A Round Robin of Residential Unbundling

Fortnightly Magazine - October 15 1996

Whether you're a utility commissioner in Wyoming or Georgia, a v.p. for a leading marketer, or a commission division director in New Jersey, you share a common activity: learning by the seat of your pants about deregulating gas markets. In this gas forum, PUBLIC UTILITIES FORTNIGHTLY highlights developments across the nation.

UtiliCorp United, Inc., a leader in noncore gas markets, plans to step into the residential market for the first time, and appears to have Maryland and Massachusetts in its sights.

Wyoming, meanwhile, is already considering changes to its recently launched residential natural gas pilot.

In New Jersey, taxes, among other issues, raised their head during noncore unbundling.

Georgia is taking another route. A failed attempt at a legislative solution to gas deregulation now pins hopes on consensus between utilities, marketers, industrials, and others. Hopefully, at least for those who plan to enter the residential market, Georgia will avoid the learning curve of Wyoming and New Jersey.


Competing on the Margin

UtiliCorp United, Inc. of Kansas City, MO, whose success signing natural gas contracts with McDonald's, Service Merchandise, and other chains put it on the gas retailing map, has dipped its toe into the residential gas market.

And what a market it is: About 55 million American homeowners use natural gas.

As a qualified gas supplier in Maryland and Massachusetts, the company's EnergyOne affiliate planned to compete for its share of the 16,000 customers up for grabs under separate pilot programs.

Richard L. Itteilag, UtiliCorp's network sales v.p., says that while the word "pilot" is common, the company considers these trials "a residential business, a long-term business." UtiliCorp wants to serve customers, then "own" them so that over time it can break even or, better yet, make money.

"The real early pilot was in Iowa," Itteilag says. That venture was pure market research for the company. Many participating companies lost money; Itteilag says UtiliCorp didn't. "Exit interviews" revealed why customers shifted suppliers, and UtiliCorp is using those answers to strengthen new programs.

What do customers want? Guaranteed savings. Which means that competition in the residential gas market comes down to price.

UtiliCorp is also preparing for Baltimore Gas & Electric Co.'s 25,000-customer pilot next year, New Jersey Natural Gas Corp.'s 30,000-customer rollout, and a 20,000-customer pilot in Pennsylvania.

How will UtiliCorp (em once said to be signing commercial-industrial contracts "like a Hollywood celebrity" (em measure success in the residential market? "For us to have in the multiple thousands of homeowners . ... We're shooting to have something like that within the next six months to a year."

UtiliCorp will have to win profits on razor-thin margins, sometimes measured in tens of dollars. Margins can be so thin that they render business not worthwhile. UtiliCorp opted out of Wyoming's pilot because the $25 to $50 rebates one marketer offered customers bumped the utility out of the market.

In Iowa, Itteilag says, "there wasn't even a prayer of breaking even." The big "winner" there, Equitable Resources, Inc., lost money. The Pittsburgh company successfully guaranteed savings, but also opened an office, hired staff, and promoted the program beyond the break-even point.

In Massachusetts, UtiliCorp planned a market test in the latter part of August. Itteilag says it's a fertile market, and the rates are better, although there are still risks. But the incumbent gas utility has spent thousands to promote the concept of gas choice that UtiliCorp won't have to spend.

Savings for residential customers, he says, will be less than the 5- to 10-percent average of the commercial/industrial market.

Besides overcoming the largest hurdle (em getting the lowest price in commodity gas (em marketers must bridge barriers at the local distribution company (LDC) to get customers converted. "The biggest challenge today is walking through a contract at an LDC," Itteilag says. Some are faster than others.

Residential program rollouts also encounter barriers. You should be allowed to telemarket customers and reduce the flow of paper customers must contend with to authorize a switch from an LDC to a supplier, Itteilag complains. Massachusetts has no paper flow; Maryland has "zillions of pages of paper. That's very difficult for homeowners."

Lastly, he says, "you shouldn't have short fuses of only two months to try and recruit customers. This is a long-term exercise."

What has UtiliCorp learned from its experience in commercial markets, from signing more than 80,000 customers, and from watching evolving residential markets?

s You can't stay in the residential business by losing money.

s You need to know exactly what customers want; you need the research.

s "Early and ugly" isn't good strategy. Follow that plan and you could miss the pulse of the customer. Plus, you give away your offer. PECO Energy Co. came out early in Maryland with its promotional literature, tipping its hand to customers and competitors. "You can't share that stuff anymore," Itteilag says.


No "Choice" Without Competition

When does a residential natural gas pilot become a reality?

In Wyoming, the Choice Gas Service Program gives 10,000 of KN Energy Inc.'s 60,000 residential consumers a chance to pick their gas supplier for the first time.

The program began May 1 (Docket No. 30004-GT-95-37). By mid-August, Wyoming Public Service Commission (PSC) chair Steve Ellenbecker was talking about the need to tweak it.

The limited unbundling program affects the gas commodity. KN retains the gas balancing of the interstate pipeline functions.

KN doesn't consider the program a test; the PSC does, if only because it will make changes this winter, Ellenbecker says.

So far, the only customers who have been able to take advantage of the program are irrigators that power pumps with natural gas. This year's heating season will provide a better test. The 10,000 customers were picked because they're served by the highest-cost gas supply in the state.

Only three competitors signed the minimum 500 customers needed to participate in Choice Gas; KN won 81 percent of the market.

"I would have hoped for closer to 10 competitors, and hope we get there," Ellenbecker says. "I hope it happens for the next heating season."

Some of the lack of competition could be attributed to marketers offering customers "signing rebates."

"I would say that kind of competition, ironically, hurts the program," the PSC chairman says. "Because it makes it that much more difficult if you're operating on a thin margin."

If KN's entire 60,000 customer base were open, he argues, the program would attract more competitors seeking better margins.

In moving the pilot to reality, the PSC will look at the program's advantages for customers. Is it reliable? Is there safety of supply? Adds Ellenbecker: "We need to look at price advantage. The customers are going to see a 7- to 10-percent reduction in prices for this season."

Another item on the PSC's review list: After the first year, customers who picked new suppliers will pay a $37 "change fee." Will this fee prove a disincentive to competition?

Other issues the PSC will scrutinize after more than six months of Choice Gas in action:

s Balloting. KN managed it, and the PSC received reports that signup material wasn't objective. Wyoming Gas Community, a partnership of municipalities aggregating customers, felt it could have signed more than 13 percent of the pilot customers if an independent company had handled balloting.

s Supply. KN said that the program's reliability relied critically on gas entering the system at the same historical points in and out of state. This approach, however, hurt Wyoming Gas Community, which wanted to market and exclusively deliver Wyoming gas.

s Reciprocity. In the Choice Gas docket, the PSC voted against requiring neighboring gas utilities that entered KN's service territory to open their own markets to competition. Ellenbecker dissented. He considers reciprocity an issue of fairness worth tackling again.

The PSC also will consider gas-supply management farther upstream for competitors, raising the reliability question to a new level.

State commissioners can't change Wyoming's population: a mere 480,000 people, served by about 15 natural gas utilities. But if the PSC can prove Choice Gas works, rural distribution shouldn't hurt the outcome of Wyoming's residential gas marketing.

New Jersey:

Paying for Choice with Lost Taxes

Here's a dilemma for gas unbundling in the 90's: Savings for residential customers turn into millions of lost gross receipts and franchise taxes.

How? State gross receipts and franchise taxes are assessed as unit charges on various parts of gas utility rates. Customers that switch from a local distribution company (LDC) to an unregulated marketer no longer pay the taxes on the commodity portion of their bills.

For New Jersey, this has eroded taxes by as much as $30 million a year, ramping up from when the commercial/industrial (C/I) market unbundled in late 1994.

The Board of Public Utilities (BPU) and the state's Department of Treasury have proposed a legislative solution, says Robert S. Chilton, the BPU's energy division director.

"It cuts both ways," Chilton says of the tax loss. "On one hand, it has allowed business to become more competitive. ... If you have a large industrial customer in your district, it has allowed his costs to become more competitive and has saved jobs."

The experience is one of many that have helped New Jersey as it moves toward residential unbundling, planned this year in the state's four utility service territories.

"Some of the issues that have come up in the C/I program are going to require even closer attention on the residential side," Chilton adds.

One is a technical issue that will require adopting more level balancing penalties.

"There was some gaming going on in some of the real hairy days, like in January, when prices were going crazy," Chilton says. "A marketer would purposely not deliver the gas to the city gate in New Jersey, but would move it somewhere else where the imbalance penalty was greater, or where the commodity costs were going through the roof. . . . They could incur the balance penalty in New Jersey and still make money by sending it elsewhere."

Another issue is a higher degree of certifying criteria to protect less-sophisticated consumers. The BPU also learned it will have to protect consumers from "negative" telemarketing practices; some small commercial customers were switched from supplier to supplier without proper authorization.

The BPU could decide to factor such abuses into revoking a marketer's certification.

"We've had pretty good experience," Chilton says of the C/I

program. "We're in the middle of review modifications ... but we're not looking at overhauls."

Better distribution of market share will be another goal for the residential program. Although

40 gas marketers are certified in New Jersey, only 4.5 percent of eligible C/I customers have switched to transportation service.

"We have seen there is certainly substantial market share for the native affiliate marketer," Chilton says. "And without exception, in all four territories, the affiliate has the largest market share." The average share ranges from 20 to

50 percent.

Chilton has an interesting take on a pilot's role, however, as well as on its indication of a true market: "When you compare a pilot to a full-blown thing, you want to make sure you realize that even if you opened up the whole market, you're not going to have the whole market switching. So the pilot may not be, in reality, that much different than the market penetration you'd get from opening up your whole market."

The pilots pending include those within the territories of South Jersey Gas Co. (a few thousand customers), New Jersey Natural Gas Corp. (30,000 customers over three years), Elizabethtown Gas Co., and Public Service Electric & Gas Co. The BPU hopes to launch a public education program this fall.


Commission Leads, Choice Follows

Unlike New Jersey, Georgia's core and noncore gas unbundling will come at once. Residential and commercial/industrial markets will open together. And deregulation will come once the legislature stamps the solution all parties (em marketers, utilities, regulators, and consumers (em agree upon.

A meeting of the House and Senate Gas Conference Committee was set for September 18 so that participants could begin debating overall deregulation; "flex" pricing for large, "interruptible" customers; and other issues.

"We don't know if a bill will pass next year, but if I were a betting man, I would expect something to come out of the legislature," says Stancil O. Wise, Jr. of the Georgia Public Service Commission (PSC). "Certainly, the largest obstacle has been the attempt by everyone in the debate to tilt the rule in their favor."

The PSC had a gas deregulation bill ready to go this year, but was hammered by opposition from Atlanta Gas Light Co. (AGL) and large industrial users (who proposed a very extreme model, Wise says). No legislation passed, but the conference committee was formed. The PSC expects AGL to press its position again in the new legislative session.

So far in Georgia, the PSC has approved a small residential pilot for United Cities Gas and a service-provider selection plan for AGL. Neither program will be implemented until after the

1996-97 heating season (em but before October 1, 1997. The overall plan for the transition to increased natural gas competition was approved by the PSC on May 31 (Docket No. 6455-U).

As Wise puts it, the PSC wants to examine the "rules of engagement." How will everyone compete fairly? Brokers and marketers are concerned that AGL could "squire" its old customers to its new unregulated marketing subsidiaries.

The PSC will have to ensure that local distribution companies like AGL erect Chinese walls to separate affiliates.

"We don't know if they're quite as separate as they need to be yet, and that's what we're going to look at," Wise says. "If we tell the Texacos and the Chevrons to come to Georgia, we want them to come knowing we'll enforce the rules of the game. They don't have to worry about AGL cutting their legs out by aiding their own marketing folks."

So far, it appears pilots won't be needed. Larger customers with flexibility as to alternative fuels and pricing wouldn't want to participate in a pilot anyway, Wise says. Residential participants, meanwhile, simply want their gas.

Exit fees could pose a problem, however. "I think that's going to be a real tough issue as we get down the road," Wise says. "How do you protect the incumbent? Does the incumbent need protecting?

"I believe in the next couple of years [that issue] will end up in this commission's lap."

Once the rules are set, he says, the PSC has to get out of the


"We've got to be willing to change. We've got to change the way we regulate, change the way the commission operates, and we've got to be flexible in the market, too."

Foretelling the FERC:

Experts Weigh the Issues

To get a sense of attitudes toward Federal Energy Regulatory Commission (FERC) initiatives, PUBLIC UTILITIES FORTNIGHTLY interviewed two natural gas attorneys as well as a representative from a major pipeline. Since the issues addressed below are still open for comment, the answers we obtained may well shape policy to come.

The respondents are:

Katherine B. Edwards, a natural gas attorney and partner in the Washington, DC, practice of Grammer, Kissel, Robbins & Skancke. Edwards notes that her views do not reflect those of her law firm or her clients.

Robert O. Reid, v.p. of planning and evaluation for Colorado Interstate Gas Co., a subsidiary of Coastal Corp. of Houston. Reid also serves as chair of the policy analysis committee of the Interstate Natural Gas Association of America (INGAA).

Philip Marston, an attorney in the Washington, DC, practice of Dewey Ballantine and a former special counsel to the solicitor at the FERC. Marston notes that his views do not reflect those of his law firm or his clients.

Should the FERC lift the cap on secondary rates from its July 31 notice of proposed rulemaking (NOPR) on capacity release?

Edwards: "If there is a sufficient showing of lack of market power, then under those limited circumstances, it might be appropriate to remove maximum lawful price ceilings, price caps. ... Absent a showing of lack of market power, I do not think it's appropriate, or legal even, to remove price caps.

Reid: "The cap has, in fact, already been moved from bundled transactions in the secondary market. If you bundle transportation with gas supply, and gas supply is obviously deregulated, and you deliver a bundled commodity to the city gate, how do you determine how much of that is transportation and how much is gas supply? You can't. . . . The value of the transportation will achieve whatever is necessary in order to achieve an equilibrium.

"This will free up the market to a certain extent, allow other people to participate. But as I understand from INGAA's data, about 75 percent of the transactions in the secondary market are prearranged deals for capacity release. And that 75 percent basically constitutes this grey market."

Marston: "That's a complex question. The downstream market has become complex, and the downstream markets are their own individual markets. This is a not a linear market.

"The Commission has largely succeeded in fungibilizing capacity. It's much more fungible today than it was prior to Order 636. So what that means is that the downstream market has its own set of prices that are determined by market conditions in that the downstream market may reflect supply pricing in a half-dozen different supply basins, alternate fuel pricing, plus transmission cost coming from a whole bunch of different pipelines.

"How do you even calculate the new ceiling price?

"I guess what I would say, without taking a specific position on whether the cap should be raised or not, is that the markets are much more complex than that when you talk about adding various value-added services to a delivered product. And I think the NOPR doesn't really recognize that market complexity and dynamism."

Shifting to the FERC's alternative ratemaking policy statement: Is a negotiated rate with a default rate fallback (or recourse rate fallback) the way to go?

Edwards: "I think the negotiated recourse rate structure, in many ways, is the worst of all possible worlds because it permits pipelines to negotiate rates (em i.e., implement market-based rates. But this is with the express concession on everybody's part, and acknowledgement on everybody's part, that the pipeline retains

market power. And so what this means is that there will be cross-subsidies between the unregulated rates and the rates that are deemed to be the recourse rates that will be the fallback rates for both parties who don't have enough leverage to negotiate something else.

"I also think that it turns Order 636 on its head in the sense that 636 promoted and required, as a legal matter, equality of transportation service and straight fixed-variable (SFV) rate design. The negotiated-rates policy permits wholesale deviations from SFV rate design without any justification, without any Commission determination as to whether the new rates are just and reasonable. I think that the procedures that the Commission has implemented to date in ramming this policy down the throats of the industry are defective as a matter of law under the Administrative Procedures Act."

Reid: "I support negotiated rates. I think that as we move from a very tightly regulated industry to a 'lighter-handed' regulated industry, you need the freedom to be able to negotiate deals and make sense from the commercial market. And I don't know of any commercial market that doesn't have the freedom to both negotiate price and to negotiate terms and conditions.

"Anyone can read our tariff, anyone can interpret an SFV rate structure. Those rates and tariffs are subjected to excruciating settlement discussions and litigation. How you manipulate something in black and white and out there on a tariff sheet is, quite frankly, kind of beyond me."

Marston: "The basic structure of the filing requirements under the Natural Gas Act gives certain inherent advantages, for example, with regard to timing, to the pipeline. The pipeline, as the regulated entity, decides when to file a new rate case. That means if they see a period of time when their costs in the base period are high, but will be trending down, then if they file a rate case with the right timing, they get to justify higher rates than their actual costs. . . . You're always going to have that. And I don't think there's anything illegitimate about the company taking advantage of that."

Should bidding still be required for capacity release, even though a majority of releases involve "prearranged deals"?

Edwards: "The bidding requirement certainly helps to ensure that capacity release is implemented on a nondiscriminatory basis, and also that capacity is sold at a market-clearing rate. I am also sensitive to the concern of many firm shippers that it creates inefficiencies and slows down the process, that the market really works and needs to work faster and needs to be more efficient. So I'm somewhat ambivalent, to be truly honest, on this one."

Reid: "Now that the market is mature enough, you don't need that kind of control. . . . I think the market is telling us that it thinks it's a very inefficient way of going about it and the market would prefer a more open system. And I think the 75 percent [prearranged deals] speaks to that."

Marston: "I think the market has pretty well voted. . . . The bidding mechanism is poorly designed and unattractive, from the standpoint of both parties.

"I think the Commission had it correct when it said experience has shown that it is cumbersome, introduces delay, introduces uncertainty."

The final word on capacity release: What should stay the same,

or change, or be addressed that isn't?

Edwards: "I think the proposed pilot program as an option should be eliminated. I think the Commission basically has current regulations on its books that require cost-based rates. The pilot program would allow a pipeline to come in, with its local distribution company, by August 30 (em which is not even time for the Commission to act on any rehearing requests under this new proposed policy (em and implement [capacity release] on an experimental basis. And I think that's illegal.

"It's also bad policy. And what's particularly egregious about that potential is that the Commission, in its NOPR, says it will not

have to make as strong a market-showing analysis or lack-of-market-power analysis than it would otherwise. . . . They're weakening the standards."

Reid: "In the interest of doing commercial transactions, the one thing that should be modified are the disclosure requirements. I think those requirements should be between the buyer and the seller. And they're free to negotiate what they need to negotiate.

"Currently, at least in the pilot program that the FERC wants to see, there's a great deal of information about buyers and sellers and volume and prices. Maybe that's appropriate in the pilot program, but I don't think over the long term it's appropriate."

Marston: "It is certainly a good thing that the Commission has decided to reexamine the whole topic. There's a couple of years' experience under capacity release, and I think the Commission has something to work from rather than flying blind. . . . What the Commission has yet to grasp is the extent to which capacity is being reshuffled." t

Joseph F. Schuler, Jr. is associate editor of PUBLIC UTILITIES FORTNIGHTLY.


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