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Power Procurement: What's in Your Mix?

Why competitive markets are scaring regulators.

Fortnightly Magazine - November 2006

and working capital costs. This consideration, however, does not take into account long- and short-term decision making that may be inefficient, or that benefits can be realized by providing customers with more accurate price signals. At the same time, there are concerns that the shorter-term risk-management costs incurred to supply power in states that have introduced retail competition are consistently higher than those that would be incurred under a portfolio resource mix approach. No evidence suggests that this is true. Instead, there is simply a great deal of concern at the moment that the marginal cost of electricity is causing consumers to pay too much for electricity. Evaluating the true cost differences between these approaches may be impossible, but as time passes we will accumulate evidence on how well each approach performs overall.

Two Approaches

A national debate surrounds the regulatory process behind procurement of electricity supplies. There are broadly two approaches: the competitive-solicitation approach in regions that have introduced retail competition and the portfolio-resource-mix approach in regions that have not introduced retail competition. The two approaches provide different means for managing the risk inherent in a world of growing energy needs and changing fuel prices. In the portfolio-resource-mix approach, the utility that faces no competition directly oversees risk management under the regulator’s scrutiny. In the competitive-solicitation approach, market forces manage risk through competition to supply utilities, and regulators assess the outcome. To date, no evidence exists to suggest that market forces cannot manage risk effectively. If anything, regions that have introduced retail competition are beginning to see the start of a healthy wholesale market, with the help of innovative and previously impossible regulatory decisions regarding supply choices. At the same time, regions that have not introduced retail competition are seeing IRP usage with ongoing prudence reviews of utility resource-mix-procurement decisions. These regions have experienced increases in procurement costs from fuels in the current portfolio resource mix; in some cases, these procurement costs have led to increases in retail rates, while in other cases there have been disallowances. No current studies suggest any one approach is preferable.

During periods of escalating prices, shorter-term procurement approaches inevitably will come under criticism when compared with the longer-term fixed-supply options that had been in place prior to the price increases. During periods of declining prices or technological innovation, we would expect the opposite. Regulators can narrow the gap between these approaches, however, by promoting longer-term supply commitments in restructured markets and more flexible market-based pricing approaches in non-restructured markets. However, the most important action regulators can take to minimize consumer electricity costs is, and will continue to be, ensuring competitive wholesale markets while demanding a rich mixture of products from the suppliers in these markets. The less often utilities find themselves “competing” with wholesale market suppliers, the easier the process will be for regulators to oversee, and the better the outcome for retail consumers.

 

Endnotes

1. See, for example, United States of America Electric Energy Market Competition Task Force and the Federal Energy Regulatory Commission (June 5, 2006), Docket No. AD05-17-000, Report to Congress