Default Service Retail Competition and Procurement Seabron Adamson

Default Service, Retail Competition and Procurement Seabron Adamson Tabors Caramanis & Associates Ph: (617) 354 -5304 Fax: (617) 354 -5882 www. tca-us. com Restructuring Roundtable May 2 nd , 2003 1

Will new entry into the small customer retail market be an economically viable strategy? • Customer transaction and information costs greatly favor incumbent suppliers even on a “level playing field” • Even a more efficient or higher value added competitive retailer would face substantial costs and risks in building a sustainable customer base if they have to start from zero • Policy issue – is default service the last resort or the first? 2

If there is insufficient retail competition, how should permanent default service be regulated? • Retail competition provides market-driven incentives for suppliers to contract efficiently (low price, low risks) • Without retail, distributors need a defensible method of selecting the portfolio of contracts in their procurement strategy Contract market Risks (market and regulatory) cannot be completely eliminated as forward markets are fairly illiquid and opaque in power (especially locationally) Distributor • • 3 But since distributors have no opportunity to profit on procurement it is difficult to create cost reduction incentives, other than “heads I win, tails you lose” Seller Cust Seller Cust

A few conclusions 4 • Retail competition was presumably included in the original Act as legislators thought that market forces could provide better cost and risk reduction incentives over time than regulatory policies • On first impression, the 02 -40 Order reduces the scope for competitive forces to play a significant role in small customer procurement • The interests of customers and distributors may quickly diverge with respect to procurement. Customers want low default service prices at reasonable market risks. Distributors want to minimize their regulatory risks, as they can do no better than breakeven anyway. • Without competition to discipline default service prices, and where the interests of customers and distributors diverge, customers will rightfully expect regulation and detailed oversight to protect their interests • This in turn raises the regulatory risks for distributors providing default service