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Redundant Restructuring: How the Dual-Retailer Model Makes Electric Markets Too Complex

Fortnightly Magazine - July 1 2000

current implementation standards.

Missing Incentives. The third disadvantage of the dual-retailer model comes from the lack of incentives for firms to increase the efficiency of their retail services. The lack of incentive is evident in utility cost studies. Although generation and transmission costs have declined during the last decade, distribution and back-office accounting costs have remained flat. 9 LDCs embed retail costs in their distribution prices regardless of efficiency. This cost adder prohibits the supplier from offering meaningful retail savings to customers. In addition, suppliers have little reason to invest in large-scale retail infrastructure because the LDC's subsidized back-office infrastructure is provided to them at marginal cost. If retail services were moved entirely to competitive suppliers, increased efficiency could be realized through technological innovation and economies of scale.

Under regulation, the scale of the LDC's regulated territory determines the scale of retail services, Q R. As shown in Figure 3, Q R is determined by the Q D of distribution's natural monopoly.

If transferred to the unregulated retail supplier, Q R could be determined by finding the minimum of the average cost curve of supplying these services.

It is true that through mergers LDCs can change their scale. However, the LDCs' scaling is less flexible because their Q R is subject to regulatory administration and predefined blocks of franchise territories.

Billing is a Function, But Not a Need

Many restructuring plans across the country provide for the further unbundling of billing and retail services at some point in the future. However, these plans treat retail services as an entirely independent service that, almost as an academic exercise, can be spun off to even more "competitive providers." In fact, retail services should be left in the hands of the supplier of the commodity, because suppliers have the most flexibility in determining their scale. This matter can be understood by considering the nature of the demand for Q D', Q R, and Q E.

Consumers in the market exert a demand to be connected to the electric grid, equal to Q D. This demand is not for the sake of connectivity itself, however, but is related to the demand for energy, Q E. If a supplier could more efficiently provide electricity with solar cells or fuel cells, then connectivity would be unnecessary and Q D would vanish. However, since the network usually is the most efficient means for supply, LDCs fill an important role as a natural monopoly.

Likewise, consumers do not express an inherent demand for retailing services, Q R. They do not request to be billed, to have a place to send payments, or to talk to call center representatives, except as a means for receiving electricity. Retail services are demanded by firms in order to offer products and services. In other words, Q R is a function of Q E. Only the unregulated retailer has flexibility in scaling Q E', and therefore they can scale Q R such that average retail costs are minimized.

If retail services were moved entirely to suppliers,