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California's Dueling Electricity Bills

Customer choice is needed

Lynne Kiesling
April 26, 2004

Last week the California Assembly passed new piece of electricity legislation, AB2006. The bill is meant to break the regulatory limbo in which the California electricity industry has been for the past three years. It contains the usual compromises to make it politically palatable, but also happens to contain some substance that would introduce a measure of meaningful value-creating competition. Its legislative competitor, AB428, has some beneficial features that are superior to those contained in AB2006. Each of the bills, though, is a curate's egg, meaning that each is "partly good and partly bad and so not wholly satisfactory".

The foundation of AB2006 is dividing customers into core and non-core groups. Core customers are those who have a maximum peak demand of less than 500 kilowatts. Core customers will not be allowed to choose different electricity suppliers or different electricity contracts, but will be on a cost-based, fixed, average rate plan with their utility. Noncore customers can choose between the cost-based plan, other plans that the utility might offer, or direct purchases from an independent power producer.

A lot of the bill focuses on investment and what's called in the business the "resource adequacy" requirements on the utility. Resource adequacy basically means the utility has to plan for how it intends to meet the demand facing it. One of the really good things about this bill is that it explicitly includes demand reduction as a tool for resource adequacy. This is important because it gives the utility an incentive to consider using price to prioritize use, shift load away from peak hours, and shave peaks as ways to meet its resource adequacy requirements.

The bill also stipulates that the utility will not be responsible for having a resource adequacy requirement for the noncore customers that choose direct access to an independent power producer. The good news about this setup is that it gives the right signals to the right parties (especially customers and independent power producers) about the risks that they are taking on. And the flip side of that is that is allows for flexibility between noncore customers and independent power producers in the types of contracts and levels of reliability that they choose. But it also says that noncore customers who do not choose direct access must sign five-year contracts with the utility. This provision stifles direct access and locks in utility customers. What happened to choice and the benefits of competition?

Another area in which to be careful here is that the utility as transmission owner and transmission service provider must still take into account those power flows in its transmission investment and planning. Nothing in this bill provides for transparency and the flow of information through market processes into the transmission investment decision.

The worst feature of this bill is its requirement that core customers are forced into a fixed, cost-based rate. While this is clearly a compromise that is meant to assure small customers that they will be protected, it imposes a cost on those core customers who would choose a more flexible contract instead of a fixed, average, cost-based rate.

In fact, one of the complaints being lodged against the bill is that the cost-based rate saddles the core customers with the overpriced long-term contracts that the State of California signed in the winter of 2001 while allowing noncore customers to negotiate more attractive contracts. Perhaps the Governor's energy advisors can suggest some creative ways of renegotiating or restructuring those contracts, much in the same way that it's done in commercial contexts, to remove this political obstacle.

But there is hope for at least some demand response programs for those core customers. Pilot programs in both California and Illinois have demonstrated that even residential customers respond to price changes over the day in accordance with changes in the cost of providing them with power. So we may be taking small steps toward retail choice even within the regulated, core customer context.

AB2006's legislative competitor, AB428, has been kicking around the Senate Energy Committee since last July. AB 428 has the same core/noncore structure as AB2006, but says that the noncore customer has three choices: direct access, a contract with the utility for three years or longer, or default (i.e., cost-based) service. The three-year lock-in is not quite as onerous as the five-year lock-in of AB2006, although it's no great improvement. AB428's supporters think that it's more market-oriented than AB2006.

I don't entirely agree. I do think that AB2006 creates opportunities for utilities to get back into the generation business, which I don't think we want to induce artificially at this point. And I think AB2006's explicit recognition of the importance of allowing demand reduction to be considered a reliability resource is a very good thing. But the rest of AB2006 is more restrictive.

A truly market-oriented approach that still acknowledges some of the political obstacles would take the direct access provisions from AB428 and the demand reduction as resource adequacy provisions from AB2006, and throw out the rest. This would rescue each bill from being a curate's egg and create one bill that, while not perfect, is more satisfactory.

An approach that would be more fair to all customers would be simply to have as part of AB(428+2006) the statement that

All customers have the right to choose from a menu of contracts how they will buy and pay for their power.

Then let the customers to whom that choice is valuable exercise it.

Lynne Kiesling is an adjunct scholar at Reason Foundation and director of applied energy research at the International Foundation for Research in Experimental Economics.

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