SB 1269

Legislative Transition Task Force of the Virginia Electric Utility Restructuring Act

September 7, 2001, Richmond

The first meeting of the Legislative Transition Task Force featured the presentation of the State Corporation Commission's report on the status of the development of a competitive retail market for electric generation within Virginia.

Development of Regional Competitive Markets

The Restructuring Act requires the SCC to report to the task force and the Governor, by September 1 of each year, on the status of competition in the Commonwealth, the status of the development of regional competitive markets, and its recommendations to facilitate effective competition in the Commonwealth as soon as practical. Dr. Kenneth Rose of the National Regulatory Research Institute, who addressed the development of competitive regional markets, provided an evaluation of the current performance of retail and wholesale markets.

Retail market performance is highly dependent on prices in the wholesale market because most retail markets have overall price constraints and do not fluctuate with changing conditions in the wholesale market. The "standard offer" or "price-to-compare," which refers to the price for generation service paid by a retail customer who does not select a competitive supplier, is the benchmark price used by consumers in determining whether to switch to a competitive service provider. This benchmark price is also used by competitive suppliers in determining whether the difference between the price-to-compare and the cost to procure power to serve customers is sufficient to allow them to offer customers an opportunity to save on their power costs compared to the standard offer price, while covering the costs of securing and delivering the power. This lack of "headroom" is the primary reason that retail markets, after a period of initial success in some states, have shown stress or why other markets have seen very few competitive offers.

Fifteen states and the District of Columbia currently allow retail choice, and three states (Virginia, Michigan and Texas) will allow retail choice effective January 1, 2002. The recent failure of California's electricity market has slowed the move of other states toward restructuring their electric utilities. No state has passed restructuring legislation since California's problems began last summer, and no state appears close to doing so. Six states (Arkansas, Nevada, New Mexico, Oklahoma, Oregon, and West Virginia) that passed restructuring legislation have postponed retail access. At least 14 states have decided to discontinue considering the issue at this time, and 12 other states continue to study the issue.

Dr. Rose's evaluation of retail markets examined such factors as the numbers of competitive offers, offers priced below the price-to-compare, number of competitive suppliers, and percentage of customers selecting alternative suppliers. Competitive activity in other states open to retail choice is in significant decline. During the 12-month period ending July 2001, the number of competitive offers at or below those prices available to nonshopping customers from incumbent utilities dropped from 48 to nine nationwide. Pennsylvania, which has been lauded for its deregulation successes, has seen both the number of competitive residential offers and customer load (for all classes) served by alternative suppliers plummet. The number of statewide residential offers at prices below the price-to-compare has dropped from 28 in July 2000 to two by July 2001. Over the same period, the number of total offers (including offers for more expensive "green power") in Pennsylvania has fallen from 75 to 23. Additionally, many suppliers are now only willing to offer electricity on a month-to-month basis. Similar results are evident from the retail markets in California, Massachusetts, and New Jersey.

Dr. Rose's evaluation of wholesale market performance is based on how closely actual prices are tracking what would be expected in a fully competitive market, where suppliers are not able to control the price. The discrepancy between actual and expected price is a measure of market power, which is the ability of a firm or group of firms to raise and maintain the product price significantly above a competitive level.

The degree of market power that a supplier of electricity can exercise is partly a function of characteristics of electricity. Unique characteristics of electricity include the inelasticity of demand for the product, the high degree of concentration of markets for most geographic regions, and the fact that market entry by other firms is limited by transmission constraints or the need to build new generation facilities. Power suppliers may try to exercise market power either by physically withholding power from the market or by economically withholding capacity, which involves setting a very high price for the plant or unit. This results in the plant or unit being dispatched at a price that exceeds its marginal cost or not being dispatched at all, which produces the same benefit as physically withholding the electricity.

California's recent rise in wholesale power prices was attributed to a combination of scarcity conditions, higher natural gas prices, and market power impacts. Market power may be averaging over 40 percent of the wholesale price in California since June 2000. In the PJM spot market, total costs were estimated to be 41 percent higher ($224 million) than they would be under perfect competition. Evidence of withholding of capacity in the summer of 2000 and earlier in 2001 to manipulate prices was alleged to exist in the PJM installed capacity market.

Dr. Rose concluded that wholesale market prices and volatility have hampered the development of retail markets. The evidence suggests that generation owners have significant market power in wholesale markets. Given the characteristics of electric supply and demand, this market power may persist for some time. In sum, the transition to competitive retail markets has been more difficult, and is taking longer, than many had expected.

Nationally, the amount of generation supply compared to demand varies among regions, with not all regions having the traditional 15 percent reserve margins. A substantial amount of generation facility construction is planned or underway. However, as 92 percent of new generation is fueled by natural gas, supplies of gas and pipeline capacity may cause difficulties. Electric power transmission capacity poses a more immediate problem.

Dr. Rose observed that the primary determining factor in whether a state has proceeded with deregulation is whether the state's power costs exceeded the national average. Of the states that have passed restructuring laws, 10 had prices below the national average; of these, at least half have delayed implementation of their statutes.

In response to a request for suggestions for what Virginia could do to improve restructuring efforts, four items were identified. First, states should increase their generation and transmission capacities. Second, states should address concentration in the wholesale market by seeking a diversity of ownership among new market entrants. Third, information exchanges for customers, such as Ohio's "apples to apples" data for comparisons of offers, should be implemented. Finally, increased demand responsiveness is needed, in order to determine if adjustments in usage are reflected in power prices.

Status of Competition in Virginia

Beginning January 1, 2002, and extending in a phase-in period running until January 1, 2004, customers in Virginia will be eligible to choose their supplier of electricity. Eligibility to choose a supplier does not guarantee that competitive suppliers will be making offers in Virginia. Whether customer choice for electricity occurs here will depend in large part on whether competitive suppliers decide to enter Virginia's retail market. While the SCC has licensed 16 new competitive suppliers of electricity, these newly licensed firms may decide not to offer electricity at retail here if wholesale prices inhibit their ability to sell power profitably.

Experimental retail choice programs in Virginia have not attracted the hoped-for level of participation either by consumers or suppliers. However, the pilots have aided the transition to a restructured electric utility industry by developing and testing electronic data interchange systems. Concern was expressed that four suppliers in natural gas pilot programs defaulted, that reliance on contracts with rates set on a month-to-month basis is increasing, and that many of the competitive suppliers selected by pilot participants are affiliates of incumbent utilities.

Richard Williams, director of the SCC's Division of Economics and Finance, told the task force that the commission is committed to making Virginia ready for competitive suppliers of electricity by the start of competition on January 1, 2002. Numerous proceedings are underway at the commission in connection with the transition to competition, including cases to unbundle incumbent utilities' rates, determine the level of wires charges, consider functional separation plans, and approve plans to transfer control of transmission assets to regional transmission entities.

The SCC is confident that Virginia is laying the proper foundation to have a fair, efficient and effective market. Success in attracting these suppliers to Virginia's retail electricity market, however, will depend greatly on a healthy regional wholesale market—a market that is currently showing signs of stress.

In preparing its report on the status of competition, the SCC asked stakeholders to identify actions that would facilitate the development of a competitive retail power market in Virginia. The stakeholder recommendations are compiled in the SCC's report. While the SCC commented on several of the proposals, it did not specifically present the task force with any proposals for legislative changes to the Restructuring Act. When questioned about the absence of SCC recommendations, Mr. Williams observed that the SCC's most valuable function at the present time is to lay the foundation for the development of competition. The SCC may offer recommendations at a later date. For now, he described the process as heading on the right track. Even if a proper framework is established, however, there will not be competition unless competitors come in and make attractive offers to customers, and high wholesale prices have inhibited competition in other states.

Members raised concerns that generation facilities being constructed in Virginia may sell all of their power in other states. While planned merchant plants can sell their power in any market, Mr. Williams noted that protections are in place to protect Virginia customers for the next several years. The Restructuring Act does not address the issue of the SCC's authority to require incumbents to build generation capacity to serve Virginia's load in the future. The theory underlying the act is that reliability will be provided through the competitive market. However, the act does not expressly condition industry deregulation upon the development of a competitive market. Members asked whether the General Assembly could require new generation facilities, as a condition to siting approval, to reserve a portion of their capacity exclusively to serve the Virginia wholesale or retail market. The task force has decided to examine this issue this year.

Kenneth J. Schrad, director of the SCC's Division of Information Resources, provided an update of Virginia Energy Choice, the SCC's consumer education program. A survey conducted in May indicates that only 28 percent of Virginians are aware of the transition to a competitive market. However, 80 percent of respondents are interested in the competitive market and desire more information. The SCC, which is charged with implementing the five-year, $30 million program, will commence media advertising in November. Other commission activities so far include hiring consultants, conducting community-based consumer outreach, preparing booklets, retaining a call center, and updating the Energy Choice web site.

The SCC is undertaking numerous other proceedings in preparation for the advent of competition. Reviews of the proposed transfer of control of transmission assets by Dominion Virginia Power and AEP-Virginia to the Alliance regional transmission organization are underway. The Federal Energy Regulatory Commission (FERC) is also reviewing the Alliance's proposal and has expressed concerns about its independent governance provisions. The SCC has sought clarification of a recent FERC order and has asked that further activities be stopped until the independent governance issues are resolved. The SCC has also intervened in a FERC proceeding involving the application by AEP for the break-up of its Ohio power pool. If the application is approved, it is estimated that AEP-Virginia's capacity will be one-quarter short in peak demand periods. The SCC is concerned that AEP-Virginia would meet its needs by purchasing power on the open market, which may increase power costs and raise reliability issues.

Next Meeting

The task force will convene its next meeting in Richmond on October 16, 2001, at 10:00 a.m. The focus of the meeting will be on the process for the siting of electric generating facilities.

The Honorable Thomas K. Norment, Jr., Chairman
Legislative Services contacts: Franklin D. Munyan
C. Maureen Stinger


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