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Deregulation Comes to Texas

On January 1, 2002, Texas became the most recent state to step into the contentious arena of electricity deregulation.

Once seen as inevitable, the nationwide movement toward deregulation has become mired in controversy due largely to the highly publicized collapse of California's flawed deregulation system.

Proponents of deregulation contend that it will bring consumers lower prices and reduce the costs of doing business. Consumer watchdog groups argue that "dereg" will have the opposite effect, portraying it as a potential disaster for families and small companies. Both camps agree on one thing, however: the results of Texas' experiment will be crucial in determining whether deregulation really is the wave of the future.

Utility basics
Until recently, electric utilities throughout the United States operated as regulated monopolies, with exclusive territories and guaranteed returns based on rates set by state regulators.

Typically, utilities controlled all three portions of the process needed to bring electricity to the home: generation, transmission and final distribution to end-users. Transmission and distribution are examples of what some call "natural" monopolies. Even if allowed to do so, no one could economically build competing, state-spanning networks of power lines, for instance.

Deregulation, then, aims to bring retail competition to power generation, allowing consumers to pick their electrical suppliers based on price and other concerns, such as the sources of power and the amount of pollution involved.

Dereg, Texas-style
Texas began moving toward deregulation in 1995, when the state opened its wholesale power market to competition. The Legislature expanded the deregulatory process further in 1999 with Senate Bill 7, legislation that deregulates retail electricity markets for customers served by private, investor-owned utilities. Texas' 77 electric cooperatives and 73 city-owned utilities will not be a part of the deregulated retail market unless they opt to join.

S.B. 7 calls for private utilities competing in Texas to "unbundle" into power generating companies, transmission and distribution entities, and new companies called retail electric providers (REPs), which will buy power from generating facilities and sell it to end users.

Texas' Public Utility Commission (PUC) will continue to regulate transmission and distribution and will license REPs. The retail market will be overseen by the Electric Reliability Council of Texas (ERCOT), a private, nonprofit organization that manages the energy grid that handles 85 percent of the state's power. Certain areas of the state, including El Paso and portions of East Texas and the Panhandle, do not fall under ERCOT's authority and will not participate in deregulation.

Texas followed the lead of other states by building in guaranteed customer savings. Beginning in January 2002, existing investor-owned utilities must offer residences and small commercial customers rates representing a savings of at least 6 percent over their January 1999 price. This "price to beat" will remain in effect until January 2007. It is designed to benefit customers who choose not to switch providers and to represent a built-in challenge to REPs wishing to lure customers away from their traditional utilities.

Due to this benchmark price, as well as lower natural gas costs for generators, many Texans are guaranteed to see lower utility bills over the next year. A 2001 report by the Energy Institute at the University of Houston's C.T. Bauer College of Business estimated that deregulation will save Texas households an average of $78 each in 2002. And Representative Steven Wolens, a sponsor of S.B. 7, says that the benefits should extend beyond savings.

"As the competitive market matures in the next few years, we should see the development of new technologies and new services, similar to the explosion of retail communications products and services following the deregulation of phone service," Wolens says.

California screamin'
Twenty-four states including Texas have adopted some form of electricity deregulation, although many have not completed the process. Six of those states--Arkansas, Montana, New Mexico, Oklahoma, Oregon and West Virginia--have delayed its implementation, while California and Nevada have suspended the process.

This epidemic of cold feet is due in large part to California's disastrous experience with deregulation in 2000 and 2001.

California's experiment began well, reducing average rates by about 10 percent. In 2000, however, the process went off the rails in a welter of power outages, skyrocketing wholesale and retail prices, bankruptcies and allegations of price-gouging. Some electricity rates rose nearly a hundredfold.

The crisis has been described as a "perfect storm," a combination of events that led to market havoc. California's economy was still flourishing in the high-tech boom, and power generators were struggling to keep up with a growing population. An unusually hot summer switched on air conditioners throughout the West Coast just as a prolonged drought led to a shortage of hydroelectric power.

Tight federal emissions standards have made it difficult for California to add power generating capacity, forcing it to depend heavily on energy purchases from out of state, while an inadequate transmission infrastructure impedes the transfer of power among the state's regions.

Still other aspects of the crisis, however, seem attributable to the way in which California approached deregulation. California froze the retail rates charged by incumbent utilities on the assumption that competition would lower prices. The freeze prevented power companies from passing on sharply higher fuel costs, contributing to the bankruptcy of one utility and driving another to the brink before the state authorized price increases. Moreover, California required utilities to buy and sell power through a volatile short-term market, preventing utilities from locking in rates with suppliers.

At present, California's electricity rates are higher than before deregulation began.

Texas: not California
Proponents say, however, that Texas' deregulation program has advantages that should prevent any repetition of the California crisis. For one thing, Texas imports less than 1 percent of its power from out of state, compared with 25 percent for California.

"California also relies on water and wind, two intermittent resources, for more than 20 percent of its generation needs," says Wolens.

Texas, by contrast, draws its power from a variety of sources, leaving it much less vulnerable to uncontrollable factors such as the Pacific Northwest drought.

According to Kathleen Magruder, vice-president of Government Affairs for The New Power Company, an REP already serving more than 80,000 Texas customers.

"Texas is blessed in that it sits on top of a lot of natural gas, the preferred fuel for generating electricity," Magruder says.

And unlike California, Texas has expanded its power generating capacity rapidly. According to the PUC, 45 power plants have been built in Texas since 1995. Another 17 are under construction and 32 are in the planning stages.

"A lot of people predicted exactly what happened in California," Magruder says. "They built a fundamentally flawed model that was doomed from the beginning."

Texas' law does not include the short-term market for energy that proved so hazardous in California. Texas' REPs are free to strike stable, long-term agreements with energy generators. And Texas has avoided another pitfall by allowing incumbents to raise the "price to beat" as often as twice a year if fuel prices rise, which should help guarantee their solvency.

Of course, this hardly means that Texas' plan has been without controversy. Some prospective providers have complained that Texas has set its price to beat too low to cultivate a competitive market, a claim consumer groups reject.

Customer protections
Texas is attempting to protect consumers as they enter the sometimes-confusing world of deregulation. To ensure that Texas' energy supplies remain abundant, the PUC is developing rules that would require power companies to buy extra reserves if the state's excess power capacity drops below a certain level.

Customers may cancel any contract within three days without penalty and can also leave a contract if the provider changes its terms. State law also contains provisions to prevent people from being switched from one REP to another without their knowledge.


Power shopping Beginning in January 2002, many Texans were able to purchase electricity from competing providers. It's an opportunity to save money--if you're a careful shopper. Here are some points to remember: You may switch providers at any time, so don't feel pressured to make a decision.

Review your old utility bills or contact your current provider to obtain a year's worth of your usage data. This should give you a good idea of what your own summer and winter consumption patterns are like--an important thing to know, since some providers' rates will vary depending on the amount of electricity you use.

Always read providers' electricity facts labels, which will provide you with vital comparative data on factors such as average prices and contract terms. If you don't have a copy of a company's label, you can find comparative information for providers in your area on the Public Utility Commission's (PUC's) Texas Electric Choice Web site www.powertochoose.org.

Compare prospective providers' rates with your current provider's "price to beat." Make sure that any offers you receive include all charges, including taxes, generation and delivery charges and any service fees.

Study prospective providers' contract terms. Be sure you're aware of items such as cancellation fees. Check providers' track records. The PUC can tell you about any complaints that have been lodged against a company in Texas. If they are new to the Texas market, find out where they have been active in the past and check on their reputations in those states.

Bruce Wright