PART ONE

Executive Summary

The five state programs examined in Part One include: Georgia's natural gas competition program at Atlanta Gas Light Co., New York's Consolidated Edison’s electric restructuring program, Massachusetts' electric competition program (statewide), Ohio's electric competition program (statewide), and Texas' electric competition program (statewide). Part One analyzes the terms of service provided to residential customers through both Default Service and the offers made by competitive suppliers; the consumer protection programs and policies adopted by each states; the extent of the development of the retail market; and the scope and type of competitive suppliers who have sought to obtain residential customers. The status to date of these five state energy competition programs suggests the following important conclusions and recommendations:

1. In those states that have relied on market-based prices for Default Service, residential customers appear to be worse off, compared pre-restructuring rate policies, and are certainly worse off compared to customers in states that have adopted rate caps and rate freezes that insulated customers from price volatility, rate shocks and market uncertainty during the transition period.

Four of the states in this study adopted a transition plan that exposed some residential customers to market-based prices without any regulated option in the form of a price cap or rate freeze during the transition period: Massachusetts, New York (Consolidated Edison territory), Georgia (Atlanta Gas Light territory), and the Texas Provider of Last Resort (POLR) program for customers who are dropped by their incumbent provider. In each of these states, the experience with market-based rates has persuaded legislators and regulators to consider significant changes in restructuring policies to stabilize residential rates and shift from short-term to longer term pricing policies. For example, the Texas PUC just adopted a change in its POLR rule that will shift defaulting residential customers to the incumbent’s regulated rates instead of the higher priced POLR.

Ohio was the only state of those studied that adopted a transition period with capped rates or rate reductions for Default Service, which shielded residential customers in general, and low-income customers in particular, from price volatility and the effects of an immature wholesale market. While the Ohio model exists in most other restructured states, including Pennsylvania, New Jersey, Illinois, Connecticut, Michigan, Maryland, and the District of Columbia, the end of the transition period will require new decisions from all of these states about the structure and pricing of Default Service, and many observers have proposed reliance on short-term market based prices in those states. The analysis of the five states clearly demonstrates that residential customers are likely to be worse off with any price plan that exposes them to short-term volatile rates in an immature wholesale market.

2. As states move to the end of the transition period, it is clear that the method of pricing and delivery of Default Service will be crucial to residential customers.

When a competitive market has not yet developed at either the retail or wholesale market level, residential customers are likely to be exposed to short-term price volatility and unreasonable prices unless regulators focus on how to provide stable prices to residential customers. Default Service should be designed to assure stable, predictable, and affordable prices for customers who do not shop, who are unable to obtain reasonably priced service from alternative providers, or who are not the subject of offers by mass market retail providers. No state has yet confronted the long-term policy implications of the failure of a competitive market to develop for residential customers or adopted policies and programs that will govern the provision of Default Service after the end of the transition period.

Default Service has been required in most restructured states (the only exception was Georgia, which did not adopt a Default Service provider until recent legislative reform adopted in 2002) in order to provide continued service for consumers who "choose not to choose" a new provider, customers whose alternative provider terminates service or who goes out of business. Typically, the Default Service provider is the regulated distribution utility company. Even in situations where elements of Default Service may be bid out to other providers, the distribution company generally retains metering, billing, and customer service functions for Default Service customers. If default service is properly designed, the competitive market will win customers by offering either a service or product not otherwise available ("green" energy; time-of-use meters; bundled products) or a more efficiently provided basic service that is priced lower than the more traditionally priced default electric service.

3. With the exception of Georgia at the onset of its market opening, the five states studied have adopted consumer education, licensing and consumer protection rules designed to foster price and fuel mix comparisons among competitive offers and have sought to prevent the most obvious abuses of a competitive market.

The other four states have adopted comprehensive consumer protection programs and policies: consumer education programs, supplier licensing, mandatory price and fuel mix disclosures, enrollment and switching protocols designed to prevent slamming, contract and bill disclosures, prohibitions on redlining and anti-discriminatory conduct, and beefed-up Commission enforcement tools, particularly the ability to assess civil fines and penalties for noncompliance. Texas and Ohio, in particular, are models for well-designed consumer education and protection programs.

Georgia's natural gas program is the model for what can go wrong when well-designed consumer protection measures are either not adopted or not enforced at the onset of the retail competition program. As detailed in the paper, Georgia's Governor and legislature took corrective actions during 2002.

4. Competitive market abuses, particularly door-to-door marketing, point to the need for additional regulatory oversight.

The number of customer complaints about marketer activity in the other states studied has been relatively low due to the lack of marketing to residential customers. Door-to-door marketing by some energy providers in Georgia, Texas, New York and elsewhere has resulted in the highest number of customer complaints. According to reports, these door-to-door marketing representatives have sought to appear as representatives of the customers' former utility or have implied that electric service would be terminated if a customer did not choose an alternative supplier. These practices suggest that door-to-door marketing may require closer regulatory supervision and the adoption of additional disclosures and educational materials.

Furthermore, the abrupt failure or departure of some natural gas marketers in Georgia and New York, as well as electricity marketers in Pennsylvania and elsewhere, suggests that consumers will bear the risk of losing any prepayments or security deposits paid to marketers. This is a significant deterioration in consumer protection compared to regulated electric or natural gas service. In order to allow consumers to leave their incumbent providers without fear of such losses, states should require marketers to post a security bond to provide a source of funds for consumer payments in the event of supplier failure. This would be similar to the deposit that many marketers require customers to pay in the event of customer default.

5. None of these states has yet been able to create and sustain a vibrant and robust market for electricity or natural gas services aimed at residential customers.

The lack of development of a competitive electricity market for residential customers is true not only in those states that have adopted price caps or rate freezes for Default Service customers, but it is true even in states that have passed through wholesale market prices changes to residential customers (Consolidated Edison in New York and Massachusetts).

In Ohio, Massachusetts, and New York, there are either no marketers or only one or two marketers offering competitive electric service to residential customers in most utility service territories. Texas has a larger number of marketers and has reported over 300,000 customer enrollments, but the data have been clouded by delays in switching and billing as a result of its statewide switching system problems. Furthermore, several marketers (e.g., Shell Energy and New Power) have either folded or abandoned the residential market. Nonetheless, the rate of Texas switching to date suggests the highest level of marketing to residential customers of any state.

The Georgia natural gas market is unique due to its requirement that all customers switch natural gas providers or be assigned to a competitive provider. No other state has adopted such an approach to electric or natural gas competition. However, the Georgia model has suffered from lack of new entrants and a rash of supplier failures and bankruptcies, resulting in a high concentration of customers with only a few suppliers.

Even the Pennsylvania market, which initially appeared to stimulate a relatively large number of marketers aimed at residential customers and where choice participation levels exceeded 30 percent in some territories, has experienced a steady decline in marketer offers and customer participation in the competitive market.

6. It is clear that the transition period is going to last longer than initially contemplated in all of the states.

The lack of development of a competitive market for residential customers in most states, the turmoil that has accompanied the development of wholesale market prices, the delays in the development of a Standard Market Design by the Federal Energy Regulatory Commission (now scheduled for implementation of a multi-year period starting in 2003), and the failure of competitive suppliers to "beat" the Default Service price in each state have combined to create significant uncertainty and, at the least, a longer transition period. This uncertainty, combined with the large-scale failure or sharp reduction in activity by many energy trading firms and an uncertain economic situation, suggests that states must rethink the time scale and structure of energy markets for residential and small commercial customers for the post-transition period.

At a minimum, the experiences documented by this project suggest that legislators and regulators should develop policies that protect such customers from uncertainty and short-term price volatility. Any attempt to expose such customers to short-term "real time" prices, as proposed by some observers, is likely to harm the customers who are least able to take alternative actions or to afford costly mistakes in public policy.

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