Jun. 12--The law that opened Texas' power markets to competition with the promise of lower electric bills may actually be driving them higher, particularly for customers in cities like Houston and Dallas, according to a recent study.

Residential customers in Houston and other deregulated markets paid an average of 22 percent more per kilowatt-hour in October 2004 than in December 2001, versus 10 to 13 percent increases in parts of the state not opened to competition, according to the study by University of Texas professor and energy industry consultant Jay Zarnikau.

The reason: Companies in the competitive markets charge customers for the cost of fuel used to run power plants based solely on the price of natural gas -- which has tripled in recent years -- even though they also rely on other less expensive power sources. Other utilities base their fuel factor on an average of all the fuels used.

The study has drawn the ire of companies working in the deregulated markets, such as Reliant Energy and TXU Energy, as well as Texas Public Utility Commission officials. They have challenged the validity of Zarnikau's methods, defended the fuel cost calculation as a key to avoiding a California-like market meltdown and point to the range of choices in products and prices that have come with competition.

"Savings and innovative products in the Texas electric market are real," PUC Chairman Paul Hudson said. "Customers must be diligent in educating themselves on their available options."

Zarnikau, who co-authored the study with graduate student Doug Whitworth, said he's not an opponent of restructuring. He just believes the fuel factor method allowed under deregulation exaggerates the relationship between natural gas costs and electricity costs.

"Whenever you restructure there will be winners and losers," Zarnikau said. "There could be benefits that residential customers will eventually see, but I think the jury is still out."

Texas' 1997 electric deregulation law was intended to provide price competition among power companies by making room for new competitors.

From January 2002 until January 2007, the incumbent retail companies, like Reliant Energy, are forced to set a fixed price per kilowatt-hour that is high enough to let newcomers come into the market to offer lower prices and new services profitably. The idea is that competition will keep prices in check rather than regulation.

This so-called "price to beat" can only be increased twice per year if the price of natural gas -- the fuel for about half of the state's power production -- rises significantly based on a particular formula.

A majority of large commercial power users were quick to take advantage of the choices deregulation offered, but so far only about 20 percent of the state's residential customers have changed providers. While that figure is considered high compared with other deregulated markets, it was hoped that closer to 40 percent of customers would switch and spur vigorous price competition.

Customers did see savings over pre-deregulation prices in the early days of retail competition -- as much as $200 million for Houston customers, according to Reliant Energy. But that changed when natural gas prices began to soar in 2002.

While 57 percent of Reliant's power comes from natural gas-fired plants, deregulation allows them to charge a fuel factor to customers as if 100 percent of its power came from gas plants.

A utility like Austin Energy, which has about 30 percent gas- fired power, is going to pass only about 30 percent of that rising fuel price on to customers.

According to Zarnikau, deregulation provided better prices for Reliant's Houston-area customers until natural gas passed the $4.80 per thousand cubic feet mark based on the City Gate price for Texas. Today it's above $6, with no signs of dropping below $5 soon.

Critics of the study don't dispute that prices have grown at different rates depending on how companies calculate fuel costs. But they say the price-to-beat method is the best.

"It allows retail electric providers to change their rate when underlying commodity prices change, while in California companies faced bankruptcy because they couldn't increase rates," TXU spokesman Carlos Santos said.

The method may not always work in the favor of electric providers in the deregulated companies, either. Companies can raise the price twice per year, but if prices spike after the increases take effect, they will have to cover the difference for the rest of the year.

"We don't bear the same risk of increases in the price of fuel that Reliant and TXU do," said Michael McCluskey, senior vice president of wholesale and retail markets for Austin Energy. "The companies in the competitive markets bears the risk of the fuel price changing on him. But he can also earn the premium if it drops."

Even with higher natural gas prices, Houston customers could get their bills closer to the pre-deregulation prices if they simply shop around, PUC spokesman Terry Hadley said.

In Houston, the difference between Reliant's price to beat and the lowest rate offered by a competitor, which at the time of this article was from Gexa Energy, is about 18 percent.

Customers also can now buy power made from renewable resources, like wind, an option that wasn't available before deregulation.

"From the standpoint of the PUC, competition works so long as you exercise your power to choose," Hadley said.

Charles Griffey, senior vice president of regulatory affairs for Reliant Energy, said the comparison between the deregulated parts of the state and those not under the law are not apples to apples.

Entergy, the company that serves customers in the Beaumont and Conroe areas that are not covered by deregulation, has been under a government-imposed rate freeze for more than a year.

And San Antonio enjoys a significant price advantage because it was allowed to invest in the South Texas Project nuclear plant on a pay-as-you-go basis, instead of having to take on interest-bearing debt, as other companies would have to do.

The study also doesn't include the costs from all electric co- ops and municipal utilities because not all of them report their data to the state, Hadley said. That means cities like San Marcos, where power costs have risen by as much as 52 percent in recent years, aren't accounted for.

Electric co-ops and municipal utilities also don't face the same profit-maximizing pressures that public companies face from shareholders, said Bennie Fuelberg, general manager and chief executive of Pedernales Electric, a Johnson City-based co-op with 190,000 customers spread out over a large area.

"It's a big advantage to have your customers be your owners," Fuelberg said.

Pedernales has to make a profit to pay for the bonds it issues for capital projects, but it doesn't face the same pressure as the investor-owned power companies.

"We come closer to what utilities used to be, vertically integrated," Fuelberg said. "In the old days, HL&P had its profit margins to meet, but now under deregulation you have the retail provider, the transmission company and the generation company all trying to get that return."

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