REMARKS OF STEWART E. FARRAR,
SOLICITOR GENERAL,
STATE CORPORATION COMMISSION
TO THE SB 1269 LEGISLATIVE TRANSITION TASK FORCE

July 13, 1999

Discounting of Capped Rates

The Virginia State Corporation Commission ("SCC") hereby responds to the Legislative Transition Task Force's ("LTTF") request for views on the appropriateness of discounting the capped rate service which incumbent utilities are required to provide under Section 56-582 of the Virginia Electric Utility Restructuring Act.

Summary

I will first summarize the key points which we believe have an impact on the issues, and then discuss them in more detail. At its essence, the appropriateness of the discount depends on whether, at the time an incumbent utility proposes to offer discounted capped rates to a customer, that customer is eligible or ineligible to purchase generation services in the competitive market.

  1. If the customer is ineligible to shop for competitive generation services (because (i) the phase-in of customer choice under the provisions of SB 1269 has not yet begun; or (ii), the phase-in has begun, but this particular customer is not yet eligible to shop for generation services), the utility may seek the Commission's approval of discounted rates for that customer under the provisions of pre-1999 law.

  2. If the customer, however, is eligible to shop for competitive generation services, authorizing the utility to discount capped rates for such a customer would conflict with two key legislative mandates expressed in SB 1269: functional separation and stranded cost recovery.

    1. The discounting would be in conflict with functional separation because discounting under current law is a competitive tool, and capped rate service is a noncompetitive service.

    2. The discounting would be in conflict with recovery of stranded investment because the purpose of the capped rate is to recover stranded costs.

  3. There is one type of discounting that may make sense once competition begins: selective discounting of the noncompetitive, regulated physical distribution service that the utility is obligated to provide.

I will now elaborate on these points.

I. Statutory Background

Five main provisions in SB 1269 bear on this matter.

  1. Section 56­582 (A) requires the Commission to establish capped rates for (i) incumbents' bundled generation, distribution and transmission services; and (ii) incumbents' unbundled generation services only.

  2. Section 56-582 (A) also states that the capped rates will be in effect from January 1, 2001 until July 1, 2007.

  3. Section 56-582 (D) requires each incumbent utility to make service at the capped rate available to customers in its service territory until (i) the capped rate expires at the end of the above capped rate period, or (ii) the capped rate is terminated earlier by order of the Commission upon application of a utility and a Commission finding that effective competition for generation exists in the incumbent's service territory.

  4. Section 56-584 stipulates that such capped rates, in conjunction with the wires charges authorized under 56-583, are the exclusive means by which utilities will recover stranded costs.

  5. Section 56-595 establishing the LTTF directs it to determine "whether and on what basis incumbent electric utilities should be permitted to discount capped generation rates established pursuant to section 56­582." Our presentation today assumes that the question before the LTTF is whether incumbent utilities should be allowed to discount capped, bundled rates. We make this assumption because the "capped generation rates" referred to in Section 56-582 have only one function: to serve as a mathematical variable, established and used by the Commission, in calculating wires charges for shopping customers under Section 56-583. Consequently, the "capped generation rate" is not a product to be sold to any customer, and therefore is not a logical subject for a discount.
II. Present law authorizes discounts for utilities' bundled electric utility service under specially defined circumstances.

  1. Utilities ordinarily must charge uniform rates to all customers similarly situated. See Section 56­234. In 1996, however, the General Assembly authorized Virginia's utilities (with Commission approval) to offer, on a selective basis, alternative rates, such as those commonly called "economic development rates," to incumbent utilities' customers within their service territories. See, Section 56­535.2.

  2. Alternative rates authorized by Section 56­235.2: (i) may not transfer the costs of these incentives to other ratepayers not receiving such discounts or incentives; and (ii) are subject to Commission review and approval pursuant to statutory criteria, including requirements that the rates

    1. are in the public interest,

    2. will not jeopardize reliable electric service,

    3. will not "unreasonably prejudice or disadvantage any customer or class of customers."

  3. Section 56-235.2 was not affected by SB 1269. Thus, this provision remains applicable to and available to incumbent utilities.
III. An incumbent's discounting of capped rate service to customers eligible to shop for competitive generation services would conflict with two key features of SB 1269: (i) the functional separation of incumbent utilities into competitive and noncompetitive units, and (ii) the stranded cost recovery mechanism established in that legislation.

  1. Discounting of capped rate service conflicts with the statutory requirement of functional separation.

    1. Discounting is a competitive tool. Companies discount their prices to retain or attract customers. In the past, a utility would discount rates (with Commission approval under Section 56-235.2) to attract a new customer, or to keep an existing customer on the utility's system, when that customer had alternatives that were viable and lower­priced.

    2. Once customers are permitted to shop for competitive generation services, capped rate service is a noncompetitive service.1 Customers who want "discounts" can shop for them in the market. Moreover, there is no reason to discount so as to retain the customer's contribution to fixed costs; any customer choosing to purchase competitive generation services will pay a wires charge to its incumbent utility (pursuant to Section 56-583) thereby ensuring that this contribution will be made.

    3. In short, once customers are eligible to shop, those who want "discounts" (i.e., better prices) will shop for them. Customer retention will be the concern of competitive generation business units (resulting from the functional separation required of each incumbent utility by January 1, 2002, pursuant to Section 56-590), and not of the disaggregated incumbent utility charged with making available the capped rate service through 2007.

    4. Put another way: a desire to discount stems from a desire to win competitive gains. But in the competitive era, there should be ­­ and the General Assembly has required (see Section 56­590) ­­ a separation between the noncompetitive and competitive activities of the incumbent. Consequently, the very notion of a former incumbent utility (as distinct from its functionally separate generation arm) discounting capped, bundled rates for the benefit of a customer eligible to shop for competitive generation services, conflicts with the principal tool for implementing competition.

  2. Discounting of capped rate service undermines the exclusive statutory means of stranded cost recovery.

    In addition to the incompatibility between capped rate discounting and functional separation, discounting of capped rate service can have one other adverse effect: pressure on the utility's stranded cost recovery. If the customer leaves its incumbent utility to obtain a lower generation rate from a competitive supplier, the customer has to pay a wires charge, and the statutory mechanism decreed for stranded costs recovery is adhered to. But, if the customer stays on the incumbent utility's system and receives a discounted capped rate instead, (1) the customer pays no wires charge, and (2) the utility receives less capped rate revenue than envisioned by the statutory mechanism.

  3. What about the price break available from discounting?

    1. A frequently cited benefit of discounting is, of course, the availability of a price break to the discounted customer. This benefit does not justify allowing the incumbent utility to discount capped rate service. For a customer who has a right to shop, the benefit of a lower price will be available from a competitor (otherwise the customer would have no basis for seeking a discount from the utility).

    2. The foregoing comment does not mean that the incumbent utility's functionally-separate generation entity will be foreclosed from de facto discounting, i.e., offering competitive generation services to customers eligible to shop for competitive generation at prices below the unbundled capped generation rate established by the Commission pursuant to Section 56-582. Consistent with functional separation rules (which will be developed by the Commission as required by SB 1269) aimed at preventing anticompetitive activities, the incumbent utility's functionally-separate generation entity will be free to charge whatever price it wants for competitive generation services. In this context, "discounts" would simply mean price competition among similarly situated competitors.
IV. Selective discounting by incumbent utilities of noncompetitive, physical distribution service could continue to make sense even after customers begin to shop.

  1. The economic development policies promoted by alternate rate plans under Section 56­235.2 assumed the existence of a single utility supplier of electricity. With the passage of SB 1269, much of those economic development benefits will be available from the market, assuming competition develops effectively.

  2. The policies advanced in Section 56­235.2 could, however, be adapted to a competitive environment. Under competition, the utility still will provide the noncompetitive services of physical distribution and transmission. Allowing the utility to discount physical distribution service, subject to review and approval by the Commission, could be a tool useful in encouraging commercial or industrial customers to locate or expand usage in Virginia.2

  3. This discounting would have to be available on an objective basis and reviewed by the Commission. Otherwise, there would be some risk that the utility might use discounting to favor customers of its competitive generation arm. Assuming the fair availability of discounts to customers of any generation supplier, this practice could help increase Virginia's competitiveness relative to other states.

  4. To ensure that the distribution service discounts do not cause distribution rates for the non-discounted customers to rise, the Commission would need to require that discounted rates recovered, at a minimum, the appropriate measure of the marginal costs of delivery.

  5. In summary, distribution service discounting could continue the policies currently reflected in Section 56­235.2, if such discounts:

    1. were competitively neutral,

    2. would not increase distribution costs of non­discounted customers,

    3. would not result in utility cost under-recovery; and

    4. were subject to Commission review and oversight.

Conclusion

This memorandum has made three main points:

  1. If an incumbent utility's customer is ineligible to shop for competitive generation services, the utility may seek the Commission's approval of discounted rates for that customer under pre-1999 law.

  2. Discounting capped rate service for customers eligible to shop for competitive generation services is inconsistent with two key goals of SB 1269: (i) functional separation of incumbent utilities into competitive and noncompetitive units, and (ii) stranded cost recovery.

  3. Discounts of regulated physical distribution service, if designed to be competitively neutral and not harmful to non­discounted customers, could continue promoting the economic development goals previously embraced by the General Assembly in its 1996 amendments to Section 56­235.2.

It is possible that some or all of the principles set forth above can be accommodated under present statutes. However, since the 1996 amendment was not enacted with the 1999 statute in mind, the Commission is presently considering whether to recommend statutory clarifications or refinements on this issue.

1We are assuming that the obligation to provide capped rate service does not apply to the provider of default service; and that therefore the LTTF mandate to investigate whether the incumbent utility should be authorized to discount capped rate service does not apply to default service. There are three related reasons for this assumption. First, the 1999 Act makes clear that the provider of default service might be an entity other than the incumbent utility; yet the obligation to provide service at the capped rate is, expressly, an obligation of the incumbent utility only (within its former service territory). Second, the General Assembly's reason for authorizing the Commission to choose a provider of default service other than the utility was to ensure that the service was provided by the most efficient entity. To require default service to be set at a legislatively fixed rate would prevent prospective providers of default service from competing for the job based on price. Third, the General Assembly intended default service to be a "default;" i.e., a last resort for those who were unable to or did not select a competitive supplier. Discounting is a technique for retaining a customer. Since default service is an exception to the main objective of competition, it would make no sense to use discounting to make default service more attractive to particular customers.

2The same could be said for transmission service, but the pricing of transmission service is subject to the exclusive jurisdiction of the Federal Energy Regulatory Commission.