The Changing Face of Electric Industry in the U.S. And Around the World. Yogesh Kulkarni Engineering Management Department http://www.umr.edu/~yogesh
Agenda What Is Deregulation. Pre-deregulated Electric Industry. Restructured Electric Industry. Competitive Market Mergers and Acquisitions California Crisis Key Issues in Transition to Deregulation
What Is Deregulation? Transition of: Customers from a monopoly to a free market. Companies from a regulatory to a competitive market. Provide Incentives for: Customers to shop wisely to get a better product at less Cost. Companies to expand their horizons and service offerings without any regulated boundaries.
Various Deregulated Industries 1978: U.S. Airline Deregulation Act 1978: National Gas Policy Act 1980: Deregulation of U.S. Savings and Loan, Trucking, and Rail Passenger Industries 1982: Bus Regulatory Reform Act 1983: Cable Communications Policy Act Deregulates Cable TV 1989: Natural Gas Wellhead Decontrol Act 1990: Privatization of British Electricity Grid
1992: National Energy Policy Act Lays Foundation for Wholesale Electricity Deregulation 1992: Cable TV Deregulated 1996: Telecommunications Act 1996: FERC Order 888 Gives Non-utility Generators Open and Equal Access to the Transmission Grid 1998: By Joint Decision All European Members (EU) Required to Open Their National Telephone Networks to Competition 2001: European Commission Directive Requires All EU Member Countries to Open Electricity Grids to Competition by January 2005
Electric Industry Generation of Electricity Producing electricity. Delivering power to the interconnected grid at the required voltage level. (Gas Turbines/ Coal Fired/ Hydro/ CCGT) Transmission of Electricity Transporting electricity High voltage from Generators to the Local Distribution System.
Electric Industry Distribution of Electricity Delivering electricity at low voltage. Transmission System to the end-use customer. Customer Service Metering and Billing the end-user consumer.
Restructured Electric Industry Depending on the market structure, the restructured industry will broadly consist of the following entities: Generator company (GENCO) Produce electricity. Sell in the competitive market. Currently they are the part of the vertically integrated utility. They will be completely independent of any other utility functions.
Restructured Electric Industry • Transmission Owning Utility (TOU) Own transmission facilities. Currently transmission facilities are also owned by utility companies. • Independent System Operator (ISO) Operate a regional network of transmission facilities. Not own those facilities. It will be independent of the utilities. Utilities will not be able to control the operations of ISO. ISO will also make sure the impartial access to transmission facilities for all Gencos.
Restructured Electric Industry • Local Distribution Utility (LDU) Own the distribution wires. Provide distribution wires services to the end use customers. It may also provide customer services. It may provide certain limited generation services. Services will be provided to the customer at regulated rates. • End – use consumers. Ultimate users of electricity. Industrial, commercial, residential that can be served by any number of alternative providers (Gencos).
Restructured Electric Industry • Retail Electric Provider (REP) Retail sellers of the electricity to end-use consumers. REP will buy and procure electricity from Gencos. It will arrange for the transmission of electricity with either TOU’s or the ISO’s. In certain market structures REP’s may be allowed to provide customer services. REP will be a separate entity from that of the LDU, if a vertically integrated utility chooses to be an REP.
Restructured Electric Industry • Poolco Operate in a regional competitive market for generation. It will have the responsibility and authority for commercial terms for all transactions within the region. Sales and purchases of power through the Poolco are mandatory.
Restructured Electric Industry • Power Exchange (PX) Operate in a regional competitive market for generation like Poolco. It will have the responsibility and authority for maintaining a spot market for the electricity in the region. Sales and purchases of power through the PX are optional.
Commercial Arrangements Transmission Co Distribution Co Generation Co Suppliers Customers
How Will It Work ? Producers can only obtain a fair market price for their energy. If price is too high, wholesalers/customers will seek alternative arrangements. Transmission of electricity will be a natural monopoly. Price of transport is likely to be directly controlled by regulation. ISO/RTO will make sure that the market is functioning smoothly.
Competitive Market Spot prices will be volatile depending on the availability of the raw material required to produce power. Bilateral agreements on prices over a period will be executed. Forward/future/option contracts will be employed in due course of time. Average prices will reduce over a period of time. Average prices will stay just above marginal costs.
Factors Affecting Wholesale Prices Market Control Single or very few participants make the market oligopolist. It places power in hands of very few players. It may cause a rise in prices of power in the market. Fragmented market will cause the prices to fall towards marginal costs. One pricing pattern develops in a more interconnected market than the other.
Factors Affecting Wholesale Prices New Entrant Prices Incumbent generators are in a strong position if new entrants have higher prices. Prices tend to fall if new entrant prices are lower. Then, the existing players have 3 choices: Reduce Prices to Retain Market Share. Maintain Prices and Be Resigned to Loss of Market Share. Ask for State Protection.
Factors Affecting Wholesale Prices Marginal Costs Marginal costs are attained in a highly fragmented market. Different marginal costs will exist for regions with weak interconnection. Marginal costs are determined by marginal fuel prices. Fuel mix used in a particular region will decide the marginal prices for that region. In a competitive market, a plant at margin sets the prices.
Reliability Concerns Simple theory of Supply - Demand Rise in demand rises prices. Good prices attract new suppliers. Thus, supply problem should not be an issue. Problems in the theory: Long lead times for large power station development. High cost of storing electricity. Low price elasticity as a result of prevailing metering systems.
Mergers and Acquisitions Mergers of Gencos adds to share holders value. In the competitive market the utility functions are segregated. Generation is competitive. Mergers can achieve cost savings. Benefits of Scale And Benefits of Size Mergers should not give a market power to resultant entity.
Benefits of Scale and Size Benefits of scale can be achieved by saving in following areas: Procurement Head Office Costs Marketing Power Trading Administration Customer Care Best Practices Transfer Lower Finance Costs
Benefits of Scale and Size Benefits of size can be achieved by savings in the following areas: • Trading • Reassembling market power • Reciprocity
Deregulation In California CA was one of the first states in the U.S. to implement deregulation of electric markets. Starting March 31, 1998 most of the customers in CA were allowed to shop for their electricity. Prices were frozen at June 1996 levels. Additional 10% rebate was applied to small customers. Since 1999 CA started experiencing rolling black outs. Prices of power in CalPX shot up sharply during summer 2000 putting deregulation in jeopardy.
California Crisis • Different scholars have different opinions about the causes of California crisis. • Most of them attribute the flawed legislation at the heart of California’s power crunch. • A principle of physics/economics can be applied here. “If a rapid pressure builds in a confined space, and if it has no where to go, there result is obvious.” • CA had abundant energy supply with the wholesale prices being considerably low. • The situation demonstrates how soaring demand combined with artificially low prices can disrupt a commodity that everybody relies on – and take for granted.
California Crisis In summer the demand for power is highest. Ironically, the crunch occurred in winter. It took two years for the crisis to occur after the enactment of deregulation. The legislation traded economic realities for short term fixes to satisfy consumers and utilities. In return for more freedom from state regulation, PG&E and SCE agreed to freeze residential prices. The economy of the state started booming.
California Crisis Economy was using all the power. The capacity tightened rapidly. Heavy state politics and bureaucratic indecision stopped the growth of in-state-supplies. Public opposition to new power plants is also one reason. Investor uncertainty to the regulatory regime was another reason. Starting in May the imbalance became apparent. Also, the prices of natural gas sky rocketed. Unusually dry weather reduced hydro-electric power throughout the West.
California Crisis Average prices were $54/MWh. PG&E and Edison paid an average $320/MWh for power in December. Massive losses led to default on some debt payments. Suppliers got worried about unpaid bills. State had to intervene.
Conclusions: • Regulators must let utilities pass on reasonable costs. • Adequate sources of power should be purchased on stable long-term basis. • Better metering technology should be put in place. • Faster steps should be taken, in case any state faces another power crunch.
Key Issues to Be Considered • Stranded Costs Pre-deregulation, utilities estimated future power requirements. Accordingly, they built power plants to suffice the need for about a decade or more. They took loans for new plants and recovered the money over a period of 20 – 30 years from the permanent customers. Deregulation causes the customers to switch to lower cost electricity provider leaving stranded costs for the utility.
Key Issues Remedies suggested to recover stranded costs include: • Divestiture of all generating assets to recover 100% of stranded costs. • Competition transition charge (CTC) on the bills of customer. • ‘Floating CTC’ – a nonbypassable wire charge paid by the consumers. • Securitization and sale of bonds can be employed to recover the stranded costs as well. • Stockholders should share stranded costs recovery with ratepayers.
Key Issues • Unbundling Pre-deregulation, utilities charge the customer for generation, transmission, distribution and customer service in a single charge. Post-deregulation, utilities are required to functionally unbundle generation, transmission, distribution and customer service. Filing of unbundled rates with PSC is required. Competitive suppliers may have to provide information on price, service and generation sources. A standard bill format should be used. Provide proof of technical, operational and financial capability by furnishing a bond.
Key Issues • Rate freezing, shopping credits, discount for loyal customers In the beginning, rate freezing will have to be incorporated to increase the prevailing customer base. Shopping credits should be given to customer for switching from traditional supplier. x% reduction in generation portion of the bill should be given to a loyal customer.
Key Issues • Power Requirement The PSC or the ISO should forecast power requirements and encourage building of new power plants. • Market Based Bidding Market based bidding should be carried out after deregulation is enacted fully. Thus utilities will bid for power within PX. It will bid for longer periods into future using Block Forward Market products. This will enable the company to purchase power at lower prices during periods of high demand. Thus it will help avoid price spikes.
Key Issues Bilateral Agreements Utilities may enter into bilateral agreements with generators. It will help shield themselves and consumers from volatile price spikes. They will have to contact third-party suppliers via the PX. Negotiate contracts to hedge against price hikes. Buy power at set rates for long periods (up to 5 years). Thus power will be available during periods of high demand and low reserves.
Key Issues New Business Ventures Utilities may have to form a holding company. This will make it easier for them enter into new business ventures in the competitive market. Business ventures will provide economies of scale. Efficiencies will be gained by combining different expertise, giving consumer a better choice.
Key Issues Provider of Last Resort (POLR) POLR will serve customers in areas of competition, if REP of choice fails to continue service. If a utility is to be a provider of last resort, it will have to ensure adequate transmission import and distribution capability. POLR must offer a firm, non-discountable, seasonally differentiated rate to any consumer. This service is not supposed to be competitive or innovative. It will just be the standard basic service.
Key Issues Standard Offer Service It is a default service for the consumers, who have left their competitive supplier, or are new to the utility’s territory. Companies will be selected to provide SOS. It will be at a reasonable price. Utilities will have to look into distribution, default generation services, standard offer generation, aggregation requirements and ownership of meters.
Key Issues Public Workshops Public workshops should be held to address the issues related to restructuring and transition mechanisms. Issues under study should be Consumer Education Regional Planning and Reliability Market Power Independent System Operators Regional Transmission Operators Transition Mechanisms
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