Texas wins raves from the big players for its rules and systems, but the small consumer, as in other states, sees little reason to switch.

Six months into the opening of the restructured Texas electric market, industry players are generally pleased with the results, but the jury is still out, as the state's vaunted system design has shown some cracks, and consumers still see little reason to switch their energy supplier.

It's true, of course, that Texas has won raves for putting much of the metering, switching, and data management software in the hands of ERCOT, the Electric Reliability Council of Texas, which acts as independent system operator for the Texas grid and regional market.

And Texas comes out ahead in most comparisons with Illinois, the other major state also pushing electricity competition in the post-Enron, post-California era.

Texas can count numerous retail electric providers (REPs), as alternative power suppliers are called in Texas. Those REPs are vying to sell the electricity commodity to the residential and small commercial sector, as well as to larger commercial and industrial (C&I) customers.

In Illinois, for example, you won't find the same level of praise from retail suppliers, especially those targeting the residential sector. Illinois law (S.B. 24) allowed residential customers of investor-owned utilities to buy electricity from third-party suppliers beginning on May 1, about 18 months after commercial and industrial (C&I) customers had won the same right. But by the time that May Day had rolled around, not a single third-party supplier, dubbed alternative retail electric suppliers (ARES) in Illinois, had stepped forward to sell competitive energy to residential customers. Two months later, customers were still waiting for a competitive offer.

But why should they worry? After all, those same customers won nice rate cuts under the new law. Legislators mandated a 15 percent rate cut by fall 1998, plus another 5 percent by May 2002. And the Texas restructuring law (S.B. 7) also required rate cuts. (A 6 percent rate reduction took effect Jan. 1, 2002.)

In fact, some analysts see few incentives for consumers to switch, whether in Illinois, Texas, or elsewhere. The savings, they say, come more from legislative fiat than from competition.

"You can give people choice in the legislation at the state level," explains Steve Behrens, vice president with the Utility Consulting Practice at Cap Gemini Ernst & Young U.S.

"If aggregators or electric suppliers choose not to come into your state, you can say, well, we must be doing pretty well then. If the existing utilities were run that poorly, then people would be coming in, saying that they could offer a lot better service at a level cost."

And even the Lone Star model has begun to show some tarnish. Recent news reports cite software problems in logging service and switching requests and in getting bills generated and sent to customers.

Consumer advocates now warn that the Texas system could fall prey to a California-style virus. One such voice comes from Janee Briesemeister, senior policy analyst in the Austin, Texas office of Consumers Union, a nonprofit consumer research organization.

Briesemeister contends there are similarities between the alleged manipulation of markets during the California power crisis and what occurred in Texas during its pilot phase last summer.

"To say that what happened in California had to do with only a lack of generation is to misunderstand what happened in California," she says. "The evidence that Enron purposefully manipulated the market proves that. Jamming transmission doesn't have anything to do with having enough generation or not. It's about not having enough transmission. And we don't have enough transmission in Texas."

Market Penetration

The big industrial and commercial customers were some of the biggest proponents of the Texas choice plan. They saw a chance for substantial savings on power bills. Reliant Energy Solutions, the Houston-based energy marketer to C&I customers, says its clients now are saving between 10 and 30 percent, depending on their consumption rates. "I know in our portfolio alone, that compared to what my clients were paying last year for electricity, [there] is about a billion dollars in savings right now," says Jim Ajello, president of Reliant Energy Solutions, the retail marketing affiliate of Reliant Energy HL&P, the regulated pipes and wires company.

He says about 40 percent of the large customers have chosen to switch to a new supplier. The rest decided to stay with the affiliate. "There are six to eight major competitors in this market," Ajello adds. "Pricing is very tight between the respondents. There's a great variety of ways to contract for the service. I think the industry's perspective is that it's a pretty competitive one and we can see that through the switching rates."

At Consumers Union, Briesemeister won't argue the point.

"Overall, we didn't see any pressing need to deregulate electricity," she says. "But as far as the law goes, I think the Texas law was one of the better ones. It didn't neglect customer protection as California's law did initially. Some of the provisions such as the price to beat, the length of time the price caps extend, were meant to protect small consumers."

Meanwhile, because the transition period in Illinois lasts through the end of 2006, it appears there won't be much of an incentive to get the residential market working right away, says Tom Michelman, senior professional at Xenergy, a Burlington, Mass-based consulting company. "As the transition comes to an end, then that's a different story," Michelman explains. "But that's a long way off in Illinois."

Customers of Commonwealth Edison (ComEd), which serves 70 percent of Illinois' population, are paying less than they were in 1990, a benefit created by the restructuring process in Illinois, according to ComEd's top regulatory official.

"If you take an average bill, which is less than $100, and you save 10 percent, that's $10 or less per month. Is that worth peoples' time and effort?" asks Arlene Juracek, vice president of regulatory and strategic service for Commonwealth Edison in Chicago. "And for the competitive supplier, I've heard that it takes maybe $150 to acquire a customer. Is it worth his time to go after someone smaller?"

As suppliers work out their transaction cost issues and as the market matures, Juracek foresees profit opportunities for ARES willing to test the Illinois market. "But it takes time for markets to work their way down," she explains. "When you look at how long we've been at telephone and gas deregulation, it just takes a long time, and 10 years is not unheard of based on the experience we've had in these other industries."

ComEd sells about 80 billion kWh, Juracek says. So far some 21 billion kWh of that total load (C&I and residential) has taken delivery-only service and jumped into the market (see Figure 1).

By contrast, more than 40 companies have filed as REPs in Texas and about 20 are actively engaged in attracting customers in the market. That number includes the unregulated marketing affiliates of the distribution companies in the state, as well as big independent retail marketers such as Centrica's Energy America and Green Mountain Energy.

Overall, the Texas restructuring law provided stronger incentives up front for suppliers wishing to serve residential customers, but it's still a real tough business, says Michelman.

"Reliant and TXU spent $100 million to get all their systems in place to deal with the chance of getting all these customers. That is clearly not an option for almost any retailer out there."

Fear of California

The failed restructuring scheme in California is obviously the one that most Texas restructuring boosters hold up as the poster child for the wrong way to organize a new electricity system.

"We learned a lot from California," says Brett Perlman, a commissioner of the Public Utility Commission of Texas, who was appointed to the post in 1999 by then-Governor George W. Bush.

"The key legislators who wrote the bill actually went out to California and they said, 'If this is what choice is about, [we don't] want it.' The learning experience from California has been something they brought back and was a foundation of S.B. 7. We've continued to monitor the market for some of the activities that have gone on in California."

Unique features, such as a self-contained transmission system-only two small interconnections tie Texas to outside electric grids-and its 20 percent power reserve, are two key factors identified as reasons why the state has succeeded in attracting suppliers to the market and maintaining a reliable power supply. Bill Hunter, utilities restructuring leader at Cap Gemini Ernst & Young, has been unable to find anything in the Texas system that signals a repeat of California.

"I don't foresee anything happening in the Texas market that would create the kinds of problems locally in terms of spiking prices, blackouts, and that sort of thing that would drive a retail retrenchment in Texas," Hunter says. "Texas has more margin than certainly California did. But obviously, if for the next three or four years nothing gets built in Texas and demand continues to increase and you get some weather, all of the uncontrollables turn against you, then I would suppose there could be a problem. But I think the problems from this point forward are going to be created politically."

Reliant's Ajello hasn't noticed any fallout from Enron's bankruptcy or disclosures of round-trip trading by large energy merchants, including accusations against the wholesale marketing arm of Reliant Energy, on Reliant Energy Solutions' ability to sign up C&I customers.

"The customers that we work with are very sophisticated, very large customers, and they have the wherewithal to evaluate the fundamentals of our business as we evaluate the fundamentals of theirs," Ajello says. "I think they are able to dissociate some of the noise from the substance of our business, which is very solid."

Still, some aren't convinced the Texas system is mature enough to warrant any weakening of the guard. Xenergy's Michelman says any significant gaming of the wholesale market in ERCOT, although unlikely to happen given the structure of the market, could have a knock-on effect on the newly restructured retail market in the state. "There could be a big political backlash," Michelman says. "It wouldn't necessarily be the retail market's fault for what happened, but it's easy to think, 'We changed this big thing and maybe we shouldn't have.' "

Briesemeister contends there are similarities between the alleged manipulation of markets during the California power crisis and what occurred in Texas during its pilot phase last summer.

"My point has always been that now we all say that California had a flawed market design," she explains. "Californians didn't sit down and say, 'Hmm, how can we really screw up this market design? How can we do a market design that will maximize the opportunities for gaming and price gouging?' They didn't do that."

Any market system, however intelligently designed, can be gamed if someone has enough incentive and enough cleverness, Briesemeister argues. "So what you really need, I think, more than the market design, is to ensure that the market has the transparency and the oversight to ensure that any monkey business is detected quickly and that there are harsh penalties. That's what creates the big disincentive to game the system."

Regarding allegations of gaming of Texas' wholesale transmission market last summer, Hunter says he's not sensing that the Texas PUC's investigation into the claims is discouraging activity in the market. "I think you've always got different people spinning what happens for their own agenda," Hunter contends, adding that one of the PUC's priorities in Texas should be to add more market surveillance, no matter if operations appear to stay above board.

A lot of the skepticism with California's restructured system, Hunter says, was hindsight. "I didn't hear anybody-and I was very involved in California at the time-predicting the kinds of issues that came up two years in, and I don't think anybody really predicted that, although in hindsight everybody can see where it came from."

Software and Systems

There's certainly little skepticism, at least from industry participants, that Texas has crafted the most effective set of rules, systems, and software of all the state programs for retail electric choice.

"We can go in there and we can do business in the entire area of ERCOT with one set of rules, one control system, one back office," says Dave Cenedella, marketing manager for Xcel Energy's deregulated group, which operates in Texas under the name Xcel Energy Retail Services. "When you go into somewhere like Illinois, Pennsylvania, etc., you're dealing with different rules for each transmission delivery company."

Xcel Energy, the Minneapolis-based diversified energy and utility company, owns Southwestern Public Service Co., which serves power customers in the panhandle of Texas. The Texas panhandle, however, is situated in the Southwest Power Pool, outside of the ERCOT control area, and is exempt from Texas' restructuring law.

Gillan Taddune, president of the Texas region for Austin-based Green Mountain Energy, a renewable energy retailer, says another important element of a healthy energy market is whether it has standard electronic transactions and uniform business rules. These standards would need to apply to every utility in the region, "not like in New York, where if you're going to deal with one utility you've got to adjust your systems one way, and if you want to go into another service territory you've got to rebuild your systems."

Green Mountain began offering its wind-generated power to residential and small commercial customers in TXU's and Reliant Energy HL&P's service territories during the Texas retail competition pilot. That pilot began last summer and then expanded into Texas-New Mexico Power's service territory in January and Central Power and Light's service area in April. The premium for Green Mountain's "green" power usually runs $4 to $5 a month.

Whether Texas' restructured market, if it continues to thrive, can and should be used as a model for other states thinking about injecting competition into their electric power industry is open to debate. Green Mountain's Taddune firmly believes the basic concepts from Texas-uniformity in business rules, standardized electronic transactions that apply to every utility, not requiring a "wet signature" for a customer to switch suppliers-can be transferred to any state.

Texas also has shown how to move quickly on building new generation and addressing transmission issues, says Tom Rose, vice president of public policy for TXU. Another important factor in Texas' success, Rose suggests, is the fact that state authorities made sure to allow the establishment of a robust wholesale market before opening the retail side to competition.

"If you don't have the wholesale infrastructure in place-and that's both power plants and transmission lines-you're not going to have a successful retail market," Rose says. "We will tell any state that that's the most important thing is to get that infrastructure in place as you move into these retail markets, and make sure you've got that going in the right direction before you open the retail market because they're new markets."

Xcel Energy's Cenedella says the way Texas structured the market and its single control area made it possible for many new players to enter the market and be successful. "I think there are some unique things about Texas, which allow this market to work," Cenedella says. "But I also think it's a good model for the future, too."

Michelman says there are "profound lessons" to be learned from the Texas market. The Texas PUC's jurisdiction over ERCOT and its ability to coordinate wholesale and retail initiatives, unlike any other market to date, have been critical to Texas' success.

One of the big differences between Texas and all other states is that the ISO has retail responsibilities along with its wholesale functions. "I think that is something that potential competitors find very attractive about Texas but at the same time it has been very difficult to implement," says Briesemeister. "The systems are still not functioning properly and customers are not getting switched [and are not] getting bills."

As of mid-May, as many as 150,000 customers in TXU's service territory still had not received an electric bill since the debut of the new unbundled system, and 90,000 customers in Reliant's service territory had not received an electric bill.

"There you have over 200,000 people in the state who I'm sure don't think dereg was good from them," Briesemeister says. "They're faced with getting a very large bill that they will have to pay off."

The unique infrastructure of the Texas system has caused some to argue that, while the model may be good for Texas, it's not exportable to other regions. With no FERC oversight in Texas, industry players can expect consistent policy initiatives from the state legislature and the Texas PUC, which has sole authority over retail and wholesale markets in the state. In other states, there often are frustrating struggles between state authorities and FERC.

"Texas is a world unto itself. It's a market unto itself," says ComEd's Juracek. "It's regulated by one entity, instead of FERC and the local PUC. In Illinois, we've got a different situation. We've got a regional market. We've got dual levels of regulation and we were doing this a whole lot sooner than Texas was. So there was a whole lot of uncertainty."

Juracek says that Illinois legislators, regulators, and industry officials had the luxury of looking at California's market design and understanding that state officials in California had a predetermined picture in their minds of what the industry should look like. "And we said, 'no,' we think the market should evolve intelligently, the way it wants to evolve," she explains. "And Texas comes along a little bit further and says, well, we kind of see how markets possibly are evolving, so we'll prescribe something that causes the utilities to split themselves up differently."

When Juracek looks at how Texas forced the utilities to separate their merchant operations from the transmission and distribution functions, she doesn't see much difference: there's still the utility and its affiliate. "It's sort of the same cast of players," she says. "They've just reshuffled the deck."

The Price to Beat: Flexible, But Rigged?

The Texas rule mandates that customers who don't choose a third-party supplier automatically will be matched with their regulated utility's affiliated retail marketer. These customers are charged the "price to beat," Texas's version of the "shopping credit," a concept mapped out in deregulation plans in many other states.

In Texas, the price to beat includes the electric commodity charge, transmission and distribution costs, and non-bypassable items such as system benefit charges and stranded cost recovery. A customer thinking about switching suppliers will compare competitive offers for generation supply against a standard-offer price quoted by the regulated utility as supplier of last resort.

But the question remains whether regulators stacked the deck by setting the price to beat unreasonably high to encourage switching and to make the results look better, at least in the residential market.

Prior to restructuring's launch this past January, the Texas PUC set each affiliated retail supplier's initial price to beat based on utilities' filing of the forward prices of natural gas in each month of 2002. Affiliated retail suppliers can adjust the price to beat twice a year as long as they can demonstrate to the PUC that there have been significant changes in the market price of gas and other purchased energy.

"I think the price to beat is clearly the linchpin for establishing a competitive model," contends Commissioner Perlman. "It has to be a balance between protecting the interest of customers in the traditional sense and providing customers with options. In order to provide customers with options, there has to be sufficient amount of margin in the market for new players to come in and compete."

Although it doesn't serve customers in its regulated affiliates Texas service territory, Xcel Energy Retail Services is aiming to sign up commercial and industrial customers elsewhere in the state, primarily in the service territories of TXU and Reliant Energy HL&P. "One of the attractive things was that the price to beat was set at a level that would allow people to come in and offer additional savings," the company's Cenedella says.

Allowing power prices to take into account fuel prices was a concern for the affiliated REPs in Texas when the Texas legislature was designing the state's system. "That's why they put in the flexible price to beat," says TXU's Rose. "If you kept the retail rate fixed-as obviously they did in California-you would do away with any retail competition."

Massachusetts and Pennsylvania had features in their systems that would permit some change to the commodity price. "It just wasn't recognized up front in the legislation that that needed to happen and the regulators haven't been as responsive," Rose says. "It's the mechanism we put in that makes the difference."

TXU and other affiliated REPs this past spring filed for a price to beat increase in the fuel factor. "It's a mechanical process based on the index of fuel, not on some rate case," Rose says.

Most retailers view Texas' price to beat system as the determining factor in deciding to enter the state. "I think it's the most fair system that we have in any deregulated state," Green Mountain's Taddune says. "The major problem with a lot of markets is setting a price to beat that is below commodity prices of energy. It makes it uneconomic to do business in a state. The Texas price to beat rule allows the rate to increase or decrease based on natural gas prices."

Because so much of Texas' power load runs on natural gas, retail suppliers will want to see if gas price volatility continues. "I think first off a natural gas price spike has the potential to impact all suppliers," Cenedella says. "If an REP is not hedged properly, it could put them out of business. We don't operate that way. I think most of the REPs in Texas understand that and they're going to keep themselves protected."

Allowing only two changes per year to the price to beat system may not have been everyone's first choice. Michelman says the "adjustment mechanism is the second-best solution. I'm sure it was a compromise between what the reality is and those people who didn't want the prices to change at all. They just wanted it fixed all the way through. But this happened after California and it became pretty clear that there had to be a release valve."

Ideally, the Texas PUC could have forced ERCOT into a different structure "so that there would be a day-ahead market and then suppliers would be able to do adjustments according to that," Michelman contends. Others are a slightly more skeptical of the price to beat mechanism. According to Consumers Union's Briesemeister, "We didn't open this market to guarantee a profit for New Power or anybody else. It's supposed to be about savings for consumers."

She suggests that if the PUC sets the price fairly under the rules established by the legislature and REPs can't enter the market profitably, "that means that opening the market to competition was a mistake because it cannot result in savings. They want to artificially inflate prices to make dereg look like a success."

Cap Gemini's Behrens says creating headroom for alternative suppliers to enter a restructured electric market could be construed as creating a windfall for affiliated retail suppliers. "If you increase the price to beat, over the short term those companies could get a windfall," Behrens says. "What you're doing is you may be setting things a little bit higher than they could be."

The Residential Conundrum

Some of the participants in Texas admit that residential customers aren't racing to switch suppliers. "Generally speaking, customers are reluctant to make the change, absent dissatisfaction with their current provider and significant differences in prices," says Jack Chambers, president and CEO of Texas-New Mexico Power, the Fort Worth, Texas-based utility that serves more than 200,000 electric customers in the state. "Our strategy was that if we can keep our current customers satisfied that they would tend to be more sticky, and therefore we would retain a lot more."

Chambers says that Texas-New Mexico has been able to get a feel during the past few years of what kind of price differentials it took for all customers types to respond to his company's service offerings. In some of Texas-New Mexico's areas of operation, the utility has been forced to compete with other utility companies for customers' business. Texas law, prior to S.B. 7, allowed dual- and sometimes triple-certified areas.

"I think we've learned [that] if you can keep your price differentials within about 10 percent and your satisfaction levels quite high, your customers will stay with you, except for maybe the very, very large customers who are pretty much shopping on price," Chambers says.

Lack of noticeable savings and comfort with their long-time electric power provider may keep residential and small commercial customers from warming up to choice across the nation.

"You'll have a group of customers who don't like their utility or they just like the option of having choice," Briesemeister explains. "They'll see three or four dollars being worth it and they'll switch."

But then there's a larger group of customers, she says, who will think, "Three or four dollars, that's not a whole lot of money. Why don't I wait to see how this goes first." For these customers, they'll eventually hear stories about the person in the Texas market who didn't get a bill for several months. "They tried to switch companies, but it took ERCOT two or three months to get them switched," Briesemeister says. "Those are the stories that will confirm for consumers that they were right to be skeptical and to sit out the market. Then you get this cycle that they don't want to test the market, they don't switch, and then why will companies want to come here if customers don't want to switch?"

Perlman admits it will take customer education to get the switching numbers higher, particularly on the mass-market residential side. "Electricity is not something people think about every day," he says.

In the coming years, in both Texas and Illinois, retail suppliers hope that the regulated default price will give them enough headroom to get customers thinking about how much they could save by making a choice.

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