RD37 - Status Report: The Development of a Competitive Retail Market for Electric Generation within the Commonwealth of Virginia


Executive Summary:
It has been over four years since the Virginia General Assembly passed the Virginia Electric Utility Restructuring Act (*1) ("'the Act"), less than four years remain until the mid-2007 end of the transition period set forth in the Act. Section 56-596 of the Act requires the Virginia State Corporation Commission ("SCC") to report to the Commission on Electric Utility Restructuring ("CEUR"') and the Governor by September 1 of each year on the status of competition in the Commonwealth, the status of the development of regional competitive markets and the SCC's recommendations to facilitate effective competition in the Commonwealth as soon as practicable. This section of the statute also requires the SCC to report any recommendations of actions to be taken by the General Assembly, electric utilities, suppliers, generators, distributors, and regional transmission entities that the SCC considers to be in the public interest.

The SCC offers this Report pursuant to the requirements of the Act. We also note that on December 30, 2002, the SCC submitted an Addendum to its status report issued September 1, 2002, that addressed the Federal Energy Regulatory Commission's ("FERC") Notice of Proposed Rulemaking ("NOPR") on Standard Market Design ("SMD"). (*2) That Addendum, entitled "Review of FERC's Proposed Standard Market Design and Potential Risks to Electric Service in Virginia" raised several concerns we had regarding electric industry restructuring and its likely impact on Virginians. In the December 2002 Addendum, the SCC stated:

"Only if the Commonwealth reverses the Act's requirement to unbundle rates and defers the Act's requirement that Virginia's utilities join an RTE [regional transmission entity] can Virginia preserve state jurisdiction. If rates remain unbundled or control of the transmission system is transferred to an RTE, then Virginia's choice will likely have been made. It will be difficult -- if not impossible -- to reverse that choice."

In the months since the SCC issued its December 2002 Addendum to the September 1, 2002 status report, industry events have not lessened our concerns nor cause us to alter our recommendation that the General Assembly take action to preserve Virginia's authority to ensure reliable electric service at just and reasonable rates. Industry, federal regulatory, and legislative uncertainty continue and Virginia's ability to ensure control over its restructured electric utility industry cannot be assured. Consequently, the SCC believes that it is in the public interest to suspend portions of the Act by re-bundling rates and continuing the moratorium on the transfer of control of Virginia's electric transmission systems to federally-regulated regional transmission entities. We note that such a suspension will leave in place rules, procedures and systems that enable retail access. The SCC recommends suspension only as a means to best preserve Virginia's jurisdiction and only as long as necessary to provide Virginia policy makers a reasonably clear view of the likely nature of the transformed industry.

This Report consists of three parts. Part I is a description of evolving regional retail and wholesale markets prepared by Dr. Kenneth Rose, Senior Fellow, Institute of Public Utilities at Michigan State University. Part II reports on the status of retail access and competition in the Comnl0nwealth. Part III presents and discusses recommendations to facilitate effective competition in Virginia that were raised by stakeholders responding to an annual SCC solicitation of potential recommendations. Part III also contains and discusses the SCC's recommendation that the Virginia General Assembly take action to preserve Virginia's jurisdiction relating to its electric utility industry by suspending elements of the Act.

Part I of this Report contains detailed data and information on restructured wholesale and retail electricity markets around the United States. The economic health of these markets is questionable. Three major generating companies have filed for bankruptcy protection thus far in 2003 and other generation providers face substantial financial difficulties. The industry credit crunch continues as does fallout from securities and trading scandals. At the same time that generating companies are facing these difficult financial conditions, Dr. Rose reports that there continues to be strong evidence that significant market power is being exercised in all wholesale markets that have been independently analyzed. The coincidence of these two phenomena -- the alleged exercise of market power that serves to increase market prices and thus the returns to generators, coupled with the widespread financial distress in the industry which should be alleviated by the exercise of market power -- is puzzling. These two coincident results. taken together, illustrate the difficulty of fashioning electricity markets that ensures both the provision of safe and reliable service and the vigorous competition needed to forestall any exercise of market power.

Dr. Rose's Part I also provides extensive descriptions of retail markets on a state-by-state basis. He reports that 16 states and the District of Columbia continue to allow retail access. Several states have decided to delay retail access, restrict retail access to only larger customers or otherwise curtailed their retail access efforts. Of the 17 jurisdictions that allow retail access, there is little, if any, effective retail competition for electric service in the residential and small commercial market. Although some states have significant switching for larger customers, except for Texas no state has substantial state-wide competitive penetration in markets for residential or small commercial accounts. Even here, switching rates average around 11% and 17% for residential and small commercial customers, respectively.

Texas market penetration is explained by requirements that customers not choosing to take service from a non-affiliated retail electric provider ("REP") were automatically transferred to their utility's affiliated REP. Smaller customers so transferred are charged a regulated rate known in Texas as the "price-to-beat." ·This regulated rate at one point reflected a 60/0 decrease from pre-restructuring regulated rates. Importantly, Texas purposely set the price-to-beat with some '''headroom'' allowing non-affiliated competitors to offer service at prices that both saved customers money and allowed the non-affiliated REPs to make a profit on the sale. The price-to-beat is adjusted as energy prices change. The Texas PUC has the tools to ensure that non-affiliated REPs can continue to serve profitably customers in significant numbers. This comes, however, at the cost of higher regulated charges if a customer chooses to remain with an affiliated REP.

Increased switching In Texas has led to claims about the ultimate test of the efficacy of the Texas restructuring: customer savings. The picture is quite muddled and turns on forecasts of what regulated rates would be in the absence of the restructuring. The years chosen as the basis for comparison and the impact of mandated rate reductions and changes in regulated fuel charges. It should also be noted that utilities have yet to finalize their stranded cost determinations and are required to do so in 2004 through a market valuation of assets.

Ohio is witnessing substantial retail residential market penetration but only in the FirstEnergy service territory. This is explained by widespread ''opt-out'' municipal aggregation. There is little penetration in the service territories of Ohio's other distribution utilities where prices are lower.

On the basis of the extensive information submitted by Dr. Rose in Part I of this Report the SCC concludes that. while retail access is widely available in many jurisdictions, vigorous retail competition has yet to develop. This national result, when combined with results obtained here in the Commonwealth as detailed in Part II of this Report, leave us with substantial doubt as to the ability of retail electric competition to provide, at the present time, lower prices for Virginians than would have been charged under the traditional regulation of the industry.

The SCC's concerns are shared by others around the country. For instance, in Ohio the "Dayton Daily News" reported on May 13, 2003 that "some critics urge that Ohio abandon deregulation as an experiment that isn't working. After two years and four months, no outside electricity marketers have become competitors as DP&L [Dayton Power & Light] hoped. This is attributed to DP&L's relatively low rates ...Some critics complain that electricity deregulation is a failed experiment with little chance of meeting the goal of lowering consumer prices." Ellis Jacobs, an attorney for the Community Action Partnership, said "the Ohio General Assembly should consider abandoning deregulation. Other states are moving in that direction. Seven states without deregulation have now put that on the back burner. A number of states that deregulated, Nevada, Oklahoma, and California among them, have reversed course." David Hughes, executive director of Citizen Power, a regional utility watchdog organization, also believes "The [Ohio] General Assembly should reinstitute regulation of electric generation prices and supply before the MDP ends. PUCO keeps glazing over the real story which is that there is virtually no competition in the electricity generation market."

New Jersey Citizen Action, a consumer advocacy group, states "We don't see competition on the horizon and from the beginning citizens have said we don't want deregulation for the sake of deregulation. It's the worst of both worlds, we'll have higher rates and unregulated monopolies." On July 23, 2003, "Electric Power Alert" reported that "They point to a recent decision by slate utility regulators to increase rates for the State's largest utility - with other utilities soon to follow - along with an end to price controls in August under the State's deregulation law, as the reason consumers will see electric rates increase by 15 percent."

The "Ashbury Park Press" reported on June 26, 2003, that in New Jersey. "There still are practically no alternative electricity suppliers looking to pick up residential customers. BUI regulators and advocates hope that a growing market of suppliers vying for the state's largest electricity consumers - industrial, commercial and institutional users - will eventually trickle down so homeowners can find good deals." Effective August 1, 2003, under a program adopted by the New Jersey Board of Public Utilities, large electricity users will be subject to electricity prices that change hourly and are influenced by market fluctuations. Hal Bozarth, Executive Director of the Chemistry Council of New Jersey, states "Come August 1. the world as we knew it under the (electric) monopolies is over, and there will be rate shock of significant proportion."

As rate caps expire in Maryland. market observers warn that residents should expect to begin paying more for electricity. Mark Travieso, a state advocate for residential utility customers, said "that consumers cannot expect to see a true competitive market that makes it worthwhile to switch energy providers."

"Electric Power Alert" reported on June 11, 2003, that "The Connecticut legislature voted to permit consumer rates to increase and fees to be collected for utilities administering billions of dollars in energy contracts - in a move to keep the lights on and the possibility of retail electricity competition open in the future despite disappointing results thus far. The transition period for restructuring the state's market is set to end with contracts and price caps expiring in December. Lawmakers devised a plan to strike a balance between the cost increases and reliability, because competition just hasn't occurred. The legislation increases the amount ratepayers will pay by four to six percent - on top of an eight percent increase incurred from New England's standard market design charges - and ensures reliability through creating a system of procurement fees that allows the default server, Connecticut Light & Power, to charge customers for its management of contract bidding. "

Part II of the Report focuses on activities in Virginia related to retail access and resulting competition in the electricity market over the past year. It also reviews the SCC's efforts to develop a proper infrastructure to accommodate competition and to prepare Virginians for consumer choice for generation, as directed by the Act.

During the past year the SCC has continued to implement the Restructuring Act. At the present time, about 2.9 million electricity customers in Virginia have the right to choose an alternative supplier of electricity. By January 1, 2004, when an additional 168,500 customers will gain the right to choose, nearly all of the customers of Virginia's investor-owned utilities and electric cooperatives will have the right to switch to a competitive supplier. The exception is the approximately 29,400 customers in the southwestern part of the Commonwealth exempted from the Act by legislation enacted by the General Assembly in 2003 and approximately 7,000 customers served by Powell Valley Electric Cooperative.

As we reported last year, the right to choose has not yet evolved into the ability to choose. While it is clear that the SCC, the utilities and the various stakeholders have effectively enabled almost universal retail access in Virginia, there is little competitive activity in the Commonwealth. We understand that many suppliers still perceive little economic incentive to enter the Virginia retail market. No competitive service provider is offering energy priced so that switching customers may save money. Currently, one supplier continues to serve about 2,300 residential customers and 22 small commercial customers in northern Virginia with an environmentally-friendly "green" power offer. This service is more expensive than Dominion Virginia Power's price-to-compare. Again, as detailed in Part I, this lack of activity is not unique to the Commonwealth; in other states currently offering retail access, few customers have the option to purchase power at a price lower than their incumbent's price to compare.

Over the past twelve months, the SCC, aided by the incumbent utilities and interested stakeholders, continued to make strides in preparing the Commonwealth for the arrival of competition for the generation component of electric service. Various work groups coordinated by the Staff have been assisting the SCC to provide the foundation for retail access by examining many issues. including competitive metering, supplier billing, default service, energy infrastructure, stranded costs, and regional transmission organizations ("RTO'"). The SCC appreciates the time and effort of the respondents that have participated with these work groups.

The SCC has issued orders during the past year relating to issues such as competitive metering, supplier billing, market price/wires charge determination, regional transmission organizations, and several access programs within electric cooperative territories. In addition to the September 1 reports on the status of competition and the December 2002 Addendum, the SCC has issued reports addressing energy infrastructure information and stranded costs. Slow development of competitive activity and statewide budget constraints have caused the SCC to suspend its consumer education efforts for the present.

Part III of the Report consists of two sections. The first section includes a discussion of recommendations advanced by various stakeholders as means of facilitating effective competition in the Commonwealth as soon as practicable. The second section of Part III discusses the SCC's recommendation that a suspension of the Act is in the public interest because delaying implementation of the Act is a prerequisite to the preservation of Virginia's jurisdiction.

To assist development of a comprehensive list of recommendations to foster effective competition, the Staff sent a letter to over 70 interested stakeholders seeking their suggestions. In a letter dated April 16, 2003, Staff posed eight questions designed to stimulate respondents' thoughts on specific restructuring issues. Although the Staff's mailing list targeted stakeholders thought most affected by electric restructuring issues, responses were received from just twelve stakeholders. In a similar survey conducted in 2002, the SCC received sixteen responses. The twelve 2003 responses are included as Appendix III-A to this Report.

Generally. most of the comments received are similar to those expressed in last year's report and reiterated during the past year via various forums such as work group discussions. Respondents' recommendations, while discussed in detail in Part III, do not provide new ideas; the recommendations presented have already been considered by the SCC and the CEUR. Many of the twelve respondents continue to believe that the major obstacles to effective competition in Virginia include:

• The existence of low, capped rates of the incumbent utilities,
• The existence and method of determining wires charges.
• The recovery of yet-to-be-quantified stranded costs.
• The lack of a functional RTO. and
• The lack of effective customer demand response programs.

SCC Recommendation

Section 56-596 of the Act requires the SCC to report its recommendations to facilitate effective competition in the Commonwealth as soon as practicable, which shall include any recommendations of actions to be taken by the General Assembly, the SCC, electric utilities, suppliers, generators, distributors, and regional transmission entities it considers to be in the public interest. This year, the SCC has one recommendation, and it is not new.

Our concerns with the bedrock issues of electric service adequacy and electric service prices likely to be available to Virginians prompted the SCC to issue its December 2002 Addendum. In the December 2002 Addendum, we described the many serious problems likely to result from implementation of the FERC's proposed rules on Standard Market Design. These problems include the elimination of native load preferences, the questionable ability of FERC to oversee market monitoring efforts, the potential exercise of market power by wholesale suppliers, increased costs, resulting from the use of locational market pricing in transmission-constrained areas, and regional resource adequacy requirements.

We were and continue to be particularly troubled by the potential loss of the ability of Virginia's electric utilities to provide priority transmission service to Virginia customers under a FERC designed and regulated wholesale power market platform. FERC believes that long-standing practices whereby local utilities favor local customers constitutes undue discrimination. Currently in Virginia, "'native load" has priority. This means that if a Virginia electric utility has sufficient generation and transmission to serve its control area or native load customers (including certain wholesale customers such as cooperatives and municipals), the utility may use excess transmission capacity to facilitate other transactions. However, service to native load customers in its control area will be the priority in the event that service interruptions are required to maintain system integrity. Under the current system, wholesale transactions --- serving non-Virginia loads --- are curtailed first because native load customers have paid for that utility's transmission system in retail rates over time. Virginians are protected to a great extent.

In response to criticism levied by Virginia and other jurisdictions, on April 28, 2003, the FERC issued a ·'White Paper" entitled "Wholesale Market Platform." The FERC White Paper has been carefully studied by the SCC. In our opinion. the FERC White Paper neither clarifies nor alleviates our concerns with the SMD NOPR.

As outlined in this Report, the problems that are impeding the development of retail competition in Virginia and other regional markets continue unabated. Events in 2003 deepen our concern that problems are becoming increasingly complex and their implications irreversible. We face the likelihood that staying on the current path may cause such distress that the development of an effective competitive market at a future date will be foreclosed.

The continued lack of current and expected market activity leads directly to our recommendation that the Act be suspended in order to preserve Virginia's authority. It is in the public interest to avoid ceding jurisdiction over transmission, generation, reliability and, ultimately, the cost of power, to federal regulators and regional entities. The likelihood that increased prices may be required to foster competition and uncertainty regarding Federal direction with regard to RTOs poses additional uncertainty as to what will occur when capped rates end on July 1, 2007.

For these reasons, we renew our recommendation that the General Assembly suspend the Act. Suspension of the Act would require rebundling the components of retail electricity rates and continuing a moratorium on transfers of control over transmission assets to RTOs. However, the General Assembly could allow other aspects of the Act to continue to evolve while these two elements of the Act are temporarily suspended.

Pausing in the implementation of the Act is the best course if we are to preserve Virginia's ability to protect its citizens from the problems that are likely to result from the ceding of regulatory authority to FERC and regional transmission entities. The potential costs of adhering to a perceived schedule for the sake of implementing change outweigh the risks of delay. It is possible that any future benefit of retail access could be affected by a delay of retail access. However, we currently have the basic rules, systems, and procedures in place to harmonize retail access. If Virginia delays full implementation now and retail access proves successful elsewhere, we will be in position to implement retail choice quickly and effectively. This ability to respond quickly should minimize any loss to Virginians with a delay at this time.

In summary, the status of competition is not encouraging. There has been little change in market conditions around the country or in Virginia since we submitted the December 2002 Addendum. Though there are isolated instances in other jurisdictions of competitive activity among larger commercial and industrial customers. retail choice is not yet providing meaningful benefits or yielding sustained savings anywhere in the country. Even more distressing than the absence of sought-after competitive activity is the likelihood that the implications of the SMD NOPR will be detrimental to Virginia's electricity consumers.
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(*1) Title 56, Chapter 23 of the Code of Virginia.
(*2) Remedying Undue Discrimination Through Open Access Transmission Service and Standard Electricity Market Design, Notice of Proposed Rulemaking, 67 Fed. Reg. 55452 (2002) (to be codified at 18 C.F.R. pt. 35) (proposed July 31, 2002).