Ken Silverstein EnergyBiz Insider Editor-in-Chief

The electricity sector has undergone a sea of change in the last decade. The tumultuous ride that includes price spikes and market manipulation has left consumers and state regulators weary of deregulation. The transition was never expected to be easy. And while there are certain unwelcome events that should have been anticipated, the choice movement says that none of them obviate the need -- and the potential benefits -- associated with free markets. They say that a marketplace that operates without subsidies for electrical suppliers is also one that would afford residential, commercial and industrial users better services and a well-rounded portfolio of new products.

"The benefits are greater than in a cost-of-service regulated monopoly scheme," says James Steffas, vice president of U.S. government and regulatory affairs for Direct Energy that is a subsidiary of UK-based Centrica. "Transitioning from 100 years of regulation won't happen overnight." The 1992 law that provides open access to alternative natural gas suppliers, for instance, went through at least seven years of revisions.

Direct Energy says it is on the cutting edge of retail competition: It offers a host of products to consumers that include "price droppers" in Ohio that has a high initial price but declines significantly in the next two years and "green services" in Texas. All told, electric retailers serve more than 69,000 megawatts of peak electricity demand, up from 52,000 MW in 2003 and the pace will continue, says KEMA Consulting. Texas, Illinois, California, New York and Ohio account for most of the activity, it adds. About 25 states have restructured their electricity markets to varying degrees.

In Texas, 9 to 13 separate alternative providers exist in markets there that provide up to 21 different options for consumers, adds C.H. Guernsey & Co., a consulting firm. And they provide power at rates that can be 10 percent less expensive than the incumbents. While commercial and industrial consumers represent the 70 percent of the load that has changed providers, residential consumers are also getting involved: switch rates among this class of consumers is going up by 7 percent a year and they represent 30 percent of the load. By contrast, New York says that just 6 percent of its residential users have switched companies since it began deregulation in the late 1990s.

The push to deregulate the power sector started when energy-intensive businesses began demanding the right to choose their suppliers. Aerospace companies in California, for instance, threatened to move across state lines unless regulators acquiesced. Other states then created laws to allow their industrial base the right to sidestep the local monopolies. The movement had really gathered momentum in the late 1990s, when about half the states had enacted some form of restructuring. Since the California and Enron debacles, however, skepticism abounds.

Tipping the Balance

Clearly, a lot of state regulators and consumer groups say that the push to deregulate the electric utility sector has destabilized markets and raised rates. The Consumer Federation of America says that electricity is too valuable of a commodity to leave to the whims of the free market and particularly one that has shown it can be "gamed."

In a deregulated system, generators and transmission owners have demonstrated the ability to manipulate the market and withhold supplies to drive prices up, it says. While a tenfold increase in California has attracted most attention, market power cost increases of 20 to 30 percent have been documented across the country. How so? Generators and transmission owners enjoy excess profits when the price of scarce resources is bid far above their costs in tight markets. These overcharges can add 50 percent to the wholesale price of electricity, the consumer group adds.

"You are not doing the average residential user a favor by making them figure this all out," says Tim Brennan, with Resources for the Future in Washington, D.C. "You can't impose deregulation from the top under the guise that free markets are wonderful in theory."

Virginia is one of those states struggling with what to do next. While it has opened its electric markets to competition, it has capped the rates that incumbents can charge customers until the end of 2010. That makes it hard for alternative providers to compete, especially because the price of wholesale power -- the underlying fuel source that allows the generators to run -- keeps going up. At present, no competitive supplier there can offer a price that beats the mandatory capped price offered by regulated utilities.

Understandably, state regulators are hesitant to end the price controls given the volatility of the market. The ultimate objective, however, is to phase-out the artificial caps and to institute a competitive market. Along those lines, advocates of free markets say that the market rules should be standardized across all the states -- a move that would diminish the barriers to entry and subsequently work to reduce the rates consumers pay.

Consumers can be shielded from price risks. Under a free market model, they could opt for a flat rate plan that basically overcharges them in months when they use little energy and undercharges them when their usage peaks. Or, they could choose a "real-time" pricing structure to try and drive their rates down below what they might otherwise be. The goal, say supporters of competition, is to provide consumers with a variety of options, just as wireless telecom users now have.

"Texas has enticed alternative providers to come in," says Tom Oney, a lawyer for Hunton & Williams in Dallas who focuses on deregulation issues. "Generators can interconnect easily and there are few restrictions as to where they can build. Customers are switching by the day and retailers are undercutting the prices of the integrated utilities. This structure could serve as a role model for the rest of the country."

Texas could well tip the balance and prompt other states to get off the fence or institute market reforms. For now, though, the emphasis nationally will be on getting wholesale markets right. The rationale is that the biggest buyers understand risks and have the resources to make informed decisions whereas the smaller ones lack such expertise and need the protections.

The debate, no doubt, will continue as to whether electricity can be made into a competitive enterprise, or whether it is an uncommon commodity that should be tightly regulated. Markets will get pried open in the wholesale sector where power providers buy from generators -- a path that leads to the large industrials. But competition in the retail sector remains an open question.