TO DATE, RETAIL NATURAL GAS UNBUNDLING HAS proven to be only marginally successful. In political terms, state legislators and utility commissioners can point to significant progress in passing initiatives to mandate local utility unbundling. Many utilities have developed and won approval of new rate structures that enable small industrial, commercial and even residential customers to purchase natural gas from non-utility suppliers. As a result, many customers now technically have a choice: They can choose to purchase natural gas from non-regulated suppliers or remain with the utility and continue to receive regulated bundled service. In reality, however, relatively few customers procure their natural gas from non-regulated suppliers. Most energy customers are either so satisfied with their utility service that they see no reason to switch, or they find that purchasing gas from non-regulated suppliers is economically unattractive.
Many natural gas utilities structure transportation rates for residential and commercial classes to preclude real customer choices. As such, most current rates serve as a profound impediment to the successful transformation of the retail gas industry.
Some Progress, in Political Terms
As of late August, some six states had already issued some type of political order requiring their local distribution companies, or LDCs, to initiate rate changes that will result in choice for their natural gas customers. At least 26 other states either have introduced limited open access for commercial customers or are considering proposals to unbundle their gas utilities.
Beyond the political process, many utilities have won approval for rate changes that will allow residential, commercial and industrial customers to procure their supplies from non-regulated suppliers. Large industrial customers have had that ability, particularly with respect to interruptible service for many years. However, during the past five years, smaller-volume industrial, commercial and residential customers have obtained the ability to purchase firm service from non-regulated suppliers. At least 97 utilities have firm transport rates for small-volume industrial transportation rates; 75 have transportation options for commercial customers; 44 have transportation options for residential customers (either through pilot programs or standard rate options).
Although many utilities have transportation rates for all categories of customers, customers largely have not switched away from utilities en masse. In New York for example, where residential customers have enjoyed the right to purchase gas from non-regulated suppliers since 1996, as of June 1998 only about 10,500 residential and 21,000 commercial customers had turned to suppliers other than their utilities. Programs in California, New Jersey and Pennsylvania have been similarly slow to develop.
But Few Incentives,
for Customers or Suppliers
Unbundling has proceeded so slowly because customers in general have little incentive to switch suppliers. Particularly for residential customers and small- volume commercial customers, the potential to save money through use of a non-regulated supplier is minimal at best. (Savings are defined as the difference between what the LDC would charge and what the non-regulated supplier charges.) Conversely, if one assumes that the savings potential of a customer is effectively the equivalent to the non-regulated supplier's gross margin, then the margins are too small to trigger and sustain significant investment in the people and processes that are needed to create retail marketing organizations.
This conclusion is based on a multi-client study that my company recently completed. Our study compared the savings potential of residential, commercial and small-volume industrial customers across 100 local distributors located throughout the U.S. We employed a simple method, developing standardized consumption profiles for residential, commercial and industrial customers, as follows:
Residential customers are assumed to burn between 435 and 912 therms annually, depending on the region of the country in which they are located.
Two hypothetical profiles were constructed for commercial customers, reflecting high (70 percent) and low (30 percent) load factors, with each consuming 20,000 therms annually.
Four industrial profiles were reviewed, reflecting high
(70 percent) and low (30 percent) load factors across two different levels of consumption (300,000 vs. 1.5 million therms annually).
Each profile was evaluated at all 100 utilities. We compared the cost associated with the LDC's sales and associated transportation tariffs, using a database of gas tariff data our company has created. City-gate gas prices were developed for all 100 LDC city gates, based on either published indices or NYMEX prices plus basis estimates.
Of the 100 utilities that we analyzed, relatively few had tariff rate structures that allowed customers to save significantly by purchasing from non-regulated suppliers (see Table 1). Only 18 percent of the utilities had residential rates that allowed customers to save any money. Only 5 percent allowed customers to save more than 10 percent against the traditional LDC bundled sales option. If the average cost of regulated residential supply service is $763, this means that customers at only five utilities nationwide can expect to save any more than $76 a year, or about $6 and change per month.
The results for commercial customers appear only marginally better. Approximately 36 percent of the utilities studied had rates that allowed for savings. Only 25 percent allowed for savings greater than 10 percent. Given the load profiles we used in the study, the average annual regulated supply cost for commercial customers totaled approximately $13,600. At only 25 of the utilities could commercial customers save more than $1,400 annually by switching to a non-regulated supplier.
Industrial customers enjoy the greatest potential for savings. We found that 72 percent of gas LDCs charge rates that allow for savings; one-half of them allow for savings above 10 percent. The average annual cost for regulated supply (industrial customers taking 300,000 therms per year) was approximately $821,000. By choosing unregulated marketers, these industrial customers could expect savings at least as high as $82,000 per year as against bundled rates for about one-half the natural gas LDCs analyzed in our study.
While savings potential appears limited, the range of potential savings varies widely, even within a single state (see Table 2).
The accompanying figure illustrates the range for commercial class savings for a particular LDC, Brooklyn Union Gas Co., and how its commercial customers would fare versus opportunities at other LDCs in New York. As the table shows, a commercial customer of one utility who switched to an unregulated marketer would lose approximately $1,600, while at another New York LDC, a customer with the same profile could save $2,000 by switching. Similar inconsistencies are evident for the residential and industrial customers.
It is difficult to generalize the specific aspects of utility rate structures that impede customers in their search for savings. The factors vary by utility and by customer class.
For example, among utilities offering residential transportation programs, the sales service gas costs and administrative charges are the most important factors that determine the potential for savings. The higher the LDC's gas costs, the easier it is for marketers to offer significant savings. Conversely, the higher the administrative charges that the utility imposes on transportation customers relative to the administrative charges that form part of the corresponding sales service, the more difficult it is for marketers to offer prices to customers that offer significant savings from LDCs' bundled sales rate.
Among the commercial rates that were studied, three factors had the greatest effect on the potential for savings: (1) administrative charges, (2) tax levels and (3) mandatory requirements for upstream capacity utilization.
The utilities whose rates exhibited the lowest savings potential tended to impose relatively high administrative charges on their transportation customers. The average annual administrative charge for the 15 utilities that showed the worst savings potential was $3,565 compared to $441 for the 23 utilities with the best savings potential. Even more significant, we found that at the 15 utilities with the worst savings potential, the average annual administrative cost for the corresponding sales tariff was $174, which suggests that utilities employ the administrative fee to discourage use of the transportation rate. Small-volume customers simply cannot absorb these large fixed costs.
Mandated assumptions of interstate capacity requirements also correlated with savings potential. Several utilities require their commercial (and small volume industrial) transportation customers to pay for and use the utilities' interstate pipeline capacity. Often, the rates charged for this "service" lead either to transportation costs that run higher than the bundled sales rate or to minimal savings for customers.
Tax burdens also prove significant. State and local tax burdens that are imposed more heavily on the LDC sales customers than on transportation customers facilitate greater savings. This said, however, for any specific utility, details of the rate structures must be analyzed in order to explain the inability (or ability) to generate significant savings.
Lessons, for LDCs and Marketers
The success of unbundling is a matter of customer economics, not political pronouncements. Regulators and legislators can mandate open access, utilities can create unbundled tariffs, but if the customers cannot save money or non-regulated marketers cannot profit by selling either the commodity or new services, unbundling will proceed very slowly.
That is not to say that political input is not important. It serves as a key facilitator. However, customers are only likely to switch away from the security of their historic suppliers, the utilities, if they can either save money or obtain new or higher-quality services. Since many utilities have reduced their gas costs to compete more effectively with marketers, future cost savings must likely come from more efficient use of the interstate pipeline, the local distribution pipeline and storage assets, as well as in lower customer acquisition and maintenance costs by regulated and non-regulated companies. Until rates are reformed to eliminate artificial impediments such as excessive administrative charges and allow for (even encourage) creative reconfigurations of the transportation and supply functions, marketers and others have little incentive to sustain their investments in the retail business.
The disparity between sales and transportation rates within states and regions suggests opportunities for creative and aggressive utilities. From a customer standpoint, it is difficult to understand why one New York LDC charges $16,994 annually to transport 20,000 therms for a commercial customer, but another LDC in the same state, with the same general upstream linkages charges $12,057 for the exact same service. This disparity surely reflects the lack of competition of the kind that disciplines other markets. In time, the utilities that can offer such services as standby, balancing and storage at relatively low costs will learn how to package and market their services to the customers behind the higher cost utilities, thereby creating market discipline. Those utilities that determine early that in the new unbundled world their business is transportation and learn how to be high quality, low-cost transporters will eventually reach a position from which to acquire the weaker LDCs. New information technologies create opportunities to manage the retail gas business with much larger economies of scale than have been possible up to now. While regulators could do more to question the underlying cost structures of the utilities that they regulate, they should make sure that tariffs hasten the restructuring, rather than impede it.
The non-regulated marketers must also recognize that in all likelihood the retail gas business will never have the large margins that once were possible at wholesale. Barriers to entry are relatively low, which explains why over 1,000 companies, most of which are very small, call themselves gas marketers. Also, natural gas supplies are relatively abundant. Service offerings are remarkably homogenous. Until the industry learns how to compete on some basis other than price, the bulk of any improved savings that arise from rate reform will go to customers in the form of greater savings, not suppliers.
Accordingly, marketers must become far more efficient in transacting their business. Processes and systems - billing, customer care, customer acquisition and volume management - are uniformly weak. Data from transactions are frequently entered multiple times. Sales processes and relationships with customers are rarely institutionalized as the industry continues to use relationship based sales techniques that are common among wholesale marketers. Marketers must invest in new business practices and the associated systems so that they can improve their own margins and competitive positions. Again, until tariff rate reform proceeds, the needed investments cannot be sustained. Profit margins are simply too low.
Certainly, regulators must become more aggressive in monitoring transportation tariff rates. The most egregious examples of counter-productive tariffs should be targeted for review, including examples where the charges are significantly higher than those of other similarly situated utilities. Marketers must attend more to improving their cost structures. Customers, particularly the large commercial and industrial users that run operations in many jurisdictions, must become far more vocal and demanding in the political process. All these actions will help speed the unbundling process. Absent these actions, however, the process will continue albeit slowly with the consequence that for many consumers - commercial, industrial and residential - the potential benefits of unbundling will remain exactly that: potential, and not much more.
Porter Bennett is President of BENTEK Energy Research, Inc. and BENTEK Information Services Inc.. Over the past 15 years, Bennett has conducted projects for natural gas producers, pipelines, marketers, energy service companies, utilities, end users, trade associations, software vendors and equipment manufacturers. The findings described here are taken from a company study entitled, "Retail Gas Markets: How Open Are They?" and were analyzed using the company's database of utility tariffs, the BENTEK Automated Tariff System.
1 To a less significant degree, the rates charged by LDCs for small-volume industrial customers also preclude savings, thus, do not provide real economic choices for customers.
2 Source: Enron Capital and Trade Web site (www.enron.com). The six states that have passed legislation or comprehensive PUC orders are California, Georgia, New Mexico, New York and Nevada. States that are considering legislation include Arizona, Colorado, Iowa, Kentucky, Louisiana, Maine, Minnesota, Missouri, Oklahoma, South Carolina, Virginia, Vermont and Washington. The states that have access for some commercial customers include Connecticut, Florida, Illinois, Indiana, Massachusetts, Michigan, Nebraska, New Jersey, Ohio, Pennsylvania, Rhode Island, Wisconsin and Wyoming.
3 New York has approximately 4 million residential and 315,000 commercial gas customers, thus, only about 0.3 percent and 7.0 percent respectively purchase from non-utility suppliers.
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