Competitors would have LDCs quit the merchant function and restrict
their dealings with affiliated marketers. But is that really good for consumers?
Those who would restrict business dealings between natural gas local distribution companies and their marketing affiliates (em going so far as to ban LDCs from the merchant function (em often overlook one critical downside: what those rules would mean for the small gas customer.
A regulatory policy for a code of conduct and LDC merchant service must improve the position of consumers. A regulatory structure that ultimately prevents utilities from staying in the merchant business and forces all consumers to buy gas from deregulated sellers may not provide the best answer, particularly for small consumers. Likewise, codes of conduct and separation rules that significantly burden the competitive position of utility marketing affiliates may hurt the consumer.
Such regulation will reduce, rather than increase, consumer choices if utilities and their marketing affiliates cannot compete for gas sales. In the short term, gas supply prices for residential and small-commercial users (em set by a market that is somewhere between monopoly and true competition (em may still require some level of regulatory oversight. But that oversight should be more "light-handed" than today's gas cost pass-through mechanisms.
At the end of the day, the market should allow natural gas consumers to choose the products and services they want from a broad range of competitors. It is up to regulators and state legislatures to balance the conflicting competitive interests of all of the market players (em both regulated and deregulated (em in moving the retail natural gas business toward a more competitive model. Importantly, the parochial interests of a particular industry segment (em whether utility or deregulated marketers (em in preventing others from offering competitive alternatives to their own services should not overshadow the real objective. That objective is meaningful consumer choice.
Unbundling (em What Competitors Want
Unbundling %n1%n of local distribution company services for all customers (em including small-commercial and residential consumers (em is among the most discussed issues in the natural gas industry today. New orders emerge from various state regulatory commissions on a regular basis. They tend to: 1) initiate a generic inquiry; 2) establish generic unbundling guidelines; or 3) docket a proceeding in which an LDC has filed for approval of an "experimental" residential unbundling pilot program. %n2%n
In anticipation of retail service unbundling, many distributors have announced the formation of marketing affiliates and energy service companies. %n3%n These new, deregulated companies offer a range of supply and supply-management services both inside and outside the affiliated utility's traditional market area. As the number of utility marketing affiliates has grown, so have the concerns among certain segments of the industry (em particularly other competing marketers. %n4%n They claim that an LDC can use its monopoly position to favor its marketing affiliates.
The regulatory solutions urged upon state utility commissions by these companies include: 1) organizational separation of LDCs and their marketing affiliates; 2) a standardized code of conduct to govern the relationship and business dealings between LDCs and their marketing affiliates; and 3) elimination of the LDC merchant function. %n5%n (It appears that this last item has surfaced as the principal goal of deregulated marketers.) The proponents maintain the market requires these extreme measures to develop workable, competitive retail natural gas.
From a consumer perspective, these restrictions on LDCs and affiliates likely will reduce competition and consumer choice, particularly for small retail consumers. However, the proponents of a utility-affiliate code of conduct have advanced many arguments. They maintain that such regulation is critical in developing a level playing field for competition at the retail level. Proponents of universal separation rules refer to the Federal Energy Regulatory Commission's adoption of Order 497, part of the pipeline unbundling process, in support of their position.
The Pipeline Example (em Not Always Instructive
While it might have been necessary to constrain activities between pipelines and marketing affiliates to encourage the development of third-party-marketer businesses in the 1980s, the circumstances in today's energy market are very different.
In 1985 when the FERC implemented Order 436, pipeline marketing affiliates represented the dominant supplier alternatives to pipeline merchant service. The same situation is not true for LDC marketing affiliates. To the contrary, today there are many well-established, national and regional marketing companies effectively competing with LDCs and marketing affiliates when there is open access to the end-use market.
Unlike the fledgling, start-up marketing companies of the early 1980s, today's marketing companies have significant financial resources. These companies are experienced network information managers that control and sell large volumes of natural gas on a daily and annual basis. %n6%n Compared with most utility marketing affiliates, or natural gas utilities themselves, the marketing company giants like Enron, Natural Gas Clearinghouse and PanEnergy, enjoy far greater market power over gas supply sales in open access markets.
As utilities continue to unbundle services and expand direct access to end users, including residential consumers, competition from the national marketing companies will only increase. These same national marketing companies that now dominate the wholesale market (some of which are leading the charge for retail affiliate separation) will stand well positioned to dominate the retail gas commodity market. The use of rigorous code of conduct and separation rules will only reinforce the market position of these companies by making it much more difficult for start-up LDC marketing affiliates to compete.
Affiliate Restrictions (em
The Negative Impacts
What are the likely consequences of imposing rigorous separation rules on start-up marketing companies? At a minimum, both the affiliate and the utility will see an increase in administrative costs. In addition, depending upon the degree of required separation, the transaction costs of both companies likely will increase because of a ban on shared staff. Moreover, divorcement of the marketing affiliate's corporate identity from the utility will adversely affect its market position and its cost of doing business. Thus, any potential competitive synergies between the LDC and its affiliate are minimized, if not eliminated.
While transactions between LDCs and marketing affiliates are becoming increasingly, if not disproportionately, burdensome, traditional pricing mechanisms (gas cost recovery factors) are making it impossible for LDCs to retain gas sales in markets open to competition.
As the market continues to move from monopoly to competition, LDCs are struggling to remain competitive selling supply under a traditional, weighted-average-cost pricing structure. Distributors offer unbundled transportation service for industrial customers in markets that have largely abandoned utility gas supply for gas from third-party marketers that can customize gas sales service. %n7%n The shift away from utility gas supply occurred because, on a comparative basis, utility bundled sales service (em made-up of a weighted-average-cost gas commodity plus full-margin delivery service (em is almost universally noncompetitive with alternative supplier prices.
As unbundling continues down to smaller customers, including residential customers, it is likely the same trend will emerge. That is, deregulated marketers, with unrestricted flexibility, can package customized gas delivery services to meet the varying needs of a segmented commercial and residential retail market. They will be able to "give the customer what he wants." Utilities that offer only a traditional merchant service with a commodity price based on a weighted-average cost will find it increasingly difficult to compete against these customized supply options.
The need to reevaluate purchased gas adjustment clauses at the retail level is obvious. In some jurisdictions, state regulators are taking steps to set up pricing models that are more consistent with the emerging market. Aside from these efforts, the transition from traditional pass-through, purchased gas adjustment clauses to a pricing structure that better
emulates pricing in a competitive market will take some time. If there is a lag between realignment of gas supply prices and distributor service unbundling, the utility will fall behind as a potential gas supplier to much of the newly unbundled market, except as a supplier of last resort.
On the other hand, a utility would at least have the opportunity to compete for gas supply sales to transport customers by offering a customized gas supply arranged through its marketing affiliate and delivered through an unbundled transportation service. However, conduct and separation rules will prohibit utilities and their marketing affiliates from providing "seamless" merchant services to consumers previously served through a bundled utility sales service.
Surely consumers will end up better off with more, rather than fewer, competitive options. Why not let customers have a choice of a bundled utility sales service, a repackaged gas commodity and delivery service offered jointly by the utility and its marketing affiliate, or a repackaged gas commodity and delivery service offered by third parties? If the services offered by the utility and/or its affiliate are not premised upon a preferential delivery service, then the consumer will benefit from aggressive competition among these service alternatives.
Residential Users (em
Not Like Industrials
If increased competition in the industry has done one thing, it has exposed all participants to the "the-customer-is-king" view. To stay in business, utilities need to give the customer what he or she wants. Services need to be "user friendly." Prices need to be competitive and flexible. Customers who want reliability should get reliability. Customers who want choices should get choices. These are all essential service elements.
Utilities, however, constrained by gas cost adjustment clauses and a uniform, weighted-average commodity price for all users, cannot compete in an increasingly segmented and unbundled
market. Although the utility's competitive position would be significantly improved if it offered a "repackaged," customized, gas-supply option with its affiliate, that activity would be barred by the model code of conduct. In other words, the utility will not be able to give customers what they want; therefore, it will not be a viable supply competitor in the emerging, unbundled market.
While there is a choice among deregulated suppliers, does it really matter if consumers will not have the option of buying gas from their traditional service provider, the local distribution company?
Looking to the federal model (em which ultimately eliminated pipeline merchant service as a part of Order 636 (em would suggest that getting rid of utility merchant sales is a nonevent. Except for the transition costs, the elimination of pipeline merchant service has occurred without incident. So why not follow the same model at the state level, starting with codes of conduct and organizational separation rules? The answer is simple. Most retail consumers are in a different market position than were wholesale consumers who had traditionally relied on pipeline sales service.
Residential and small-commercial users are not like LDCs or large industrials who were the primary merchant customers of pipelines. Unlike an LDC or an industrial customer, these small consumers clearly do not have the market power, sophistication or resources to deal directly with the competing alternatives that will replace bundled LDC merchant service. Therefore, even in an unbundled market, residential consumers and small-commercial users will be dependent upon a market intermediary, or aggregator, to arrange their natural gas supply and to manage their delivery services.
Traditionally, the only retail aggregator has been the local utility. As unbundling occurs, the same deregulated aggregators who currently sell to LDCs and industrials will compete to aggregate for residential consumers and small commercial users.
Giving consumers the option of buying gas supply (and related aggregation services) from a supplier other than the local utility is desirable. But, is it necessary, in the process of giving consumers the ability to buy from third parties, to eliminate their current aggregator (em the local distributor (em as an alternative supplier? Again, from a consumer perspective, the answer is "no."
LDC Merchant Sales (em
A Key Alternative
Having the option of choosing to buy aggregation service from an LDC (with whom the customer has a longstanding service relationship) or from a handful of well-established, national aggregators gives the consumer the advantage of choice. The more choices a consumer has, the better his or her bargaining position with potential sellers.
Forcing LDCs out of the merchant function, through restrictive affiliate conduct separation rules and outdated supply pricing mechanisms so that only deregulated supplier options remain, may also adversely affect consumer prices for natural gas service. In this regard, if utilities remain in the merchant function then there will be some level of regulatory review of prices charged for merchant service.
Even in those recent instances where state commissions have approved gas cost incentive mechanisms, as an alternative to the traditional gas cost recovery clause, LDC supply prices are still subject to regulatory review compared with established benchmark prices that are subject to periodic adjustment. Thus, regulators have a continuing role in regulating utility merchant gas prices.
From a consumer perspective, regulatory oversight of gas commodity sales by utilities provides an important check on all supply prices, beyond the check provided by price competition among alternative suppliers. As a practical matter, by overseeing the prices that a utility can charge for gas supply, state regulation impacts (perhaps as a cap) the prices that third-party competitors can charge to residential and small-commercial users for substitute services. %n8%n
Similarly, if a utility is allowed to provide a "repackaged" supply-delivery service using gas supplies provided by its marketing affiliate, presumably state regulators would have review authority over the transactions between the affiliate and the utility. Although the gas commodity sales would not be price regulated per se, the aggregate transaction would be subject to some level of regulatory review to insure, at a minimum, that inappropriate service cross subsidies had not occurred. t
Pamela L. Prairie provides consulting services to a variety of energy companies through P.L. Prairie, Ltd., an independent consulting firm. Prairie works with the Institute of Public Utilities on a project basis. She has worked in the energy industry for more than eighteen years (including stints at ANR Pipeline and Michigan Consolidated Gas), holding positions in marketing, gas supply, planning, business development, legal and regulatory relations.
1Unbundling, per se, appears to aid consumers. In fact, unbundling of gas LDCs will probably lead to the same kind of competitive benefits (lower prices greater range of choices) that have followed from pipeline service unbundling.
2See, e.g., Case No. PUD 960000133, filed May 17, 1996 (Okla.Corp.Comm'n); Dkt. No. 6355-U, filed May 21, 1996 (Ga.P.S.C.); Case No. 8683, filed June 28, 1996 (Md.P.S.C.).
3While some utilities have long-standing marketing affiliates (e.g. Michigan Consolidated Gas Company set up its marketing affiliate, CoEnergy Trading Co., in 1986), many distributors set up affiliated marketing companies after Order 636 was introduced.
4Especially Enron Capital and Trade Resources, Tenneco Gas Marketing and MidCon Energy Services.
5Arkansas, Georgia, Maryland, Ohio, New Jersey, New York and Wisconsin are among the states that have or are considering organizational separation and affiliate codes of conduct.
6Among the largest national marketing companies are: NGC-Chevron (1995 average 9.6 Bcf/day); Enron (1995 average 7.8 Bcf/day); PanEnergy (1995 average 7 Bcf/day); Coastal Gas Marketing-West Coast Energy Services (combined 1995 average 6.8 Bcf/day); and Amoco (1995 average 5.6 Bcf/day). The combined volumes of these five companies (37 Bcf/day) represent a substantial portion of the total natural gas market.
7See "Fossil in Your Future? A Survival Plan for the Local Gas Distributor," by Vincent J. Esposito, III, PUBLIC UTILITIES FORTNIGHTLY, Apr. 1, 1996, p. 18, which discusses the decline in LDC sales. According to the author, in 1984, one-hundred percent of utility deliveries were sales gas; by 1994 sales throughput was less than half of the aggregate deliveries by the utility industry.
8In a true competitive market, of course, there would be no need for regulatory oversight of prices. However, in retail sales to traditional core customers, the energy market is currently in a "transition state" somewhere between a traditional monopoly and a competitive market. So long as there remains an issue whether gas commodity sales to any class of customers is workably competitive, it is far better from a consumer protection standpoint to maintain some level of regulatory responsibility for service prices to that class.
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