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Power Procurement: What's in Your Mix?

Why competitive markets are scaring regulators.

Fortnightly Magazine - November 2006

Despite significant differences in how electricity is procured across the country, the objective often is the same. Regardless of whether the region has implemented retail competition or is subject to traditional regulation, the intention of the regulatory framework is to minimize the amount consumers spend on electricity. Industry observers, however, have begun to ask whether states that have introduced retail competition face demonstrably lower or higher electricity prices than those states that rely on a more classical, vertically integrated regulatory framework.

The answer largely is a function of the competitiveness of the wholesale electricity markets, as opposed to the specifics of how different states regulate their natural monopoly transmission and distribution companies. If the underlying wholesale electricity markets from which supplies are procured are competitive, then the remaining concerns regarding price levels and volatility can be addressed through regulatory policies.

Where Retail Competition Exists

In regions that have introduced retail competition, legislation has authorized public utility regulators to design and implement power-procurement processes to replace the previous obligation of utilities to plan supplies for all customers. As is well known, retail competition has been ineffective at producing competitive supplies for residential customers, and has had mixed results for other customer classes. 1 As a result, regulators have found it necessary to create clear procurement policies for utility transmission and distribution companies. The procurement policies generally force utilities to competitively purchase generation supplies from the wholesale market to meet the expected demands of customers that do not obtain service from a competitive supplier. These electricity commodity procurement obligations are referred to under many names: provider of last of resort (POLR), supplier of last resort (SOLR), standard offer service (SOS), basic generation service (BGS), and default service. 2

Far from being universal, the competitive solicitation processes and the product structure for these POLR services varies greatly. Thus, considerable effort is required to understand in detail how the POLR service is specified in each state. Even a simple classification of these services is complex because of the various factors affecting the pricing and volume definitions of these services, and ultimately the power products themselves. Laws promulgated by state legislatures and the regulatory policies developed to implement these laws form the basis for defining important pricing and volume attributes of the POLR products.

When determining the POLR services’ pricing and volume definitions, regulators and utility companies need to consider a variety of factors that cannot be examined in isolation. At a minimum, these factors include:

1) The existing utility customer classes;

2) The existing utility rate schedules;

3) The perceived levels of risk each customer class is willing to manage; and

4) The policy objectives of the state’s regulators.

For example, existing utility customer classes often are the starting point for breaking up volume obligations with typical classifications being residential, small commercial and industrial, and large commercial and

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