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Power Procurement: What's in Your Mix?

Why competitive markets are scaring regulators.

Fortnightly Magazine - November 2006

industrial. Within each of these classifications there may be numerous different rate schedules. Each rate schedule historically may have built-in subsidizations creating the need for careful consideration of how to translate competitive supply prices into rates. The perceived risks customers are willing to bear will have a significant impact on pricing terms. Regulators must decide whether utilities are to obtain the entire supply in a single solicitation or to obtain portions of the supply at various intervals over a longer time horizon. A closely related decision is to determine the term of the supply contract. Regulators also must decide whether utilities are to obtain wholesale supply at fixed annual prices, fixed seasonal prices, or fixed monthly prices, or simply obtain wholesale supply at varying hourly prices. These numerous decisions result in markedly different state-procurement frameworks.

Table 1 surveys the structure of POLR services and associated procurement policies across the Northeast and Mid-Atlantic where retail competition has been introduced. Generally speaking, requests for proposals (RFPs) are the most common electricity procurement approach utilized in the United States. As Table 1 shows, POLR service definitions vary among states in a number of ways:

1) The groupings of retail customers for the purposes of POLR supply solicitations;

2) The contract term of POLR supply;

3) The pricing format of the wholesale POLR supply; and

4) The pricing format of the retail POLR service.

State regulators’ complex decisions in implementing POLR procurement processes have led to some notable changes in customer rates and rate structures. An objective often associated with introducing retail competition is to align customer class electricity pricing with the actual costs incurred to meet that particular customer-class demand. In many regions, all that is needed to achieve this alignment is for regulators to implement policies that specify the type of product and pricing a particular group of customers should face. To accommodate pricing that varies seasonally as well as diurnally no longer requires utilities to develop complex wholesale price-to-rate structure translations. This type of pricing can be obtained simply by requesting it from wholesale suppliers.

However, there can be obstacles to taking full advantage of the ability to specify pricing in a POLR supply solicitation. Indeed, it can sometimes be difficult to incorporate competitive market prices into existing rate structures due to the historic cross-subsidization among certain customer classes. In these circumstances, despite the reliance on wholesale suppliers for generation commodity pricing, the competitive price must be translated into retail rates that may not reflect the actual costs incurred to serve a particular customer or rate schedule. 3 Table 2 provides examples of how some utilities obtain retail rates from wholesale prices and shows that these “translation processes” can be simple or very complicated.

By deciding how to group customer classes (and whether to maintain certain rate structures) and the term periods for supply, regulators have the ability to create a menu of supply options they see as appropriate. Through these options, regulators can achieve policy goals, such as signaling when electricity is most costly, encouraging associated demand responses, and minimizing price volatility.