The Retail Electric Provider and the Smart Grid: Reviewing the Past and Anticipating the Future to Understand the Present: Part One of Three

Posted On: May 25, 2011

By Stream Energy Director of Market Research Mike Rowley

Mike Rowley A former British Caribbean Colony’s parliament was attempting to create efficiency by changing old policies. The fact that the populace still drove on the left side of the road, an old British holdover methodology, was brought up. The financial argument was that American cars were cheaper and that shipping from a geographically closer manufacturer, like those in the US, would also be much cheaper than the alternative. Another faction stated that they thought that a change like that was a large endeavor and should be phased in slowly. The wisest of the wise agreed and suggested that the phase-in should start with the semi-trucks.

Multiple accidents ensued.

Needless to say, even when there is no other way to do it, I don’t like any phase-in methods. And, in association with AMI, I see a variety of methods where the cart is being placed before the…semi-truck. Yes, mistakes and disconnects are abundant. This paradigm shift is feeling like a series of small earthquakes.

My resume shows that I have originated, built and operated power plants … supervised grid operations at the distribution, high voltage and extra high voltage levels … designed and implemented interchange scheduling and energy accounting systems … and even participated in the start-up of companies like Calpine Power Services Company and the Automated Power Exchange, not to mention my latest project, Stream Energy. I spent my first 20 years in the industry at the Salt River Project, Arizona’s second largest electrical utility.

Concern about the ultimate consumer is something that I am experiencing for the first time in my “almost” 38 year electricity career. I have always been on the generation, grid operations and market design side of the business and usually saw the consumer sector as a huge energy eating amoeba. I joined Stream Energy in 2004 as the wholesale supply director, never even thinking twice about the ever-present amoeba that we were serving. After building the supply procurement department at Stream Energy, I hired a new director as my replacement, who is much more intelligent than I am, and then moved into my current position. My title actually has very little to do with my duties to my Stream Energy partners. What I am expected to do is to constantly be looking in all directions, especially forward, and to keep the ship from hitting icebergs or running into sand bars. I look for opportunities and pitfalls, study how other companies are handling the changes and opportunities and generally read every industry news rag daily and discuss it with other energy professionals in my personal network. Stream Energy’s chairman Rob Snyder always seems to feel better if he never hears from me … the assumption being that there are no icebergs or sandbars in our immediate future.

I was asked to do a comparison between ERCOT and PJM as to what smart grid issues affect a retail electricity provider operating in a deregulated market. But, I need to explain more about what history has shown us, and then delve into my own fantasies about what the future holds before I can talk about what the present offers a company like Stream Energy.

I have become acutely aware of the consumer and the individual opportunity that our customers are going to have as they become players in the energy markets instead of captives of the system. Currently, the consumer has a choice of suppliers and a choice of several packaged products in the states in which we do business. But that is the tip of the proverbial iceberg. For the retail electric provider, ownership of the customer relationship will be the most important aspect of our business in the future.

Let me get historical and take a look backwards.

Mark Burlingame asked me this question, and then published my answer in anticipation of the SmartGridPoint seminar. “Has deregulation lived up to its promise of lower prices and innovative products”? My answer to that question was a question … ”Who made that promise?” If you read my whole answer, forgive me, but I want to address it again. Simply stated, regulation is a surrogate for competition. The practice of governments in capitalist countries is to protect consumers from natural monopolies by imposing regulatory constraints. Electricity utilities were deemed natural monopolies in the “post-Thomas Edison Era” after the short stint in the beginning where electricity supply competition thrived, where several electricity companies would arrive and compete for customers in a city and eventually be consolidated into a single company. With the help of anti-trust laws that were relatively new, the governments imposed a regulatory compact on these natural monopolies as competition gave way to consolidation.

Regulation was needed until technology paved the way for competition to be reinstated by dissolving the regulatory compacts with those parts of the industry that could be pushed into a competitive market, i.e. generation and customer service (with the wires companies, still being natural monopolies, remaining in the regulatory compact and acting as a common carrier of the product). So, what is happening is a return to competition after years of regulation. Technology, in the form of computers, arrived and now we see the capitalistic balance being restored. So, the surrogate is being set aside. Competition is being restored. Why? Because there is a natural balance that unconstrained competition creates that is the basis of our capitalistic economy. Bankruptcy is not a bad thing in our economy; it is a “survival of the fittest” tool to keep our economy strong and pure. Almost all of the naysayers in our sector are not saying that competition is bad; they are saying that we still live in a constrained energy economy where the largest players can manipulate the markets for corporate gain and history has shown these naysayers to be, at least, partially correct. The rudimentary tool that economists use to determine a constrained competitive market is called the HHI Index (Herfindahl-Hirschman Index). The simple equation is to take all of the market sector participant’s market shares, square those numbers and then add up all the resulting products. So, if you have 10 generation companies serving a region, and they all have a 10% market share, the sum of the squares would be 1000. The HHI says any sum less than 1600 is a non-constrained market and that no single participant should be able to artificially set market prices. In Texas, when the market deregulated, the largest generator company had an approximate 35% share, followed by a generator company with an approximate 20% share. Just these two companies created 1625 points on the HHI which determined that ERCOT was a constrained market. True competition could not occur without extreme market monitoring and penalties for market manipulation; and still, there is some manipulation that falls within an acceptable range, even for the market monitor and market participants. But, in my humble opinion, I believe that our market monitoring systems are getting better, and that the economic benefits of competition far exceed the cost of the manipulation.

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