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Energy Strategy: Flat Bills, Peak Satisfaction?

 

Why a risk-hedging product for small customers isn’t the gamble you may think.

Fortnightly's Energy Customer Management - Jan-Feb 2002

during the 12-month period we experienced a hot summer, a mild winter and an increase in fuel price. Though that caused Georgia Power to see a negative financial impact for the flat bill customers, it supported the natural hedge theory because the company earned a higher than normal return from weather-sensitive customers not taking the flat bill. 

The program is not designed to win every year; rather, it’s designed to earn a given return over multiple years. The scenario is similar to the bet a casino wagers. On any given roll, a customer can beat the house, but over a course of multiple rolls, the odds are set so that the house comes out ahead. Referring back to the free-ridership risk, most casinos “bet” that few winners will walk away from the table immediately after winning. The analogy with the flat bill is that even those few who leave the program will maintain higher consumption habits, which have become embedded in their behavior and will be captured in normal tariffs. The trick is managing the risk. 

 

Norm 4: Regulators Won’t Approve It. Even if the potential load growth is manageable, customers want it and the risks can be managed, many suppliers believe that commissioners in regulated regions will be opposed to the program’s innovation and risk.

It’s easy to understand why regulators would scrutinize this product. The industry norms suggest that there are established opinions against such a product. But we believed that by challenging each of these norms through market research, modeling and risk analysis, this product could be approved and introduced into the regulated electric market. After all, IPALCO had received regulatory approval in 1998 and offered a similar product ever since. In addition, we could address regulatory concerns through standard regulatory accounting to shelter regulated non-participants of the program from flat bill risk, exposing only utility stockholders.

Reality Check. In June 2000, Georgia Power received regulatory approval for a one-year pilot with a maximum number of 500 participants. The utility recently earned approval to expand the offering to 100,000 customers with no cap on participation. 

Managing Flat Bill Risk 

Energy companies can manage the financial return of a flat bill program based on its appetite for risk. It’s kind of like having your foot on your car’s accelerator: You can press down to go faster or release it to slow down. Likewise, there are two simple methods to control your risk and return. 

The first method is managing the number of participants (see Figure 1). You can phase the program in by offering a small pilot, then slowly expand eligibility to larger markets. That can give you time to assess risks and returns and make small adjustments to the pricing model, as well as to the program’s terms and conditions. 

The second method is to manage risk through a risk adder (see Figure 2). The risk adder is the premium charged to compensate the company for the additional risk it assumes. In any given year, the program could take in more or less money than what customers would