Electric versus Gas Industry ESD 126

Restructuring

Presented To
ESD 126
Massachusetts Institute of Technology
Cambridge, Massachusetts
March 12, 2001

Rick Hornby
Tabors, Caramanis & Associates

ESD 126 #1
Electric versus Gas Industry ESD 126
Restructuring
• Overview
– Privatization vs. restructuring vs. deregulation
– General objective of restructuring
– Trends in economic policy
• U.S. Industry Characteristics (pre-restructuring)
– Size
– Segments
– Ownership
– Regulatory Jurisdiction
– Supply/Demand Balance
• U.S. Restructuring Experience
– Driving Forces
– Transition Period
– Transition Costs
– Development of Workable Competition
– Unanticipated Factors/Flawed Analyses
ESD 126 #2
 Overview ESD 126

• Privatization vs. restructuring vs. deregulation

– Privatization entails a change from government ownership to
private sector ownership; continuation of existing approach to
economic regulation
– Restructuring entails a change in approach to economic
regulation, reducing reliance on regulation and increasing
reliance on market forces. Restructuring does not result in the
elimination of all regulation.
• General objective of restructuring
– ensure reliable service at reasonable prices through less
reliance on regulation and more reliance on market forces
• Trends in economic policy
– Restructuring in other industries (railroads, long-haul trucking,
airlines, banking)

ESD 126 #3
 Industry Size ESD 126
Industry Size

250

200

150
billion $

Electric
Gas

100

50

0
1

ESD 126 #4
 Industry Sectors ESD 126
Industry Segments

250

200

150

Distribution
billion $

Transmission
Production

100

50

0
Electric Gas
ESD 126 #5
 Industry Sector ESD 126
Characteristics
• Production/Generation
– Gas – extraction process, location constrained by
resource
– Electricity – manufacturing process, location primarily
constrained by siting considerations
• Transmission
– Gas – relatively simple technology and siting
– Electricity – very complicated technology and siting

• Retail Markets
– Gas & Electric – bifurcated market (large industrial and
commercial; small residential, commercial & industrial)
– Gas – competitive alternatives
– Electricity – no competitive alternatives
ESD 126 #6
 ESD 126
A Vast Network of Pipelines Provides
Interstate Transportation

ESD 126 #7
 Gas - industrial and large
commercial vs small commercial ESD 126
and residential
Gas Use is Concentrated in the Industrial and Commercial Sectors

100.00%

90.00%

80.00%

70.00%

60.00%

Customers
50.00%
Usage

40.00%

30.00%

20.00%

10.00%

0.00%

Residential Commercial Industrial

ESD 126 #8
Electricity - industrial and large
commercial vs small ESD 126
commercial and residential
Electricity use is concentrated in industrial and commercial
sectors

100.00%

90.00%

80.00%

70.00%

60.00%

50.00%
Customers
Usage
40.00%

30.00%

20.00%

10.00%

0.00%

Residential Commercial Industrial

ESD 126 #9
Industry Ownership ESD 126

• Gas
– Production - 8000 producers (24 majors)
– Transmission - 160 (20 majors)
– Distribution - 1500 (300 majors)

• Electric
– Production, transmission, distribution (1995)
• integrated 200 utilities, 70% of capacity
• distribution 3000 rural and municipal,15%
• wholesale 70, 15% of capacity

ESD 126 # 10
Regulatory Jurisdiction ESD 126

• Production/Generation
– Gas – primarily Federal (intrastate market
approx 25%)
– Electricity – primarily state
• Transmission
– Gas – Federal, rates and siting (eminent
domain)
– Electricity – Federal for rates but not siting

• Retail Markets
– Gas & Electric – state
ESD 126 # 11
U.S. Restructuring Experience ESD 126
Driving Forces
• Gas (primarily market driven)
– Production – shortages (new production not being developed
at regulated prices); regulation of production administratively
impractical
– Transmission – producers and buyers wanted to do business
directly
– Retail market – competition from oil for large buyers; equity
for small volume customers
• Electric (primarily policy/regulatory driven)
– Production – regulatory problems re nuclear plant cost
overruns; PURPA & cheap gas & advances in turbine
technology
– Transmission – FERC (based on gas experience)
– Retail market – large buyers seeking lower rates; policy
makers/regulators seeking equity for small volume customers

ESD 126 # 12
U.S. Restructuring Experience - ESD 126
Transition Period

• Gas (primarily market driven)

– Wholesale 1978 – 1985
– Transmission 1983 - 1992
– Retail 1985 – present (varies by state)

• Electricity (primarily regulatory driven)

– Wholesale 1998 – present (varies by state)
– Transmission 1996 - present
– Retail 1998 – present (varies by state)

ESD 126 # 13
 Shopping experience in long-
distance telephone service ESD 126
market
Long Distance Carrier Shares of Market Revenues

100%
90%
80%
70%
60%
Percent

ALL OTHER
50%
AT&T
40%
30%
20%
10%
0%
1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

ESD 126 # 14
 ESD 126

C h o ic e s o f P ip e lin e S e r v ic e s H a v e C h a n g e d in th e 1 9 9 0 ’s

25

20 R e le a s e d C a p a c ity
Quadrillion Btu

In te r r u p tib le T r a n s p o r ta tio n
15
N o -N o tic e
S e r v ic e

10

S a le s
5 F ir m T r a n s p o r ta tio n

0
1 987 1988 19 89 1990 19 91 1 992 199 3 1 994 199 5 1 996 1997

ESD 126 # 15
 U.S. Restructuring
Experience -Transition ESD 126
Costs
• Gas
– Commitments to purchase specific volumes at
high prices under long-term contracts
– Settled AFTER implementation of competition
– Settled at less than 25% of value of contract

• Electricity
– Investments in generation units
– Settled BEFORE implementation of
competition
– Settled at 100% of book value of investments
ESD 126 # 16
U.S. Restructuring Experience
Unanticipated Factors/Flawed ESD 126
Analyses

• Gas – lucky breaks led to excess production capacity

(gas bubble) and low prices for 15 years
– improvements in exploration and development
technology
– end-use efficiency
– relatively low oil prices

• Electricity –vary by state

– Absence of price response
– Absence of “shopping”
– Dramatic increase in gas prices
– Increase in rate of load growth

ESD 126 # 17
U.S. Restructuring Experience-
Development of Workable ESD 126
Competition
• Criteria for Workable Competition
– many sellers (e.g., 5 sellers with equal market share
according to the HHI index of market concentration)
– many buyers, who are price elastic
– ease of entry and exit
• Gas
– Wholesale market – pre-existing sellers and buyers; supply
service at regulated rate continued until 1993
– Retail market – pre-existing competition for large buyers
(industrials); supply service at regulated rate continues
• Electric
– Wholesale market – very few pre-existing sellers and buyers;
no supply service at regulated rate (some bilateral “buy-back”
contracts)
– Retail market – very limited pre-existing competition for large
buyers; supply service at regulated rate continues
ESD 126 # 18
 Gas retail market
economics ESD 126
The portion of total gas rates subject to competition varies by
sector

9.0000

8.0000

7.0000
$/thousand cubic feet

6.0000

5.0000
Local Distribution Service
Default Supply service
4.0000

3.0000

2.0000

1.0000

0.0000

Residential Commercial Industrial

ESD 126 # 19
Gas retail markets - what are
the economics of ESD 126
competition?
Sector Annual Gas Supply 5%
Use Supply Cost Savings
dth $/dth $/year $/year
Industrial 3,990 3.72 14,858 743

Commercial 207 3.72 772 39

Residential 124 4.17 515 26

ESD 126 # 20
Electric retail market ESD 126
economics
The portion of total electric rates subject to competition varies by
sector

12.0000

10.0000

8.0000
cents/kwh

Local Distribution Service

6.0000
Default Supply Service

4.0000

2.0000

0.0000

Residential Commercial Industrial

ESD 126 # 21
Electric retail markets - what
are the economics of ESD 126
competition?
Sector Annual Standard Supply 5%
Use Offer Cost Savings
kwh cents/kwh $/year $/year
Industrial 1,700,000 4.15 70,550 3,528

Commercial 60,000 6.14 3,684 184

Residential 9,000 5.65 509 25

ESD 126 # 22
Retail markets - what are the ESD 126
trends in gas markets?
Third-Party Share of Retail Gas Market Sales in PA

100%

90%

80%

70%

60%

Commercial
50%
Industrial
40%

30%

20%

10%

0%

1992 1993 1994 1995 1996 1997

ESD 126 # 23
 Retail markets - what are the ESD 126
trends in electricity markets?
TPS Share of Retail Electricity Customers

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Residential Commercial Industrial

ESD 126 # 24
Retail customer shopping for
electricity ESD 126
(PECO in PA)
Market Share (Load) served by TPS on PECO Since Inception of Retail Com petition

100

80
Per cent of load

60

40

20

0
0 3 6 9 12 15 18 21
Months from m arket opening on 1/1/99

Residential Industrial Commercial

ESD 126 # 25
 Conclusions ESD 126

1. competitive markets
u must either exist or have a high probability of developing
within a reasonable time period
u legislation and regulations do not have the ability to
mandate or force the development of a competitive
market
2. transition period
u may take many years, e.g. over ten
u requires careful planning
u will require the presence of a “default” subject at
regulated rates until markets are workably competitive
ESD 126 # 26