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Wild Prices Out West: What Can Be Done?

The problems stem from a lack of incentives for long-term, fixed-price contracts.
Fortnightly Magazine - November 1 2000
  • error—price caps.

Misstep No. 1 — No Incentive for Long-term Contracts

Under California's restructuring plan, investor-owned distribution utilities, like San Diego Gas & Electric Co., were required to buy all their supplies in the newly formed California Power Exchange (PX), where most transactions are for the next day and prices vary hourly. The utilities were not allowed to buy long-term contracts outside the Power Exchange that could have locked in prices for longer periods.

Only recently has the California Public Utilities Commission relaxed this restriction on long-term contracts outside the PX. But this relaxation does not fix the situation. Given that utilities are allowed to pass through to consumers the entire cost of PX prices, regardless of how high they are, they have little incentive to enter into long-term contracts. Such contracts will expose them to risk of disallowed overpayment, should Power Exchange prices fall, whereas any savings are passed on to the ratepayers. The net effect is that utilities until now had not been able to enter into long-term contracts that could stabilize retail prices, and now that they can, they have no incentive to do so.

For consumers, the impact from this lack of long-term contracts is analogous to forcing homebuyers into taking adjustable rather than fixed-rate mortgages. While fixed-rate mortgages may have higher interest rates on average, most homebuyers still prefer them as an alternative to the risk of volatility in short-term rates that comes with an adjustable mortgage. Retail customers in San Diego, and soon, in other parts of California, however, have no such choice for meeting their electricity needs.

Misstep No. 2 — No Incentive for Stable Rate Plans

The original intent of regulators in deregulating electric markets was to leave it to the competitive energy service providers, or ESPs, to offer service contracts with stable prices for consumers who switched from the utility in favor of a competitive retailer.

Nevertheless, that option was effectively muted by the decision of regulators to fix artificially the retail price offered by the utilities during the so-called "transition period." (The transition period allowed utilities to recover their costs for stranded investment, but only out of any revenues available after recovery of costs, and with rates frozen at a level 10 percent below the historical price.)

This approach was politically expedient, because it gave consumers a quick and visible benefit from restructuring. Unfortunately, however, by artificially shielding consumers from price fluctuations during the transition period, regulators in effect preempted the ESPs from attracting retail customers by offering service contracts with stable prices. Hence, retail competition was virtually killed, forcing competitive retailers such as Enron out of the California electricity retail market and leaving retail consumers with the exclusive option of purchasing their power from the regulated utilities. Now that the transition period in San Diego is over and the artificial retail price cap is removed, San Diego retail customers have been thrown into a volatile price world with no options for cover. Customers in the rest of the state are soon to follow.

Power plant investors prefer long-term contracts. These reduce