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Standard-Offer Service: Beauty or Beast?

Fortnightly Magazine - September 2008

more involved undertaking as compared to natural gas. The process essentially involved legislative and regulatory changes, at both the federal and state levels, to facilitate the separation of the core functions of the electric industry: generation, transmission and distribution. Today, generation competes in the PJM Interconnection wholesale electricity market and PJM, as the RTO, is responsible for the reliability of the electric power supply system. The restructuring of the electric utility industry and the deregulation of generation supply was accomplished by clearly breaking apart the traditional functions of the vertically integrated utility. Many issues needed to be resolved to facilitate the large-scale changes in the industry, including: sale or divestiture of generation assets, establishment of regional transmission markets as independent operators of the open-access transmission system, unbundling of the utility’s rates, provisions for price protection (or frozen/capped rates during transition periods), stranded costs, etc.

Retail Choice: The success or failure of retail choice should not be judged by simple metrics showing the number or percentage of customers served by alternative competitive suppliers. Rather, with respect to a broad evaluation of energy markets, a first and foremost distinction must be made between wholesale competition and retail competition. It is imperative that both the supply of electricity and natural gas can be acquired in well-functioning wholesale markets providing reliable supply at competitive prices. Then the progress of retail choice should be evaluated separately for both mass market (residential and small business) customers and larger commercial and industrial customers. And finally, there is the fundamental conflict between the utility provision of supply services as a standard offer and the development of a robust competitive retail market.

Providers of Last Resort

The sale of natural gas by BGE as a standard-offer service is determined by a procedure that establishes gas prices based on the market price for gas at BGE’s “city gate.” A sharing mechanism, introduced in 1996, reflecting the difference between the market price for gas and the actual costs, provides an incentive for BGE to efficiently manage its gas acquisition costs in a manner that yields benefits to both ratepayers and the company.

The incentive-sharing mechanism provides for an equal sharing of the difference between the actual costs for gas and the market-based benchmark (the City Gate Index). If actual gas costs are less than the benchmark, then 50 percent of the savings will be credited to the customers’ commodity costs. If actual costs are greater than the benchmark, then 50 percent of the difference will be added to the commodity rate. The mechanism is designed to encourage BGE, without being prescriptive, to implement innovative strategies for obtaining natural gas supplies that will yield lower prices to customers and create the potential for additional earnings for the utility’s stockholders. In order to achieve the best possible results under the provisions that allow for a sharing of gains or losses as compared to the market indices, BGE has adopted risk-management strategies (hedging strategies) to manage commodity price risk, contracting strategies for the purchase of gas in spot, seasonal and long-term markets and strategies to optimize