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Power Procurement: What's in Your Mix?

Why competitive markets are scaring regulators.

Fortnightly Magazine - November 2006

The ability regulators have to determine this menu is a significant benefit of retail competition.

Where Retail Competition Does not Exist

In regions that have not introduced retail competition, procurement policies continue to be tightly aligned with the development of integrated resource plans (IRP). 4 In recent years, several utilities in the Western and Southern regions of the United States have submitted updated IRPs 5 which, in most instances, have identified the need for additional generating capacity. However, the approaches by which utilities have obtained the needed capacity have varied considerably. While there are some instances where utilities are self-building generation capacity, this typically has not been the case. Instead, utilities are buying unregulated generation capacity and contracting for generation supply. In some instances, when utilities seek additional generation supplies, they issue requests for proposals from competitive developers of generation resources. 6 In other instances, utilities may compete (or negotiate bilaterally) to purchase the assets of firms that are exiting the generation business or restructuring. In many regions, this particular strategy has been facilitated by a generation supply surplus. As supplies tighten, there may be more self-build programs.

To the extent that a utility is short or long on generation over seasons, or that a utility needs to balance shorter-term supply and demand, there is a reliance on wholesale electricity markets. In this manner, these utilities often rely on competitive suppliers for portions of the generation capacity even though they are engaged in regulatory planning processes. Thus, competitive wholesale markets continue to be the source of power supplies on the margin throughout the United States.

In general, utilities in these regions no longer can conduct planning in isolation from commercial markets. The outcome of the planning process has been affected as open access to the transmission system has resulted in the construction of unregulated generation facilities. With these new generation facilities integrated into the transmission system, opportunities emerge to rely on these facilities for needed generation supplies. The primary difference between procurement from the unregulated plants in these regions and procurement from unregulated plants in regions that have introduced retail competition is that IRPs often identify longer-term supply commitments. This difference is due to the latitude utilities have to make longer-term purchases in regions without retail competition. Indeed, one of the key distinctions appears to be the greater propensity to make longer-term commitments in regions without retail competition.

The procurement approach in states that have not implemented retail competition is to minimize energy expenditures through a combination of using the least-cost mix of underlying generation supply identified by the IRP and ongoing wholesale transactions. This procurement method can be loosely described as a portfolio-resource-mix approach where the utility’s portfolio, or resource mix, dictates its average total costs at any point in time. 7 To ensure timely payment of all supplies, utilities usually are allowed to pass through variations in fuel costs using fuel-adjustment clauses. 8

Most utilities ultimately price supplies on an average total-cost basis. The implication is that it is more difficult to expose customers to prices that are reflective of