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Lawrence Glazer

Lawrence M. Glazer

Electric Choice

January 22, 2016

Imagine you are the CEO of Hometown Power Company, an investor-owned utility with 100 customers. On the hottest weekday of the year with the air conditioning on full blast, each customer is using 1000 watts (these are very homogenous customers). So you need enough generating capacity to generate 100,000 watts at a time.

To build this generating capacity will require investment of $1 million and take four years. So you need to raise $1 million. That’s no problem; Hometown is a fully regulated utility and potential investors know that your state public service commission will approve electric rates that are high enough to pay your reasonable ongoing expenses (such as fuel, salaries and maintenance) plus enough to pay interest on the $1 million.

But sometimes generators will be shut down, either for scheduled maintenance or because a part broke. So, to keep up with demand, you will also need a 20% reserve capacity. Otherwise, the power supply in your territory would become unreliable. So make that $1.2 million.

You go to Wall Street and borrow the money by issuing bonds.

Then your state enacts an “electric choice” law, opening the generating business to competition. The law provides that anyone can buy or build a generator and create electric power for sale to customers in your service area and you will have to transmit that power over your distribution network of local power lines.

Pretty soon independent generating companies are springing up, attracting investors and offering to sell electricity to your customers at lower rates than yours. They can do this because they don’t have to build a distribution infrastructure or generating capacity to service everyone who requests electric power. But the law commands you to do so.

Some of your customers sign contracts with these companies and pretty soon your sales drop and your revenue shrinks.

A few years go by and some of your customers (but far from all) come back. They were not satisfied with the service from the independent generating companies. Since the law requires you to serve all customers who request electric power, you have to take these customers back.

A few more years go by and the federal government puts new emissions standards into effect. Several of your older coal-burning generators cannot meet the new standards and must be replaced. The economy is growing and so is the demand for electric energy. Your staff projects that total peak demand in your service territory will reach 150,000 watts in a few years.

And here is your dilemma: You have to act now, based on assumptions about the future. But what will you assume?

You could assume that your competitors will get into trouble. Some of them are under-capitalized and can’t survive a downturn in the demand for energy. Some of them are led by inexperienced people and have a lot of outages. Some of them could go bankrupt (it has happened).

In that case you would plan for serving ALL of your potential customers; you would go back to Wall Street for enough money to build up your capacity to 150,000 watts.

If you do that, and significant numbers of your customers defect to your competitors under the electric choice law, then you will be stuck having to pay principal and interest to the investors who financed that 150,000 watts of generator capacity – generators that are not earning enough revenue to pay for themselves. The only way to generate enough revenue to cover expenses and principal and interest payments will be to raise electricity rates to the customers who stayed with you. And that, of course, will drive more of your customers into the welcoming arms of your competitors, and you will have to raise the remaining customers’ rates even more, because there are fewer of them to share the same fixed costs.

So let’s take a look at your other alternative. Instead of assuming that your former customers come back, assume the opposite – that most of them are gone for good. So you would only build up to 100,000 watts of capacity.

If you do that, and it later develops that the wayward electric choice customers come back, you won’t have enough capacity. Since the law requires you to serve these customers, you will have to buy power from other companies on the spot market. That will cost a lot more than generating the power yourself, and you will either have to take a loss or pass the expense onto your customers – if your state public service commission will allow it.

Which brings us to a third alternative: try to get the law changed.

The above described conundrum is not fiction. It describes the situation facing Michigan’s investor owned electric utilities, including DTE (formerly called Detroit Edison) and Consumers Energy. DTE plans to retire two plants in 2016. Consumers Energy plans to retire seven plants, constituting 30% of its generating capacity.

Michigan’s electric choice law, as amended in 2008, allows customer choice (i.e., competition) for up to 10% of the total electric generating business in the state. The 10% is completely filled, and there is a long waiting list of customers, mostly industrial and commercial companies, who want to take advantage of it. Those customers who have taken advantage can move back to the regulated utilities essentially whenever it suits them.

Does de-regulation result in lower rates? The answer depends upon whom you ask. The pro-choice advocates present data which seems to show that the electric choice states have lower rates. The pro-regulation advocates present data supporting their argument that any lowering of rates in deregulated states was the result of other factors, such as lower fuel costs, state-imposed rate caps and national economic trends.

In 2013 the Michigan Public service commission and Michigan Energy Office invited all interested parties to debate this and other issues relating to de-regulation. After hearing from all sides, they concluded:

“Many broader market factors make it very difficult to separate the signal from the noise when it comes to measuring the impact of deregulation. Such factors include national events (such as terrorist attacks or hurricanes), policy changes in other state jurisdictions … and regional similarities or differences (climate, culture). Numerous studies and articles have attempted to discern what effect deregulation has on rates, and come to very different conclusions.” [“Readying Michigan to Make Good Energy Decisions: Electric Choice”, November 20, 2013, page 41]

The utilities would be happy to wave goodbye to customer choice entirely. Standing in the way are a lot of powerful industrial and commercial customers who would like to expand it.

The result easily could have been a legislative stalemate. But policy makers and stakeholders saw this problem coming early and have been working to put together proposals that would earn enough support to achieve enactment.

State Senator Mike Nofs, chair of the Senate Energy and Technology Committee, put together an energy working group in the summer of 2014. The group included representatives of various stakeholders. Including the utilities, environmental groups, large industrial and commercial users and legislators.

Last March, Governor Snyder delivered a special message on energy policy. In it he endorsed continuation of electric choice and retention of the 10% cap, but with added protection for the utilities. He also pushed for a goal of at least 30% of Michigan electric energy needs to be achieved by renewables and energy waste reduction by the year 2025.

The clear and immediate need for building new generating capacity and the concomitant need to attract enough investment to build it was convincing, and we are likely heading for compromise legislation. A number of proposals have been floated in the Legislature, but the one that seems (at least to me) to have the best chance is House Bill 4298, which was reported out of committee in December and is mostly in accord with the Governor’s announced policy. It retains the 10% cap on customer choice, but requires any customer who returns to the regulated utilities to pay the utility’s costs for the additional generating capacity necessitated by that customer’s return. It also mandates that the customer remain with the utility for at least 15 years after returning.

It also deals with a number of other energy policy issues, such as setting a goal (but not a mandate) of 30 percent of Michigan’s power needs to be met by waste reduction and renewables by the year 2025.

Our Michigan political structure can be maddeningly slow, even obtuse at times, and sometimes the opposite, blasting new laws through without any real debate or refinement. But in the case of energy policy our governor and legislators seem to have at least made a thoughtful study and are headed for hopefully timely action.

Lawrence M. Glazer is the author of Wounded Warrior, a recently published biography of former governor and Supreme Court justice John Swainson. He is also a retired Ingham County Circuit Court Judge and former legal advisor to Gov. James J. Blanchard.

January 21, 2016 · Filed under Glazer


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