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Retail Power: Double Down or Fold?

Utility retail is at a crossroads. Energy executives must decide which path to follow.
Fortnightly Magazine - June 1 2003

of renewable generation, and the possible emergence of residential combined heat and power plants over the next five to 10 years, suggest continued long-term downward pressures on generation margins and commodity prices. The variability of gas prices has created periods of time where falling gas prices add to these downward price pressures. Further, during these periods of declining gas prices, the regulatory lag for past under-collections can amplify the gap between market prices and regulated prices. Thus, in some markets, forwards fall much more rapidly than the retail price ceilings, be they default, price-to-beat, or standard-offer tariff rates during specific periods of time. Of course, the opposite is also true when prices move the other way. Therefore, the timing of retail marketing campaigns is crucial. The net result of this price volatility is the creation of marketing windows where, depending on the exact nature of a retailer's supply options, opportunities exist to price deals based on a declining forward market, while competing in the mind of the customer with a lagging price ceiling. It is just this sort of window of opportunity that sparked the rapid transformation of the U.K. gas markets in the 1990s.

This, of course, is an ever-changing situation to which retailers must adapt. The natural gas price-induced cycles may be much shorter in duration and come with greater frequency. With sharp timing of retail marketing activities, retailers can capture the combined value of both. In addition, given the fact that many financially hobbled generators are in need of revenue to cover short-term interest payments and fixed costs, energy retailers are much better positioned to negotiate a portfolio of supply arrangements that can profitably match a growing retail book. Another positive condition is due to the continued expansion of gas infrastructure. This expansion supports more new, creatively located generating facilities that can mitigate congestion costs and ensure reliable delivery of power. Again, this provides a clear benefit to an expanding retailer's book of business. In summary, the pendulum has swung in favor of retail. Generation had a field day in the late 1990s worldwide, but today the pendulum has swung away. Retail electricity prices are unlikely to fall as fast as generation prices for a number of reasons. First, there are far fewer retail competitors than there were just 18 months ago. In addition, there continue to be retail businesses available for sale. Finally, the remaining retailers appear to be committed to much more informed pricing.

For these reasons companies willing to double down are well positioned to reap the substantial profits of savvy retail service providers in a world of cutthroat wholesale commodity competition. Retailers that transform a mass-market retail segment and grow to dominate the new category have created immense shareholder value over time. McDonald's, Home Depot and Wal-Mart have each transformed a portion of the retail landscape, renamed it as their own, and created immense wealth along the way. Each of these retailers serves the basic needs of human existence. Food, clothing, and shelter are at the base of Maslow's hierarchy of needs. These goods are