Retail wheeling has been repeatedly condemned by opponents who claim that it would cause rate discrimination between customer classes. They allege that it would unfairly reduce rates for large customers, while raising them for small ones. But discriminatory rate structures already result from the selective discounts that utilities grant their large customers. Ironically, the easiest way to eliminate this discrimination is to make retail wheeling available to all customers.

Traditional cost-of-service ratemaking structures rates to avoid discrimination between customer classes. Regulators determine a utility's total revenue requirement and then allocate it across customer classes according to the costs of serving the various classes. The resulting rate structure is nondiscriminatory in that rate differentials between classes of service are tied to cost differentials.

Competition will undermine the structure of cost-of-service rates in most but not all circumstances. For instance, competition would not affect the rates of a utility whose cost-of-service rates equal those that would exist under competition (em that is, whose rate for each class of customers matches the competitive rate. Permitting retail wheeling in such a case would have no effect on rates, and thus cause no discrimination. This result would be true whether retail wheeling was extended to all or only some customers.

When competition encroaches on a utility whose rates exceed competitive rates, however, the rate structure will become discriminatory if access to competitive market rates is not available to all customers. This is the current situation. Competitive forces have begun to impose themselves, producing a mix of regulation and competition. Traditional rate regulation remains in place, while rate discounts proliferate as result of the growing market power of large customers.

A customer with enough market power to gain access to the competitive market can either extract a discount from its utility or buy competitively priced power from another vendor. If the utility grants a discount and retains the customer, the discounted rate will fall below the applicable cost-of-service rate. Since it does not relate to the rates charged to other customers according to costs, the discounted rate is discriminatory. If regulators allow the utility to offset the revenue loss caused by the discount through an increase in the rates charged other customers, the extent to which rates depart from their cost differentials will increase, accentuating the discrimination.

If the utility refuses to grant a discount to a customer who can buy market-priced power from third-party vendors, the utility will lose the customer and the associated revenue. In that case, regulators will likely allow the utility to raise rates for its remaining customers in order to satisfy its revenue requirement. This is even more discriminatory, since rates would be increased to offset all of the revenue of the departed customer, instead of just the amount of the discount.

Introducing retail wheeling to some but not all customers would also produce a discriminatory rate structure. Customers who are eligible for retail wheeling would either be able to obtain discounts from their utility or buy market-priced power from third parties; these options would not be available to ineligible customers. Rates would thus be reduced only for eligible customers. Moreover, this discrimination would be exacerbated if regulators allow the utility to offset the revenue loss from retail wheeling by increasing rates for the rest of its customers.

The common element in these scenarios is unequal access to competitive market-based rates. Once some customers gain access to competitive rates, as is the case now, discrimination can be eliminated only by making access available to all (em that is, by providing retail wheeling to all customers.

Universal retail wheeling would give all customers access to competitive market prices. Effective marketplace competition for each class of customers would remove rate discrimination. Small as well as large customers could obtain competitive rates, and rates could not be raised for any customer class to offset the utility's loss of revenue from retail wheeling. All classes would benefit from competition, and no class would bear the discriminatory burden of ensuring that the utility meets its revenue requirement.

Extending access to market rates to all customers, of course, would eliminate regulators' ability to set rates at levels that will satisfy a revenue requirement and produce a specified allowed return. A utility that can fulfill its revenue requirement and achieve its allowed return at market rates would be unaffected; utilities that can't would suffer a shortfall in revenue and earnings.

Retail wheeling is not inherently discriminatory. It will contribute to a discriminatory rate structure only if it is made available to some customers and denied to others. Actually, universal retail wheeling offers the easiest and perhaps only way to eliminate the discrimination now creeping into utility rate structures. Traditional ratemaking can do little to check rate discrimination as long as retail wheeling is prohibited. Rate discrimination can only be reduced by giving all customers free access to competitive markets, and this can be done best by making retail wheeling universally available as quickly as possible.

While regulation cannot manage competition, it can promote equitable rate structures by ensuring that utilities and other power suppliers do not exercise undue market power. Rate structures will be nondiscriminatory only when there is effective competition for all customer classes. Otherwise there will be special rates for special customers. At least initially, competition will be more effective for large customers than small ones. And because suppliers of small customers will have undesirable market power, regulators will need to constrain that power to ensure that effective competition is extended to all customers. t

Charles M. Studness is a contributing editor of PUBLIC UTILITIES FORTNIGHTLY. Dr. Studness has a PhD in economics from Columbia University, and specializes in economics and financial research on electric utilities.

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