Duke, AEP Ohio Settlements Copy Market Structure Leading to Only Two Residential Choices -- A Significant Step for Competition?

During an earnings call yesterday, Exelon CEO John Rowe continued a victory lap on recent, yet unapproved, settlements at Duke Energy Ohio and AEP Ohio that would require both utilities to begin procuring 100% of capacity for customers through the Reliability Pricing Model in 2015.

Rowe, who is known for straight talk, or arguably hyperbole, on earnings calls, said of the Ohio developments:

"I view this as one of the most important step[s] forward for competitive markets in the past decade."

Now Matters understands the need to talk up the settlements for a variety of reasons (especially as the AEP Ohio settlement is still contested), and does not wish to minimize the extraordinary improvements each settlement would eventually make in the Ohio market: which, in Matters view, is most importantly the separation of utility-owned generation and the end of the obligation to serve, and the institution of a competitive bidding process for default service.

Nevertheless, upon first hearing Rowe's quote, Matters was incredulous, as we view all issues related to competition at the end user level, or related to retail competition. And although both settlements are vast improvements over the status quo at each utility, we can hardly view them as, "one of the most important step[s] forward for competitive markets in the past decade" when it comes to retail choice, as will be explained below.

However, the settlements are indeed huge wins for the owners of non-rate regulated generation, and, in that vein, the settlements may be one of the most significant developments for competitive generation in the last 10 years. That's because two utilities with very large amounts of load will now serve their capacity needs through the RPM construct and not through their retained assets under the Fixed Resource Requirement, and we can understand how other competing asset owners would be happy about that.

Whether these settlements actually result in workably competitive retail markets remains to be seen, but Matters believes there is good reason to be skeptical that Ohio will mirror the results of Pennsylvania, or even Maryland or Illinois, especially for mass market competition.

Indeed, the AEP Ohio and Duke Energy Ohio settlements largely look like the current structure in place at the FirstEnergy Ohio utilities (the precise laddering may differ marginally, but the general structure of default service is similar). Indeed, the competitive bid process at the FirstEnergy utilities is even explicitly referenced as a model in the AEP Ohio settlement.

So it's instructive to look at what's happening at the FirstEnergy Ohio utilities.

And the bottom line is that until about a month ago, residential customers at the FirstEnergy utilities had one -- this needs to be emphasized, just one -- competitive retail supplier actively making them offers according to the PUCO Apples to Apples chart -- and that was the affiliate of the incumbent utility. Despite nearly three years of the FirstEnergy utilities using a market-based, competitive auction to set default service, only in the past month has a second retail supplier, Duke Energy Retail Sales, begun offering service to individual residential customers at the FirstEnergy Ohio utilities.

While suppliers also compete for residential customers at the FirstEnergy utilities through municipal aggregation, and while such load is served competitively, this hardly represents customer choice.

While there is greater choice for larger loads at the FirstEnergy Ohio utilities, overall, according to the most recently disclosed data by FirstEnergy Corp. (as of December 31, 2010, with FirstEnergy no longer disclosing this data point in earnings reports), FirstEnergy Solutions, either through retail, aggregation, or wholesale sales as an SSO provider, was serving 81.4% of retail volumes at the FirstEnergy Ohio utilities. That's hardly robust competition, and it's hard to see a settlement copying such a market structure as representing some landmark step for competitive markets, at least when it comes to customer choice.

This is not to pass judgment on the design of the FirstEnergy Ohio utilities market design, or in any way be pejorative to participants in that market; Matters understand that the current design is a result of litigation, concessions, compromise, and competing interests, some of which oppose more market-reflective pricing, and that the design essentially represents what was attainable when adjudicated (much as the AEP and Duke settlements do). Matters' point is that it seems very strained to hail settlements which copy a market design which has produced all of two active competitive offers for residential customers as "one of the most important step[s] forward for competitive markets in the past decade," -- unless you're more concerned with an opportunity to earn capacity revenues rather than the ability to serve residential customers.

Now, there is one key difference between the FirstEnergy utilities' market design and that of at least Duke Energy Ohio -- namely, Duke Energy Ohio will implement a zero discount Purchase of Receivables program. Notwithstanding a challenging default service portfolio, POR, along with the seven residential suppliers already active at Duke, should provide an opportunity for residential choice at Duke Energy Ohio to mirror the growth seen in Illinois or Maryland, which have laddered default service with POR. But, as in those other markets (neither of which has received the same praise lauded upon the Ohio settlements), ultimate migration activity will depend on where prices are set in the staggered auctions.

However, AEP Ohio's settlement does not provide for a Purchase of Receivables program, and therefore, there is little reason to think its service area will see any more residential choice than seen at FirstEnergy Ohio.

Additionally, if we're Pennsylvania PUC Chairman Robert Powelson, we're insulted by Rowe's statement. Competitive suppliers are saying Pennsylvania's retail market is not workably competitive due to its default service structure, which generally has more market reflective pricing than anything in the AEP Ohio or Duke Energy Ohio settlement, but these same constituents are now hailing Ohio default service settlements which contain laddered contracts lasting as long as 41 months as one of the most important steps forward for competitive markets in the past decade.

It should also be noted that the Ohio laddered contracts are not class specific. Rather than recognizing the sophistication of larger customers and providing them with shorter term, more market reflective default service, the Ohio settlements group these customers' load into the same portfolio used to serve residential customers -- rather than providing them hourly pricing or a non-laddered annual rate.

Now, let us be clear we're not suggesting Ohio could have gone from an essentially negotiated default service rate under the ESP straight to hourly rates for large customers; obviously, that would be unrealistic, no doubt opposed by many stakeholders, and needs to be addressed gradually. The point, however, is that while praise for the Ohio settlements is worthwhile and justified (especially in removing utility assets from any obligation to serve default service), the stratospheric praise for these settlement, which frankly create a challenging choice environment (especially if market prices rise in the near future and the laddered default service portfolio lags these increases) is unjustified, unless your main concern, is, again, selling market-priced capacity without concern to whether it's to a retail provider or to Standard Service Offer wholesale suppliers.

And if we're PSC Chairman Douglas Nazarian, which is right now reviewing a proposal by Exelon to acquire one of my state's distribution utilities, I'm thinking, if Exelon thinks the Ohio market structure is so great, maybe we should copy it and include some longer default service contracts for not only residential and Type I customers, but current Type II and hourly customers as well. After all, default service plans with 41-month default service contracts for industrial customers have just been hailed as "one of the most important step[s] forward for competitive markets in the past decade."

To be clear, Matters does not wish to minimize the positive developments under the settlements, but is forced to comment due to such outlandish praise for the settlements which do not reflect their real impact on the retail market. Even with significant market design changes, the settlements fall well short of assuring small volume customers of a robust competitive retail market with a dozen suppliers as seen in Maryland and Illinois, or the 30 suppliers seen in PECO or PPL. All the settlements assure is that by 2015, competitive generators will get to compete for capacity at AEP Ohio and Duke Energy Ohio. That means nothing when it comes to bringing actual competitive choice to customers. And as has been seen at the FirstEnergy Ohio utilities, simply instituting competitive bidding for default service, when it includes staggered contracts of three years, or more, does not necessarily produce real choice for residential customers. Accordingly, as positive as they may be, we can't accept the settlements as one of the most important steps forward for retail competitive markets in the past decade.