• Criterion #1: Overall rate reduction. How significant is the level of rate reduction in percentage terms compared to existing rates? How much progress does the rate reduction represent in moving the utility’s overall rate level toward the national average price for electricity?

• Criterion #2: Rate equity. Are rate reductions distributed fairly among residential, commercial, and industrial customers? Will price structure changes, such as adjustments in minimum monthly service charges and energy prices, be implemented in a way that minimizes the potential for customer bill increases?

• Criterion #3: Rate certainty. How secure can consumers be that promised rate reductions will actually occur over the next several years? Have automatic increases for less predictable costs, such as fuel, been eliminated? Have procedures permitting the utility to obtain rate increases been kept to a minimum?

• Criterion #4: Stranded cost treatment. Are the interests of customers and utility stockholders balanced in the treatment of stranded costs?

• Criterion #5: Access to competitive suppliers. Have obstacles to participation by potential competitive electric suppliers been minimized? Will customers gain access to competitive sources on a reasonable schedule? Have the rules for retail access ensured that impediments to customer choice cannot be erected by the monopoly utility?

Measuring Rate Reductions

Because each of the NYPSC’s decisions sets rates for a number of years, and because each utility begins with rates that exceed national average electric prices by varying degrees, at least two different measures of overall rate changes are meaningful.

• The total customer bill savings measures the difference between the utility’s total revenue at current rates and at reduced rates, over the term of the settlement. The total customer bill savings, expressed as a percent, provides an indication of the total dollar savings to be provided to consumers.

• The maximum overall rate cut measures the percentage change in rates achieved by the end of the settlement term. The maximum overall rate cut indicates the final rate reduction provided to consumers, whether it is provided immediately or phased in over time.

A significant disparity between the total customer bill savings and the maximum overall rate cut indicates that only a small portion of the rate reductions are provided in the early stages of the settlement term. If, on the other hand, the entire rate reduction is provided at the beginning of the settlement term, then the total customer bill savings and the maximum overall rate cut would be equal. Neither of these measures accounts for potential rate adjustments that may be allowed to cover unanticipated cost changes, an issue that is addressed in the context of the rate certainty criterion. Except in those cases where adequate data did not exist, all rate changes were calculated here to exclude the effect of the recently enacted reduction in the Gross Receipts Tax (GRT), since it would occur in any event.

Table 1

Rate Cuts Fail to Close Price Gap

Table 1 presents the total customer bill savings and maximum overall rate cut provided in each of the recently approved rate settlements. Table 2 presents more detail on the rates produced by the settlements and compares them to the 1996 national average price for electricity of 6.86 cents per kilowatt-hour (kwh). All percentage rate changes are in the single-digits. Customers of Central Hudson, Orange & Rockland, and Niagara Mohawk may not even notice the small rate reductions they receive. As for the extent to which the rate settlements help move New York’s electric prices closer to the national average, Table 2 shows very little progress. When the likelihood of rate reductions in other states is considered, New York electric customers may actually lose ground and find the price gap between New York and the rest of the nation growing.

Table 2

Most Customers Get Poor Deal

Table 3 presents a summary of the distribution of rate reductions between those customers receiving the largest benefits ("Best Deal") and those receiving the smallest benefits ("Worst Deal"). The rate reductions shown are the maximum reductions offered, which are often provided only in the final year of the four- to five-year settlement period. In every case, the greatest rate reductions are offered only to industrial customers or to the largest commercial and industrial (C&I) customers.

Some Customers Face Bill Increases

The inequitable distribution of rate reductions among different categories of customers is made worse by rate structure changes incorporated in several of the settlements approved by the NYPSC. Rate structure changes included in the Niagara Mohawk settlement would have increased bills for 44 percent of residential customers and 55 percent of small commercial customers. Although the NYPSC did not approve the immediate implementation of these changes, it will consider them again in 1999, when Niagara Mohawk submits its detailed proposal for the rates that will apply when retail access is implemented for residential and commercial customers. In the case of Rochester Gas & Electric, the NYPSC approved an increase in the fixed monthly customer charge for residential and small business customers. As a result, 27 percent of residential customers and an unspecified percentage of small business customers will experience bill increases even after the overall reduction in rates is implemented.

Table 3

Each utility is provided some means to recover costs that are imposed in the future by changes in laws or regulations. Table 4 presents examples of other costs that can be recovered and the manner by which the utility will be permitted to recoup its higher-than-anticipated costs. The customers of NYSEG are unlikely to face significantly different prices than provided for in the settlement, because of the very limited settlement provisions for passing through cost increases to customers. However, all other electric customers in New York will have no assurance that the prices provided for in the settlements approved by the NYPSC will be the prices that they will pay. All or a portion of the rate reductions scheduled to be implemented under the terms of the settlements could be offset by surcharges and rate adjustments designed to cover cost increases. Niagara Mohawk has openly stated its expectation that the small rate reductions provided to the company’s residential and commercial customers in the first three years of the settlement could be wiped out by rate increases allowed in years four and five.

Stranded Cost Rate Adjustments

One key factor that could have a sizable impact on customers’ bills in the future is the rate mechanism designed to recover stranded costs. A stranded cost recovery mechanism, generally referred to as a competitive transition charge (CTC), has been approved by the NYPSC in each of the six electric rate settlements. In most cases, the CTC will be imposed as a charge on customers’ bills for an indefinite period of time. More importantly, the amount of the CTC is not known; although there are provisions in the settlements that address how the CTC will be calculated, the amount of the charge will depend on developments in the electric market that cannot be predicted.

Table 4

In nearly every case, the NYPSC has assigned most of the responsibility for stranded costs to electric ratepayers (see page 11 for description of stranded costs). This result runs contrary to one of the guiding principles the NYPSC itself established for the transition to competition. In its 1996 decision adopting principles for competition, the NYPSC explicitly rejected the notion that utility shareholders should recover all stranded costs from ratepayers, and instead decided that the assignment of responsibility for stranded costs would require a balancing of ratepayers’ and shareholders’ interests.

While "just and reasonable" rates must reflect a reasonable balancing of ratepayer and shareholder interests, they may or may not include stranded investment.
. . . New York State law does not require the public to pay excessive rates in order to provide a company a return on stranded investment.
. . . We have considerable leeway to set rates that balance ratepayer and shareholder interests. While we do not accept [the utilities’] legal arguments, we are not rejecting appropriate rate recovery. Cost recovery will ultimately depend upon the particular circumstances of each utility.

Case Nos. 94-E-0952 et. al., Opinion and Order Regarding Competitive Opportunities for Electric Service, issued and effective May 20, 1996, pp. 49-51, footnotes omitted.

Most Stranded Costs Charged to Customers

The settlements approved by the NYPSC dealing with Central Hudson and NYSEG explicitly provide for full recovery of stranded costs from ratepayers. A requirement that Con Edison stockholders absorb $300 million in stranded costs can be avoided if Con Edison can show that it has taken steps to develop a competitive market. In the RG&E case, the stranded cost issue was deferred until the end of the settlement period. O & R’s shareholders were held responsible for a share of stranded costs, but the sale of O & R’s generating plants resulted in a net gain, leaving no stranded costs. Only NiMo’s share- holders are expected to accept a significant share of stranded costs, by forgoing between $1.4 billion and $2 billion in earnings over the term of the settlement approved by the NYPSC. Even then, NiMo will be allowed to recover its original investment costs from customers.

The Effect of Stranded Costs on Rates

It is not possible to calculate the effect on rates of the NYPSC’s decisions to impose most stranded cost responsibility on customers. Although estimates of the magnitude of stranded costs for individual utility companies were offered by a number of parties involved in the cases, the estimates frequently varied widely, and no consensus estimates are available. However, there is sufficient information available to offer a few examples of the effect of stranded costs on rates. In the RG&E case, the NYS Consumer Protection Board (CPB) proposed that one-eighth of the utility’s stranded costs be charged to stockholders, in order to reduce rates by an additional 3.4 percent. In the CenHud case, the CPB recommended that shareholders absorb just over five percent of total stranded costs to provide an additional rate cut of five percent. Neither of these proposals was adopted by the NYPSC. However, these examples show that the effect of stranded costs on rates varies from one utility to another, and that the NYPSC’s failure to require stockholders to share in the burden of stranded costs translates to a significant rate-cutting opportunity lost.

Inadequate Back-out Rates Will Stifle Competition

The NYPSC has approved different methods for calculating the back-out rates, or shopping credits, that will determine how much customers will pay for delivery of electricity from competitive electric suppliers (see page 11 for a description of back-out rates). Back-out rates represent the benchmark against which competitors must price their product in order to offer customers savings compared to the regulated utility’s supply. Although different back-out rates have been approved for each of the six utilities covered by the recent NYPSC decisions, some preliminary conclusions can be drawn from the back-out rates approved for the two largest utilities, Con Edison and NiMo. The outlook for competition in New York State is not bright in large part because of the back-out rates approved for these two companies.

Con Edison and NiMo will have back-out rates, or shopping credits, based on the wholesale market price for electricity. Both utilities will provide incentives to encourage customers to switch electric suppliers, but the funding for those incentives is limited both in amount and duration. Back-out rates that are set, like Con Edison’s and NiMo’s, no higher than wholesale prices are unlikely to be high enough to allow truly competitive markets to form. Since most competitors will be buying power at wholesale prices, they must charge something higher than wholesale prices to cover such costs as marketing, account management, and administrative overhead. Yet, if competitors charge a price higher than the wholesale price, and the back-out rate or shopping credit is equal to the wholesale price, customers will rightly choose to stay with the regulated utility company, since that will be the cheapest option available.

The back-out rates for some of the other utilities do not suffer the same infirmities as Con Edison’s and NiMo’s, since they include an additional credit amount, above the wholesale price for power, to account, for example, for the cost of retailing. However, Con Edison and NiMo, taken together, serve the vast majority of electric customers in the service territories of the six utilities covered by the NYPSC’s recent decisions. Inadequate back-out rates for those two companies are likely to put a substantial damper on the extent to which electric competitors become active in New York State and are certain to reduce the cost saving potential of electric competition for consumers.

Tax Advantages For Competitors Will Disappear

While back-out rates are set too low to allow for effective competition, some retail competition has been spurred by the different tax treatment applied to sales by non-regulated electric suppliers. Electric competitors have been exempt from certain sales-based taxes, and customers choosing alternative suppliers have been able to realize up to five percent savings as a result. These savings have been enough to foster competition for those customers singled out for early retail access.
However, a change in the interpretation of state tax laws will result in the elimination of this tax advantage for electric competitors. A January 1, 1999 ruling by the State Department of Taxation and Finance reverses an earlier decision and eliminates the exemption of the delivery of non-regulated electric sales from state and local sales taxes. Proposals have been made to delay the effectiveness of the new tax law interpretation. Nevertheless, the elimination of the tax advantage for competitive electric suppliers, when implemented, will foreclose the only real opportunity for customers to obtain savings from electric competition under the NYPSC’s approach.

Retail Access Rules Create Obstacles to Competition

A number of barriers to effective competition have been created by the retail access schedules adopted by the NYPSC, not the least of which is the lack of uniformity among utilities. Table 5 indicates the final deadline for all customers to be offered retail access as well as the scheduled elapsed time between the initial offering of retail access to some customers and the date by which all customers are offered access to competitive suppliers. Potential competitors will be unable to conduct state-wide marketing campaigns because of the different schedules. The drawn out phase-in periods for introducing retail access within each service territory will complicate customer recruitment and limit competitors’ advertising and marketing options. In addition, the NYPSC has not precluded the use by unregulated utility affiliates of the utility name or trademarks, so competing energy suppliers will typically be at a competitive disadvantage in marketing against utility-affiliated energy suppliers. These obstacles to competition can be expected to translate into fewer active competitors, less aggressive competition, and smaller cost-saving opportunities for customers.

Table 5

Each of the six NYPSC decisions came as a result of settlements among some of the parties, the NYPSC staff, and the relevant utility. However, most of the cases were settled on terms that were unacceptable to nearly every party representing residential and small business customers, and only one settlement was endorsed by a majority of the parties involved. The NYPSC process that produced the rate settlements was open to public participation in a technical sense, but not a practical one. The process by which each of the settlements was negotiated and reviewed was complex, costly, and extraordinarily time-consuming. The six different cases ran generally in parallel, and, on several occasions, negotiations or hearings were held in different cases during the same week. The ability of consumers and consumer groups to participate in the process was put to the extreme test by the burden imposed by the process itself. In addition, the NYPSC settlement guidelines, requiring that all parties be notified of and allowed to participate in negotiations, were waived in the Con Edison, O & R, RG&E, and NYSEG cases. Although this was done to allow the parties more flexibility, the effect was to limit the serious negotiations to representatives of the utilities, the NYPSC staff, and one or two prominent parties, generally representing large industrial customer interests. The result of this process was a series of settlements that were subject to wide opposition among participating parties.

In the negotiations that led to the settlements approved by the NYPSC, the NYPSC staff was working from a weak bargaining position against the utilities. The fact that all affected electric utilities had sued the NYPSC, challenging its legal authority to order the introduction of retail competition, clearly weakened the bargaining position of the NYPSC’s staff in negotiations with the utilities. Since dropping their lawsuit against the NYPSC was a strong bargaining chip on the side of the utilities, the utilities were able to make more favorable deals for themselves. In addition, the NYPSC had indicated a strong preference for negotiated settlements rather than the more usual process by which the NYPSC issues a decision after hearings. As a result, the NYPSC staff could not credibly threaten to walk away from the bargaining table and pursue the normal hearing process. A key negotiating tactic was effectively unavailable to the NYPSC staff, further weakening their position and strengthening the position of the utilities. Further, the NYPSC turned a blind eye to the opportunity to require better deals for customers that a clear statutory requirement for retail competition could have afforded. Such a mandate would have neutralized the utility lawsuits and provided the NYPSC with a firm foundation from which to require better deals for consumers.

The implementation of competition in New York, as designed by the NYPSC, has thus far revealed a series of missteps by the Administration and unexpected consequences for customers. In implementing competition for natural gas customers, the NYPSC first ruled that regulated gas distribution companies would not be allowed to perform simple maintenance for customers, including re-lighting pilot lights. Only after an outcry from the public did the NYPSC reverse course and permit gas utilities to perform these important services for customers. Another mid-course correction involves the changing interpretation of tax laws, discussed earlier, which has introduced an element of uncertainty in an important aspect of the business environment for customers and electric suppliers.

Although retail access is not yet available to most electric customers, a number of unforeseen problems have already arisen from the NYPSC’s actions to introduce competition. NiMo customers have discovered that they now must pay a fee for the privilege of paying their electric bills to banks and pharmacies that have traditionally accepted utility bill payments from customers. Con Edison customers who choose alternative electric suppliers and opt to make a single payment to their new supplier, including charges for Con Edison’s delivery services, have discovered that they may have to pay twice for Con Edison’s service, if the new supplier fails to pass along the customer’s payment to Con Edison. Thus far, as these problems have arisen, it has been the consumer who has suffered. As retail access continues to be implemented, further problems such as these can be expected to arise.

Legislative authority for securitization that does not clearly set out the criteria by which utilities will be allowed to issue securitized bonds runs the obvious risk of forcing utility customers to pay for costs that should not be their responsibility. Securitization legislation, as proposed by the Administration, does not include clear guidelines and criteria, but instead designates the NYPSC as the body responsible for deciding which costs may be securitized and subject to irrevocable rate orders. In considering whether a broad mandate to issue irrevocable rate orders should be given to the NYPSC, it is important to examine that body’s track record in the six electric restructuring cases recently concluded. The NYPSC’s recent decisions, described in this briefing paper, should give pause to those who would give that agency unbridled authority to approve utility requests for securitization, and instead support the notion that specific, unambiguous standards are an essential component of any comprehensive electric restructuring legislation which could include authority for securitization.

A Back-out Rate, sometimes called a "shopping credit," is subtracted from the utility’s full-service rate for customers buying electricity from alternative suppliers. Theoretically, the back-out rate should be calculated to equal the costs that are saved by the regulated T&D utility when it avoids the need to generate electricity and maintain enough generating capacity to meet expected demand for customers that buy their electricity elsewhere. What is left after these avoided costs are subtracted from the full-service rate should equal what it costs to deliver electric supplies to customers. The higher the back-out rate, or shopping credit, the more inducement there is for customers to shop for power and the greater the opportunity for competitive electric suppliers. If a competitor charges more than the back-out rate for the electricity it sells, the customer would be better off purchasing electricity directly from the T&D utility, which will remain a "provider of last resort" for customers that do not buy electricity from a competitive electric supplier. Therefore, competitors either must sell electricity at a price below the back-out rate, or must provide a higher quality or more valuable service, in order to attract customers.

How Retail Electric Competition Would Work: Competition in the electric industry need not fit a specific mold, as there are numerous choices, for policy-makers and electric suppliers alike, in establishing the framework and structure for competition. Nevertheless, certain general observations can be made about the likely form that electric competition would take if policy-makers choose to open the industry to retail competition.

The transmission and distribution of electricity would remain regulated, with prices for these services set by regulators based on traditional ratemaking methods. The supply of electricity by generating companies, or unregulated generation affiliates of regulated utilities, would be subject to competition. Purchasers would buy electricity from competing electric generators, with transmission and delivery provided by regulated T&D utilities. Very large businesses might buy directly from electric generators, but most smaller customers are likely to buy electricity through energy marketers or energy service companies (ESCOs). ESCOs would recruit customers to sign up for their "brand" of electricity, much like long-distance telephone companies do now. ESCOs could differentiate themselves from each other through prices, customer service, "green" power sources, or by offering additional services, such as energy efficiency services, natural gas supplies, or even cable television. ESCO customers would pay for the electricity supply and the transmission and distribution service, as well as any additional services, either through two bills — one to the regulated T&D company and one to the ESCO — or through a single bill issued by either the T&D company or the ESCO.