Pace of Retail Gas Competition Disappoints Some Observers

Enron's announcement last week that it will terminate residential power marketing efforts in several states (please see story p.6) should be a wake up call for the gas industry as well, where the pace of change toward retail competition has been a disappointment for many observers.

While Enron isn't getting out of any residential natural gas pilots, the level of competition in the residential gas sector is still very poor, according to the Arlington, VA-based consulting firm Hagler Bailly. The firm's National ACCESS Index scores the current level of residential natural gas competition nationwide as of April 23 at 1.6 on a scale of 1-100. The index measures the openness of the market based on a number of components, not least of which are state regulatory policies. According to the index, commercial gas competition isn't moving much faster, with a score of 12.9 out of 100.

A recent Salomon Smith Barney report finds 41 LDCs in 16 states have moved toward retail competition but many of them have made only halfhearted attempts at installing successful customer choice programs.

"Although initial customer reaction has been favorable, the number of eligible customers that have signed up to participate [in retail customer choice pilots] has been disappointing," the Salomon Smith Barney Quarterly Review of LDC Regulatory Activity stated. "Customers are not convinced of any potential benefit. If a customer is happy with the service that an LDC is providing, there is no reason for that customer to switch to another supplier unless there is a great economic incentive." And in many cases, the economic incentives are reduced even further when choice is made available. LDCs typically lower or freeze their rates when installing customer choice pilots (please see MichCon story p. 11).

Many existing residential pilot programs have attracted less than 15% of the eligible customers. For example, only 1% of the residential customers in KeySpan's entire New York service territory are buying gas from participating marketers. Only 7% of those eligible signed up in the first two years in MichCon's Grand Rapids pilot. And 6% of the residential eligible signed up in Northern Indiana Public Service Co.' pilot.

What's worse is those numbers aren't likely to grow much over the next five years as long as state regulators follow their current path and LDCs try to preserve the existing framework, according to Ken Malloy, a senior consultant with Hagler Bailly. The firm scores the openness of the residential market in 2003 at only 7.1, up slightly from 1.6 in 1998.

There are many reasons the retail market is opening so slowly, but some explanations are very subtle, Malloy said following his speech on the issue last week at a Federal Energy Bar Association conference in Washington, D.C.

One is there's little difference in the price of the commodity offered by the LDC and that offered by the marketer because both enjoy the benefit of a competitive wholesale market. "When an LDC's price is not that far from marketer's you can see why there would be slow penetration," he said. The state commissions haven't done much to unbundle the other $4-$5 out of a residential customer's average $7 gas bill.

"All they're doing right now is playing around with the $2 for gas costs and a little bit of the $1 for pipeline transportation. They are not yet going in there and touching that $4 for distribution costs. They are not spinning off metering and billing and forcing cost allocation studies that really force the LDCs to expose some of its services that might be offered competitively but that are part of the distribution bundle.

"When you're in retail you have to reach a critical mass of dollars with the residential customers" by combining gas, electricity, communications, home security services, appliances, windows and other energy services. "Right now there hasn't been enough work by state regulators to ensure that there is symmetry and integration between gas regulation and electric regulation that allows the opportunity to sell a joint product." Regulators need to think in terms of creating a regulatory scheme that encourages the sale of a "converged bundled offering of a wide variety of goods and services."

But to make the picture even more bleak, Malloy believes even if every state did a good job, "the sum total of all 50 states doing it separately with all the little differences they might have.would still be highly dysfunctional to marketers doing business in regions and nationally." It would be akin to each state setting their rules for VCR formatting. Each format might be good, but requiring a VCR company to sell 50 different types of VCRs certainly would create quite a headache for manufacturers.

"That's exactly the situation [energy] marketers find themselves in. Each service territory has its own set of rules and its very expensive to have to comply with all of them. They would prefer, my guess is, one set of rules nationally, even if it was a bad set of rules.

"Right now the incumbent can use the ability to establish different rules for implementing unbundling as a wedge against deep penetration by marketers," he said.

Malloy believes the retail industry now is in a situation similar to where the wholesale gas market was at the beginning of the 1980s. At that time, FERC gave multiple pipeline companies a wide degree of discretion to come up with their own transportation programs for fuel switchable customers. And each pipeline did it in a way that garnered advantage for itself to the disadvantage of the captive customers in many instances. "That's sort of where we are right now [in retail]. Each LDC and each electric utility is given a fair amount discretion in how they will implement unbundling. Even if each did it well, the fact that you need to do business on 250 different systems in order to hit 90% of the load in the U.S. makes it highly dysfunctional." Because LDCs are state regulated entities in contrast to the pipelines, however, the possibility of preventing the development of a "crazy quilt" of retail gas markets is even smaller.

"In the [last] 18 months...I've seen [energy] marketers go from almost jubilation at the prospect of being able to get a piece of this huge consumer market, to what I now regard as at best discouragement at worst anger over the fact that they've lost a lot of money and there's no end in sight because it is just too difficult to do business on the kind of patchwork quilt system that we have today."

For many utilities and regulators who predicted retail competition would not work, it has become like a self-fulfilling prophecy.

"I think that Georgia and Atlanta Gas Light's implementation of the Georgia legislation over the next two to three years will be a water shed in terms of giving us a model that tests the degree to which residential customers will participate in the customer choice market," said Malloy.

"I obviously believe that we will find that there is a lot more enthusiasm for choice when it's done right. You need some mechanism to ensure that it isn't easy for the customer to remain within the regulated umbrella. The customer to some extent has to be forced out into a competitive market and forced to choose among competing alternative suppliers. As long as it's easy to remain within the regulated company.they are going to be slow in moving out from under that paternalism."

Rocco Canonica

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