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

While Enron isn’t getting out of any residential natural gaspilots, the level of competition in the residential gas sector isstill very poor, according to the Arlington, VA-based consultingfirm Hagler Bailly. The firm’s National ACCESS Index scores thecurrent level of residential natural gas competition nationwide asof April 23 at 1.6 on a scale of 1-100. The index measures theopenness of the market based on a number of components, not leastof which are state regulatory policies. According to the index,commercial gas competition isn’t moving much faster, with a scoreof 12.9 out of 100.

A recent Salomon Smith Barney report finds 41 LDCs in 16 stateshave moved toward retail competition but many of them have madeonly halfhearted attempts at installing successful customer choiceprograms.

“Although initial customer reaction has been favorable, thenumber of eligible customers that have signed up to participate [inretail customer choice pilots] has been disappointing,” the SalomonSmith Barney Quarterly Review of LDC Regulatory Activity stated.”Customers are not convinced of any potential benefit. If acustomer is happy with the service that an LDC is providing, thereis no reason for that customer to switch to another supplier unlessthere is a great economic incentive.” And in many cases, theeconomic incentives are reduced even further when choice is madeavailable. LDCs typically lower or freeze their rates wheninstalling customer choice pilots (please see MichCon story p. 11).

Many existing residential pilot programs have attracted lessthan 15% of the eligible customers. For example, only 1% of theresidential customers in KeySpan’s entire New York serviceterritory are buying gas from participating marketers. Only 7% ofthose eligible signed up in the first two years in MichCon’s GrandRapids pilot. And 6% of the residential eligible signed up inNorthern Indiana Public Service Co.’ pilot.

What’s worse is those numbers aren’t likely to grow much overthe next five years as long as state regulators follow theircurrent 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 atonly 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 hisspeech on the issue last week at a Federal Energy Bar Associationconference in Washington, D.C.

One is there’s little difference in the price of the commodityoffered by the LDC and that offered by the marketer because bothenjoy the benefit of a competitive wholesale market. “When an LDC’sprice is not that far from marketer’s you can see why there wouldbe slow penetration,” he said. The state commissions haven’t donemuch to unbundle the other $4-$5 out of a residential customer’saverage $7 gas bill.

“All they’re doing right now is playing around with the $2 forgas costs and a little bit of the $1 for pipeline transportation.They are not yet going in there and touching that $4 fordistribution costs. They are not spinning off metering and billingand forcing cost allocation studies that really force the LDCs toexpose some of its services that might be offered competitively butthat are part of the distribution bundle.

“When you’re in retail you have to reach a critical mass ofdollars with the residential customers” by combining gas,electricity, communications, home security services, appliances,windows and other energy services. “Right now there hasn’t beenenough work by state regulators to ensure that there is symmetryand integration between gas regulation and electric regulation thatallows the opportunity to sell a joint product.” Regulators need tothink in terms of creating a regulatory scheme that encourages thesale of a “converged bundled offering of a wide variety of goodsand services.”

But to make the picture even more bleak, Malloy believes even ifevery state did a good job, “the sum total of all 50 states doingit separately with all the little differences they might have.wouldstill be highly dysfunctional to marketers doing business inregions and nationally.” It would be akin to each state settingtheir rules for VCR formatting. Each format might be good, butrequiring a VCR company to sell 50 different types of VCRscertainly would create quite a headache for manufacturers.

“That’s exactly the situation [energy] marketers find themselvesin. Each service territory has its own set of rules and its veryexpensive to have to comply with all of them. They would prefer, myguess is, one set of rules nationally, even if it was a bad set ofrules.

“Right now the incumbent can use the ability to establishdifferent rules for implementing unbundling as a wedge against deeppenetration by marketers,” he said.

Malloy believes the retail industry now is in a situationsimilar to where the wholesale gas market was at the beginning ofthe 1980s. At that time, FERC gave multiple pipeline companies awide degree of discretion to come up with their own transportationprograms for fuel switchable customers. And each pipeline did it ina way that garnered advantage for itself to the disadvantage of thecaptive customers in many instances. “That’s sort of where we areright now [in retail]. Each LDC and each electric utility is givena fair amount discretion in how they will implement unbundling.Even if each did it well, the fact that you need to do business on250 different systems in order to hit 90% of the load in the U.S.makes it highly dysfunctional.” Because LDCs are state regulatedentities in contrast to the pipelines, however, the possibility ofpreventing the development of a “crazy quilt” of retail gas marketsis even smaller.

“In the [last] 18 months…I’ve seen [energy] marketers go fromalmost jubilation at the prospect of being able to get a piece ofthis huge consumer market, to what I now regard as at bestdiscouragement at worst anger over the fact that they’ve lost a lotof money and there’s no end in sight because it is just toodifficult to do business on the kind of patchwork quilt system thatwe have today.”

For many utilities and regulators who predicted retailcompetition would not work, it has become like a self-fulfillingprophecy.

“I think that Georgia and Atlanta Gas Light’s implementation ofthe Georgia legislation over the next two to three years will be awater shed in terms of giving us a model that tests the degree towhich residential customers will participate in the customer choicemarket,” said Malloy.

“I obviously believe that we will find that there is a lot moreenthusiasm for choice when it’s done right. You need some mechanismto ensure that it isn’t easy for the customer to remain within theregulated umbrella. The customer to some extent has to be forcedout into a competitive market and forced to choose among competingalternative suppliers. As long as it’s easy to remain within theregulated company.they are going to be slow in moving out fromunder that paternalism.”

Rocco Canonica

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