The Good

Headroom in competitive pricing compared to the incumbent utilities. Per the PUCT rules the incumbent utility retail companies now called Affiliated Retail Energy Providers (e.g. Reliant in Houston and TXU in Dallas) have to offer a regulated ”price to beat” (PTB) price to their consumers in their historical franchise area until 2007. However, starting 2005, they can (if they want) undercut that price. Thus far, about 20% of their residentials have switched to another Retail Energy Provider (REP) but after 3½ years, retaining 80% of your core, most profitable customer base in the face of competing REPs who offer pricing as much as 18% less - is not bad. The big question is when or if the incumbent REPs will cut price to regain share and thwart further customer defections. At this point it seems unlikely that they will cut price and start a price war that cuts their profits- but REPs have to watch out for this.

Wholesale supply from many sources. An REP can purchase wholesale energy supply from 10 or more different generators with no ties to the AREPs - so he can strike the best deal on his the merits of his company. The problem for the REP is growing to the size where he has buyer power (at least 20 MW) and putting up the credit to buy a block of power for a term of 12 months or more. That is, if the REP has fixed price contracts with his customers, he should buy 12 month or more fixed price supply to match, and hence risk manage.

ERCOT Management of the Market. ERCOT (the ISO for Texas except for El Paso, the Panhandle and parts of East Texas) has done a really good job in the huge task of managing the market. After myriad systems and data problems during startup in 2002, ERCOT and all the stakeholders in the market clearly did a remarkable job in hunkering down and getting the blocking and tackling right. The billions of transactions that occur in managing and accounting for a huge 60,000 megawatt market broken into tiny 15 minute intervals is mind-boggling, but it works quite well and is quite fair now. No longer do you have to worry about customers being switched and when, how much power will be credited to you for which interval, etc.

Wholesale Pricing has been reasonable taking into account nat gas prices. ERCOT started de-reg with a reserve margin of over 30%. Many inefficient generation plants had been recently mothballed with this oversupply, but reserve margin for Summer 2005 is still predicted to be a healthy 17%.

The Bad

Natural Gas volatility (read mostly up, not down). Nat gas price fly-ups have been problematic in several ways. Nat gas prices have more than doubled since the market opened in 2002. In ERCOT about 50% of the electric energy over the year is produced from nat gas and on the margin it is nat gas setting the price- although usually at a bare bones heat rate for the generators who use gas. The REP has a tough time hedging his customer contracts (if they are fixed price for a term). Also, it makes de-reg look bad as prices in ERCOT have risen over 20% since 2002 due to the over 100% price increase in nat gas. A number of large commercial and industrial consumers with management experienced in the energy industry seem to believe that nat gas will tumble back to $4 per MMBtu and have been waiting and waiting - but are still reluctant to sign a fixed price term contract with power prices led by the current $7 plus nat gas prices.

Lack of transparency in the wholesale supply market. Yes, there is a downside to death of Enron. With their innovative online and very transparent trading of wholesale power gone, now the only way for an REP to gauge wholesale energy prices is to telephone or email as many wholesalers as possible to get pricing. This is ancient in terms of efficiency, but it’s the only game in town. It takes some time for a small, new REP to get good responses from wholesale power suppliers. ERCOT is studying opening a transparent day-ahead wholesale market which would be a big improvement- but it is a year or so away.

High price competitiveness in the C & I. With over ten solid REP suppliers to this market segment, price competition has been fierce, with no signs of at let up. The key to adding new small C & I customers is to convince them to switch from their old incumbent utility; the key with the larger customers is price.

The Very Good

GEXA sale. Talk about a shot in the arm to entrepreneurs who are working to get their REP companies established - look at GEXA! FPL Energy agreed in May to purchase GEXA for a reported $80.4 million or about $800 for each of their 100,000 meters, a healthy price. But GEXA has become very profitable, reporting 2004 annual net income of $8.2 million. Profits in the REP business come from balancing customer growth with expense growth, most importantly matching energy supply acquisition prices to the REP’s sales prices, to achieve a gross margin of about 10%. In 2004 GEXA achieved a 13% gross margin and spectacular growth in customers (2004 revenues were $274 million), so the $80 million price is not unrealistic. Startup REPs have taken this success to heart as they build their businesses. GEXA was a startup in 2001, and in 4 years they built up a market value of $80 million, with relatively little dollar capital but plenty of sweat equity - it is a model that others are now focused on copying.

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