Alternative Models ofElectric Industry Restructuring

Bruce EdelstonDirector, Southern CompanyPresentation to Carnegie Mellon Electric Industry CenterSeptember 23, 2004

Who We Are Southern Company is an investor owned energy company in the Southeastern

U.S. and a holding company for:Alabama Power CompanyGeorgia Power CompanyGulf Power CompanyMississippi Power CompanySavannah Electric & Power CompanySouthern Power Company

supplying electric service in the states of Alabama, Florida, Georgia, Mississippi. Other Businesses

Southern Company GasSouthern NuclearSouthern LINCSouthern Telecom

Southern Company Profile

Generated 183 billion KWh of electricity in 2002 with 39,000 MW

Earnings for 2002 of $1.3 billion on total revenues of $10.5 billion

More than 26,000 employees Fortune magazine’s most admired electric

and gas utility in America for the past two years

Rates 20% below national average

Generating Mix

281 generating units at 69 plants in the Southeast 2004 Generation Fuel Mix:

Nuclear15.1% Hydro

3.7%

Coal71.5%

Gas9.6%

Oil0.1%

ALTERNATIVE MODELS OFELECTRIC INDUSTRYCOMPETITION ANDRESTRUCTURING

The Original California ModelGeneration --

Utility, IPPs, Marketers

Network Operator (ISO)

Customers

Distribution Utilities

Contracts

Competitive Suppliers

Contracts

Power Exchange/Pool

ContractsContracts

The Original California Model (cont.)

All utility generation had to be sold into Power Exchange

Customers could buy from the distribution utility, directly from a generator, or from a competitive supplier

Distribution utility had to buy all its needs from the Power Exchange

Retail rates of distribution utilities remained regulated

Competitive suppliers could buy their needs from generators or from the Exchange, or some combination

Customer Choice Model (TX)Generation --

Utility, IPPs, Marketers

Network Operator (RTO/ISO)

Customers

T & D Utilities

Contracts

Competitive Suppliers

Contracts

Customer Choice Model (cont.)

Customers may contract directly with generators or competitive suppliers (power marketers) for their own needs

Network operator runs transmission system, does planning and scheduling, balances supply and demand through bid-in balancing market, and is responsible for reliability

Distribution company simply operates distribution system - it may put out bids for “standard offer service”

Centralized Dispatch Model (PJM)

Distribution- “POLR” Service

Generation --Utility, IPPs, Marketers

Centralized Pool (e.g., PJM)Network Operator

Competitive Suppliers- Billing

- Value Added Services

Centralized Dispatch Model (cont.) Retailers (either utilities or competitive

suppliers) buy all of their needs from pool, resell to end users

All generators bid into pool on an hourly basis

Pool dispatches generation from lowest cost bid to highest cost bid

Highest cost bid that gets dispatched becomes market clearing or “spot” price

All generators that are dispatched are paid the spot price

Centralized Dispatch Model (cont.)

Pool is either “energy only” or energy and capacity are separate products (and markets)

May be a minimum capacity requirement for suppliers

Customer choice is really a matter of risk management for suppliers

Vertically-Integrated, Incremental Wholesale Competition Model

DistributionExisting Needs - Use Own Units

Incremental Needs -- Buy from Market

Network Operator (RTO/ISO)(Plans and Operates)

Existing Generation --Regulated

Integrated Utility

New Generation – Competitive

Vertically-Integrated, Incremental Wholesale Competition Model (cont.)

No customer choice (limited exceptions) Existing generation used for retail sales remains

regulated New generation and existing (excess) generation

available for wholesale sales are market-based (assuming regulatory approval)

Integrated utilities with service obligations buy incremental needs via requests for proposals

Utilities may or may not bid a “self-build” (rate base) option

Utilities choose incremental option based on price and non-price factors and signs purchase power agreement (typically 5-7 years)

Vertically-Integrated, Incremental Wholesale Competition Model (cont.)

Utility affiliates may also bid if permitted by state regulators

Over time, more and more generation is acquired through purchase power agreements, rate base diminishes

Transmission and distribution planning and operations continue to be performed by integrated utility

Integrated utility also distributes power and makes retail sales at rates set by state regulators

CURRENTMODELS

Customer Choice States

Source: EIA

Retail Choice State

Non-Retail Choice State

Centralized Dispatch Areas

New England New York PJM ERCOT California Planned: Midwest ISO

Vertically-Integrated States

Source: EIA

Unbundled

Vertically-Integrated

Comparison of Models

Customer Choice - Pros

Lets customers decide Risks shifted from customers to

suppliers Spurs product innovation Spurs technical innovation Maintains competitiveness of

economy

Customer Choice: Issues

Competitive Markets: Electric Markets:Consumers should face true costs of supply

Consumers have regulated option available, regulators likely to cap very high prices

Customers should be responsive to prices

Demand is very inelastic

Large number of sellers and buyers

Few sellers, few buyers

Customers can choose level of reliability

Reliability is a public good

No inter- and intra-class subsidies

Subsidies abound

Are Prerequisites for Competition Satisfied?

Customer Choice – Issues (cont.) Do small customers want choice? Can regulators/politicians let competition

work? Who will pay for reserves needed for

reliability but not revenue producing? Are there significant economies of scope

that are lost by unbundling? Should any one care about fuel diversity? What about externalities? Transaction costs vs. savings? How is success measured?

Centralized Economic Dispatch:Pros

Production efficiency clearly the greatest potential benefit

Locational price signals tell where generation and transmission should be built

Physical system is separated from financial system

Relatively easy for areas with existing traditional power pools

Provides hourly price signals to customers Lessens market power concerns PJM has made it work (some experience)

Centralized Economic Dispatch:Issues

Costs of RTOs (vs. benefits)

RTO Costs (2003)

Revenue Requirement

Cost per Unit

($/MWh)PJM $252,164,806 0.723

NYISO 117,578,796 0.718

ISO–NE 102,924,000 0.787

CA ISO 235,240,000 1.020

ERCOT 184,159,748 0.545

Ontario 107,204,400 0.705

Source: Public Power Council

RTO Cost Trends (2000-2004)

0

0.2

0.4

0.6

0.8

1

1.2

2000 2001 2002 2003 2004

All

-In

Co

st (

$/M

Wh

)

PJM NYISO NE-ISO CA ISO ERCOT Ontario

Source: Public Power Council

Centralized Economic Dispatch:Issues (cont.)

Will regulators (politicians) accept price volatility and high prices necessary to pay for peakers (that must recover fixed costs in only a few hours per year)?

If not, how will sufficient generating capacity be ensured?

Centralized Economic Dispatch:Issues (cont.)

How will demand side interact with pool?

Who will build transmission? What incentives will they have?

Fuel diversity Externalities/public benefits

Centralized Economic Dispatch: Issues (cont.)

What is appropriate size? Seams issues Requires transfer of jurisdiction from

states to FERC Reliability responsibilities dispersed

(more complicated) Unregulated utilities (coops and

government-owned) must participate, especially where they are a major presence (NW, SE)

Vertically-Integrated, Incremental Wholesale Competition: Pros

Clear accountability for reliability and service obligations

Fuel choice and externalities can remain part of resource planning

Generation, transmission and distribution can be planned jointly, lowering total costs (economies of scope)

Vertically-Integrated, Incremental Wholesale Competition: Pros (cont.)

Because of stranded cost recovery, most of the benefits of competition come from incremental generation, not existing

Customers get benefits of wholesale competition without transaction costs (and hassle) of choosing supplier

Integrated utility manages risks on behalf of customers

States retain jurisdiction

Vertically-Integrated, Incremental Wholesale Competition: Issues

Perception of market power– Generation dominance– Transmission access– Other barriers to entry

No transparency of dispatch Few buyers Lack of regional planning Retail customers retain risks of bad

utility decisions

Possible Additions to Vertically-Integrated Model

Independent operation of OASIS and granting of interconnections and transmission access

Regional planning and security coordination by independent entity

Short-term formal competitive procurement process

More formalized long-term RFP process with greater transparency and independent oversight

Other Critical Issues Lack of investment in both generation and

transmission Credit ratings of IPPs/marketers Relationship between federal and state

regulators August 14 blackout and its ramifications Lack of mandatory reliability rules Tug of war between environmental

objectives and competitive objectives Elected vs. appointed Commissions

Conclusions

All of these models (except California) can work if issues are properly addressed

Regional characteristics and concerns drive choices

Competition should be a means to an end (reliability at lowest possible cost) rather than the end itself