployment of "third-wave" designs that go beyond risk management. These designs would involve sophisticated bundles of energy commodity, linked with a variety of "value-added" service attributes such as power quality, energy efficiency, consolidated billing of multiple utility services, Internet access, and facilities management.

Some companies already are testing third-wave designs in the U.S. market. 20

States Joe Polaski, a former employee of Public Service Electric & Gas, "There is little money to be made in the competitive market by simply selling the commodity. Electricity providers are learning that value-added services are the key to increasing revenue."

In a similar vein, Joe Lanoe of Domosys Corp. says value-added services have a profit margin of 25 percent to 75 percent, as compared with the 2 percent margin in commodity sales. 21

Earnings are beginning to accrue to the shareholders of ESPs that deploy such third-wave designs. Enron Energy Services, which specializes in the bundling of energy-efficiency services with commodity risk management, finally broke into the black in the last quarter of 1999, and earned $16 million in the first quarter of this year. 22

In Britain, oil, gas, and water companies, encouraged by the resurgence of interest in retailing energy, have entered the business. 23 Every PES has been divided into a distribution-only company and a retailing company. A total of 56 other companies, besides the 14 PESs, now market retail energy. All the major generators have acquired PESs, paying between £150 to £200 ($236 to $315 U.S.) per customer. New entrants are paying about £60 ($95 U.S.) per customer.

A similar phenomenon is being seen in the Australian market. Electricity distributor United Energy has formed a four-way joint venture with companies such as Royal Dutch/Shell to pursue the 7.4 million customers that will have