Energy Connections.

With energy services in the new millennium, you can lose as well as gain.

Navigating the New Landscape

Investor-owned electric utilities all over the country are being required by state lawmakers to make available to customers alternative sources of power. Navigating this

new landscape of unregulated energy marketers will require exceptional knowledge of how the wholesale and retail utility businesses operate. Financial officers and facilities managers alike will need market savvy and keen purchasing depth to earn their fair share of the potential savings and new benefits. Facility managers who are now being offered alternatives by new suppliers of energy services have realized that, in the competitive energy market, knowledge is truly power. The first step is understanding the new energy marketplace, including the variety of new energy services providers being organized.

By mid-1999, 24 states had passed legislation phasing in competitive power markets, and most of the other states are considering such legislation. Competition is under way in the early-adopter states, including Massachusetts, Rhode Island, Pennsylvania, New Jersey, Illinois, and California. By 2004, some estimators forecast that about half the U.S. population may be able to choose their energy provider, much like they presently choose a long-distance telephone carrier. Several bills have been introduced in Congress to stimulate and standardize further competition for power providers throughout the states.

Since it is not in the best interest of incumbent utilities to explain how their customers can switch energy suppliers, deregulated states must conduct public education campaigns. Users must be much better informed in order to make the best decisions with regard to purchasing energy services for their facilities. Building owners need to become smart shoppers because the coming choices among available alternative energy services providers may be confusing. While building owners and financial officers may have sound reasons to be optimistic over potential savings, new options, and more choices, there are an equal number of reasons to be cautious. The downside includes concerns about the following trends:

* Consolidations that require restructuring and early retirements.

* The end of utility rate-based, energy-efficient retrofits.

* Environmental impacts of relying upon low-cost, highly-polluting coal/oil combustion generation.

* Decline of system reliability.

* Cost increases for some customers.

* Increasing competition for electrical/mechanical contractors.

What energy users must understand simply is this: Investor-owned utilities are losing the monopoly franchises they had for electric power, and their executives must somehow make up lost profits for their stockholders. Energy consumers must realize that a variety of competitors are being turned loose as deregulation goes into effect. These competitors will not only include unregulated companies affiliated with utilities, but also new independent power brokers and power marketers from out of state. They may claim to have all the answers you need to negotiate for and buy electricity on the emerging open market. But do they?

Economic Drivers

The traditional, vertically integrated utility companies offering power generation, transmission, and distribution are being separated into three separate lines of business. Generation is exempted from the Public Utility Holding Companies Act; transmission is regulated by the Federal Energy Regulatory Commission; and distribution is regulated by the states. In addition, unregulated operations are being set up in three main categories: Power Marketing, Telecom/Internet and related lines, and Energy Services Contracting (see "Restructuring of Electric Utilities" chart, page 40).

These changes are being driven by federal and state policies in response to organized efforts by consumer groups and large energy users to obtain the benefits of more competition. Measurable results attributed to increased competition in previously deregulated industries, such as trucking, banking, telecommunications, and airlines, have included:

* Economic growth.

* Accelerated technology.

* Increasing employment.

* More consumer options.

* Arguably, lower prices.

Some readers may dispute these benefits of previous deregulation, but the trend toward enabling more consumer choice is now irreversible. The basic goal of electric industry restructuring is not only reducing prices, but enlarging consumer choices and stimulating creative, innovative new energy services. Primary factors driving the push toward electric industry restructuring include the following assumptions:

* Widespread perception that power is available on the national market at prices well below imbedded costs of many utilities.

* Large regional and inter-utility variations in prices should no longer be permitted due to costs of prior investments, contractual obligations, regional differences in fuel costs, purchase power obligations, taxes, labor costs, environmental factors, and regulatory decisions.

* Exposing monopoly utilities to competitive forces would produce cost reductions and produce additional consumer benefits through market innovations and technological improvements.

* Members of the rapidly growing independent power marketing industry should be permitted to aggressively pursue their ability to sell power directly to consumers.

Some states wonder if they should deregulate at all. States with electric rates lower than the national median of 6.92 cents per kilowatt-hour have a stake in keeping the present system in place, because deregulation might actually cause price increases for their consumers. As a result, a group of 23 states with lower rates formed the Low Cost Electricity State Initiative (LCESI) to lobby Congress for the right to choose whether or not they will join the crowd and open all consumer classes to competition. The LCESI seeks to: publicize the importance of preserving low rates for native customers; shelter rural electric rates from price increases in a competitive market; raise awareness of "negative stranded costs" and protect states' rights to allocate such costs; and ensure that economic advantages of low-cost states are not eroded by restructuring.

Their worry is that utilities currently serving low-cost states would begin selling their power in higher cost areas at rates higher than they charge in their native areas, but still lower than the higher-cost suppliers; then, rates to native customers might rise to that common level. Higher rates would be harmful to rural customers that have benefited from low-cost hydro and coal-fired supplies. The stranded cost issue works in reverse of high-cost states where utilities have been successful in getting price adjustments to cover payback of noncompetitive generation facilities. In low-cost states, the market value of generation plants might be higher than book value, and that could be money in the bank for native consumers that could be lost under a federal mandate. Through its lobbying efforts, the LCESI wants to assure that an "opt out" clause is included in any federal legislation being considered to mandate state deregulation.

As deregulation events occur continually, it will be useful to download the current version of state developments that is updated monthly. It is available, along with detailed state-by-state legislative summaries, from the U.S. Department of Energy website (www.eia.doe.gov/cneaf/electricity/chg_str/regmap.html).

Legislative History

Genesis of the present situation arises from The Public Utility Regulatory Policy Act of 1978. Among other things, this federal law requires utilities to buy electric power at avoided cost rates from private "qualifying facilities" that use fuel more efficiently by using the energy from hot water and steam discarded in conventional power plants. The avoided cost rate is equivalent to what it would otherwise cost the utility to generate or purchase that power itself. This policy stimulated formation of a new group of independent power producers and exposed regulated utilities to a new form of competition for electric power called "cogeneration."

Passage of the Energy Policy and Conservation Act of 1992 (P.L 102-486) initiated restructuring of investor-owned utilities. EPAct created an unregulated competitive market for wholesale power generation. It effectively decoupled generation from transmission and distribution and created a new category of Exempt Wholesale Generators (EWG). They are not classified as utilities under the Federal Power Act, and, therefore, are exempted from the Public Utility Holding Company Act of 1935. EWGs can generate electricity for sale at wholesale, purchase power for resale, or engage in wholesale and retail sales outside of the United States. EPAct left control of local power distribution and consumer choice up to the states, while transmission continues to be regulated by the Federal Energy Regulatory Commission. Thus, utility deregulation is more properly defined as electrical industry restructuring.

The EPAct also authorized all federal agencies to negotiate a new form of "performance contract" for energy-efficiency retrofits funded by sharing the energy cost savings with the contractor at no cost to the energy user. Federal building managers were required to reduce energy consumption by 20 percent per square foot by the year 2000, and 30 percent by 2005, relative to a 1985 baseline. This program was initiated in 1994 by Executive Order 12902, and President Clinton revised this policy in Executive Order 13123 in June 1999. The Federal Energy Management Program (FEMP) in the Department of Energy administers this program. FEMP maintains a list of all qualified performance contractors on its Internet site (www.eren.doe.gov/femp).

Performance contracts have been adopted heartily by commercial energy users as a way of obtaining energy-efficient building retrofits with no capital outlays. When they are combined with competitive power supplies, performance contracts have stimulated a new infrastructure of energy services business. This new industry is offering many options that could be confusing to uninformed energy buyers. To avoid the confusion, some facility managers are looking for a single source to supply all their energy needs -- so-called one-stop shopping.

Investor-owned Utility Restructuring

Competition is reducing the profits for some utilities saddled with non-competitive power generation, forcing them to reconsider their corporate strategies. Some are selling their power plants and concentrating on the "wires business," i.e. the local area distribution of power that is still regulated by the states. Utility executives have three simultaneous challenges:

* Offer new services to existing customers to prevent them from choosing competitors.

* Expand their business in unregulated markets to compensate for lower profits from electric power lost to competitors.

* Enlarge their territories through mergers and acquisitions for more economies of scale.

The most common response of utilities has been to transfer assets to a holding company and organize operations into separate regulated and unregulated wholly owned subsidiaries. The motivation for forming a holding company is perhaps best explained in the statement published by Constellation Energy Group on its homepage (www.constellationenergy.com) after it was formed from the Baltimore Gas & Electric Co. (BGE) in April 1999:

"BGE's traditional regulated business of providing electricity and natural gas to customers in its service territory is being opened to competition. Partially in response to this competitive environment, BGE has increased its unregulated, energy-related business.

However, under Maryland public utility law, BGE cannot raise capital for its unregulated businesses. Since we anticipate that in the future the capital needs of the unregulated businesses will be greater than that of BGE, the holding company structure will separate the operation of the regulated business from the unregulated businesses, allowing Constellation Energy Group to raise capital for its unregulated businesses in the public markets, which is more efficient and cost effective. In addition, the capital structure of each unregulated business may be tailored to suit its individual business. These factors will enhance Constellation Energy Group's competitiveness.

A holding company structure is common for companies engaged in multiple lines of business and is preferred by the investment community because it is easier to analyze and value individual lines of business. A holding company structure also makes it easier for regulators to assure that there is no cross-subsidization of costs or transfer of business risk from unregulated to regulated lines of business. Finally, a holding company structure provides the regulated utility legal protection from the results of unregulated business activities." For more information, access (www.consteilationenergy.com/about/about6.htm).

The unregulated utility subsidiaries commonly operate as energy services companies (ESCOs), or power marketing firms. Sometimes also called energy services providers (ESPs) or competitive services providers (CSPs), these are a new breed of companies emerging to take advantage of opportunities created by the restructuring of the energy industry. Their common goal as unregulated, utility-affiliated companies is to help users make and implement cost-effective decisions about their energy needs. An industry trade directory of some 125 ESPs is available on-the World Wide Web (www.espio.com). These companies, according to the description, typically perform the following services:

* Study energy use patterns and suggest ways that customers can reduce wasted energy and lower operations and maintenance costs.

* Help customers select and install energy-efficient equipment.

* Provide equipment financing options, as well as maintain and operate equipment at owners' facilities.

* Offer advice about how to best purchase energy.

* Analyze and offer the most cost-effective combination of these services.

Lewis Tagliaferre is proprietor of C-E-C Group, Springfield VA., consulting on the opportunities in utility deregulation. Portions of this material were developed through a grant from The Electrical Contracting Foundation Inc. Tagliaferre can be reached at 703-321-9268 or (lewtag@aol.com).