For large energy users, flexibility and choice are the new buzzwords as restructuring gathers steam in the electric power industry. THE CHANGING ENERGY LANDSCAPE
By Danialle Weaver Manufacturers, retailers, and other large energy users will likely be among the biggest and earliest beneficiaries of changes that continue to occur in U.S. energy markets as electric and gas utilities respond to the competitive challenges created by the restructuring of the nation's electricity industry. Utilities are responding in various ways to the increased competition brought about by restructuring. New power-supply entities are being created as investor-owned electric utilities merge with gas utilities or other electric utilities. Many cities are considering creating their own utilities to facilitate faster customer choice. Some utilities are spinning off unwanted assets; others want to become one-stop national energy suppliers. Both municipal and investor-owned electric and gas utilities are seeking to stimulate new profit centers by providing industrial and commercial customers with telecommunications services: two-way energy information systems that can reduce load demand, defer new construction, control costs, and improve power quality. Many utilities are building two-way energy services systems that will allow new billing methods, more convenient maintenance scheduling, rapid emergency communications, and remote equipment diagnosis and alert customers of impending environmental or operational problems. Most utilities plan to lease out parts of their extensive fiberoptic networks to other businesses; many others aspire to provide local telephone service, cable television, and Internet access. Other possible offerings are videoconferencing, broadband integrated service digital network (ISDN) service, and local area network (LAN) connections for businesses. The magnitude of the investments is staggering: In just two months - October and November 1996 - electric utilities committed more than $500 million in new telecommunications investments, according to Chartwell Inc., an Atlanta consulting firm.FINANCIAL FLEXIBILITY
On a state-by-state basis, electric and gas utilities are gaining increased flexibility to negotiate discount electricity rates or other incentive arrangements with large industrial and commercial energy users. Many companies, including Ford, GM, Chrysler, Raytheon, and Pratt & Whitney, already have lowered their energy costs through negotiation, industry experts say. Large retailers such as Hannaford Brothers; Sears, Roebuck and Co.; Wal-Mart; and Federated Department Stores have sought national or regional suppliers for their energy needs. Others, such as Destec Energy, a Dow Chemical unit, are reversing the process by selling excess power to municipal utilities. Some large customers that now generate their own power hope to cut costs by wheeling excess power generated at one site to another company site. Electricity rates for industrial and commercial customers already have fallen. According to the Natural Resources Defense Council, industrial rates fell 22 percent between 1985 and 1994. The Gas Research Institute (GRI) predicts that by the year 2000, electricity prices will fall 20 to 30 percent in the industrial sector and 10 to 20 percent in the commercial sector. The price advantage that natural gas has enjoyed over electricity during the past decade will evaporate as competition grows, GRI predicts.OPENING THE GATES
These competitive forces were unleashed by the Energy Policy Act of 1992, which allowed federal regulators and electric utilities to set conditions and prices under which other wholesale power purchasers, including direct competitors, would be allowed to move, or "wheel," bulk electricity over existing transmission lines. The law leaves states with the discretion of allowing energy providers to transmit power directly to retail customers. In some states, retail wheeling is occurring already; in others, it may take a while. By late 1996, at least 47 states were studying or implementing retail choice. Lawmakers are expected to consider eliminating this patchwork of regulations in favor of a uniform national approach during the current Congress. Among the issues to be resolved are whether states will be required to fully deregulate wholesale and retail energy markets and whether utilities will be allowed to collect "exit" or "transition" fees from their departing industrial and commercial customers to recoup "stranded investments" made under monopoly conditions that are now uneconomic under market conditions. Even if some utilities are allowed to collect these fees, the situation probably won't last long, says Robert Michaels, professor of economics at California State University at Fullerton. "It is already clear that stranded-cost compensation is a barrier waiting to fall," says Michaels. "Even if questions of state and federal jurisdiction are resolved quickly, nonbypassable charges will exist in name only because small users will have abundant self-generation options with the advent of low-cost, small power technology. As rate differences between high- and low- stranding states become apparent, existing-users will demand relief, and prospective users will not relocate without it."CHANGING TECHNOLOGIES, CHANGING SERVICES
New technologies will also make it possible for large manufacturers to rely on flexible production and market-responsive supply arrangements. That means manufacturers "will be able to schedule and use power with a new sensitivity to its price," Michaels says. Smaller manufacturers and businesses will also begin to benefit from the same types of contract negotiations currently aiding the largest users. "The range of contractual terms will grow with improved metering capacity, the development of new financial instruments, and new market options for handling, contingencies," notes Michaels. By negotiating with industrial and commercial customers early, utilities hope to lock up "a sizable share of targeted segments that provide an ongoing-stream of profitable energy-management service revenues and position [themselves] ... to serve as a 'broker' or perhaps even the 'provider' of the electric or gas commodity," explained Dilip Kamat, Ken Ostrasky, and Richard Stuebi of McKinsey & Co. in a recent issue of The Electricity Journal. Once each function previously provided by vertically integrated utilities is broken down and priced separately, the services, along with some new ones, will be repackaged and sold to energy consumers by commodity marketers who will allow buyers to lock in prices or will index them to the customer's costs, the McKinsey analysts explain. "A hallmark of the new energy industry will be the increased number and variety of new players," notes GRI's Steve Ban. "Of growing importance is the 'energy service company' that will provide whatever form of energy and related services the end-use customer wants. Other entities are also taking shape to sell or lease equipment, broker energy transactions, or provide a variety of other services from information management, engineering and design, and capital risk management to telecommunications and environmental cleanup. Options for more flexible delivery, storage, and price hedging, or gas supply planning could be strong selling points as services are unbundled."ASSUMING NEW ROLES
More than 200 companies, including independent power producers, electric utilities, and gas pipelines, want to fill the new commodity marketing role. Major players include Enron, Duke-Louis Dreyfus, and LG&E Energy. Other multicompany marketing alliances are also being formed. Salt River Project; Tenaska Power Services Co.; and Powerex, a B.C. Hydro subsidiary, are combining to market wholesale energy. Cinergy Corp. inked a similar deal with Wheeled Electric Power. Some utilities are selling off unwanted assets. Edison International plans to sell all its California fossil plants but will still generate power through a non-regulated company, Edison Mission Energy. Both Pacific Gas & Electric and the Littleton, Mass., utility will specialize only in distributing electricity and natural gas to end users. UtiliCorp, on the other hand, wants to create a "one-stop energy shop" with a nationally recognized brand name: EnergyOne. Other utilities are bulking up. As of December 1996, a total of 11 friendly, $1 billion-plus U.S. mergers have been announced, according to The Wall Street Journal. These include mergers of electric utilities with other electric utilities and mergers of electric and gas utilities. Of note are the mercers of Enron Corp. with Portland General Corp.; Duke Power and PanEnercy Corp.; Wisconsin Energy and Northern States Power; Baltimore Gas & Electric and Potomac Edison Co.; and Centerior Energy and Ohio Edison. More are expected. In December, Cinergy Corp. and Trigen Energy Corp. announced a joint venture that will invest as much as $1 billion in the construction and operation of co- and trigeneration facilities for industrial plants, office buildings, shopping centers, hospitals, and universities. The joint venture is designed to offer large energy users combined heat and power production. Meanwhile, investor-owned utilities (IOUs) have stepped up their interest in acquiring city-owned electric distribution facilities, as illustrated by the offers received by the Hagerstown, Md., municipal utility from both Potomac Edison Co. and Allegheny Power, according to the American Public Power Association. Some IOUs are also expected to pursue mergers with local gas distribution companies in order to control both the pipes and the wires needed to deliver fuel choice to end users, says Steve Ban.NEW NICHES FOR MUNICIPAL UTILITIES
Municipal utilities also see new opportunities. In a deregulated environment, municipal utilities could serve as aggregators of electric load or compete directly for industrial customers, says the Terra Group, a consulting firm. The city of Palm Springs, Calif., for example, has chosen to form a new municipal utility to aggregate the city's retail electric load. Palm Springs is not alone. The Edison Electric Institute says that more an 40 U.S. cities and towns including five Long, Island communities are considering bypassing their current electric supplier by creating new municipal utilities. Recently, New Mexico's Mesalero Apache Tribe announced the formation of a tribal municipal utility that will buy wholesale power from Texas-New Mexico Power Co. Even in states where retail wheeling is not allowed, municipal utilities can serve as the go-between for retail customers and wholesale suppliers. Washington's Tacoma City Light is providing direct access to the wholesale power market to five industrial customers: Occidental Chemical, ELF Atochem North America, Simpson Tacoma Kraft Co., Praxair, and Stone Consolidated. Elsewhere, Lakeland, Fla., officials are offering 10-year contracts that allow large customers to switch suppliers if retail wheeling occurs and the city cannot match a competitor's price.A DIFFERENT LANDSCAPE
In short, while the final outcome of restructuring is uncertain, the energy landscape in 1997 and beyond will certainly look far different than when debate began. In the meantime, large energy users will reap the benefits of deregulation as new players enter the market, forcing energy prices down and expanding the variety of products and services available.FOR ADDITIONAL INFORMATION PLEASE CONTACT: AREA DEVELOPMENT AT (800)735-2732