what do customers really need from state regulation?

3
What Do Customers Really Need From State Regulation? William H. Smith, Jr. Dangerous as it is to generalize about customers, the regulatory system must be designed to meet their general needs. The first point in any overview of end users is that they fall into at least three categories, with dissimilar characteristics and needs. The second point is that any generalizations must recognize that within any customer category, many customers do not fit the mold. The third observation is that in recent years, end users have become more disparate as their market choices and their ability to react to those market choices have changed. These points lead to the conclusion that the regulatory systemmay need to be differentiated if it is to se.me properly the needs of various customers. Customer Needs Some customer needs (Figure 1 is an oversimplified Figure 1. Characteristics of Customer Categories Residential Commercial Industrial Alternative gas supply no Alternative fuels Eapabili ty Long-term only Knowledge of options low Ability to use Reliability high ?rice level moderate ?lanning horizon long ’rice stability high 3pity comparison all users knowledge low ?rice certainty low Jsage pattern seasonal safety reliance utility no low moderate moderate high low high long high all fuels seasonal utility Yes high high high must know high high short low petitors year round self COm- Villirm H. Smith, Jr. is chief of the Bureau of Rate and Safe0 Svaluatbn at the Iowa State UtiWes Bod and &o directs the Id’s FERCparticiporion. TheaurhorocAnowlulgcsthecrssistonce $us0 ClurLohnm, supervisor of economics and furonce, and William 1. Adams, supervisor of gas mtes, lo wa Utilities Boord. summary of these needs) involve supplyissues: the custom- ers* knowledge of supply options, their ability to exercise choices both in the short term and in the long tern, and their tolerance of uncertainty of supply. Other needs are matters of price: the level of gas prices compared to other fuels, the stability and predictability of gasprices, and the certaintyof quotedprices. Equity issues involvethe customers’ percep- tion of whether they are being treated fairly. ~~ One still hears grumbling about the “unbundling” of the telephone system because end users fmd it more difficult to mesh the services of multiple suppliers to recreate the unitary service oflered up to 1983. Residential-customer usage is highly seasonal where weather sensitivity is a factor. These users place a high value on reliability of service, especially at peak times. Moreover, most of these customers want a system that is easy to use. They bring no special knowledge or interest in how the gas system delivers its service. One still hem grumbling about the “unbundling” of the telephone system becauseend users find it more difficultto mesh the services of multiple suppliers to recreate the unitary service offered up to 1983. The residential-customersegment retains an expecta- tion of moderate prices and absolutereliability.Much of the public demands the comfort of having some agency to guard against the possibility of utility greed and high- handedness. “Real people’’ customers reasonably expect respectful and sensitive treatment from what they often perceive as monolithic institutions. These customers rely on the utility to be responsible for the physical safety of the system, even the portions inside their houses. A number of smallercommercialcustomersm i m r these characteristics. Indusbials’ Needs At the opposite end of the spectrum are the largest xstomers, usually industrials. These customers have the cnowledge and resources to be self-reliant in terms of fuel ;election. Most have the ability to use multiple fuels based NATURAL GA~~ECEMBER 1991 copyright Q 1991 by Executive Enterprises 15

Upload: william-h-smith-jr

Post on 12-Jun-2016

212 views

Category:

Documents


0 download

TRANSCRIPT

Page 1: What Do Customers Really Need From State Regulation?

What Do Customers Really Need From State Regulation? William H. Smith, Jr.

Dangerous as it is to generalize about customers, the regulatory system must be designed to meet their general needs. The first point in any overview of end users is that they fall into at least three categories, with dissimilar characteristics and needs. The second point is that any generalizations must recognize that within any customer category, many customers do not fit the mold. The third observation is that in recent years, end users have become more disparate as their market choices and their ability to react to those market choices have changed.

These points lead to the conclusion that the regulatory system may need to be differentiated if it is to se.me properly the needs of various customers.

Customer Needs Some customer needs (Figure 1 is an oversimplified

Figure 1. Characteristics of Customer Categories Residential Commercial Industrial

Alternative gas supply no Alternative fuels Eapabili ty Long-term

only Knowledge of options low Ability to use

Reliability high

?rice level moderate ?lanning horizon long ’rice stability high 3pity comparison all users

knowledge low

?rice certainty low

Jsage pattern seasonal safety reliance utility

no

low moderate

moderate high low high long high all fuels

seasonal utility

Yes

high high

high must know high high short low

petitors year round self

COm-

Villirm H. Smith, Jr. is chief of the Bureau of Rate and Safe0 Svaluatbn at the Iowa State UtiWes B o d and &o directs the I d ’ s FERCparticiporion. TheaurhorocAnowlulgcsthecrssistonce $us0 ClurLohnm, supervisor of economics and furonce, and William 1. Adams, supervisor of gas mtes, l o wa Utilities Boord.

summary of these needs) involve supply issues: the custom- ers* knowledge of supply options, their ability to exercise choices both in the short term and in the long tern, and their tolerance of uncertainty of supply. Other needs are matters of price: the level of gas prices compared to other fuels, the stability and predictability of gas prices, and the certainty of quoted prices. Equity issues involve the customers’ percep- tion of whether they are being treated fairly.

~~

One still hears grumbling about the “unbundling” of the telephone system because end users fmd it more difficult to mesh the services of multiple suppliers to recreate the unitary service oflered up to 1983.

Residential-customer usage is highly seasonal where weather sensitivity is a factor. These users place a high value on reliability of service, especially at peak times. Moreover, most of these customers want a system that is easy to use. They bring no special knowledge or interest in how the gas system delivers its service. One still hem grumbling about the “unbundling” of the telephone system because end users find it more difficult to mesh the services of multiple suppliers to recreate the unitary service offered up to 1983.

The residential-customer segment retains an expecta- tion of moderate prices and absolute reliability. Much of the public demands the comfort of having some agency to guard against the possibility of utility greed and high- handedness. “Real people’’ customers reasonably expect respectful and sensitive treatment from what they often perceive as monolithic institutions. These customers rely on the utility to be responsible for the physical safety of the system, even the portions inside their houses. A number of smaller commercial customers mimr these characteristics.

Indusbials’ Needs At the opposite end of the spectrum are the largest

xstomers, usually industrials. These customers have the cnowledge and resources to be self-reliant in terms of fuel ;election. Most have the ability to use multiple fuels based

NATURAL G A ~ ~ E C E M B E R 1991 copyright Q 1991 by Executive Enterprises

15

Page 2: What Do Customers Really Need From State Regulation?

on spot price differences. Utilities have been increasingly responsive to the needs of industrial customers in recent years. but these utilities are often constrained in the range of responses they can make by state regulation.

For these customers, regulation is useful only to in- crease options, lower cost, or reduce uncertainties. Too much of what regulation does works against these needs. State regulators generally have not allowed utility systems to be as open as the pipelines have become. Many large customers still believe rate designs do not give them the lowest possible prices. Surcharges and other direct-bill burdens make gas options, and LDC gas supplies in particu- lar, more expensive than other options.

Utilities have been increasingly responsive to the needs of industrialcustomers in recent years, but these utilities are often constrained in the range of responsesthey can make by state regulation.

With some justification, these users feel unable to make well-founded choices between utility gas rates that are subject to potential refunds andnonregulated supply choices for gas and other fuels that can be quoted at a price certain.

Regulatory Responses These growing differences in customer needs and ex-

pectations suggest a review of the regulatory systems covering service to these customers. The changing federal regulatory structure also makes a review of state regulation timely, because it is important for the two systems to be workably compatible.

Status Quo Certainly the existing ratemaking system is a candidate

for retention. Its principal features are a revenue require- ment limited to the actual cost of service, including a reasonable return on capital invested in facilities; cost- based rates; and gas-cost recovery on a dollar-for-dollar basis with no markup on merchant gas. This system satis- fies many of the requirements of firm residential and commercial customers. The system provides moderate and predictable prices, given reliable service without forcing customers to assume responsibility for supply decisions, and the system assures equity among all gas users. Also in this system’s favor is its predictability and the fact that it is well-understood. In fact, most other options currently being discussed use the current system as a base.

Open Access Many states now allow customers to use the LDC as a

transporter only, using gas from a third-party supplier. At the LDC level this system brings the same benefit it has

brought at the pipeline level: increased access to competing gas supplies. It is primarily aimed at meeting the price- sensitive requirements of larger customers.

Some states limit open access to customers above a minimum usage level or those with backup fuel capability. Some do not allow critical end users like hospitals and residential facilities to use third-party supplies. Other states allow backup arrangements from the utility or accept an informed certification that the customer’s management knows and accepts any risks of nondelivery.

Comparability The FERC’s consideration of fully separated merchant

service makes it inevitable that this proposal will receive some consideration at the state level as well. No one has yet suggested that LDCs should stop offering a bundled sales service, but many believe their transportation services are not functionally equivalent to the sales services. Like open access, this concept is directed to larger customers who have the resources and ability to acquire and manage a third-party gas supply. The service components offered by the LDC would still be priced using existing rate- making methods.

Price Cap Gas producers and marketers believe the future may

bring a supply service priced a certain amount below the next-most-economical fuel. This concept could lead to price differences between an area where propane is the primary alternate heating fuel and an area where electricity, say, is the next best choice. This kind of difference is seen in negotiated rates for price-sensitive large users, but it is not clear whether it would meet the residential customers’ needs for moderate prices and equity. It is a fresh idea, however, that deserves more public debate.

Gasproducers and marketers believe the future may bring a supply service priced a certain amount below the next- most-economical fuel.

In some variations, the price cap would apply to the burner-tip price, thus including distribution costs in the calculation. In other formulations, only the gas cost itself would be price-capped at the city gate, treating the distribu- tion cost as an add-on.

“Dual Pool for Dual Fuel” Most states have insisted on a single gas cost for all gas

sold by a utility. The logic is that the small firm customers should be the beneficiaries of the least expensive gas a utility can buy. This logic serves their needs for equity and moderate prices. It also precludes a utility from what can

16 NATURAL GA~DECEMBER 1991 Copyright 0 1991 by Executive Enlerpnses

Page 3: What Do Customers Really Need From State Regulation?

look like sweetheart transactions with large customers at prices below the prices of its system supply or from offering discounts at the expense of firm customers.

A few states have moved away from the unitary gas cost. Recognizing the differences in the needs of the small firm customers and the large industrials, these states allow utilities to maintain two separate gas portfolios. The firm portfolio may have a higher cost, but it should also be made up of more reliable sources in order to meet customers’ needs for reliability. The lower-priced portfolio may not carry all the values the firm customers require. The expec- tation of regulators favoring this system is that the dual pricing structure will bring better use of the LDCs’ facili- ties, thus lowering the distribution cost to all customers. This system has not been in use long enough to have a track record to support its effectiveness.

Many novel regularory schemes have been adopted under the heading of incentive regulation, with equally mixed results.

I ~ ~

Incentive Rates Incentive programs canbe designed to increase autility ‘s

interest in particular behavior or in achieving particular results. Many novel regulatory schemes have been adopted under the heading of incentive regulation, with equally mixed results. A typical program might allow pricing flexibility within a band of 20 percent up or down from traditional cost of service rates, with incremental revenues shared fifty-fifty between shareholders and ratepayers. Needless to say, these programs can be more difficult to administer than to describe in a single sentence. Despite the regulatory inconvenience of these programs, many utilities

propose them to gain the flexibility they need to meet the individual needs of various large customers, and many regulators have seen benefits returned to other customers as a result. If these programs consistently deliver benefits that respond to the different needs of customer categories, they will keep a place in the regulatory repertoire. Some states do not allow flexible rates for gas cost or for certain other rate elements.

Both pipelines and LDCs point out that current ratemaking at the FERC and in most states does not allow any profu to be retained on merchant gas.

For a lengthier discussion of incentive plans, see this column in the February and March 1991 issues of Nmral Gas.

Profits on Merchant Gas Both pipelines and LDCs point out that current

ratemaking at the FERC and in most states does not allow any profit to be retained on merchant gas. To state the case completely, though, some states do allow a return on the working capital tied up in gas inventory.

The price-cap concept discussed above, and some incentive plans are directed at allowing a profit on the commodity. Consexvationists will be quick to point out that profits tied to volumes sold may improperly stimulate gas consumption. Just as quickly, however, those interested in maintaining a long-term, reliable gas supply will argue that there must be an opportunity to profit on the commodity supply service in order to encourage LDCs, suppliers, and producers to maintain inventories and dedicate new reserves.

I NAWRU GAS/DECEMBER 1991 Copyight Q 1991 by Executive Enterprises

17