Power Deregulation: A Bumpy Road Begins the Free-Market Ride

Make no mistake. The global electricity deregulation revolution has not been unplugged.

But that revolution has hit a brownout, suggesting a far slower, evolutionary unfolding of business expansion’s ballyhooed brave new world. Cautionary voices have grown into a veritable chorus:

• “There was nationwide deregulation euphoria last year,” says Eugene Coyle, a Corte Madera, Calif.-based deregulation consultant. “What’s happened in California, though, has slowed things down.”

• “You’ll probably lose money on every small customer you hook up,” says Ken Lay, CEO of Enron, the Houston-based giant that junked its US$5 million effort to recruit residential customers only three weeks into California’s deregulation.

• “American citizens have been asleep at the wheel while legislators and lobbyists scripted deregulation,” charges Citizens for a Sound Economy spokesman William Armistead.

That backlash looks predictable, at least in 20/20 hindsight. Nonetheless, many expanding firms are capitalizing on the deregulation of the $200-billion-a-year U.S. electric utility industry. Simultaneously, the transition is putting a steep premium on new corporate skills in energy management and negotiation. Potential rewards are higher, but so are risks.

“Corporate buyers have no experience in competitively purchasing electricity,” says Sidney Pelston, senior vice president of national programs for Los Angeles-based New Energy Ventures, formed in 1995 to act as a buyer’s agent in deregulated markets. “Identifying the best energy options can mean significant savings. A wrong choice, though, can be costly.”

Backlash notwithstanding, those power choices have already begun. California, Massachusetts and Rhode Island have implemented full-blown electric industry deregulation, and all U.S. states are in various stages of implementation (see map). Clearly, the business expansion benefits of borderless U.S. freedom of choice are coming. Many prohibitively high-cost areas will become feasible business locations.

But those benefits aren’t just around the corner. The ultimate shape of nationwide deregulation remains shrouded, and the first few state plans indicate a delay in broad-scale corporate benefits.
Nonetheless, deregulation’s mere specter has added substantial negotiating leverage — particularly for facilities with consistent, high power demands. The prospect of large firms moving has sent many electric utilities scurrying to the bargaining table.

Big Three, MCI Capitalizing

Detroit Edison, for example, saw the light for the 54 Big Three automakers’ facilities it supplies in southeastern Michigan, a state where deregulation hasn’t even started. After analyzing the havoc deregulation wreaked in the telecommunications, gas and airline sectors, Detroit Edison developed an appetite for risk, a trait that now typifies the once-staid power industry.

For $2 billion in revenues over 10 years, Detroit Edison acted before deregulation took full-blown form. It signed three virtually identical contracts giving the Big Three $30 million in annual discounts through 1999, with yearly discounts then expanding to $50 million. Chrysler expects $18 million in savings in only the contract’s first five years.

“The Big Three made it clear they wanted to cut energy costs,” says Michael Holton, Detroit Edison assistant vice president and chief sales officer. “Even though we’ve historically operated as a monopoly, we said, ?We can give you an option more attractive than deregulation.’ ”
MCI is also capitalizing on the deregulatory environment.

“As a mid-size commercial user, MCI is leveraging growth and expansion to provide a more competitive environment for rate negotiations,” says Beth Choulas, MCI corporate real estate’s manager of government relations.

For example, MCI is “targeting major hub locations, where we have high concentrations of facilities,” Choulas explains. MCI is aggregating those hubs’ electrical loads and then negotiating regional contracts, she says.

Not all companies, though, can expect such rate-cutting receptiveness. Most don’t have potent bargaining chips like the Big Three’s energy-intensity or MCI’s ability to aggregate its real estate portfolio’s sizable scale. Indeed, smaller firms’ modest benefits have been one bone of contention in California, Massachusetts and Rhode Island’s deregulation.

Gold Rush or Fool’s Gold?


National trend-setter California has provided an inordinately high-profile example of deregulation’s huge potential and pitfalls.

After dramatically improving its business location appeal in recent years, California on April 1 created the largest competitive U.S. energy market. Eschewing pilot-program experimentation, the state opened its massive market all at once. “California is providing the lead for the nation,” said then-U.S. Energy Secretary Federico Pena. (Rhode Island, which plugged in on Jan. 1, and Massachusetts, which began March 1, both went on line first, as computer glitches delayed California’s implementation by four months.)

But competition for California’s huge host of corporate facilities has faded fast — along with many firms’ cost-cutting prospects.

Some 250 providers of energy and energy-related services registered, spurred by fond visions of capitalizing on California rates that are 50 percent above the U.S. average, according to analysts. For many, though, California’s gold rush quickly became a fool’s gold quest. Only some 60 energy service firms are still operating in the state; less than 20 still actively market services.
Several factors account for the rapid attrition.

For example, to entice business users to switch, new players must price power some 10 percent below the rate that could be obtained on “the Power Exchange” (the state electricity trading market) by three in-state utilities — Pacific Gas & Electric (PG&E), San Diego Gas and Electric (SDG&E) and Southern California Edison.

“With low-use customers, we’d be lucky to make a $2 a month profit,” said Jon Sensenig, marketing services director for GPU Advanced Resources, a subsidiary of Newark, N.J.-based
utility GPU.

Deregulation also set Edison, SDG&E and PG&E’s baseline rates low enough that beating them is a profit-challenging proposition.

Stranded Costs’ Sting

In addition, California competition has been dampened by “stranded costs” — unprofitable investments that federal law mandated during the 1970s’ energy crunch, utilities contend. Increasingly vocal consumer groups, though, call stranded costs “bad investments” that utilities should eat. Estimated to total as much as $300 billion, U.S. utilities’ stranded costs will be a nationwide hot button as deregulation unfolds.

In California, stranded costs have slowed potential corporate savings. As in most states, California utilities agreed to deregulation only with a 100 percent ratepayer payoff of their stranded costs, estimated between $28 billion and
$50 billion. During deregulation’s first four years, all California ratepayers pay a mandated “competitive transition charge” (CTC), which Edison, SDG&E and PG&E collect to pay off stranded costs. For every electricity dollar California users pay, some 45 cents goes to the CTC, say industry analysts.

“We pulled out because the CTC prevents true power savings from being passed on to the customer,” says Jan Mitchell, spokeswoman for Portland, Ore.-based PacifiCorp, which nixed plans to recruit California users, focusing instead on selling wholesale power to other power providers.

Big Dogs Eat First

Those factors explain California consumers’ cool response. During deregulation’s first 60 days, only some 3 percent of 900,000 commercial and industrial customers (and 1 percent of residential users) switched suppliers.

“True deregulation” in California won’t really kick in until 2002, when the CTC expires, many critics contend. Stranded-cost payoffs in other states will similarly slow business savings, they say.

“Naturally, there are some warts critics can point to,” concedes Jesse Knight, commissioner of the California Public Utilities Commission. “But other states are just talking. California consumers are getting a rate reduction now.”
That’s true, particularly for large energy users with facilities that are part of California’s groundbreaking freedom of choice. Hotly pursued by providers, many are realizing substantial rate reductions.

Los Angeles-based Ralphs Grocery Co., for example, signed on with New Energy Ventures, while San Francisco-based Pacific Bell signed with Enron. With huge utility bills, such companies can realize million-dollar savings by cutting power costs as little as 5 percent. California’s university system, for example, expects to save some $16 million during its four-year deal with Enron.

Smaller, less energy-intensive California firms got a mandated 10 percent rate cut, reducing their incentive to shift suppliers. Then again, few providers are pursuing them. In June only four companies were still offering small business and residential services, according to a survey by the San Diego-based Utility Consumers’ Action Network.

The small business/residential rollback, though, lasts only four years; and it’s funded by a 10-year bond issue that small businesses and residential users pay off. Bond payments drop the rate cut’s true value to about 2.5 percent, energy analysts say. “It’s a hell of a rate reduction when the beneficiary
pays for it,” grouses Joe Thierren, treasurer of Californians Against Utility Taxes.

Aggregation: Number Power

Smaller businesses, though, are wielding negotiating muscle by aggregating loads. Those aggregates have drawn intense interest, both from California-based utilities and outside providers anxious for an entrée to a huge market.

Montana Power Group, for example, inked a $300 million pact with the 1,000- member California Manufacturers Assn., offering members who sign on for at least two years an 8 percent discount from the market power rate. New Energy Ventures signed a similar deal with the 1,800-member Printing Industry Assn. of Southern California.

But such aggregate pacts aren’t ironclad. In one of the real estate industry’s biggest deregulation deals, Enron Energy Services (EES) inked a four-year deal to provide energy services to western U.S. buildings managed by CB Richard Ellis, including some 40 million sq. ft. (3.6 million sq.m.) in California.

Earlier this year, PG&E Energy Services signed a two-year, $110 million pact with the Bay Area’s Building Owners and Managers Assn. (BOMA), which has 120 buildings. CB’s $100 million deal bypasses the BOMA contract, giving Enron a coveted toehold in California’s real estate industry.

“With the CB deal, we can target owners. Before, we couldn’t get past building managers,” says Alan Butcher, EES general manager.

Similar mega-aggregation deals are unfolding in Massachusetts.

PECO, Pennsylvania’s biggest utility, signed an estimated $115 million contract to supply electricity to the Massachusetts Health and Educational Finance Authority, a group of state nonprofit institutions. And Burlington, Vt.-based EnergyVision’s $50 million contract will supply electricity, natural gas and energy services to the 1,500 member Greater Boston Chamber of Commerce, which could cut members’ utility bills by 10-20 percent, EnergyVision officials say.

The Demand-Side Revolution

But the real energy revolution, many industry analysts insist, is in corporate demand-side management.

Deregulation’s potential savings have supercharged many firms’ energy awareness. Some, for example, are attaining major savings through monitoring systems that provide in-depth data on facilities’ power use, even using the data to bill cost centers.

Basic demand-side monitoring systems can cut corporate energy bills 5-10 per cent, while more sophisticated systems, which provide virtually minute-by-minute monitoring, can up savings to 25 percent, say analysts at Whitby, Ontario-based ECAM Systems.

For example, Wescast Industries, which manufactures exhaust manifolds, used demand-size monitoring to analyze energy use at its Brantford, Ontario, plant, which is centered around 24-hour-a-day electric melting. Management discovered that it could meet mandated production levels by cost-effectively “tuning” the Brantford plant to run during peak-rate hours at only half the power originally projected.

New Services Emerge

Not all companies, though, want to invest substantial personnel, time and capital in carefully monitoring energy, particularly if they’re not heavy users. That’s opened a huge window of opportunity for utilities, which are offering a host of deregulation-related new products and services.

PSE&G, for example, now offers billing and information management services, energy conservation and power quality programs, and regulatory and rate analyses, all through PG&E Energy Services, its unregulated retail energy services company. “It gives customers one-stop shopping for energy needs, allowing them to focus on their core business and enhance shareholder value,” says Scott Gebhardt, president and CEO of PG&E Energy Services.

DuPont, for example, decided that “energy supply is not core to our business,” says Corporate Real Estate Manager William Sullivan. “Energy issues received insufficient management attention, and electricity and fuel costs were too high.”

That prompted DuPont to outsource energy supply to two recently created American Electric Power-Conoco joint ventures: AEP Conoco Energy Management Services and AEP Conoco Energy Capital. Initially, DuPont’s agreements cover energy facilities at 16 U.S. plants, plus energy procurement services for the majority of its 80 U.S. sites, company officials say.

The deal also frees up substantial capital for core business activities. AEP Conoco Energy Capital will acquire and lease back DuPont energy assets valued at approximately $1 billion and provide capital for energy projects, company officials say.

Future Imperfect

Deregulation’s future is far more cloudy than its past. A federal law mandating deregulation is pending (see “Where Does a Federal Plan Fit?”), and consumer groups are trying to rewire many state plans.

For now, initial predictions of deregulation’s payoffs for corporate locations appear vastly overstated. Analysts envisioned individual plants saving 20-50 percent on annual energy expenditures, with total business savings of from $80 billion to $100 billion.

That may still happen, but probably not before stranded cost payoffs and an industry shakeout.

“The electric utilities industry of tomorrow will look a lot like the telephone industry of yesterday,” says Dan Scotto, Bear, Stearns & Co. senior managing director. “Momentum from industry deregulation and new economies of scale have made it impossible for traditional wire companies to maintain their independence. In five to 10 years, 120 companies will be reduced to approximately 20.”

Deregulation has also spurred concerns over big firms’ dominance.

“If a few large producers attempt
to manipulate prices, as they’ve done in England, policymakers need to ensure that enough firms are participating,” says Hillard Huntington, executive director of the Stanford
University-based Energy Modeling Forum (EMF), which in June released an 18-month deregulation study.

EMF’s report also warns of reliability problems. Transmission lines could be badly congested, with utilities having less incentive to invest in new capacity, transmission and distribution, it says.
Scotto sees the free market providing the solution. “Expect to see a number of bond ratings upgraded, as the new entities on both the transmission and generation sides discern new ways of addressing debt and creating cash flow,” he says.

On the whole, electric deregulation has had a halting debut. That perhaps was inevitable, but the changes aren’t likely to end soon, says Ann Althoff, client services director for St. Louis-based corporate real estate consultancy Pace Corporate Services. “The utility industry’s transition is in a state of flux and will be for some time,” she says.

However uncertain, it should be a hell of a ride, and one ultimately leading to lower corporate facility costs.
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