Ken Silverstein EnergyBiz Insider Editor-in-Chief

Price caps -- or standard offers in energy parlance -- are implemented to protect consumers until competitors fill markets. But if alternative suppliers cannot beat the state's authorized prices and go on to earn sufficient margins on the power they sell, then they won't enter the fray -- and the same old utilities will dominate.

Ideally, prices would be set by buyers and sellers. But many state regulators and legislators take a pragmatic view, recognizing that newly deregulated markets are fickle and consumers could suffer as a result. That's not to say that electricity customers should not bear some risks. They should, all to avoid a California-like situation where utilities were forced by law to sell its power to consumers for less than they were paying.

The turmoil in California and elsewhere stymied deregulation. The states with competitive laws on the books now must decide whether to retrench, delay or plow ahead with the appropriate safeguards. California considered giving its public utility more authority and limiting consumer choice under Proposition 80 -- something voters there soundly rejected last November. Other states are now in limbo, deciding whether to keep their price caps or remove them altogether as planned.

Strictly regulated markets are not healthy for anyone, says Don Nickles, chair of Compete Coalition, a trade group promoting competition in the electricity sector. The former U.S. Senator told attendees at KEMA Consulting's annual meeting that prior to deregulation "cost of service regulation had proven to be inefficient and costly. Incentives for efficiency were lacking. Transparency of price signals was non-existent. The risk of bad investment decisions largely was shouldered by consumers, who paid billions of dollars in cost overruns for expensive generation plants."

Beacon of Light

Texas has implemented a so-called price-to-beat, which is said to be "a good balance" between immediate customer savings and attracting alternative providers. Customers who don't switch to another provider receive a legislatively mandated base-rate cut of 6 percent, which can be adjusted to accommodate higher fuel prices.

The incumbents must offer the price-to-beat until January 1, 2007 -- when that artificially-set rate is expected to be lifted. While commercial and industrial customers have the most to benefit from choice, the utility commission there says that a residential customer in the Houston area who monitored markets and kept switching to competitive providers would have saved nearly $1,500 over the last four years.

By contrast, California's former electricity laws were arcane and unworkable. In the end, the major utilities were unable to shop for the lowest priced generation and were not able to recoup their underlying fuel costs. Pacific Gas & Electric declared bankruptcy as a result, although it has since regained its footing.

Other states such as Delaware, Illinois and Maryland are now struggling with what's next. Maryland, for example, has capped electricity rates since the summer of 2000, although the standard offer has been set through a competitive bid process that allows utilities to adjust their prices if fuel costs rise. That adjustable cap is supposed to end in July and market forces are to take over. A group of bi-partisan legislators, however, want to limit future rate increases for residential customers to 5 percent.

Baltimore Gas & Electric says that if it were unable to charge consumers a fair price that takes into account its fuel costs, it would have to borrow hundreds of millions to stay in business. That would cause its credit ratings to sink and end in its financial devastation. The utility says that increased rates are the result of higher natural gas prices and not because of failed energy policies.

Best Processes

With the exception of Texas, states are reluctant to remove the "safety net." In the meantime, if incumbents are offering the best prices, then so be it, says Robert Bellemare, CEO of UtiliPoint International. For now, regulators can tweak the system to protect consumers and to give alternative providers some advantages. In the long haul, though, competitive forces should emerge, allowing those competitors with the best processes to thrive, he continues.

"If the rates that are charged by competitors are not less than what incumbents are charging, I don't think customers should be made to suffer even more since they are already paying among the highest rates in the country," adds Sonny Popowsky, consumer advocate of Pennsylvania, in a prior talk with this writer. In Pennsylvania, rate caps were supposed to be lifted in 2005 but were instead extended until 2010.

The states that have restructured their electricity markets need to be careful about creating unintentional barriers to entry through their standard offer programs. Clearly, incumbent providers need to be able to pass on their higher fuel expenses to consumers, who can't be totally insulated from market forces. Such flexible policy maintains some price stability while giving alternative providers a chance to win business.

Regulatory models must balance all competing interests. Restraints may ease over time, although regulators generally can't justify it now. Competitive suppliers, meantime, want a level playing field so that those companies that are innovative, nimble and customer centric can prevail over those that have less efficient processes. For now, policymakers will straddle the fence -- leaving an uncertain future for deregulation.

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