All of the efforts of the CPUC to create a competitive marketplace are predicated on the assumption that a number of firms will target the California energy consumers. Through this process, it is hoped that all customers will have the opportunity for direct involvement in the newly created market, thereby creating a dynamic marketplace which produces significant benefits for passive, non-participating customers.
We fear that the CPUC, the legislature and many other parties have made some assumptions about how much competition will develop, without fully understanding the needs of the marketplace. Stated most simply: only if the business opportunities created are commensurate with the transactions required to pursue them will businesses be created to serve the opportunity. The CPUC has produced a variety of mixed messages to the marketplace regarding what is to be unbundled. As a result, there is disagreement among the IOUs whether the CPUC's directives apply only to the commodity portion of the electric transaction (generation), or whether a much broader range of activities can be opened up to competitive pressures. Many have interpreted Commission statements to say that they will unbundle what ever they must to kindle true competition. Even if this last position is the true consensus position of the Commission, we, the supply community, are concerned about whether the implications of that statement are understood.
Therefore, the purpose of this presentation is to make the simple point that there exists a continuum. The more that is unbundled, the smaller class of customer that direct competition can reach. This has three levels to it:
It is the role of the working groups to define the foundations of the electric restructuring, and based on the CPUC's timeline, now is the time to for the system to explicitly state the degree to which it will commit itself towards a competitive structure. Regardless of the fact that many steps in the introduction of competition may take time, the working groups must focus on the indended long term structure of the industy as the context for its short term, implementation agenda. It is therefore critical for the working groups first, and the Commission, second, to articulate a position unambiguously regarding whether it intends to make competition a direct opportunity for small customers. Then, through the evolution of the restructuring, this standard can be employed in the development of policies and procedures.
We contend that the unbundling working group in particular must, as part of its responsibilities, explicitly acknowledge the existance of the relationship between how much gets unbundled and the minimum size customer which the competitive market can be expected to directly serve. This means that as the working group conducts its business, reviews the utility filings, and begins to make recommondations, it would be an abrogation of the group's responsibility to fail to indicate to the Commission what the customer participation implications would be of any proposals or recommondations. Many parties are active in the restructuring effort, purely on the belief that small customers will be able to directly participate, so considerable effort is going into low income ratepayer issues, direct access issues consistent with serving small customers, etc. For these customers, the emperor is wearing no clothes. Based on much of the discussion within this and other working groups, the belief of a program empowering more than several thousand of California's electric customers has no grounding as we can find no marketing company that has any intention under the CPUC's promulgated rules to serve the millions of smallest customers. This avoidance is not due to lack of interest or study, but lack of unbundling.
There is one simple criterion in defining whether competition will arise in a marketplace. That is whether there is a profit potential that is commensurate with the risk and effort required to pursue the profit. This can be illustrated as follows:
Clearly, the more activities that become open to competition, the more business activities that can be developed, the more value that can be added, the more profit potential that is possible, the smaller customer that can be served. An important baseline to recognize is:
There is not one major marketing firm, of 20 that we have interviewed, who is targeting the marketplace of individual residential and small, independent commercial customers in California.
The reason is simple. Until the bundle of services and activities which enable the utility to realize a reasonable PP/TE ratio are made available to the marketplace, there will be no competition at the small customer level.
Nothing speaks to this more clearly than the CPUC's core aggregation gas program, which is limping along at 3 - 4 % market penetration levels, disproportionately representing large groups of customers aggregated through associations (Reduced Transaction Effort), and high load profile customers (increased Profit Potential) whose departure degrades the average load profile of the remaining core customer base served by the utilities.
The problem is that customer service requirements do not decline proportionately with reductions in levels of energy consumption. This means that at the small commercial and residential levels, the service costs per customer implies huge customer service costs per unit of energy consumption. This can be readily seen in the cost allocation of customer service costs by rate class of the utilities today. Thus, for the CPUC or others to assume that by creating commodity-to-commodity competition that sufficient incentive is created to serve small customers implicitly assumes a huge gross commodity supply margin. The CPUC has endeavored to insure that is not the case through the use of Power Exchange prices. It is not our point to criticize that decision, we do not endorse artificial setting of prices as a means to stimulate competition. However, we do advocate the elimination of duplicative services and functions, along with the opening up of the system for the non-discriminatory participation of qualified firms at all service levels.
The marketing community assumes that the utilities are currently inefficient, but not grossly so. However, over time, due to the advent of competition their efficiency will increase significantly, thereby decreasing available margins for customer savings and supplier profitability. Unless the bundle of services which can be provided is sufficiently large, this narrowing of margins will prevent market penetration in the smaller customer classes, and over time move up the minimum threshold of eligible customer size. This is simply logical, and should not even be controversial.
We need flexibility. We are much less concerned about the precise costs of a narrowly defined service, our bundles to customers will almost never identically track the utility bundle. Instead, we need to know the value of the full bundle, within which we can work. In the long run, utility unbundling needs to be based on firm, well understood and agreed upon cost avoidance of the utilities, enabling competing firms the ability to price their service, make investments accordingly and take customer acceptance risks. However, in the short run, we merely need a good understanding of the approximate size of the bundle that is to be made competitive, (metaphorically, the forest rather than the trees) and it is up to the marketplace to craft program and service offerings within that unbundled amount. From the perspective of implementation that should be easier as it permits the utilities to estimate their unbundled program at a more gross level, knowing that the sum of the detailed studies should approximate this gross level. While this may be easier from a utility costing and implementation perspective, from a policy perspective this it may be more complex
Our proposal is that:
Another issue here relates to the utility role as default supplier. We distinguish between being the default supplier on 1/1/98 from assuming that the utility is to maintain a service staff, and excess capacity ad infinitum, just in case someone wants to come back to the utility fold. We have no problem with the notion that customers not wanting to be bothered by the evolution to competition have a default option that is seamless. To assume, however, that some significant portion of the marketplace will default back to only the utility is to admit defeat, and produce such a large overhead on the system as to insure that defeat. We specifically have three problems with this. First, we cannot come up with a single service that we believe deserves this status. Second, we are concerned that such a designation inherently produces a discrepancy in service costs, due to ratepayer subsidization of base service costs. This, in turn prevents competition and makes utility default service a self fulfilling prophecy. Third, we strongly advocate that the mere presence of the marketplace will create far more redundancy in every unbundled function than the utilities would be able to sell to the CPUC, paid only by the customers of the service firms.
All capital charges from which utility profitability is currently driven must be opened up, through the ability of the marketplace to prepay the utilities, thereby not stranding investments, while enabling the customers to realize the lowest possible costs available from the marketplace. This is critical, otherwise the marketplace is forced to compete with the utilities on only on those items that are the non-profit functions of the utility. This would leave the potential profitability for most customers with the utility, and could be seen as a means by which these non-capital services are essentially subsidized through profits on capital. This aspect of the unbundling is expected to require a pilot scale implementation, to test and evaluate prior to full implementation over an extensive period of time.
The tools employed by the utilities associated with providing liberal credit terms to customers must be unbundled to insure that the credit standards of the marketplace are the same as those of the utility in all neighborhoods of the entire utility territory. Specific tools include making a single uncollectibles account, administered as an insurance fund for all qualifying companies to pay into and collect from, as well as a systemic set of termination rules for failure to pay. Failure to provide these minimal tools will result in very different credit acceptance standards being employed by utilities and marketers, which from a policy perspective limits direct access to a significant portion of the utility customer base. In other industries this is called red-lining.
All system issues associated with power dispatch, control and planning must look at the supply community the same as the IOUs operating within their historic territory.
We want to cover one final issue regarding system costs and risks. We firmly expect that the utilities, through the deployment of a segregation of their existing personnel and infrastructure on a competitive basis will remain the dominant market party. We expect that in a properly operating market that they could retain a two thirds to three fourths market share. The CPUC will need to monitor the progress of the new supply community to evaluate service impediments if this level of market penetration is not achieved, as it will serve as prima facie evidence of a lack of competition at work in meeting customer needs.
In this regard, if this is the degree of market penetration that we may expect, and we have before us a phased implementation schedule extending over several years, there will be numerous opportunities for the CPUC to monitor system performance, cost allocations and customer benefits at relatively low system participation rates. Thus, if cost allocations associated with unbundling are somewhat in error initially, or utility cost avoidance is slightly lagged to the implementation of unbundling of charges, this is not a large scale problem unless allowed to remain fully into the full implementation when significant penetration rates may be achieved. We have to assume that the utilities will stand up and make their case if their competitive positions are too severely disadvantaged.
Thus, our need for a less precisely defined large bundled of services to be the basis for cost and service unbundling for 1/1/98 carries little risk. There should be plenty of time to do the detailed cost studies to verify that the sum of the individual costs approximate the bundled amount, and make the necessary adjustments to insure that the system is neither increasing transition costs nor limiting competition through excessive utility service and cost retention.
Finally, regarding costs and risks, it must be recognized that the efficiency we seek is the dynamism the marketplace can introduce in how energy is bought and sold. If a cost of this is to impose an unbundled structure on the utilities which limits their ability to manage all functions centrally, we are talking about cost impacts of a very few percent at absolute worst. However, the effects of competition, which depend on the creation of a level playing field, offer savings measured in the tens of percent, when considering cost alone. More fundamentally, competition offers new ways to buy and sell energy that will make direct comparison with today's costs seem absurd as many new values can be added to the sale transaction of commodity energy at moderate cost. This cannot happen under the current structure. We caution against trying to maximize the efficiency of the current system, as we strongly believe that without true competition, we have an extremely inefficient system.
The purpose of this presentation is to illustrate the reason behind the marketing community's unanimous conclusion, that to limit the arena of competition to only the commodity transaction simply means that there can be no competition at the small commercial and residential level. Fundamentally, commodity markets are high volume, tiny margin transactions. This is true in every commodity, because by definition commodities are undifferentiated items traded within highly liquid markets. Similarly, by definition, a commodity market price is only for the commodity, at a specified place and time. To begin to add services to the transaction takes it out of the commodity realm by differentiating the product, and through the specificity of the services limiting the "liquidity" of the transaction. Thus, to depend on the margins from only this narrow business activity of commodity transactions to pay for the costs of providing services to even medium sized customers is a failure to recognize the market realities. An illustration may be helpful.
As a result of the generation only unbundling, and assuming no change in the methods of CTC and rate base finance, we should see very little change in the above economics until the CTC is paid off. The CPUC has endeavored to insure that all customers are able to enjoy market based commodity pricing from the beginning of the phase in of restructuring, calling it "virtual direct access". That insures that the difference between the marketing community' price and the utility's power exchange price will be small, thereby benefiting customers who do not directly participate in the restructuring. The implication of failure to provide extensive unbundling can be described in sequence.
Incentives from Unbundling Services: Moving then to the services side, even if the services component were unbundled, it must be remembered that this component is purely a cost pass through item for the utility meaning that this is virtually without utility profit. Thus, to unbundle only this is to request the marketing community to match the current level of utility service, using newly deployed facilities and personnel, in competition with the utility using existing personnel and facilities on a non-profit basis. The marketing community is confident that this can be done in the initial period. However, all believe that with the increased competitive posture of the utilities (assuming this component is actually unbundled), that this utility cost target will come down significantly within only a few years, much of which could occur during the phase in implementation period through the year 2002. Thus, a significant investment in the infrastructure required to compete with the utilities in their non-profit arena may be seen as a risky proposition.
Incentives from Unbundling Rate Base Finance: The answer, simply stated, is that if the CPUC is serious about creating robust competition, then all aspects of the utility service program must be unbundled, including the capital charges, where the profitability lies. Only if the marketplace can pay off a customer's embedded, undepreciated rate base, and can both provide for and charge for a broad range of services can there be created a profit potential that begins to match the transactions cost for these customers.
Without the third dimension of unbundling, it is unrealistic to expect competition in all segments of the marketplace. This is not because the market is inefficient, not because these customers require a monopoly utility, not because the utilities are uniquely efficient, but because the profit opportunity is not commensurate with the tasks and risks required to serve this market.
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