Electric Re-Regulation and Effects on Industrial Customers Robert A. Durham Central & Southwest Services Marcus O. Durham THEWAY Corp / U of Tulsa Robert A. Durham Central & Southwest Services Marcus O. Durham THEWAY Corp / U of Tulsa

Introduction u Regulation began in 1935 u Consumers see utilities as last monopoly u States are making rapid changes Yipee!

Introduction u Process ties closely to dereg of oil u Many models, all have effects on consumers u Needs of small consumers must balance w/ industrials ?

History Utility Life Cycle u First “power World’s Fair of 1893 u First “utilities” were large consumers u Consumers diversified to provide power to others u Some were created by cities

History Utility Life Cycle u Companies started by technologists u Large conglomerates formed by Industrialists u Federal government created authority to regulate u Consumers see limited risk and demand change u Those that adapt do well, those that don’t fail

$ Time Concept Development Growth Regulation Deregulation Technological Growth Figure 1 - Regulated Industry Life Cycle

History Federal Regulation u Federal Power Act 1935 –To restrict “undue discrimination” –“Natural Monopolies” due to geography u Public Utility Holding Company Act 1935 –To regulate holding companies of local utilities –Unprecedented control & restrictions

History Federal Regulation u SEC: “purpose of PUHCA achieved.“1955 u Public Utilities Regulatory Policy Act 1978 –Promote domestic energy, particularly renewables –Utilities forced to buy “excess” power from cogen, etc. –Created Independent Power Producer (IPP)

History IPP u Generation to supply industrial heat & energy u Auxiliary power sold to utility at “avoided cost” –Utility:Price of fuel –IPP:Cost of new plant u Different interpretations = different rules in each case

History Ancillary Organization u State Commissions –Oversee utilities & approve expenditures u Quasi-government organizations –Provided service in underdeveloped areas –Some by mandate - TVA, SPA –Some by federal loans - Co-ops u Role will change under different set of regulations

Parallels to Oil Correlations u Both industries had large, vertical integrated companies GenerationProduction TransmissionPipeline DistributionRefining & Marketing u Many Independent Producers, few distributors

Parallels to Oil How Oil looks today u Fewer producers u Price dramatically reduced u Separate “common carrier” pipelines purchase & resell u Standards set by voluntary ad-hoc organizations

Parallels to Oil Differences OIL ELECTRICITY Multiple OutletsDirect to Customers Distributed InvestmentCentralized Plants Generally, electricity market will stabilize once restrictions are released - just like oil.

Industry Reorganization u Utilities will organize themselves along three lines Generation - Transmission - Distribution u Individual risks are limited u Each entity can draw support from others G T D

MARKETER GENERATION TRANSMISSIONDISTRIBUTION PRODUCT - MARKETER - CLIENT

Darkness and Light u Historically, one entity responsible for all of system u Now, each entity has its own competing concerns u As system is pushed, reliability will suffer

Observations from Western Outages u Transmission being stressed more than ever u Not enough dynamic reactive support u Events not been studied u No one had “big picture”

What We Can Expect from Future Operations u More stress on transmission as system is pushed u Less “spinning reserve” for volt / freq support u More conditions to study => more holes u Entities focus on own business, no one w/big picture

Energy Policy Act of 1992 u Free Access to transmission u Wholesale generation allowed u Ownership of foreign utilities

Wheeling u Electricity from one system to another through third u Nebraska sells to Oklahoma through Kansas u Open Access “nondiscriminatory access to transmission systems” u Has opened market to freer competition in transmission u Already seeing some effects

Exempt Wholesale Generators (EWG) u “Engaged exclusively in making & selling at wholesale” u Potentially more impact than wheeling u Exempt from oversight: NEC, FERC & state u Cannot sell to sister company w/o state approval

Ownership of Foreign Utilities u Now own or invest in foreign utilities u Major departure from vertically integrated history u Activities w/o SEC approval u Cannot “pledge or encumber” domestic assets u Affects profitability & financial stability

SEC Proposals u Limited Repeal of PUHCA - proper state oversight u Unconditional repeal of PUHCA u More authority to exempt companies u Maybe in 1998?

State Changes I More appropriate than Federales I Each area has different needs I Can respond quicker I Interest in local economy, not national consensus

State Changes I At least 45 states have begun I Two trends Maintain regulator control of distribution Release generation to market I Each has different time tables, Jan ??? I Areas w/ highest cost will move first

Independent System Operator u California & New England have implemented u Many other states following u Charged w/ “ensuring efficient use & reliable operation of xmission”

ISO u Gains operational control of transmission network M Open Access M Distribution of tariffs M Resolution of congestion M Continued reliability u PROBLEM: No financial motivation to improve control & ops

Power Exchange u Necessary for efficient trading of power u No need for government charter or run u NYSE, AMEX, Chicago Mercantile do this kind u Competitive markets form own arenas of exchange

Generation Models u Generators must be allowed free access to markets u Several approaches have been proposed Direct Access Pool Hybrid

Figure 3 - Direct Access Model Generation Company Customer Generation Company Generation Company Generation Company Customer

Figure 4 - Pool Model Generation Company Generation Company Generation Company Generation Company ISO Controlled Power Pool Customer

System Load Price Per KWh Marginal Payout to Utilized Units Figure 5 - Pool Model Pricing

Figure 6 - Hybrid Model Generation Company Generation Company Generation Company Generation Company ISO Controlled Power Pool Customer

Models Comparison Direct accessdoes not allow for daily swings Poolcumbersome, no stability of prices Hybrid most impetus for responsive, viable Hybridwhat will exist if market is left alone

Oil for Electricity Royalty Comes to Utility u Landowner gets royalty from production u Producer gets profit from remainder after expense u Key clause: producer uses oil / gas w/o pay royalty u Producer has “free fuel” even to make electricity

Oil for Electricity Creative Idea u Proposal to OCC: direct exchange of oil for use u By-pass on-site investment, operating cost, taxes u Permit oil & utility to agree on “barter” rate w/o regs u Oil foothold into utility before others get access

Oil for Electricity An Interesting Twist in Last Year u Large gas pipelines u Formerly owned by holding co. & sole supply u Fell under OCC & PUHCA - no creative for sisters u New players: utility & pipeline can trade w/ anyone u OCC regulates oil & utility - approve in principle

Industry Models u Industry consortia of professionals develop standards u Multiple producers sell to transporters u Multiple transporters purchase from producers u Few marketers distribute directly to customers u Government regulation minimized to taxation

Industry Models u Segment companies Suppliers, Transporters, Marketers u Regulate during transition Market will dictate long term Value of investment reduced after 3-5 years u Encourage free market agreements Any transporter, any supplier, any marketer u Distribution by only a few Most efficient because of geography

What About The Existing System? u Distribution: system will remain in place u Generation & Transmission: competition will balance out advantages u Aggressive companies: will enter overpriced market

What About The Existing System? u In the past, investments forced on utilities u Some recovery must be allowed u Must change accounting from single-year to long-term

How Will This Affect Me (Us) ? u Much of push to deregulation comes from industrials u No company can stay in business w/o profit u If revenues reduced to one sector, they must be raised in another u As competition takes over, production costs are reduced

What Happens To Costs? u Initially, upward movement u More entities in supply chain, each will have a margin u Greater risk demands greater returns u Trade-off: more efficiency by reducing size of entities

What Happens To Costs? u More options u Long term - more competitive market drive price down u New technologies from striving for competitive edge

Conclusions Re-regulation is here u Regulation stymies creativity, technology & economics u Competitive utilities eventually lower costs u Must compensate old system decisions u Benefit utilities & customers

Conclusions Entities u Supply: Generation u Transportation: Transmission u Marketing: Distribution u Manage: – ISO – Transporter w/ industry standards & contracts

Conclusions Standards u Technological & economic u Industry professionals - vs - govt u Regulation: state - vs - Federales

Conclusions Cost-based Pricing u Encourage efficiency u Reduce cost u Maintain economic viability u Keeps large customers in all segments

Key Competitive utility benefits all parties Be careful, ill-crafted legislation is a burden