Alternative suppliers can offer cheaper rates

Skeptics of electric utilities - you know who you are - regard deregulation as kind of a three-card monte hustle.

How can alternative electricity suppliers sell power below a utility's rate and still make a profit? The commodity they sell is identical - it's all the same electrons. What's the catch?

Peco Energy Co.'s 1.6 million customers can thank - or curse - the wonders of the electricity marketplace for inspiring an invasion of alternative suppliers bombarding the Philadelphia market with discount offers.

As Peco shifts into market-based rates at the end of the month, at least 17 suppliers are offering discounts of 10 percent and more to residential customers for electricity supply. Even more suppliers are targeting commercial and industrial customers.

They are able to undercut Peco's default price because they are unhindered by the one-size-fits-all pricing that Peco must offer and can more nimbly navigate electricity markets, where prices shift by the hour and the season.

"Alternative suppliers could be buying for a different profile, a smaller audience," said Cathy Engel, Peco's spokeswoman.

Under Pennsylvania's Electric Choice Act, which is being fully implemented Jan. 1 after a 14-year transition period, Peco and other traditional utility companies became solely distributors of power - "wire companies." New Jersey and Delaware have undergone similar transitions.

Though billing and customer service will still be handled by the wire companies, customers are free to choose a supplier that generates the power, which accounts for about two-thirds of a residential bill. The remainder of the bill is Peco's distribution charge.

For customers who do not want to shop, the Pennsylvania Public Utility Commission requires Peco to provide basic generation service. For residential customers, Peco's 2011 "price to compare" is 9.92 cents per kilowatt-hour. It's also called the "default rate" because that is the price customers will get if they do nothing.

Discounters are enticing residential customers with offers of about a penny less than Peco's rate, saving the typical homeowner about $90 a year.

Robert F. Powelson, a PUC commissioner from Chester County, said some customers are reluctant to switch because they are worried that utilities will lose money and punish customers who defect. But utilities such as Peco make their profits from the distribution charge, not from power generation, and Peco is telling customers it doesn't care who supplies the power.

"The wire company makes no money off default supply," Powelson said. "It's simply a safety net for those customers who are willing, in some cases, to pay a higher rate and they don't want to shop."

Peco's price-to-compare is based upon procurement contracts it obtained during four auctions conducted over the last two years. The PUC designed the auction system to avoid problems encountered during the early days of deregulation, such as in California, where energy markets were famously manipulated by traders for Enron Corp.

Peco's auction system is administered by a third party, NERA Economic Consulting GmbH. The identity of the bidders is hidden, and no single supplier is allowed to dominate the process, Engel said.

Because the default rate is based on contracts obtained in several auctions, the price is based on an average. That was a hard lesson regulators learned in Maryland, where utilities based their default rate on one post-Hurricane Katrina auction in 2005, when electricity prices spiked because of Gulf Coast natural gas shortages. Outraged utility customers nearly stormed Annapolis to demand relief.

But auctions for default supply do not necessarily generate the lowest price. Because power suppliers cannot be sure how many utility customers will want the default supply, their bids incorporate a "risk premium" to protect them against the uncertainty about how much electricity they will need to supply.

That is where alternative suppliers have an advantage. They can predict their customers' consumption based on historical patterns and can buy futures contracts at lower prices to match demand.

"Competitive suppliers don't have to 'time-average' their electricity purchases," said George C. Lewis, spokesman for PPL Electric Utilities Corp., the Allentown company where 35 percent of its customers have switched to alternative suppliers since market rates arrived Jan. 1.

Advocates of deregulation say Pennsylvania customers have already benefited from competition, regardless of whether they switch.

Under the state's old system, customers assumed the risk for the cost of building power plants, and the vertically integrated utilities were guaranteed to earn a profit, whether the plants were efficient or not.

Powelson, the PUC commissioner, said the high cost of building the Limerick nuclear reactors in Montgomery County - which drove up Peco's rates for a generation - was "really the poster child for why we did electric deregulation."

In a market-based system, investors assume the risk for power-plant construction. Plants run more efficiently or are retired, Powelson said.

The result in Pennsylvania is that statewide electrical rates, when adjusted for inflation, have fallen since the legislature enacted Electric Choice in 1996.

According to the PUC, a residential Peco customer using 500 kilowatt-hours paid $81.53 a month in 2010, 16 percent more than a comparable 1996 bill. But, adjusted for inflation, the monthly Peco bill is 17 percent less now than it was in 1996.

The effect of competition among the alternative energy suppliers is already taking place in the Peco market.

A month ago, Texas supplier Spark Energy L.P. came out with a fixed-price offer of 8.93 cents, 10 percent below Peco's 2011 price-to-compare. The offer included a requirement that customers pay a $100 penalty if they switched during the one-year contract, a fee designed to compensate Spark if it got stuck with power it was committed to buy on the customers' behalf.

Several other suppliers have since made fixed-rate offers that do not include a cancellation fee, and Spark last week said it was dropping the penalty because it was a barrier to sales - Pennsylvanians are not accustomed to cancellation fees from electric utilities.

"This whole competition process is very dynamic," said Hal Poel, Spark's marketing director. "Competitors react to each other. That's really to the benefit of customers over the long run."

Pennsylvania's Public Utility Commission explains electrical choice and lists alternative suppliers at http://www.papowerswitch.com

PUC offers a primer on understanding your Peco electric bill at http://go.philly.com/pecobill

Peco Energy Co. responds to customer questions at http://www.pecoanswers.com

Pennsylvania Office of Consumer Advocate will provide a list of suppliers to those without computer access: 1-717-783-5048.

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