Retail Competition

In This Issue:
-- Retail Competition
-- Unbundling Legislation
-- The Historical LDC Role
-- The New LDC Role
-- The Energy Service Provider Role
-- Success in Retail Competition

Success In Choice....
Energy Service Providers in the Residential Gas Market

Retail competition resulting from customer choice in the residential gas markets creates exciting opportunities for energy service providers. Since the mid 1980’s initiatives to reduce or eliminate federal and state regulatory controls over the U.S. energy markets have resulted in abundant supplies and service alternatives that facilitate consumer choice in the procurement of their natural gas supplies.

With the introduction of customer choice programs, energy service providers will compete for the right to supply natural gas and services to residential consumers, who have historically been limited to purchasing their gas directly from their local gas distribution company.

For energy service providers to be effective and successful in the residential gas markets there are certain critical success factors that must be met. The energy service provider must:

"In this article the authors discuss retail competition in the residential natural gas market. They provide an overview of the local distribution company role, areas where competition will occur and the critical success factors for an energy service provider to be effective and profitability succeed in the residential market segment."

Retail Competition in many large industrial and commercial gas markets has occurred because of deregulation and necessity. Competition in the residential / small commercial / small industrial markets is viewed as the final step in the deregulation process.

State regulators are eager to pass legislation that promotes competition through mandates on local distribution companies (“LDC”) to “unbundle” their gas merchant function from their distribution services. Through “unbundling” natural gas becomes a commodity that can be sold to residential consumers by any certificated energy service provider.

With “unbundling” LDCs are mandated to provide transportation services through their distribution lines to the final consumers. This unbundling is similar to that required in 1992 for all interstate gas pipelines under FERC* Order No. 636.

A U.S. General Accounting Office (“GAO”) Report, released in December 1998, found that about ½ of the states have in place or are in the process of implementing residential customer choice programs for natural gas as follows:

The GAO reported that the total eligible participants in choice programs is approximately 15 million customers, of which about 4% have elected to participate in the available programs (excluding the recent Georgia implementation). All firm gas customers on the Atlanta Gas Light (“AGL”) system have now chosen a service provider, or have been randomly assigned to an energy provider (based on providers’ market share as of August 11, 1999).

In the past, LDCs through their exclusive franchises have supplied natural gas to the vast majority of gas consumers in their service territory. They have also had significant physical, operational and financial responsibility for ensuring the security and reliability of gas supplies to their residential consumers.

Traditionally LDC markets have been divided into three broad segments based primarily on requirement levels, load profiles and level of sophistication as follows:

Commonly residential and small commercial consumers are combined into a single category due to their similarity in consumption levels and characteristics.

Competition to supply industrial and large commercial markets has increased in the past several years as major gas consumers sought to lower their energy costs. They forced / found alternatives to buying supplies directly from the LDC through (i) physical bypass of the distribution lines, (ii) utilization of alternative fuels, or (iii) contract negotiations with threats of bypass.

Residential gas consumers have not had similar options. Neither bypass nor uses of alternative fuels were economic or physically viable alternatives. LDCs control of the distribution lines coupled with their direct responsibility for the reliability and security of supply did not have the appropriate incentives to separate the sale of the gas from the transportation service for delivery.

With customer choice, LDC distribution services and rates will continue to be regulated. Residential consumers will continue to physically receive gas supplies through the LDC distribution network (i.e., there will not be competition for the physical delivery of the gas supplies).

Regulatory mandates will require LDCs to provide transportation services to energy service providers on a non-discriminatory basis. Firm capacity on distribution systems will generally be allocated to energy service providers based on their share of firm gas customers. This access to the firm capacity may allow some service providers to create incremental profits from service to interruptible consumers connected to the LDC.

Competition for residential gas customers will be fierce. The primary areas where competition will occur are:

Residential gas consumers will have many energy service providers competing for the right to supply natural gas to them. Some service providers may be affiliates of LDCs, but they will have to compete on a level playing field with non-affiliated providers.

The service providers will be responsible for meeting customers’ gas needs both in terms of the quantities required, and at the specific time that they are demanded. The providers will be responsible for acquiring needed gas supplies from the wholesale market and contracting for transportation services both on the upstream transmission pipelines and the LDC distribution lines.

Residential consumers’ interday and intraday load requirements may vary significantly because of factors such as weather conditions, time of year and household configurations. The intraday quantity of supply needs can be impacted by less obvious factors such as what we experienced in the U.K. During the introduction of retail competition we observed that there was a noticeable jump in gas consumption during the mid-morning tea hour.

Based on our experiences, we believe that the potential for creating a steady and predictable profit margin on the gas commodity itself, and at the same time reduce consumer rates is very limited. The wholesale price of natural gas is constantly changing, and the prevailing market price at any point in time is readily available to consumers. In addition, historical LDC regulatory oversight has not allowed LDCs to generate a profit on the gas commodity. Instead, LDCs were allowed a rate of return based on the physical assets in place to deliver the product (i.e., rate base).

Significant competition will occur in connection with associated services and options that service providers will present to residential customers. We believe these services and options will evolve into the primary source of profits for an energy provider. Examples of energy services and pricing options are:

Residential customers will need to see value in the associated services and pricing options available to them. The average consumer has very little knowledge of their energy uses, alternatives and drivers of their supply requirements.

Services and pricing options offered by energy service providers to former Atlanta Gas Light customers include fixed price options, multiyear pricing with fixed prices escalated by pre-agreed levels annually, coupon books, sweepstakes entries and air travel miles. The AGL case is similar to what we experienced in the U.K. and Australian retail markets during the introduction of residential competition.

The residential gas market is best characterized by: (i) low commodity margin per customer; (ii) large transaction counts; and (iii) high transaction costs per customer. The successful service provider must be able to operate in a highly competitive market with nominal margins, and be efficient in capturing and processing transactions.

The service provider must be prepared for “on-demand” gas service to residential customers. This includes responsibility for formulating demand forecasts; securing, storing and transporting required gas supplies; customer billings and collections; and coordination of new or changes in physical connections. At the same time, service providers must remain focused on attracting new customers, retaining existing customers, service reliability, brand recognition, and the continuous development and offering of innovative services and options to expand their competitive position.

The successful energy provider will have the ability to quickly and accurately differentiate customer problems attributable to physical delivery issues from provider service issues, and be able to effect resolution of problems regardless of their originating cause.

Residential consumer choice creates opportunities for energy service providers. Although success is not guaranteed, it is possible if the identified critical success factors are mastered.

H&H Energy Consultants serves clients in the energy markets. Its Principals have been actively involved with natural gas market reformations in North America, Europe and Australia. Resources have worked directly in the introduction and implementation of retail competition in Europe and Australia working on the behalf of utilities, traders, transporters and consumers. For further information call Joe Cantu at (713) 779-2535 or contact us through our website www.hhenergy.com.

Success In Choice.... Energy Service Providers in the Residential Gas Market

Success In Choice....
Energy Service Providers in the Residential Gas Market