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Standard-Offer Service: Beauty or Beast?

Fortnightly Magazine - September 2008

the value of pipeline and storage-capacity contracts (including participation in capacity-release markets).

The mechanism (referred to as market-based rates or MBR) provides BGE with economic incentives to acquire gas supplies at the lowest possible risk-adjusted price. BGE shares 50 percent of the net benefits if the actual cost of gas is less than the market-based benchmark; alternatively there is also the risk that BGE stockholders will absorb half of the excess costs should the actual gas costs exceed the benchmark. In addition to the above sharing mechanism, BGE has a financial incentive to pursue capacity release and off-system sales opportunities. From 1996 (beginning of the MBR mechanism) through the end of 2007, MBR customers have saved about $63.6 million (their 50 percent portion of the savings) versus what they would have paid for the gas at Index. This covers flowing, storage, LNG and hedging savings, but does not include additional savings from off-system sales or capacity-release credits.

The gas commodity price that BGE charges its customers also includes adders to reflect administrative costs for commodity billing, credit and collections and uncollectibles. To the extent BGE’s gas-commodity price reflects current market conditions and applicable administrative costs, this sends the right price signal to both customers and alternative suppliers and, in that sense, reduces barriers to entry for suppliers. However, to the extent that BGE is highly successful at acquiring gas supplies at the best possible risk-adjusted price, this creates a challenge to suppliers not only to be efficient in pricing their product, but also to bundle their commodity supply with other value-added services.

The sale of electricity by BGE as a standard-offer service is determined by a procedure that establishes electricity prices based on a structured bidding process for electricity supply. The PSC approved an initial settlement establishing the local distribution utilities as the providers of last resort (POLR) in Maryland on April 29, 2003. The price to customers is based on a formula that includes: 1) the price the utility pays to wholesale suppliers for full-requirements generation service; 2) costs the utility incurs for network-integration transmission service and other transmission-related costs; 3) taxes; plus 4) an administrative charge that includes an adder to reflect the incremental costs of providing standard-offer service, including uncollectibles and a fixed per-kilowatt hour return to the utility. The overall structure requires that prices reflect market costs plus administrative costs and the utilities recover all costs and bear no market risks.

As wholesale prices have risen substantially in the last several years, the Maryland PSC has initiated proceedings, partially in response to legislative requirements, to examine a broad range of issues concerning electric-supply acquisition. While the LDC is charged with administering the bid process under the supervision of the commission, ultimately it is the competitive wholesale suppliers who must manage risks, develop supply portfolios and implement hedging strategies in order to participate in the bidding process in a profitable and efficient manner.

Best-Price Electricity

The Maryland PSC has instituted several proceedings to seek input on what changes, if any, need to be made to establish a competitive process