2004 Annual Report

From the President - Robert W. Bryant

THERE OUGHTA BE A LAW!

Or at least the Texas Legislature should require the Public Utility Commission (Commission) to examine the behavior of generation suppliers in the regulated markets (those outside of ERCOT) to see if their actions have advanced – or perhaps hindered – opportunities for competition to develop. This review may find that the non-ERCOT areas should simply remain regulated for some period into the future. It may, however, find that some actions have actually thwarted the development of competitive markets.

In 2001 with the unanimous adoption of House Bill 1692, the Legislature exempted Southwestern Public Service Company (SPS) from the requirements of Senate Bill 7. SB 7, adopted in 1999, required investor-owned utilities to begin retail competition on January 1, 2002. HB 1692 created a five year moratorium for SPS, postponing competition until at least January 1, 2007. Interestingly, HB 1692 left in SPS’s hands the “keys to the henhouse.” Subsequently, through two mergers, SPS handed those keys to Minneapolis, Minnesota based Xcel Energy, Inc. (Xcel). Xcel’s executives now make the decisions that affect SPS and its customers.

Because Xcel holds the keys that could unlock competition in the SPS area, and holds those keys in Minneapolis, SPS can avoid the consequences of competition while undermining regulation by the Commission that is designed to protect Texas ratepayers. Xcel is in a position to keep competitors out of its service area while continuing to take advantage of its status in the region as the dominant owner and controller of generation and transmission. Such dominance, when tempered by effective regulation, is bearable. When regulation is rendered ineffective, however, customers of all classes and sizes are harmed.

HB 1692 set out a two step process by which SPS could, like its sister utilities in Texas, advance to retail competition. The first step required that SPS deliver to the Texas Legislature a market power analysis no later than May 1, 2002. SPS made its analysis and, though it was seriously flawed, submitted it as required by HB 1692. Step two provides for SPS to make and file a transmission interconnection study after September 1, 2003, if SPS chooses to move its service area to retail competition. Xcel chose to not make this second step filing. Apparently, there is no requirement that it ever be made. Thus, absent further action by the Legislature, Xcel seems to be in complete control of when, if ever, the SPS service area moves to retail competition.

Clearly, the SPS market area was not ready for competition in 1999, and HB 1692 recognized that fact. When HB 1692 was adopted, SPS controlled approximately 80% of the generation market share in its area. The Legislature found that electric rates

INTERESTINGLY, HB 1692 LEFT IN SPS’S HANDS THE “KEYS TO THE HENHOUSE.”
…ABSENT FURTHER ACTION BY THE LEGISLATURE, XCEL SEEMS TO BE IN COMPLETE CONTROL OF WHEN, IF EVER, THE SPS SERVICE AREA MOVES TO RETAIL COMPETITION.

would only increase if SPS were required to sell its generating plants down to the 20% market share limit imposed by SB 7. Further, transmission lines connecting the SPS area to other areas had (and still have) limited capacity to import competitive power supplies. Because SPS was a low cost supplier, even if new power suppliers could enter the SPS market area, electric rates were not likely to drop by requiring SPS to implement retail competition.

While HB 1692 was intended to preserve the benefits of a regulated regime until a competitive market could develop, it may be having the opposite affect. It appears that an unintended consequence of the legislation is that Xcel is concentrating the SPS market power at the same time it is finding ways to “game the system” to increase SPS’s wholesale and retail rates.

For example, traditionally, regulated utilities make short term “off-system” sales to optimize the use of their generation. The purpose of such sales is to lower the costs to their long term customers by making more efficient use of the generating plants. These sales are supposed to be priced on a basis that does not result in an increase in costs to the long term customers. The most significant concern is the effect of such sales on fuel costs, which are passed through to long term customers under a fuel clause.

On the SPS system, the average monthly fuel cost has been about three cents per kilowatt-hour. However, like most utilities, SPS has different types of generating plants which have different fuel costs. The lowest fuel cost generators are the coal plants. The fuel for one kilowatt-hour from a coal plant costs about one penny. The gas-fueled generators are much more expensive. With natural gas selling at $6.50 per 1,000 cubic feet, fuel for one kilowatt-hour from a typical SPS gas plant costs almost seven cents. For some of the highest cost generators, the cost could be 10 cents, or ten times the cost of the coal-fired energy.

WHO PAYS THE OTHER THREE CENTS? THE LONG TERM RETAIL AND WHOLESALE CUSTOMERS THROUGH THEIR FUEL ADJUSTMENT CLAUSES.

To serve its load obligations most economically, the lowest cost generators should be used first, with incremental loads served from the more expensive units. For this reason, off-system sales typically have been priced to recover the “incremental” fuel cost incurred to make the sale. In this way, the long term customers are not burdened with the higher fuel costs incurred to make the incremental sale.

Golden Spread has learned that SPS’s retail and wholesale customers are subsidizing SPS’s (Xcel’s) off-system sales to customers as far away as Colorado Springs, Colorado and Manitoba, Canada. SPS is treating sales to these “off-system” customers as “long term” sales and instead of charging incremental fuel cost, it is charging average fuel cost. In effect, SPS may undertake a sale where the kilowatt-hour fuel cost to generate the electricity may be six cents, but it will charge the new customer only three cents.

Who pays the other three cents? The long term retail and wholesale customers through their fuel adjustment clauses. Why does SPS make these sales? Because it also charges a demand charge, and those revenues are not shared with the long term customers unless there is a rate case.

…ACQUIRING CONTROL OF THE LP&L GENERATORS FURTHER CONSOLIDATED SPS’S MARKET SHARE TO 90% OF THE AREA’S GENERATION, SOMETHING THAT SHOULD CONCERN THE TEXAS LEGISLATURE.

Because this works so well, Xcel wants more capacity for SPS to sell to off-system customers. So, in 2004, SPS acquired the rights to dispatch all of the generating plants of Lubbock Power & Light. In exchange, SPS sells to LP&L all of its power needs at system average fuel cost. Like the sales to Colorado Springs and Manitoba, Canada, SPS’s long term customers now subsidize sales to customers of LP&L. And, acquiring control of the LP&L generators further consolidated SPS’s market share to 90% of the area’s generation, something that should concern the Texas Legislature.

In a move that will free-up approximately 140 megawatts of additional capacity for SPS to market to new, off-system customers, the Company will terminate wholesale, cost-based rate service to Lyntegar Electric Cooperative after more than 65 years of service – a move that is legal, even if unfair. Lyntegar along with other wholesale customers, helped pay for the generating plants that SPS now uses for marketbased rate sales to new customers. The wholesale customers shared in charges for construction work in progress, contributed to federal and state taxes payments, paid earnings for shareholders, and enabled a larger investment tax credit for shareholders than SPS could achieve through retail sales alone. Without the sales to Lyntegar and the other wholesale customers, SPS could not have constructed the larger, more efficient generating system that it operates today. Certainly, wholesale customers have learned that the rules are not always fair and that, as with renting apartments or land, there are risks inherent in “renting” versus owning generating resources.

Lyntegar is not alone. SPS had already served notice that it will terminate cost-based sales to Golden Spread in 2012, making more than 350 megawatts available from its generators for sale to new customers at market-based rates. While 2012 is a few years away, left unchecked, Xcel will have an even greater opportunity to dilute the SPS cost-based rate benefits that were intended for on-system customers.

Does all of this mean that customers would be better off if SPS were forced to retail competition? No. However, leaving Xcel free to extract both monopoly rents and fuel subsidies from the SPS onsystem customers for off-system sales is hardly fair.

In an attempt to bring some sanity to the wholesale portion of this situation, Golden Spread and Lyntegar filed an intervention and protest in Xcel Energy’s triennial market-based rate filing at the FERC. Interestingly, this case has drawn interventions and protests from Texas to Wisconsin. Golden Spread and Lyntegar have also filed a complaint at the FERC asking that SPS be stripped of its marketbased rate authority.

And because we believe that Xcel has been improperly applying SPS’s fuel charges to its wholesale sales and subsidizing its market based sales with revenues from its captive customers, Golden Spread and Lyntegar have also filed a complaint at the FERC asking that SPS be required to lower its base rate for service and to recalculate its fuel costs and refund overcharges.

The FERC has authority over rates and fuel charges for wholesale sales and will eventually adjudicate the issues raised by Golden Spread. However, real progress in bringing competition to the SPS area, if that in fact is a policy goal, will require state action. There clearly are risks of rate increases in the transition to competitive markets. But as Xcel and SPS have recently proven, there also are risks of rate

…LEFT UNCHECKED, XCEL WILL HAVE AN EVEN GREATER OPPORTUNITY TO DILUTE THE SPS COSTBASED RATE BENEFITS THAT WERE INTENDED FOR ON-SYSTEM CUSTOMERS.

increases when the effort to achieve competitive markets is abandoned and the so-called “regulated” utility gets to keep its roots in the regulated arena as it branches out to seize opportunity in the unregulated arena.

The importance of fostering competitive markets in the SPS area also is underscored by the significant role that the FERC plays in that market. At the federal level, the debate between the regulated model versus the competitive model is over. The FERC is inalterably committed to the competitive model. Consequently, neither the Texas Legislature nor the

…LEAVING XCEL FREE TO EXTRACT BOTH MONOPOLY RENTS AND FUEL SUBSIDIES FROM THE SPS ON-SYSTEM CUSTOMERS FOR OFF-SYSTEM SALES IS HARDLY FAIR.

Public Utility Commission has jurisdiction to control the wholesale market in the SPS area, and those markets are becoming increasingly deregulated. If competition does not exist, and if the FERC is not aggressive in monitoring the market to prevent abuses, it will be impossible for the Texas Legislature or the Public Utilities Commission to shield citizens and businesses in the SPS area from unjust and unreasonable rates.

It’s time to re-examine the operation of non- ERCOT generation markets and the behavior of non- ERCOT generators. Texans are entitled to just and reasonable rates, and that demands periodic review and oversight to assure that utility actions comport with established public policy and/or legislative intent. A review by the Public Utility Commission and a report to the Texas Legislature would be a valuable step in documenting the progress, if any, that has been made toward developing competitive markets in non-ERCOT areas. Such a review should reveal whether actions have advanced – or perhaps hindered – opportunities for competition to develop. Following a full and open hearing process, the Commission should report to the Legislature on the extent of progress and, what, if any, actions are needed to further foster competitive markets.

Such a review may find that progress is indeed being made, and that only additional time is needed before competitive markets can be opened. However, if the review shows that the development of competitive markets is not moving forward, then it might be that a new law is indeed needed.