V. Why Competition Can't be Relied Upon to Rescue San Diego

Competition for the small business and residential customer has been slow to develop. SDG&E's local market power, its control over customer bills and the low margins on commodity prices makes local market entry economically unattractive.

Moreover, signing up small customers under the banner of a municipality for purchasing power has been frustrated by a utility-led legislative ban on aggregating residential and small business consumers.

These are just a few of the many "barriers" or hurdles faced by companies and technologies that try to enter the electric services market. To compete against SDG&E is the equivalent of competing against the proverbial 800-pound gorilla in its own jungle.

A truly competitive market could potential help choose the best technologies and strategies. But that competitive market will be very slow to develop. The prospects of competitors fighting for the small customer market any time in the next ten years are dim. And in fact, some ESPs have pulled out of the residential market in recent years.

Decisions are going to be made within the next few years that will lock San Diego into a set of technologies and strategies for a long time. By the time a competitive market occurs....if it occurs.....San Diego may not be able to take advantage of the new options that technology and choice have to offer.

A. Energy Service Providers can't Compete with SDG&E
The electric generation market is a low-profit pure commodity market. Deregulation has created ESPs (Energy Service Providers) that are potential competitors to SDG&E's market share. However small business and residential customers are not very attractive to these new energy companies. At the present time only a handful of ESPs offer service to small customers. None offer "discounted" electricity, with the exception of state-subsidized "green" power.9 In a commodity market such as electricity, small users don't consume enough energy to offset the marketing costs involved in securing the new customer. The marketing, administrative and assorted utility-demanded costs faced by these new entrants are a formidable barrier to competition with traditional utilities like SDG&E, who enjoy high name recognition, subsidized contact with customers, and billing systems that are paid for by ratepayers.

In the name of protecting consumers, California utilities pushed for limiting municipal default aggregators in AB1890. As a result of the legislation, the incumbent utility is allowed to keep any customer who does not make an affirmative choice for someone else. ESPs must add value and lower costs to survive in the competitive market.
The lack of significant penetration by Energy Service Providers serving small business and residential customers is a matter of grave concern to UCAN. Only 2% of SDG&E customers have switched to a competitor.10 This statistic is a strong testimony as to the risk and the low profitability of providing service to small customers.

Convincing small customers to switch from a reliable vendor that has served them for decades to a fledgling company is a daunting task. In the case of telecommunications deregulation, AT&T still has the lion's share of the market because consumers do not have the impetus to switch to another provider, even if the new competitor has better rates and services. Any ESP interested in entering the San Diego market is confronted by the utility equivalent of an 800-pound gorilla in its own jungle.

B. Utility Distribution Companies (UDCs) have implemented anti-competitive strategies that protect their advantage in the deregulated marketplace

1. They Have Disabled Municipal Aggregation

Municipal aggregation is a great way for small consumers to benefit from the purchasing power of a municipality. Aggregation enables government entities to provide the residents inside their boundaries with electric services, in the same way they provide water, cable and other essential services. After all, if a resident lives in a city and the city has several buildings that need electricity, why not offer that resident the option of adding their small amount of electricity usage to what the City already needs and negotiate lower rates? When electric reform was debated, the utilities fought fiercely to prevent this scenario from occurring. They were able to secure language in AB1890 that effectively prevented this.

For example, the City of Palm Springs wanted to bid on behalf of all of its customers. Because of the anti-competitive municipal aggregation policy contained in AB1890, the City had to secure written permission by each and every citizen in its jurisdiction in order to aggregate the customers. The result: only a quarter of the Palm Springs customers made the affirmative choice for the municipal aggregator . The Palm Springs effort was abandoned in late 1998 due to the difficulties of aggregating a community under the utilities' customer-by-customer limit.

2. They Have Employed a "Two Bills" Tactic

Having fended off the municipalities in the restructuring legislation, the next California utility strategy was to make sure that consumers who switch receive two bills: one from the ESP, and another from the distribution utility.
The handful of ESPs serving the small customer market in San Diego rely largely on a subsidy provided by a renewal resource credit administered by the California Energy Commission. This credit of 1/8� per kilowatt hour allows "green" energy options for small customers to be economically viable. But the stamp needed to mail the extra bill back to the ESP offsets the meager competitive advantage an alternative seller has over the default provider.

Moreover, when the default UDC (Utility Distribution Company) switches a consumer's account to an alternative ESP, the customer's record locator is changed. As a result, historic consumption graphs, such as previous month and previous year comparisons do not appear on either bill. If a consumer wants to use this information to track household consumption, they will have to call SDG&E with their old account number and ask for the information over the phone.

The "two-bill strategy" benefits SDG&E by adding a significant cost to the bills paid by the small customers served by the competition. It creates a barrier to entry by eating up a large block of the already meager commodity savings.11 The two-billing tactic is not universal, however. In Nevada, even utilities agree that one bill is expected to be the norm.

Two bills also lead to consumer confusion. For example, ACN is a gas provider for SoCal Gas. Recently, SoCal inserted an "informative" fact sheet into ACN's monthly bill. Unfortunately, the memo looked so much like a bill, that many customers paid So Cal Gas and ACN for the same charges. ACN, a large East-Coast utility has had to sue Sempra in federal court to prevent more bill-confusion tactics.

C. Creation of New Market Barriers Must be Avoided
Current market conditions in California and the lack of real-time metering12 severely inhibit an ESP's ability to:

• Make demand management (energy conservation and efficiency measures) commercially viable;

• Make demand responsiveness (changing consumption patterns and practices in response to market price signals) commercially possible. Companies have difficulty adding additional services to metering, billing and consumption; (e.g. smart meters that modify consumption as well as measuring it)

• Differentiate its product sufficiently to be distinctive (e.g., green power);

• Successfully achieve marketing goals while keeping marketing costs low, such as by working with groups of customers who are already an organized group. (e.g. affinity marketing - through churches, credit unions, environmental groups, etc.);

• Cut billing and metering costs;

• Combine (or at least promote consolidated bill paying for) other consumer services with energy, including efficiency investments, appliances, burglar alarms, long distance telephone, cable, etc.

The handful of ESPs serving the small customer market in San Diego rely largely on the partial subsidy provided by the renewal resource credit administered by the California Energy Commission to make energy service to small customers economically viable. At the present time, less than 2% of residential and small commercial customers have switched from SDG&E to a competing energy service provider.

In the face of these market realities, it appears that ESPs already face significant market barriers at the present time. It would not take much for the remaining ESPs to conclude that serving the California small customer market is uneconomic.

SDG&E has proposed that it be eligible for economic incentives for buying power for small business and residential customers in San Diego. These incentives (called "Performance-based ratemaking or PBR") will give SDG&E a clear economic incentive to further preserve its customer base over the longer term. The more lucrative this PBR is, the more likely the Utility Distribution Company (UDC) will have an economic incentive to resist new entrants into the small customer markets. The PBR thus becomes yet another hurdle on top of many that ESPs currently need to overcome to serve the small customer market.

The utility's use of cross-subsidies and transaction cost barriers to exercise market power will continue unless the state properly limits the role of the UDC. Currently, SDG&E is permitted to subsidize electricity sales by recovering overhead costs through distribution monopoly charges, thus forcing current and would-be competitors to seek niche markets to survive. SDG&E is able to influence new and existing customers in a number of ways. Specifically, it can be the competitive provider of (1) commodity services (energy and ancillary services), (2) metering services, (3) meter-data management, (4) billing services, (5) demand-management, (6) distribution system design, and (7) distribution system construction. The post-transition period is unlikely to be much different unless the regulators act proactively.

There may be ways of increasing retail competition. Ideas such as opening up "default" service to competition through bidding or compulsory assignment has been discussed by state regulators. Such experiments could be attractive; if nothing else it could help illuminate the institutional differences between SDG&E and private commodity providers. SDG&E enjoys a set of institutional advantages, or artificial competitive advantages, which need to be directly compared to the advantages offered by private market participants. As previously discussed, this will also assist with comparison of costs to perform specific commodity procurement functions. However, it could be years before state policymakers tackle this issue. The utilities are not eager to have them consider these alternative scenarios.

An overwhelming problem with SDG&E is its artificial, institutional advantages -- advantages that stem from economies of scope (in services) and scale. These remnants of monopoly regulation not only stunt competition and innovation in energy services, they also discourage innovative new competition-driven commodity procurement.
Where there are artificial economies of scope and scale, there is no reason to allow for monopoly default service, such as for commodity procurement. It is these institutional legacies which create barriers to functional separation of costs for these services and to competition that would otherwise would benefit small customers.

In sum, SDG&E has become the functional equivalent of an unregulated monopoly. Energy prices are no longer regulated. Innovative technologies that pose a threat to utility assets can be delayed or co-opted. The local distribution services are loosely regulated using "incentive mechanisms" that give SDG&E an economic incentive to discourage conservation or alternative energy production. And SDG&E's ability to use its own buyer market power and the resources of its holding company parent (Sempra) will ultimately translate into higher costs for San Diego customers.