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Report of the Competition Work Group
to the Comprehensive Review Steering Committee



Introduction


The Comprehensive Review was initiated by the region's Governors with the goal of developing "..... recommendations for changes in the institutional structure of the region's electric utility industry. These changes should be designed to protect the region's natural resources and distribute equitably the costs and benefits of a more competitive marketplace, while at the same time assuring the region of an adequate, efficient, economical and reliable power system."


The Competition and Customer Choice Work Group was established to involve a larger number of the region's electric industry stakeholders in the development of basic principles for the structure of a more competitive regional electric industry. In particular, should all customers have choices among alternative power suppliers? What are the pricing principles that should be applied to various products in the electricity markets? What actions are already being taken to increase access to alternative power supplies, are there barriers to further choice, and what actions might need to be taken to facilitate a competitive market but at the same time protect various public purposes that the power system has historically served? Is separation of the four market segments, generation, transmission, distribution, and retail electric services needed in order to have a well functioning power market?

Throughout the discussion below, four functions are distinguished that are currently performed by vertically integrated utilities. In addition to the typical three functions of transmission, generation, and distribution, a fourth is identified that is termed "retail electric service". Retail electric service is the activity of providing choices to consumers regarding the first three functions in addition to demand side resources and perhaps other energy and nonenergy services.


More than 90 members of the public and various organizations have been involved in an intensive process to develop this report over a three and a half month period. The Competition Work Group met 12 times, alternating meeting location between Seattle and Portland. Typical participation in the meetings was between 30 and 40 persons representing a broad range of interests. Figure 1 shows the mix of interests attending the last 9 meetings.


The Competition Work Group began its work with an evaluation of the status of electric industry restructuring and customer access to alternative power supplies. It is clear that large customers are actively seeking access to alternative power supplies. There are currently significant amounts of power available at competitive prices, and there are already many marketers offering to help customers gain access to those supplies. These conditions have put significant pressure on utilities to try to accommodate the desires of some of their large customers. Events in this area are moving very fast, with many actions occurring since the Competition Work Group began its work. Each state in the region has reviewed, or has begun the process of reviewing, its electric industry structure and policies. Most of the region's investor-owned utilities have taken some action to address the changing world their companies are facing. These actions have varied from offering special rates to retain large customers, to developing pilot programs for retail wheeling, to commitments to provide eventual retail wheeling for all customers.


Figure 1: Competition Work Group Attendance (Last 9 Meetings){Graphic stripped}



Pressures for electric industry restructuring are taking place in a national and international context. Several countries have recently put in place comprehensive electricity restructuring plans to introduce competitive power markets. These countries include Norway, Argentina, New Zealand, and England among others. In the U.S., the Federal Energy Regulatory Commission issued orders 888 and 889 that essentially open up the wholesale power market to competition. Allowing competition at the retail level is left to state jurisdiction, and several states have taken steps to encourage such changes. In addition, legislation has been proposed at the national level to introduce retail competition in the electricity industry.


It is clear that significant change is underway. The Competition Work Group considered alternative responses to that change, including allowing it to evolve naturally, actively encouraging and facilitating the change, and pursuing alternative approaches to achieve the desire for more customer choice. Models developed by the Competition Work Group members all fell into the second category. However, there are still some members who are skeptical that the comprehensive review should develop public policy to govern industry restructuring. The status of the regional electricity industry is discussed in more detail in the next section of this report along with important public policy issues raised by growing competition.


The third section of this report lays out the consensus principles for a desired competition end state for the regional electricity industry. Where there are significant minority views, or there is no consensus on important issues, we have pointed those out. The last section addresses transition and implementation issues that will be encountered in trying to attain the end state. The Competition Work Group found that the most significant disagreements lie in this area of transition.


Status of the Regional Electric Utility Industry and Regional Policy Issues


Changing generation technology and low natural gas prices have created a situation where many generating plants in the West that historically were used only for peaking purposes can now produce power at very competitive prices. Marketing this power has been facilitated by national legislative and regulatory changes that opened up electric transmission systems for wholesale wheeling. As a result, a surplus of low cost power has developed that is priced below the cost-based rates of many utilities. Access to this low cost power can make a substantial difference to the bottom line of many customers' businesses and these customers are actively seeking ways to access this power.

Utilities are under pressure to maintain these customers' business and have responded in various ways to do so. Bonneville has negotiated special market access provisions for its direct service companies. All but one of the region's investor-owned utilities have taken actions to accommodate increased choice on the part of their customers. In some cases, it takes the form of offering special rates designed to grant prices competitive with current wholesale market power. Portland General Electric and Puget Sound Power and Light have created rates that are tied to the wholesale power market with a markup for the utility's ancillary and distribution services. More recently, PGE has proposed a power delivery tariff that would introduce direct market access for some of its large customers. Washington Water Power has initiated a pilot program to provide retail choice to its 30 largest customers for up to one third of their power requirements. Pacificorp announced its intention to work with legislators and regulators to bring the ability to choose energy suppliers to all customers by January 1, 2001. Montana Power and, more recently, Puget Sound Power and Light have committed to phasing in retail access for all customers beginning with market access for large customers. Beyond this, some of the region's utilities have joined the ranks of the power marketers and are actively seeking to market power to customers of other utilities.


Collectively this is a lot of writing on the wall. The market clearly is moving very aggressively. Why shouldn't the region just let it evolve? Why is it desirable for the Comprehensive Review to address policies for competitive markets?


A general reason for considering this public policy is that, without some common structure, markets will develop in different ways in each jurisdiction. It is inevitable with today's technology that transmission and distribution will remain regulated and the interface will have to be defined between regulated and competitive market segments. Fragmented development of these interfaces will lead to a market with unnecessarily high transaction costs and many false starts and potential market power abuses; a market that is less efficient and less open to all customers due to the expense and expertise needed to participate.


As is evident from recent trends, absent policy to the contrary, market access will come to large customers with the money, expertise, and motivation to access alternative power supplies. Without actions to facilitate it, the benefits of competitive choice will come more slowly to smaller customers. As large customers gain market access or special rates, remaining captive customers, investor-owned utility shareholders, and possibly taxpayers, may shoulder larger shares of regulated utility costs. In addition to potential cost shifting, the revenue decreases may create stranded costs and make it more difficult for utilities to support conservation and renewables programs, low income programs, universal service support, environmental protection costs, and other public purposes that have traditionally been funded by electric utilities. While early access by large customers will help stimulate the development of a viable electricity market, the potential cost shifting and the decreased ability to fund public purposes is seen as unacceptable to many industry stakeholders.


A lack of definitive retail access policies has led to a situation in the Northwest where BPA and other transmission entities may find themselves in a position to decide whether to let specific retail transactions occur by granting or denying transmission wheeling. BPA, for example, asserts that it has the authority to wheel for retail transactions but it is currently exercising its discretion to deny such retail access.Footnote1 BPA has asked for regional guidance on this retail wheeling policy. Absent some regional or state policy on retail wheeling, market access will evolve in a haphazard way creating situations, such as BPA's, where policy and transactions can essentially be dictated by transmission or distribution providers.


Finally, a world in which there is retail wheeling is a world where the number of transactions and the types of customers using the transmission and distribution systems will greatly increase. New approaches to accountability for system reliability will be needed, and improved methods of billing and settlement will be required. These changes need to take place in an orderly and planned transition to assure the region an efficient and reliable power system.



Principles for a Competitive End-State


Customer Choice


Consensus exists with regard to the principle that all customers should have choice among alternative suppliers of electricity and related services in the ideal competitive end-state. The view is widely held that customer choice will lead to the benefits of lower prices and better products and services for consumers. Customer choice implies that marketers and aggregators must have open and nondiscriminatory access to all electricity consumers. Consumers electricity bills would be itemized (unbundled) by separate amounts for the various components of electricity service. It is customers' ability to choose among alternative levels of service and alternative suppliers that make a market work. Without this choice, a competitive market does not exist and the benefits of a competitive market will not be realized.


There is also consensus that customer choice and open access must not result in one customer class benefiting at the expense of other customer classes. The benefits of retail access should flow to all customers. For this to happen the access must be real and effective for all customers not just the largest ones who may have the interest and expertise to access the markets effectively. Further, some means of providing for low income service equivalent to that provided under the current system needs to be developed.


Another condition that most work group participants would accept is that important public purposes need to be preserved using mechanisms that are compatible with competitive generation and retail electric service markets. The means of achieving these purposes may need to be changed as well as the methods of financing them, but they should be addressed by the new structure. This issue is addressed further below.


The Role of Distribution Utilities


Retail access for all customers implies a significant change for the local distribution function of existing utilities. In a competitive retail market, customers must have open and nondiscriminatory access to power supplies, alternative aggregators, marketers, and other energy services, including efficiency delivery. Under the regulated vertically integrated system, utilities have been the sole provider of most of these services. However, this arrangement cannot continue in a competitive retail electricity market. The distribution function, or wires service, needs to be administratively or legally separated from the provision of retail electric services. The wires function likely will continue effectively to be a monopoly for the foreseeable future, but the retail electric service area should be competitive.


This change is the most fundamental one for electric industry restructuring and will take some time to accomplish. New methods of metering and billing may need to be developed to most effectively implement a competitive retail market. Customers will benefit from the development of a competitive retail electric service which has not typically existed due to the vertical integration of the electricity industry. The phasing in of retail access could move quickly for some customers and more slowly for others. This raises serious concerns about equity of benefits. At the same time, however, such substantial change needs to occur gradually as markets develop. This presents a serious transitional issue for electric industry restructuring.


Ensuring Fair Competition


There are a number of reasons for concern about fair competition in a restructured regional energy market. One is the close proximity of regulated and competitive segments in the market. Both the electricity commodity and retail electricity service to customers can be competitive industries. Transmission and distribution will continue to be regulated monopolies. The regulated and competitive segments of the industry must be separated so that monopoly segment earnings cannot be used to advantage an affiliated competitive company. Complete legal separation of these segments would be the safest assurance of fair competition, but regulatory solutions may also be effective, and legal separation poses some very complicated problems with possibly unforeseen consequences.


A second concern is excessive market power for large suppliers of generation or energy services. A similar concern may exist about concentrations of purchasing power in some large electricity consumers. Small customers may need to aggregate their demands to maximize their benefits in a restructured electric industry. Such market power concerns are typically addressed through antitrust laws, but special regional or state attention may be needed during the transition to a restructured electric industry.


A third concern about fair competition relates to the need to develop a new retail electric service industry. Some transition needs to be provided for this market to develop in a way that assures continued fair service for all customers and yet at the same time facilitates the development of a robust competitive energy service market. Provision of a supplier of last resort, whether the current distribution company or some other service company, may raise issues of market power and unfair competition. It remains a question whether a supplier of last resort should be required or whether customers should be required to choose among alternative suppliers as was done for long distance telephone service.


A fourth concern is providing for the reliability of retail electric services. Some think that competition will eventually take care of reliability effectively. Others are concerned that electricity is not like most other products and special actions may be needed to ensure reliability and protection for small consumers. It is recommended that, at least initially, new retail electric service providers to the residential and commercial classes be licensed by the state and be subject to consumer protection standards. Such requirements are probably unnecessary for the industrial customer class and for retail service providers that are customer owned and regulated. The reliability of the electric generation and transmission system is a different issue and is addressed elsewhere.


A final concern about fair competition is related to Bonneville Power Administration. Some power marketers and generators are concerned about BPA's role in a competitive market place. As a Federal agency, Bonneville is not subject to the same tax, consumer protection, antitrust, and other laws as private companies. Further, Bonneville has superior ability to seek legislative remedies to foster its competitive position in the market. Any solution to the Federal power marketing question should consider this problem, as well as the fact that BPA also has special constraints and public responsibilities not shared by other market participants.


The issue of BPA selling to retail customers came up in the Competition Work Group's last meeting. The discussion of this issue was limited and no written materials were available to review. Nevertheless, it was clear that most members were not comfortable with the idea of BPA serving new retail customers. The discussion also consolidated the position that it is important that BPA's transmission and generation be very effectively separated in an open access environment.


Monitoring of competitive conditions in the evolving electricity markets is needed to help guide the transitional steps toward the competitive end state.


Availability of Wholesale Power Markets


An effective commodity market requires a system to facilitate short-term (spot) transactions, longer-term contract transactions, and risk management through a futures market and derivative products. The exact form of these markets is not the critical issue, but they must be easily accessible to all market participants. The more difficult it is to access these markets, the higher the transactions costs of participation are and the less efficient the market will be. Spots markets, bulletin boards, and power exchanges all facilitate this access to various degrees.


In addition, any wholesale market structure must somehow facilitate the reliability control of the power system. The existing voluntary cooperation method for ensuring system reliability and ancillary services may not work as greatly increased numbers and types of customers and suppliers are accessing the wholesale power market and transmission system. New approaches to accountability for, and accounting for, system reliability will be needed in a world of retail access. There are several potential solutions to this problem. The key requirement for performance of a commercial system under retail wheeling is to establish a system of settling payment for imbalances. Absent this function, traders in a commercial environment involving a variety of wheeling transactions will have an almost irresistible urge to lean on the system for energy and reactive supplies when market prices are high. An independent grid operator would be one solution to this problem, another would be a market operator who would only be required to administer the system of accounts and payments. The transmission work group should be addressing this issue.


Encouraging Public Purposes


The public purposes work group has primary responsibility for determining solutions to continued achievement of public purposes in a competitive environment with its greatly increased number of more complex transactions. The competition work group is only concerned that the methods of financing or otherwise encouraging public purposes not create unintended distortions of the electricity and retail electric services markets. The goal should be for public purpose programs to operate compatibly with competitive markets. The region should attempt to use market mechanisms where possible, and not distort the incentives to make efficient market choices.



Transition Issues


The end state for a restructured electricity industry, discussed above, is a very large change from the current system of vertically integrated regulated utilities. It implies a much more fragmented industry with many new participants. Some of these participants will be regulated transmission or distribution companies, some will be competitive commodity suppliers, and some will be in the business of putting together the elements needed to provide retail electricity or other energy services to the ultimate consumer.


Such a large change in a very complicated electricity system will take time. It will not be possible to see exactly how this system will evolve as the region starts into the restructuring process. During the transition, the region will need to be flexible and open to new ideas. There will be many other states going through similar processes that the region may learn from if it remains open and aware. It is important to start the process with the transitional steps and issues as clearly developed as possible. This section addresses some of the key transitional issues.


Proposed Transitional Steps


There are some initial steps that could be taken that can be done quickly, without lengthy legislation. Such steps would begin the process of change, provide learning experiences, and help educate consumers about the changes that are coming. Some of these steps are already being taken by utilities in the region. The more slowly this transition occurs, the more likely there is to be cost shifting to smaller customers and difficulty funding public purposes because of new pressures on traditional utility sources. The Competition Work Group recommends that the region complete the market transition by the year 2000. There are many difficult technical challenges, and legislative and regulatory policy changes may be required, but rapid implementation is considered key to an equitable transformation.



Equity among Customer Classes


One of the consensus principles reached by the Competition Work Group was that all customer classes should benefit from restructuring. To some, this means everyone should benefit equally throughout the transition. Others take the position that at least no one should be harmed. The ability of all customers to access the competitive electricity market simultaneously may be the best way to assure that the costs and benefits of competition are shared equitably.


However, during the transition period this presents a problem. Large customers are going to be able to access the market immediately when it is made available to them. Large customers have loads comparable to wholesale customers. Marketers that are already active in the wholesale market can easily serve these large customers. The large customers have the desire and ability to take the risk of competitive power supplies and the necessary metering and billing arrangements are a relatively small part of the cost of serving them. As a result, some large customers are beginning to gain access to the market as utilities develop market based tariffs and special contracts.


In contrast to a growing number of large customers, small customers do not have access to competitive electricity markets. Aside from current distribution utilities, there is no well developed industry of retail electric service companies standing ready to provide choice to these customers. Methods of metering and billing are not in place to handle these kinds of transactions. Thus, it is a combination of market power, industry development, and technology availability and cost that limits the ability of small customers to access alternative power supplies at this time.


This unequal access to energy markets creates the possibility of cost shifting among customer classes during the transition to a time when all customers can have equal access to markets. At the same time, early access to markets by some customers can help the wholesale electricity markets to mature, to facilitate the development of unbundled retail electric service providers and transmission accounting, and to put in place electricity distribution tariffs. Others argue that early access by large customers is not essential and that the dangers to other customer classes outweigh any benefits that might accrue. Simultaneous access could be achieved quickly if early development of the market for small customers is encouraged through pilot programs designed for this purpose. Large new metering costs may be avoided through load profiling.


Inexperienced consumers may face special risks in the new market regime. Consumer protection may be necessary to protect against fraud and to insure that there is accurate information in the marketplace. Bill assistance, rate discounts, or legislative solutions may be necessary to protect eligible low income customers. Prohibitions on red-lining and shut-off rules must be developed to apply to retail electric service providers.


The Competition Work Group recommends that, at a minimum, a no harm standard be applied during the transition period. Several members held that all customers should benefit during the transition, but the Competition Work Group could not agree that such a benefit standard could necessarily be attained during the transition. When open markets are in place for all customers the competitive rates will be set by customers. The regulated segment rates will be set by cost of service regulation.


Continuation of Basic Service During the Transition


The vision of electricity service in the end state is one of multiple competing retail electric service providers who can arrange electricity supplies, transmission, distribution, and other ancillary services, including perhaps demand side services. Customers can choose among these service providers. However, such an industry is immature at this time. How should a continuation of these basic energy services be assured as this competitive energy service market is developing?


One model is that existing distribution companies, or other entities, become the providers of last resort. They will provide a default service to customers who do not choose an alternative service company. While this approach preserves the status quo for customers who do not want to be bothered with choice, it does not promote the evolution of a truly competitive retail electric service industry. First, selecting the existing distribution company seems to run counter to the separation of the regulated distribution segment from the retail electric services segment. Selecting an alternative entity to serve as the default provider, or separation of the wires and retail service function of the existing distribution utility, would ease this concern. Second, it can be argued that having a default provider, whether the current distribution utility or another designated service company, creates a strong advantage for that provider that may limit the development of alternative providers.


An alternative approach that was presented to the Competition Work Group would be to focus pilot programs and other initiatives on the development of retail competition and access for all customers at the same time. This could include, for example, developing alternatives to time of use metering, such as load profiling, for small customers. The goal would be to provide, as quickly as possible, simultaneous market access to all customer classes. In this case, consumers would be forced to make a choice of retail electric service provider as was done in the telecommunications restructuring for long distance service.


The Competition Work Group recommends that current distribution utilities, or another designated supplier, continue to provide default retail electric service during the transition. Comparable distribution access tariffs should be put in place to facilitate the development of new retail electric service providers. In addition, pilot programs should be implemented that are designed to ensure the timely development of market access for all customer classes. Ultimately, current distribution utilities should not have a special role in the retail electric service industry, although it is expected that they will participate in that business. Retail electric service and distribution ("wires") should be separate business lines.


Stranded Costs


For investor-owned utilities, Federal law and FERC Order 888 have left to the state regulatory bodies the job of providing for stranded cost recovery. For consumer-owned systems, the Competition Work Group recommends that the recovery mechanism be left to the governing bodies that determine their rates. There was a recognition that BPA may have stranded costs, especially during the next several years, but the Competition Work Group did not have time to address this issue in its deliberations. For BPA's few retail customers, costs should not be shifted to other customers as retail access is allowed.


Stranded costs eligible for recovery should be linked to prudent, unmitigatable costs. Recovery of stranded costs should be for a limited duration and there should be no guarantee of 100 percent recovery. The group did not reach consensus on whether investor-owned stranded costs should be "shared" with investors or taxpayers.


Reciprocity of Access


A concern for the transitional period is whether the access to utility systems is comparable among utilities. The Competition Work Group discussed this issue and concluded that defining comparability of access through rules and regulations would be a very difficult process. By moving to regional retail access in an expeditious manner for all utilities and customers the effects of these concerns will be minimized. Significant differences in the interim are likely to be sorted out by the markets or by state regulators on a case by case basis if they are serious enough.


Conclusion


The Competition Work Group found that access to competitive power supplies is possible for large customers and that these customers and the utilities that serve them are moving quickly to make this a reality. In order to ensure that the many benefits of enhanced competition in the electricity market are shared equitably among all customer classes, the region's legislatures, regulators, and utilities need to take action to open the electricity markets to competition for all customers. There are a number of transition issues, including stranded costs and public purposes, that may stand in the way of this goal and therefore should be addressed quickly and comprehensively. Steps should be taken to begin the separation of the wires functions from the competitive segments of the industry, to unbundle consumers' bills, and to encourage the rapid development of market access for smaller customer classes. Increased competition and customer choice, properly crafted and with concern for continuing public purposes funded in a manner consistent with market principles, will result in benefits for all consumers.






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Footnote1

Whether BPA has legal authority to wheel for retail transactions is squarely before the ninth circuit court of appeals in a suit challenging BPA's transmission contracts with its direct service industries.

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