Ken Silverstein EnergyBiz Insider Editor-in-Chief

Lots of debate has taken place over the merits of deregulation and the subsequent result that the efforts have had on all consumer classes. But there is a growing realization that the hybrid model - that believes traditional regulation is passé but still thinks consumer safeguards are a must -- is here for a while. So, a new discussion is occurring -- one that examines "portfolio management."

Portfolio management starts with the premise that utilities are focused on providing reliable power supplies at reasonable costs. At the same time, they must accommodate regulatory concerns when it comes to reducing environmental impacts and risks while improving the efficiency of their generation and transmission and distribution assets.

Getting to the heart of the matter, the goal is to facilitate wholesale competition whereby electricity suppliers have total access to all transmission lines so that larger industrial buyers can choose their providers. It also encourages utilities in regulated markets to assemble a mix of long-and-short-term energy resources to serve retail customers. That includes traditional power supplies as well as green power and other less traditional mechanisms such as energy efficiency and distributed generation.

The National Association of Regulatory Utility Commissioners "encourages state regulatory commissions to explore portfolio management techniques that may be applicable to their particular circumstances, under either traditional or restructured markets, and to adopt appropriate regulatory policies to facilitate effective implementation of portfolio management practices by regulated utilities," says Richard Morgan, commissioner on the Public Service Commission of the District of Columbia.

Volatile natural gas prices have affected all consumers. But, they are especially problematic in states that have restructured their markets and still implement rate caps. Utilities are generally allowed to adjust their rates to accommodate price spikes in the underlying commodity, although they must still provide a regulated rate to end users. Illinois customers, for example, will see increases of 20-50 percent.

The goal of all states that have deregulated, however, remains the same. They want to persuade alternative suppliers to enter their markets and bid down the price of power. They also want consumers to understand that electricity is like any other commodity and fluctuates in price based on supply and demand. If they paid market rates, advocates of restructuring say that they would be more inclined to conserve power and especially during high-priced times.

Hybrid Model

Given the dichotomy in regulatory schemes, it would appear that the consumer safeguards and competition are incompatible. But, the Ohio Consumers' Counsel is pushing for a middle ground approach that will allow utilities to enter into supply contracts that range from one year to 25 years. It also wants to require the use of more renewable energy and energy efficiency to hedge against volatile natural gas prices and make it easier to build newer and cleaner power plants.

Ohio restructured its utility market in 2000 and implemented "standard offers" as a way to guarantee prices to retail customers. But, those price caps are to expire in 2008. And, now, the state's commissioners must choose among several options that include reverting to tight regulation, lifting the caps and letting market forces take over or using some combination of the two. Ultimately, rates would be based on utilities' entire portfolios of fuel and supply contracts -- not on a single supply auction.

The plan also calls on the state legislature there to require utilities to come up with long-term forecasting requirements so that all parties understand the need for new base load generation. In Ohio, the laws prohibit utilities from increasing their rates tied to the construction of those plants. Under this Consumers' Counsel proposal, utilities would pledge the revenue from their long-term supply contracts to finance construction. And, the power plant builders would have to agree to stay on budget or absorb cost overruns.

"Rate plans previously enacted by state regulators only serve as temporary measures," says Janine Migden-Ostrander, CEO of the Consumers' Counsel. "Ohioans deserve a comprehensive energy plan for the future that will keep pace with forecasted growth in electric usage while providing consumers with greater price certainty."

Proactive utilities are developing long-term plans to meet expected future demand. NRG Energy, for example, has written a 10-year plan and will spend $16 billion to develop about 10,500 megawatts of new generation capacity. Of that total, 8,000 megawatts will be base load generation that includes 2,700 megawatts of nuclear energy. It will also develop three gasified coal units and two new wind plants in California and Texas, all of which will cut its carbon intensity by 20-25 percent per year.

The size and scope of the projects are such that the build-out must be well-considered. That is, 70 percent of the expected power to be generated is already contracted for through power purchase agreements, bi-lateral contracts and hedges with financial firms.

"NRG is strategically located in domestic markets with high and growing demand for power and an over-reliance on expensive natural gas for their power generation," says David Crane, NRG's CEO. "NRG's development program is designed to meet the growing energy needs of these regions, while both reducing their dependence on natural gas for power generation purposes and making meaningful progress towards reducing our carbon profile."

Market fundamentals today -- strong power prices and decent margins, particularly in the nuclear and coal areas -- mean that utilities are now doing well. But, they have learned to not be short-sighted and to hedge their bets. The current price volatility means that utilities must have sound risk management techniques whereby they have implicit understandings of commodities and the ability to market and trade them. They also need to own their assets so that their costs are more predictable.

Those strategies fall within the context of portfolio management -- the development of viable, longer-run options that ensure reliable, low cost power to consumers. It’s a strategy that may prove to be particularly useful in jurisdictions that are faced with whether to revert to tight regulation or whether to encourage all-out competition, which might subject consumers to wild rate swings.