third edition guide to electric power in texas...making & moving electricity texas electricity...

January 2003Houston Advanced Research Center

and

Institute for Energy, Law & EnterpriseUniversity of Houston Law Center

Guide toElectric Power

in Texas

Third Edition

January 2003

Houston Advanced Research Center4800 Research Forest Drive

The Woodlands, Texas 77381281/367-1348

Fax 281/363-7924http://www.harc.edu


100 Law CenterHouston, TX 77204-6060

713/743-4634Fax 713/743-4881

[email protected]://www.energy.uh.edu

Guide toElectric Power

in TexasThird Edition

This Third Edition of Guide to Electric Powerin Texas comes at a time of great change anduncertainty in the electric power industry inTexas and the United States. Nationwide, theoutstanding questions deal with how best tobuild workably competitive markets for bulk,wholesale transactions of power and the finan-cial settlements that accompany these sales.Should we adopt a national market design thatwill establish and enforce common standardsfor how these transactions take place? Willsuch an approach ensure adequate and effi-cient investments in transmission capacity?How can we best provide open, transparentflows of information so that trading, market-ing and risk management for both power anda critical generation fuel, natural gas, can pro-ceed with confidence and integrity? What arethe roles of national and state regulators andpolicy makers? And will our market designencourage continued experimentation withrenewable energy sources like wind and solar,where those make sense, and help to foster andimprove environmental quality across the sys-tem? These and other issues are being debatedat a time when our energy policy decisions asa nation are being monitored by other coun-tries as never before, a consequence of thesharp conflicts surrounding California’s elec-tric power restructuring program and the cor-porate governance and ethics issues emanat-ing from the energy trading sector.

Among state-based programs, our TexasElectric Choice initiative remains the one mostwatched. As a consequence, customer educa-tion and participation, as well as customerfeedback both to electric power providers and

our Public Utility Commission and Legislature,are important benchmarks.

This edition of the Guide, like previous ver-sions, was prepared to provide a comprehen-sive and balanced educational resource for awide range of retail customer groups, frominterested residential consumers to large com-mercial and industrial organizations. TheGuide was first published in 1997, after theTexas Legislature created our own wholesalemarket and when thinking began to coalescewith regard to participation in the marketplaceby retail customers. Our goal was then, andremains, to provide both background on ourstate’s electric power industry and history andthe points of debate on how best to providefree choices and a different set of options sothat the benefits of competition can be intro-duced and flourish. Texas remains uniqueamong the states in how our electric powersystem is organized. Most electric power cus-tomers reside within the Electric ReliabilityCouncil of Texas or ERCOT, an island withinthe interconnected national grids. Our statecompetes for jobs and industries with otherstates, and so how our grid and other parts ofthe electric power system work are importantfor comparative advantage. As the electricpower industry evolves nationwide we maybecome increasingly integrated, and so howour rules and framework “fit” with other stateand regional approaches is of great interest tocustomers and the electric power industry.Finally, this book serves as a resource inMexico, where there is ongoing discussionabout how best to restructure that electricpower system and where closer ties to Texasare a strategic objective on both sides of theborder.

The Guide was conceived of and prepared atthe Houston Advanced Research Center(HARC) and the Institute for Energy, Law &Enterprise (IELE) at the University ofHouston’s Law Center.

The Houston Advanced Research Center isa private, non-profit research organization lo-cated in The Woodlands, Texas seeking to im-prove ecosystem and human health throughresearch and service. HARC’s activities are

Preface

i

Guide to Electric Power in Texas, Copyright 2003, Hous-ton Advanced Research Center, The Woodlands, Texas.The University of Houston is a HARC affiliate.

This report may not be resold, reprinted, or redistributedfor compensation of any kind without prior written per-mission from the Houston Advanced Research Center orthe Institute for Energy, Law & Enterprise, University ofHouston Law Center.

focused on three primary areas – Energy, En-vironment and Life Sciences. HARC relies onthe expertise and knowledge of its researchpartners, such as the University of Houston,for projects and publications like the Guide.

The University of Houston’s IELE is a uni-versity-wide research, education, and outreachcenter on energy and related environmentalissues. Formerly the Energy Institute locatedin the C.T. Bauer College of Business, our mainfocus is on economic, legal, regulatory, and fi-nancial frameworks to support sustainable,commercially successful energy developmentworldwide. Our work at the IELE extendsacross the energy value chains, from oil andgas exploration and production, to transpor-tation and distribution, and to conversion anddelivery for end use as petroleum products(gasoline, jet fuel and so on), electric power, ornatural gas. The IELE specializes in the par-ticular problems and issues surrounding thenatural gas-to-electric power value chain, in-cluding liquefied natural gas (LNG). Thetransmission and local distribution “grid busi-nesses” have historically been operated aspublic utilities because of their strong networkeconomies of scale and potential to exert mar-ket power. For the past 25 years, the naturalgas and electric power industries have experi-enced substantial restructuring in the U.S. andother countries as ways are sought to introducecompetition, spur innovation and entrepre-neurship, and instill market pricing and mar-ket-driven behavior. These policy actions havebeen taken mindful of the public interests in-volved. This bigger picture underlies the pur-pose and intent of our Guide.

In addition to the Guide, the IELE maintainsongoing research on issues in electric powerrestructuring and our natural gas supply anddelivery system in the U.S., and on compara-tive approaches to gas and power restructur-ing both within the U.S. and across a numberof countries. Our briefing paper on the TexasElectric Choice program can be found atwww.powertochoose.org. We place particu-lar emphasis on Mexico and the emergingNorth American continental marketplace,South America, West Europe and Turkey, and

ii

For additional printed copiesof this report contact:



713/743-4634Fax 713/743-4881

[email protected]

East Asia. The IELE helps to expand energycontent in UH courses and degree programsand hosts an international education program,New Era in Oil, Gas and Power Value Creationeach May. The IELE is supported by the fol-lowing financial partners. The University ofHouston is a member of the HARC higher edu-cation consortium.

Baker HughesBG LNG ServicesBP Global LNGBracewell & Patterson L.L.P.Canadian Consulate General – DallasChevronTexaco Worldwide Power and Gasification and Worldwide LNGConocoPhillips Worldwide LNGDuke EnergyDynegyEl Paso Global LNGEnterprise Products Partners, L.P.ExxonMobilFulbright & Jaworski L.L.P.Gardere Wynne Sewell L.L.P.

JETRO – Houston/ METI, JapanMcKinsey & CompanyOcean EnergyPA ConsultingPublic Utility Commission of TexasReliant EnergyShell Oil CompanySmith International, Inc.Tractebel/DistrigasU.S. Department of Energy – Office of Fossil EnergyU.S. Department of State (Agency for International Development)Vinson & Elkins L.L.P.

Part 1Facts on Texas Electric Power ............................................................. 1

Facts and figures on the Texas electric power system.

Part 2The Basics of Electric Power ............................................................... 9

Physical and organizational characteristics of an electric powersystem; how electric power systems work.

Part 3History .................................................................................................. 19

Short history of Texas electric power and U.S. activities that havehelped shape electric power systems.

Part 4Regulations & Policies ....................................................................... 27

Brief description of major U.S. energy legislation and Texaslegislation as they affect electric power.

Part 5Major Issues ........................................................................................ 45

Discussion of major issues affecting electric power decisions —consumers, environmental, economic development, financing, andothers.

Part 6Future Trends ...................................................................................... 63

Discussion of four key trends to watch in the electric power industry.

Appendices .......................................................................................... 73

Basic Economic PrinciplesGlossaryFurther Readings

iii

January 2003Houston Advanced Research Centerand


Guide toElectric Powerin Texas

Third Edition

1

Facts on Texas Electric Power

Electricity: We Make and Use a LotBy far, Texans use more electricity than any

other state and many countries. In 2000, webought almost 10 percent of all electricity soldin the U.S., exceeding customers in California,the next largest state, by 44 percent. We usedover 60 percent more electricity than Florida,the third largest consuming state or almosttwice as much as Ohio, the fourth largest con-suming state, and more electricity than the 20lowest consuming states combined. Texas usesa lot of electricity!

Texas utilities sold 318 billion kilowatt hours(kWh) of electricity in 2000 - 97 billion morethan California and almost 122 billion morethan Florida. And this doesn’t include electric-ity generated by industry for its own use. Tex-ans use this much electricity because of the con-centration and type of businesses and the cli-mate.

Who Uses Electricity in Texas?There are more than 9 million customers that

buy electricity from Texas utilities and about86 percent of these are residential. There arenearly 1.1 million commercial customers andmore than 61,000 industrial customers. Utili-ties receive much of their revenue from resi-dential customers who spent about $9.3 billionon electricity in 2000. In this same year, indus-try spent $4.5 billion and commercial usersabout $5.8 billion.

The average Texas industrial customer con-sumes as much electricity as 114 homes. Theaverage residence consumes more than 14,500kilowatt-hours (kWh) per year while the aver-age industrial customer uses about 1.66 mil-lion kWh per year. Average commercial cus-tomers use more than 5 residences - approxi-mately 77,600 kWh.

Large volume electricity customers, such asindustries and large commercial operationspay lower rates than low volume users, such

as residences. This lower cost for large custom-ers is attributed to lower delivery costs andmore stable demand. In 2000, average rates fordifferent types of customers in Texas were7.96¢ per kWh for residentialcustomers; 6.88¢ for commer-cial customers; and 4.42¢ forindustrial customers. These areaverage rates that vary fromarea to area in the state. Also,an industrial or commercialcustomer using small amountsof electricity would pay higherrates.

Making & MovingElectricity

Texas electricity used to bemade and moved primarily byelectric utilities. However,electric power is not simpleand utilities are not the only or-ganizations involved, espe-cially now that we are imple-menting Texas Electric Choice– what this third edition ofGuide to Electric Power inTexas is really all about. Thereare several types of utilities;many investor-owned utilities

OverviewFacts on TexasElectric Power

Facts on Texas Electricity – 2000

No. of Generating Stations (2001) 531

Total No. of Electric Utilities 182

No. of Investor Owned Utilities 10

No. of Municipal Utilities 79

No. of Cooperatives 87

No. of River Authorities 4

Total Annual Consumption 318 GWh

Total Generating Capacity (2001) 79.5 GW

No. of Residential Customers 8 million

No. of Commercial Customers 1.1 million

No. of Industrial Consumers 61,280

Avg. Residential Consumption 14,570 kWh

Avg. Commercial Consumption 77,600 kWh

Avg. Industrial Consumption 1.66 mil. kWh

Avg. Residential Rate 7.96¢/kWh

Avg. Commercial Rate 6.88¢/kWh

Avg. Industrial Rate 4.42¢/kWh

U.S. Avg. Residential Rate 8.24¢/kWh

U.S. Avg. Commercial Rate 7.43¢/kWh

U.S. Avg. Industrial Rate 4.64¢/Kwh

Source: U.S. Energy Information Administration

(EIA) and the Public Utility Commission of Texas.

Electricity – it’s always thereexcept for an occasional

storm, and we expect it tobe there wherever we go. It worksso well most of the time that we’resurprised when it’s in the news. InTexas today, electricity is big news,big business and important to all ofus.

Texas electricity is different. Wemake more, use more, and have ourown niche in the U.S. system. Texasproduces and uses more electricitythan any other state in the U.S., con-siderably more than Californiawhich has about 13 million morepeople. Why? And what does thatmean for the future?

Texas also stands alone in theway it is connected to the electricpower grid – there’s the eastern partof the system, the western part, and

the ERCOT part. How did this hap-pen and why?

Texas relies heavily on coal forelectric power generation, althoughwe have more than three times theamount in natural gas generationcapacity. Fuel competition is driv-ing change in the industry. Why?

Texas electricity on average ischeaper, but we spend more andcosts vary widely across the stateand from consumer to consumer.Why is it cheaper (when it is) andwhy do prices vary?

Finally, how will these character-istics change in today’s industrynow that full competition wasstarted on January 1, 2002?

2


What’s aKilowatt-hour?

have created separate subsidiaries to make andsell electricity, and these must function apartfrom the parent company; some industriescogenerate electricity moved on the powergrid; power marketers now buy and sell elec-tricity; an Independent System Operator (ISO)has been created in Texas; and there is govern-ment involvement in all of this.

With the passage of Senate Bill 7 (SB 7) in May1999, the Texas legislature restructured the state’selectricity industry. Through the Texas ElectricChoice program, the goals laid out in SB 7 arebeing implemented. The idea is to allow cus-tomers to benefit from competition to makeand sell electricity, and to create a marketplacethat is more efficient while at the same timeprotecting customer rights and providing edu-cation and assistance to customers that needit.Importantly, while the marketplace is chang-ing, the fundamentals of electricity remain thesame. The electric power system consists ofcomplex equipment - the power plants thatgenerate electricity, the transmission system,local distribution and the control systems as-sociated with each of these.

What are Electric Utilities?Private utilities are a unique U.S. invention.

Historically they have been highly regulatedmonopoly industries that provide water, tele-phone service, natural gas, and electricity inthis country. While still closely regulated, natu-ral gas, telephone, and electricity regulationhas changed over time toward less regulationand increased competition. In most other coun-tries, these services are provided by govern-ment owned and operated monopolies. Thisis changing as these countries seek more effi-cient ways of providing these services throughprivate investment and competitive markets.

Texas actually has four types of electric utili-ties: investor-owned (IOUs), municipal utili-ties (munis), electric cooperatives (co-ops), andriver authorities. In 2000, Texas had 10 IOUswhich provided roughly 84 percent of thestate’s electricity. TXU Electric and ReliantEnergy HL&P were the largest. According toSB 7, only the transmission and distribution(T&D) activities can now be seen as utilitieswhile the generation and retail sales are nowcompetitive businesses. However, in parts ofTexas where retail competition was delayed,utilities remain integrated (see Part IV for de-

tails). There are 87 electric coop-eratives, four river authoritiesand 79 munis that are par-tially regulated by the PublicUtilities Commission of Texas(PUCT). Of the munis, 19 ac-tually generate electricitywith the remainder buyingand distributing electricity totheir customers.

Cogenerators, QualifyingFacilities and Independent PowerProducers The U.S. Public UtilityRegulatory Policy Act of 1978(PURPA) created a categoryof non-utility power produc-ers called qualifying facilities(QFs). This category includescogeneration plants, facilities

Part of our bill forelectricity is basedon how many kilo-watt-hours (kWh)we use. The “W” iscapitalized becauseit is named afterJames Watt who de-vised this measurein 1892.

A kilowatt equals1,000 watts ofpower so a 1,000watt light bulb(very bright) burn-ing one hour woulduse one kWh.

Watts are simplya measure of therate at which workis done by electric-ity with a kilowattequaling about 1.34horsepower.

Use of electricity in Texas has grown much faster than the population. By2000, consumption per capita was over 4 times what it was in 1960. Thisincrease has occurred across the board, with residential consumersoutpacing industrial customers. Source: U.S. EIA.

Texas Electricity and Population Growth1960 to 2000

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

1960 1965 1970 1975 1980 1985 1990 1995 20000.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

22.0

Population

Electricity Consumption

3


2000 ElectricityRetail Sales

Millionsof kWh

Texas 318,263

California 244,057

Florida 195,843

Ohio 165,195

New York 142,027

Illinois 134,697

Pennsylvania 133,845

North Carolina 119,855

Georgia 119,185

Michigan 104,772

Indiana 97,775

Virginia 96,715

Washington 96,511

Tennessee 95,728

Alabama 83,524

Top 15 States 2,147,992

Total U.S. 3,421,414

Source: U.S. EIA.

using waste products as fuel (such as petro-leum coke or manure), and renewable re-sources like wind and solar. Cogeneration(cogen) provides process energy (usuallysteam) as a by-product of power generation.PURPA required the host utilities of QFs topurchase energy from the QFs at avoided costs.In Texas, QF cogeneration plants may sellpower to the steam host and excess energy tothe host utility or another electric utility.

In 2000, about 15 percent of the total powergeneration capacity in Texas was associatedwith non-utility generators (NUGs). With theaddition of about another 8,000 MW of mostlymerchant plants, the share of NUGs reachedabout 20 percent by the end of 2001. Until re-cently, Texas accounted for more than 20 per-cent of total U.S. non-utility power generation.Restructuring of the industry required the gen-eration arm of utilities to be separated fromthe transmission and distribution operations.Today, even the generation companies affili-ated with the old utilities have to compete tosell the power they generate. As such, almostall generation in Texas is now non-utility.

RegulatorsTexas utilities and

electric power areregulated primarilyby the Public UtilityCommission ofTexas (PUCT). Cre-ated by the state leg-islature in 1975,Texas was the laststate to authorize aPUC.

The primary Fed-eral regulator is the Federal Energy RegulatoryCommission (FERC). The FERC regulates thetransmission and sale of wholesale power ininterstate commerce and thus has regulatoryauthority over most of the utilities in the U.S.Texas utilities are subject to FERC jurisdictiononly for the sale of electric power in the whole-sale or “bulk” market in the U.S. (FERC hasno jurisdiction in the Texas wholesale market)or the transmission of power for interstatesales. The PUCT has requirements comparableto FERC’s for utilities operating in Texas.

Recent ActionsFERC Orders 888 and

889 issued April 30, 1996were major federal actionsaffecting electric utilities.Order 888 required FERC-regulated utilities to file tar-iffs (what they wouldcharge) for wholesale trans-mission services. Order 889required FERC-regulatedutilities to create an informa-tion system for access by oth-ers (by August 1996). These two orders did not re-quire separation or unbun-dling of all utility services,but did require the func-tional separation of transmis-sion from power marketing.The FERC has left it up to thestates to decide whether andhow utilities should be reor-

Electric Utilities Generating Capacity in TexasBy Primary Energy Source — Year End 2001

Primary Generating Percentage ofEnergy Source Capacity (MW) Total Capacity

Coal Fired 16,185 20.4 %Gas-fired 56,364 70.9 %Nuclear 5,139 6.5 %Renewable 1,061 1.3 %Petroleum 220 0.3 %Hydroelectric 471 0.6 %Total 79,479 100 %

Source: ERCOT EIA-411 filing (4/1/02).

Generation

Transmission

Local Distribution Consumers

Commercial

Industrial

Residential

direct deliveryto largecustomers maybypass LocalDistribution

Basic Electric Power System

4

ganized. In December 1999, the FERCissued Order 2000. In thatpolicy, the FERC requires allowners of transmission assetsto organize these facilities intoRegional Transmission Organi-zations (RTOs). The intentionis to create larger markets forthe transmission of electricity,facilitating competition andcompetitive pricing. Under Or-der 2000, it is expected that theportions of Texas that are in-cluded in the Electric Reliabil-ity Council of Texas (ERCOT)would function as a separateRTO. The FERC is holdinghearings and encouragingmeetings among all stakehold-ers (utilities, generators, mar-keters, customers and so on) todetermine how best to imple-ment Order 2000.

When the Texas legislaturepassed SB 7 in May 1999, utili-ties were required to unbundle

their services into generation, transmissionand distribution (T&D) and retail. Today, gen-eration and sales (both wholesale and retail)of electricity are competitive businesses whilethe T&D companies remain regulated utilities.

The Equipment of an Electric PowerSystem

The physical equipment of an electric powersystem includes generation which makes elec-tricity, a transmission system that moves elec-tricity from the power plant closer to the con-sumer and local distribution systems whichmove electric power from the transmission sys-tem to most consumers.

GenerationPower plants use coal, lignite, natural gas,

fuel oil, and uranium to make electricity. In ad-dition, renewable fuels include moving water,solar, wind, geothermal sources and biomass.

Eastern InterconnectionECAR: East Central Area Reliability Coordination

AgreementMAAC: Mid-Atlantic Area Council

MAIN: Mid-America Interpool NetworkMAPP: Mid-Continent Area Power Pool

NPCC: Northeast Power Coordinating CouncilSERC: Southeastern Electric Reliability Council

SPP: Southwest Power PoolFRCC: Florida Reliability Coordination Council

Texas InterconnectionERCOT: Electric Reliability Council of Texas

Western InterconnectionWECC: Western Electricity Coordinating Council

North American Electric Reliability Council (NERC)


Some of the Utilities inTexas That ProvideElectricity Services

Investor Owned Utilities

American Electric Power (AEP)Company

El Paso Electric CompanyEntergy/Gulf States Utilities

CompanyHouston Lighting & Power

Company

Sharyland UtilitiesSouthwestern Electric Power

CompanySouthwestern Public Service

CompanyTexas-New Mexico Power

CompanyTexas Utilities Electric Company

West Texas Utilities

Cooperatives

Brazos Electric PowerCooperative

Northeast Texas ElectricCooperative, Inc.

Sam Rayburn G&T, Inc.

San Miguel ElectricCooperative, Inc.

STC/MEC Power Pool

Municipal Utilities

City of Brady

Brownfield Municipal Powerand Light

City of Austin Electric Utility

City Public Service-San Antonio

City of Coleman

City of Electra

City of Floydada

City of Hearne

Lubbock Power and Light

Public Utilities Board-Brownsville

City of Robstown

Sam Rayburn Municipal PowerAgency

Texas Municipal Power AgencyBryan, Denton, Garland,

Greenville

Tulia Power and Light

Weatherford Municipal UtilitySystem

City of Whitesboro

River Authorities

Guadalupe-Blanco RiverAuthority

Lower Colorado RiverAuthority

Sabine River Authority

Brazos River Authority

General Locations of Investor OwnedTransmission and Distribution Utility

Service Areas

5

The type of fuel, its cost, and generatingplant efficiency can determine the way a gen-erator is used. For example, a natural gas gen-erator with steam turbines has a high marginalcost but can be brought on line quickly. Coal,lignite, and nuclear units have lower marginalcosts but cannot be brought on line quickly.They are used primarily to provide the baseload of electricity.

Costs for fuel, construction and operationsand maintenance vary greatly among types ofpower plant. For example, renewable genera-tion plants, such as solar or wind, have virtu-ally no fuel costs but are expensive to manu-facture and install. Nuclear- and coal-fueledplants have low fuel costs but can be more ex-pensive to build and maintain. Coal units alsoincur additional costs for meeting air qualitystandards. Natural gas plants have higher fuelcosts than coal or nuclear, but have lower ini-tial construction costs.

Companies affiliated with utilities have thecapacity to generate almost 65 gigawatts ofpower (65 million kilowatts). This capacity hasnot changed much since the opening of thewholesale market to competition. This is be-cause, unlike other states, SB 7 did not requireutilities to fully divest themselves of all of their

electric power generation assets. As older unitsare retired, this capacity will decline. On theother hand, “merchant,” or non-utility, genera-tion capacity added almost 15 gigawatts be-tween 1999 and 2002, bringing total generationcapacity of the state to more than 80 gigawatts.By comparison, that is twice as much as theentire country of Mexico. Merchant generatorsare companies that seek to invest in new elec-tric power generation capacity based on theirassessment of supply and demand conditionsin the marketplace. Thus, these companies onlyenter the market if economic conditions war-rant.

Capacity vs. Actual Generation – As of early2002, almost 70 percent of Texas generatingcapacity is natural gas. In contrast, gas-firedgeneration accounted for only about 50 per-cent between 1999 and 2001. The rest of ourelectricity is mostly generated from coal, lig-nite or nuclear power plants. This is becauseof fuel costs. Although coal and nuclear powerplants are more expensive to build than natu-ral gas plants, fuel costs for coal and nuclearare considerably less. Thus, electricity is usu-ally dispatched first from nuclear plants, thencoal, and last from natural gas. Nuclear andcoal generators provide most of the base loadof electricity day-in and day-out, while natu-ral gas generators provide the peak loadswhich occur during certain periods of the daysuch as when air conditioning is in high de-mand.

Storing Electricity – Unlike water and natu-ral gas, electricity cannot be easily stored. Thispresents a fundamental challenge to the elec-tric power system. There is no container orlarge “battery” that can store electricity for in-definite periods (see following). Energy isstored in the fuel itself before it is converted toelectricity. Once converted, it has to go out onthe power lines.

Electricity Storage Technologies - Com-pressed air, pumped hydroelectric, advancedbatteries and superconducting magnetic en-ergy storage are the four main technologiesbeing studied for possible electricity storage.Compressed air and pumped hydro are al-ready being used in some locations in the U.S.


Texans enjoy lower electricity rates than theaverage U.S. rates, although these savingshave declined in the past 3 years. Texans alsospend more annually on electricity.

2000 Rate Savings in Texasas compared with the U.S. average electricity

costs per kilowatt-hour.

Source: U.S. EIA.

6

3.00

4.00

5.00

6.00

7.00

8.00

9.00

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Transmission SystemPower plants are located at points, which

allow access to the fuel source, generally awayfrom population centers, and electricity mustbe moved from that point to the consumer. Thetransmission system accomplishes much ofthis task with an interconnected system oflines, distribution centers, and control systems.

There are about 50,000 miles of transmissionlines in Texas. 37,000 miles of lines are locatedwithin the ERCOT system (see NERC map onpage 4). These consist of roughly 8,000 milesof 345 kilovolt (KV) lines; 17,000 miles of 138KV lines; and 12,000 miles of 69 KV lines.About 13,000 miles of linesare located in non-ERCOTareas of Texas, especiallywithin the SouthwestPower Pool territory (thePanhandle and east Texas).

Electricity is transportedat high voltages (69 KV orgreater) over a multi-pathpowerline network thatprovides alternative waysfor electricity to flow. Thelarge three-conductor linesand substations are famil-iar to most Texans, but thecontrol systems that keepthe system functioning areless visible.

The control systems


move power between T&D utilities by adjust-ing generator output in the T&D utility areasinvolved, not by switches. Movement amongseveral utilities means complex adjustments inwhich rules of operation are followed carefully.

The transmission system has been built overseveral decades and early developers could nothave envisioned the movement of electricitybeing considered under many of today’s com-petitive scenarios. As such, the transmissionsystem is a critical link in the move to changethe electric power system.

Local Distribution SystemsMost homes and businesses use 120- and

240-volt electric power while industries oftenuse higher voltages. Large commercial and in-dustrial customers may bypass the local dis-tribution system, receiving electricity at highvoltage directly from the transmission system.

Substations on the transmission system re-ceive power at higher voltages and lower themto 24,900 volts or less to feed the distributionsystems. The distribution system is the polesand wires commonly seen in neighborhoods.At key locations, voltage is again lowered bytransformers to meet customer needs.

Customers on the distribution system arecategorized as industrial, commercial and resi-dential. Industrial use is fairly constant, both

Texans pay 5% less per kWh than the U.S., but because we use28% more electricity on average, our electric bills are 21% higher.

Real Change in Cost of Electricity in TexasAdjusted to 1996 Dollars (1996 GDP Deflator)

1990 to 2000

Cents per kWh 1996$

Source: U.S. EIA.

Residential

Commercial

Industrial

Cost Per Kilowatt-Hour andAverage Annual Cost Per Customer

Texas and the U.S. - 2000Avg. Cost

Cost per kWh Per CustomerTexas U.S. Texas U.S.

Residential 7.96¢ 8.24¢ $1,160 $879Commercial 6.88¢ 7.43¢ $5,337 $5,464Industrial 4.42¢ 4.64¢ $73,287 $93,760Other 6.77¢ 6.56¢ $8,295 $7,369All 6.49¢ 6.81¢ $2,220 $1,828

Source: U.S. EIA

7


over the day and over seasons. Commercial useis less constant and varies over seasons. Resi-dential and commercial use is more variable,sometimes changing rapidly over the day inresponse to occupant need, appliance use andweather events.

Many Texas municipal utilities and co-opsprovide only distribution services, purchasingpower from the IOUs, other cooperatives orriver authorities.

Texas and the U.S.The electrical systems in the U.S. and much

of Canada are divided into three major regions- the Eastern Interconnection, the Western In-terconnection and the Texas Interconnection,which includes most of the state. These aregroups of utilities which connect to each otherto form the three power grids.

The utilities operate in such a way that elec-tricity can move reliably between utilitieswithin the Interconnections. Few direct con-nections exist between the Interconnections.ERCOT has two high voltage DC (direct cur-rent) connections, both to the Eastern Intercon-nection. The northern tie has a capacity of 200megawatts and the eastern tie, a 600 megawattcapacity. These DC ties accept AC (alternatingcurrent) in and provide AC out, but they arenot necessarily synchronous (see page 12 onsystem stability).

In response to a major blackout in 1965 inthe Northeast, the North American Electric Re-liability Council (NERC) was created. Mostelectric power systems in the U.S. and Canadaare members of one of NERC’s 10 Regional Re-liability Councils (see Part 2 for details).

ERCOT serves approximately 85 percent ofthe state’s electric load and oversees the op-eration of approximately 70 gigawatts of gen-eration and over 37,000 miles of transmissionlines. Most of the Texas Panhandle and part ofEast Texas are in the Southwest Power Pool(SPP). The El Paso region is in the Western Elec-tricity Coordinating Council (WECC). A smallpart of Southeast Texas (Beaumont area) is inthe Southeastern Electric Reliability Council(SERC).

In 1995, Texas created an Independent Sys-

tem Operator (ISO) as proposed by ERCOT.An ISO is an independent, unbiased third-party entity that oversees the activities relatedto the reliable and safe transmission of elec-tricity within a specified geographic area. Af-ter SB 7, ERCOT also provides the platform foran open, competitive marketplace for the ma-jority of Texas customers. ERCOT is requiredto (1) ensure non-discriminatory access to theT&D systems for all electricity buyers and sell-ers, (2) ensure the reliability and adequacy ofthe regional electric network, (3) ensure thatinformation related to customer retail choiceis provided in a timely manner, and (4) ensurethat electricity production and delivery are ac-curately accounted for among all regional gen-erators and wholesale buyers and sellers. Asthe ISO, ERCOT operates an information net-work for all market participants’ use as a pri-mary means of facilitating efficient and equi-table use of the transmission system.

How Much Does It Cost and What DoWe Spend?

Texas electricity is cheaper than the U.S. av-erage but because we consume more, monthlybills are higher. Electricity rates and costs forTexas residential, commercial and industrialcustomers are compared with the U.S. in thetable on the previous page.

The electricity rate averaged for all customerclasses in 2000 was 6.49¢ per kilowatt hour(kWh), 4.7 percent lower than the U.S. aver-age. The average residential electricity rate inTexas was 3.4 percent lower than the U.S. av-erage. However, higher use in Texas resultedin residential bills that were higher by $281 -about 32 percent higher.

In 2000, commercial customers in Texas paid6 percent more per kWh than the overall Texasaverage and about 14 percent less than resi-dential customers.

At 4.42¢ per kWh, industrial customers paidslightly more than half the rate of residentialcustomers. Texas industrial rates were 4.7 per-cent lower than the U.S. industrial average.With interruptible service, large electricity us-ers may have lower rates. Such rates also re-flect lower fuel costs in Texas, the economies

8


of serving large users, and lower variability.In the U.S. from 1991 to 2000, average elec-

tricity rates (adjusted to constant 1996 dollars)decreased by 17.1 percent. Industrial custom-ers have seen their rates decrease by 22.7 per-cent. Rates for commercial customers de-creased by 19.7 percent while those for resi-dential customers decreased by 14.4 percent.

In Texas, rates also declined over the sameperiod but not as much. Average electricityrates (in 1996 dollars) decreased by 10.7 per-cent. Residential rates decreased by 12.6 per-cent and commercial rates by 13 percent whileindustrial rates declined by 10 percent (seechart on page 6).

Cost Variation Among UtilitiesAs reported in the table above, electricity

rates have varied widely within the state dur-ing 2000. Each utility had its own rates and costbasis, and each was treated separately in ratemaking by the PUCT. The process of establish-ing rates and cost basis will continue for T&Dutilities under SB 7.

Residential rates varied from as little as 1.51¢per kWh (City of San Augustine, a muni) to asmuch as 17.66¢ (Harmon Electric Association

Inc., a co-op); the next lowest rate was 5.35¢(Southwest Arkansas ECC, a co-op) and thenext highest rate was 13.04¢ (Rio Grande Elec-tric Coop Inc., a co-op). The rates varied from122 percent higher than the state average of7.96¢ to 81 percent lower. IOUs averaged 7.97¢while co-ops averaged 8.42¢ and munis aver-aged 7.84¢.

Electricity rates for commercial customers inTexas varied from as low as 5.18¢ (Southwest-ern Electric Power Co., an IOU) to 27.66¢ perkWh (City of Flatonia, a muni); the next high-est rate was only 17.01¢ (City of San August-ine, a muni). The rates ranged from 24 percentbelow to 302 percent above the average com-mercial rate of 6.88¢. IOUs averaged 6.94¢while co-ops averaged 7.71¢ and munis aver-aged 8.20¢.

Rates for industrial users varied from as lowas 2.71¢ (Southwestern Public Service Co., anIOU) to 12.37¢ per kWh (City of Hearne, amuni) with a variation from 38 percent lowerto 180 percent higher than the state average of4.42¢. IOUs averaged 4.76¢ while co-ops aver-aged 5.56¢ and munis averaged 6.48¢.

The Electric Power Industry in TexasHistorically, total expenditures for all energy

have accounted for about seven percent of theGross Domestic Product (GDP) in the U.S.Purchase of natural gas and electricity serviceshave amounted to more than three percent ofGDP. Investment in natural gas and electric-ity services has been about five percent of to-tal, fixed, nonresidential investment. Energyis big business in the U.S. and electricity is avital input to our national economy.

Texas accounts for almost 10 percent of netelectricity generation in the U.S., a resultmainly of our large petroleum refining and pet-rochemical industries. We provide about ninepercent of the $226 billion electricity final salesrevenue in the U.S., more than any state ex-cept California, which provides 10 percent.

Clearly, electricity is important to Texas. It isrelatively cheap, and so has been beneficial tobusiness and residential growth. The size ofthe Texas electric power industry means thatpolicies and business trends that impact elec-tric power in the U.S. will have a big effect here.

Cost Variation Among Utilities (¢ per kWh, 2000)

Residential Commercial Industrial

Texas Average 7.96 6.88 4.42

Texas Lowest 1.51 5.18 2.71

Texas Highest 17.66 27.66 12.37

IOU Average 7.97 6.94 4.76

IOU Lowest 5.86 5.18 2.71

IOU Highest 10.60 9.83 9.26

Co-op Average 8.42 7.71 5.56

Co-op Lowest 5.35 5.26 3.31

Co-op Highest 17.66 10.9 8.18

Muni Average 7.84 8.20 6.48

Muni Lowest 1.51 5.47 3.51

Muni Highest 11.63 27.66 12.37

Source: U.S. EIA.

Rates for all customer groups vary widely across Texas. In particular, co-opand muni rates demonstrate large variability due to generation type, the ex-tent of the T&D system and the size and mix of customer types. On average,however, IOU rates are lower than those of co-ops and munis.

9

The Basics of Electric Power

Electricity travels fast, cannot be stored eas-ily or cheaply, and cannot be switched fromone route to another. These three principles arebasic to the operation of an electric power sys-tem.

Electricity is almost instantaneous. When alight is turned on, electricity must be readilyavailable. Since it is not stored anywhere onthe power grid, electricity must somehow bedispatched immediately. A generator is notsimply started up to provide this power. Elec-tric power must be managed so that electric-ity is always available for all of the lights, ap-pliances and other uses that are required at anyparticular moment.

Electricity traveling from one point to an-other follows the path of least resistance ratherthan the shortest distance. With thousands ofmiles of interconnected wires throughout theU.S., electricity may travel miles out of any

direct path to get where it is needed.As a result of these three principles, design-

ing and operating an electrical system is com-plex and requires constant management.

Defining and Measuring ElectricityElectricity is simply the flow or exchange of

electrons between atoms. The atoms of somemetals, such as copper and aluminum, haveelectrons that move easily. That makes thesemetals good electrical conductors.

Electricity is created when a coil of metalwire is turned near a magnet (Diagram 1).Thus, an electric generator is simply a coil ofwire spinning around a magnet. This phenom-enon enables us to build generators that pro-duce electricity in power plants.

The push, or pressure, forcing electricityfrom a generator is expressed as volts. The flowof electricity is called current. Current is mea-sured in amperes (amps).

Watts are a measure of the amount of workdone by electricity. Watts are calculated by

OverviewThe main function of an electricalpower system is to transmit allelectricity demanded reliably,

and in the exact amount, where it isneeded. In addition, it should providefor unforeseen contingencies arisingfrom larger than expected demand orsystem outages. The industry structurehas three main segments - generation,transmission, and distribution.

Generation – The process of produc-ing electric energy by transformingother forms of energy such as coal,natural gas or solar power.

Transmission – The movement ortransfer of electric energy over an in-terconnected group of high voltagelines between points of supply andpoints at which it is transformed fordelivery to consumers or other electricsystems. Transmission ends when theenergy is transformed for input intothe distribution system.

Distribution – The portion of theelectrical system which operates at lowvoltages and delivers electricity to anend-user such as a home, business orindustrial plant.

Most electrical services used to beprovided by large, vertically inte-grated companies that owned the gen-

eration, transmission and distri-bution (T&D) facilities within aspecified service area. Today, thegeneration and sale of electricpower in ERCOT can be providedby unregulated (but certified)companies in competitive mar-kets. T&D operations are still pro-vided by regulated utilities, whomust unbundle their systems sothat generation, sales and relatedservices are separate and so that“open access” can be provided ina fair, nondiscriminatory way toall competitors. Competitors in-clude competing generators, mar-keters, aggregators (who combinecustomers into larger groups), re-tail electric providers or REPs(who handle customer accountsand sales) and qualified schedul-ing entities or QSEs (who handlethe scheduling of electricity sup-plies from generators and demandfrom aggregators, marketers andREPs).

The Basics ofElectric Power

When a metal wire,such as copper, ispassed through amagnetic field,electrons areexchanged fromatom to atom. Thisforms a movingstream or current ofelectricity.

Diagram 1Electric Current

Basic Measures ofElectricity

VoltsThe push or pressureforcing electricity in a

circuit.

AmperageUnit of measurement

(amps) of electrical currentor flow

Watts, Kilowatts andMegawatts

A measure of electricity’sability to do work.

Equals volts times ampsKilowatt=1,000 watts

Megawatt = 1,000,000 watts

ResistanceThe measure in ohms of

how much force it takes tomove electric currentthrough a conductor.

Resistance in conductorscauses power to be

consumed as electricityflows through.

10


multiplying amps times volts. Electrical appli-ances, light bulbs and motors have certainwattage requirements that depend on the tasksthey are expected to perform. One kilowatt(1,000 watts) equals 1.34 horsepower.

Kilowatts are used in measuring electricaluse. Electricity is sold in units of kilowatt-hours (kWh). A 100-watt light bulb left on forten hours uses one kilowatt-hour of electricity(100 wattsx10 hours=1,000 watt hours=1 kWh).The average residential customer in Texas usesmore than 14,500 kWh annually. In 2000, Tex-ans used more than 318 billion kWh.

Electricity in the U.S. is generated and usu-ally transmitted as alternating current (AC).The direction of current flow is reversed 60times per second, called 60 hertz (Hz). Becauseof the interconnection within the power grids,the frequency is the same throughout the grid.Operators strive to maintain this frequency at60 Hz.

Higher voltages in many instances can betransmitted more easily by direct current (DC).High voltage direct current (HVDC) lines areused to move electricity long distances.

Types of Generators

Steam TurbineUses either fossil fuel or nuclear fuel to generateheat to produce steam that passes through aturbine to drive the generator; primarily for baseload but some gas-fired plants are also used forpeak loads; range in size from 1 to 1,250 megawatts.

Combustion TurbineHot gases are produced by combustion of naturalgas or fuel oil in a high pressure combustionchamber; gases pass directly through a turbinewhich spins the generator; used primarily for peakloads but combined cycle plants are used for baseload; generator is generally less than 100megawatts; quick startup suitable for peaking,emergency, and reserve power.

Hydroelectric Generating UnitsFlowing water used to spin a turbine connected toa generator; range in size from 1 to 700 megawatts;can start quickly and respond to rapid changes inpower output; used for peak loads and spinningreserve, as well as baseload.

Internal Combustion EnginesUsually diesel engines connected to the shaft of agenerator; usually 5 megawatts or less; no startuptime; operated for periods of high demand.

OthersGeothermal, solar, wind, and biomass; manydifferent technologies; range widely in size andcapabilities.

Boiler heats purewater circulatingin pipes to makesteam

Lignite, coal,natural gas oroil is used toheat thefurnace.

Steam turnsthe Turbine . . ..

which turns theGenerator Rotorproducing Electricity

and is convertedback to boiler waterfor another cycle

Steam

Condenser

Spent steam goes tothe Condenser . . .

Transformerincreases voltagefor transmission

Steam Turbine Electric Power PlantDiagram 2

Condensercooling watercomes from apower plant lakeor water tower

Generating Electricity There are many fuels and technologies thatcan generate electricity. Usually a fuel likecoal, natural gas, or fuel oil is ignited in thefurnace section of a boiler. Water pipedthrough the boiler in large tubes is super-heated to produce heat and steam. Thesteam turns turbine blades which are con-nected by a shaft to a generator. Nuclearpower plants use nuclear reactions to pro-duce heat while wind turbines use the windto turn the generator. A generator is a huge electromagnet sur-rounded by coils of wire which produceselectricity when the shaft is rotated (Dia-gram 2). Electricity generation ranges from13,000 to 24,000 volts. Transformers increase

11


the voltage to hundreds of thousands of voltsfor transmission. High voltages provide aneconomical way of moving large amounts ofelectricity over the transmission system.

Transmission & DistributionOnce electricity is given enough push (volt-

age) to travel long distances, it can be movedonto the wires or cables of the transmissionsystem. The transmission system moves largequantities of electricity from the power plantthrough an interconnected network of trans-mission lines to many distribution centerscalled substations. These substations are gen-erally located long distances from the powerplant. Electricity is stepped up from lower volt-ages to higher voltages for transmission.

High voltage transmission lines are intercon-nected to form an extensive and multi-pathnetwork. Redundant means that electricity cantravel over various different lines to get whereit needs to go. If one line fails, another will takeover the load. Most transmission systems useoverhead lines that carry alternating current(AC). There are also overhead direct current(DC) lines, underground lines, and even un-der-water lines.

All AC transmission lines carry three-phasecurrent -- three separate streams of electricitytraveling along three separate conductors.Lines are designated by the voltage that they

can carry. Power lines operated at 60 kilovolt(kV) or above are considered as transmissionlines. There are about 50,000 miles of transmis-sion lines in Texas.

Even though higher voltages help pushalong the current, electricity dissipates in theform of heat to the atmosphere along trans-mission and distribution lines. This loss of elec-tricity is called line loss. About 7 percent of allelectricity generated in Texas is lost duringtransmission and distribution.

Switching stations and substations are usedto (1) change the voltage, (2) transfer from oneline to another, and (3) redirect power when afault occurs on a transmission line or otherequipment. Circuit breakers are used to dis-connect power to prevent damage from over-loads.

Control centers coordinate the operation ofall power system components. One or moreutilities can make up a control area. To do itsjob, the control center receives continuous in-formation on power plant output, transmissionlines, ties with other systems, and system con-ditions.

Transmission ConstraintsThere are some important constraints that

affect the transmission system. These includethermal limits, voltage limits, and system op-eration factors.

Base Load UnitGenerates the minimum or baseload requirementof the power system; operates at a constant rateand runs continuously.

Peak Load UnitUsed to meet requirements during the periods ofgreatest demand.

Intermediate Load UnitUsed during the transition between base load andpeak load requirements.

Reserve or Standby UnitsAvailable to the system in the event of anunexpected increase in load or outage.

Base Load

Time

PeakLoadReserve/Standby

Uses of Generating Units

LoadDemand

Intermediate Load

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Thermal/Current LimitsElectrical lines resist the flow of electricity

and this produces heat. If the current flow istoo high for too long, the line can heat up andlose strength. Over time it can expand and sagbetween supporting towers. This can lead topower disruptions. Transmission lines arerated according to thermal limits as are trans-formers and other equipment.

Voltage LimitsVoltage tends to drop from the sending to

the receiving end of a transmission line. Equip-ment (capacitors and inductive reactors) is in-stalled to help control voltage drop. If voltageis too low, customer equipment and motors canbe damaged.

System Operation ConstraintsPower systems must be secure and reliable.

Operating constraints are needed to assure thatthis is achieved.

Power Flows: Electricity flows over the pathof least resistance. Consequently, power flowsinto other systems’ networks when transmis-sion systems are interconnected. This createswhat are known as loop flows. Power alsoflows over parallel lines rather than the linesdirectly connecting two points - called paral-lel flows. Both of these flows can limit the abil-ity to make other transmissions or cause toomuch electricity to flow along transmissionlines thus affecting reliability.

Preventive Operations: The primary way ofpreventing service failures from affecting otherareas is through preventive operations. Stan-dards and procedures from the NERC are fol-lowed. Operating requirements include (1)having a sufficient amount of generating ca-pacity available to provide reserves for unan-ticipated demand and (2) limiting the powertransfers on the transmission system. Theguidelines recommend that operations be ableto handle any single contingency and to pro-vide for multiple contingencies when practi-cal. Contingencies are identified in the designand analysis of the power system.

System Stability: The two types of stabilityproblems are maintaining synchronization of

the generators and preventing voltage col-lapse. Generators operate in unison at a con-stant frequency of 60 Hz. When this is dis-turbed by a fault in the transmission system, agenerator may accelerate or slow down. Un-less returned to normal conditions, the systemcan become unstable and fail.

Voltage instability occurs when the transmis-sion system is not adequate to handle reactivepower flows. “Reactive power” is needed tosustain the electric and magnetic fields inequipment such as motors and transformers,and for voltage control on the transmissionnetwork.

DistributionThe distribution system is made up of poles

and wire seen in neighborhoods and under-ground circuits. Distribution substations moni-tor and adjust circuits within the system. Thedistribution substations lower the transmissionline voltages to 34,500 volts or less.

Substations are fenced yards with switches,transformers and other electrical equipment.Once the voltage has been lowered at the sub-station, the electricity flows to homes and busi-nesses through the distribution system.

Conductors called feeders reach out from thesubstation to carry electricity to customers. Atkey locations along the distribution system,voltage is lowered by distribution transform-ers to the voltage needed by customers or end-users.

Customers at the End of the LineThe ultimate customers who consume elec-

tricity are generally divided into three catego-ries: industrial, commercial, and residential.The cost to serve customers depends upon anumber of factors including the type of ser-vice (for example, if service is taken at high orlow voltage) and the customer’s location withrespect to generating and delivery facilities.

IndustrialIndustrial customers generally use electric-

ity in amounts that are relatively constantthroughout the day. They often consume manytimes more electricity than residential consum-

Power System Limits

Thermal LimitsThe maximum amountof electrical current thata transmission line orelectrical facility canconduct over a specifiedtime period before itsustains permanentdamage by overheatingor violating publicsafety requirements.

Voltage LimitsThe maximum voltagethat can be handledwithout causing dam-age to the electric sys-tem or customer facili-ties. System voltagesand voltage changesmust be maintainedwithin the range of ac-ceptable minimum andmaximum limits. Awidespread collapse ofsystem voltage can re-sult in a blackout of por-tions or all of the inter-connected network

Stability LimitsAn interconnected sys-tem must be capable ofsurviving disturbancesthrough time periodsvarying from millisec-onds to several minutes.With an electrical dis-turbance, generatorscan begin to spin atslightly differing speedscausing differences infrequency, line loads(current) and systemvoltages. These oscilla-tions must diminish asthe electric system at-tains a new stable oper-ating point. If a newpoint is not quickly es-tablished, generatorscan lose synchronismand all or a portion ofthe interconnected sys-tem may become un-stable, causing damageto equipment and, leftunchecked, widespreadservice interruption.

13


ers. Most industrial demand is considered tobe base load. As such it is the least expensiveload to serve. Many industrial loads are ex-pected to remain within certain levels overtime with relatively little variation. Major in-dustrial customers may receive electricity di-rectly from the transmission system (ratherthan from a local distribution system).

Some industrial plants have their own gen-erators. If they are qualifying facilities (QFs)or exempt wholesale generators (EWGs), theirexcess electricity can be sold to utilities on thegrid.

CommercialCommercial loads are similar to industrial

in that they remain within certain levels overintermediate periods of time.Examples of commercial cus-tomers are office buildings,warehouses, and shopping cen-ters.

ResidentialResidential electrical use is

the most difficult to provide be-cause households use much oftheir electricity in the morningand evening and less at othertimes of the day. This is less ef-ficient to provide and thereforea more expensive use of theutility’s generators. Over time,as homeowners buy new appli-ances and change life-styles, theexpected loads also change. Ex-amples of residential loads areindividual residences.

Putting the PartsTogether

The physical parts of the elec-tric power system are genera-tion, transmission and distribu-tion. Numerous power plants,thousands of miles of transmis-sion lines, and thousands ofsubstations and other infra-structure are part of this physi-

cal inventory.In addition, hundreds of organizations and

corporations make up the electric power sys-tem. These include investor-owned utilities,municipal and cooperative utilities, river au-thorities, power producers, holding compa-nies, retail electric providers and others.

Activities are regulated by state and federalagencies under the direction of state and fed-eral legislation. Regional coordination is ac-complished through reliability councils.

OrganizationsPrivate Utilities: The IOUs are granted a li-

cense by the state to provide electrical servicesto a particular area. Many areas compete un-der multi-certifications which allow more than

FOSSIL FUELSFossil fuels are derived from decaying vegetation

over many thousands or millions of years. Coal,lignite, oil (petroleum) and natural gas are all fossilfuels. Fossil fuels are non-renewable, meaning thatwe extract and use them faster than they can bereplaced. Fossil fuels are combusted in boilers, andcombustion turbines and engines in order to convertwater to steam that is used to power the turbines inan electric generator. A concern is that fossil fuels,when combusted, may emit gases into theatmosphere that contribute to climate change.Considerable effort is underway to devise cleantechnologies that will allow fossil fuel use with fewor no emissions.

CoalA black or brownish black solid combustible

fossil fuel typically obtained from surface orunderground mines. Coal is shipped by rail topower plants and may be imported from othercountries. In Texas, as in other coal producing states,electric generating stations are often “mine-mouth,”meaning that they are built at the mine andextracted coal is taken directly to the generator.

Coal is classified according to carbon content,volatile matter and heating value. Lignite coalgenerally contains 9 to 17 million Btus (Britishthermal units, a measure of heat content) per ton.Texas lignite has somewhat lower heat content. Sub-bituminous coals range from 16 to 24 million Btuper ton; bituminous coals from 19 to 30 million Btu/ton; and anthracite, the hardest type of coal, from22 to 28 million Btu per ton.

Texas has about 10 billion tons of recoverable

lignite reserves and, in 2001, ranked first in theU.S. in consumption, fifth in production andseventh in recoverable reserves.

Natural GasNatural gas is a mixture of hydrocarbons

(principally methane, a molecule of one carbonand four hydrogen atoms) and small quantitiesof various non-hydrocarbons in a gaseous phaseor in solution with crude oil in undergroundreservoirs. Texas has approximately 42 trillioncubic feet (tcf) of proven natural gas reserves,24 percent of proven U.S. domestic reserves.

Fuel OilFuel oils are the heavier oils in a barrel of

crude oil, comprised of complex hydrocarbonmolecules that remain after the lighter oils havebeen distilled off during the refining process.Fuel oils are classed according to specific gravityand the amount of sulfur and other substancesthat might occur. Virtually all petroleum usedin steam electric plants is heavy oil. Currently,a negligible amount of Texas electricity isgenerated using fuel oil.

RENEWABLESRenewable fuels are those that are not

depleted as they are consumed. The wind, sun,moving waters (hydroelectric), water heated inthe earth (geothermal) and vegetable matter(biomass) are typical renewable energy sourcesfor electricity. (cont’d next page)

Energy Sources for Generating Electricity

14


ing emergency service, of thewires in their service territories.

Municipal Utilities: Theseutilities provide all of the samefunctions as the private utilitiesbut are managed by a municipal-ity. Municipal utilities, like theirprivate counterparts, charge arate of service sufficient to recouptheir investment and ensure forcontinued reliable serviceswithin a service area.

Cooperatives: Historically,cooperatives developed in re-sponse to the need to serve ruralareas. Public utilities could notrecover the costs of building elec-trical facilities to remote areasand, therefore, did not want toserve those areas. Federal legis-lation in the 1930’s allowed forthe creation of Rural Electric Co-operatives by providing low in-terest loans guaranteed by thegovernment. Local cooperativescoordinate closely with utilitiesin adjoining areas to ensure reli-ability to their service areas andto avoid duplication of facilities.

Municipal Governments: InTexas, municipal governmentsare generally responsible for ap-

proving rates which utilities will charge fortheir services. It is their responsibility to reviewthe prudence of investments made by utilitiesto determine if costs will be allowed to be re-covered. Municipal governments that do notwant to perform this review process can turnover this responsibility to the PUCT.

Public Utility Commission of Texas(PUCT): Established by the Texas legislaturein 1975, this statewide regulatory body wascreated to oversee the operations of private andmunicipal utilities. Originally this includedelectricity, telephones, water and sewage. To-day it includes primarily certain electric utili-ties and telecommunications companies. ThePUCT has jurisdiction over electric and phonein unincorporated areas of Texas. Municipal

HydroelectricityElectricity can be created as turbine generators

are driven by moving water. Texas has onequadrillion Btus (quad Btu) per year of potentialhydroelectric resources. (For comparison, the U.S.consumes about 99 quad Btu of energy per year.)Texas has about 472 megawatts of installedcapacity. While hydroelectricity is considered arenewable fuel, management of flowing rivers andcycles of rain and drought can impact hydroelectriccapacity greatly as well as contribute to otherenvironmental effects.

Wind ElectricityElectricity can be created when the kinetic

energy of wind is converted into mechanicalenergy by wind turbines (blades rotating from ahub), that drive generators. It has been estimatedthat Texas has four quad Btus per year of potentialwind electricity. 37 percent of the Texas Panhandlecould produce 205 gigawatt hours of electricity peryear (about 64 percent of Texas consumption), iftransmission can be built economically to movethis electricity to population centers. It has beenestimated that three states - Texas, North and SouthDakota - could provide, in principle, all of theelectricity needed in the U.S. Again, this dependson the economics of transmission. Wind energy isintermittent and in Texas, and many other states,is located away from major demand areas. SB 7calls for 2,000 megawatts of new renewable energyto be part of the total electric power generationmix by 2009. Today, there is more than 1,000megawatts of wind capacity. More than 900megawatts of this capacity were built in 2001.

Energy Sources for Generating Electricity (cont’d)Solar Electricity

Radiant energy from the sun can beconverted to electricity by using thermalcollecting equipment to concentrate heat,which is then used to convert water to steamto drive an electric generator. Solar electricityis about a decade behind wind electricity indevelopment for commercial applications.Texas has 250 quad Btu per year of potentialsolar-powered electricity, or about 90gigawatts. Solar electricity represents animportant future energy source for Texas,especially for niche markets like off-gridpower. Solar energy depends on availablesunlight and is reliant on storage orsupplementary power sources.

Biomass and GeothermalElectricity can be created when various

materials (like wood products and agriculturalwaste, or even crops grown for use in electricityproduction) are combusted. Heat fromcombustion is used to convert water to steamfor power generation. Texas has an accessiblebiomass resource base of three quad Btu peryear, although this would require a substantialamount of acreage and soil resources and largeamounts of water to produce sufficient biomassfeedstock. Electricity can also be created whensteam produced deep in the earth is used torun turbines in a generator. Texas has anaccessible geothermal resource base of onequad Btu per year. Currently, a negligibleamount of Texas electricity is generated usingbiomass.

one service provider. In exchange for the obli-gation to serve all customers, utilities are al-lowed the opportunity to earn a reasonablereturn on those investments which are deemedby the state to have been constructed in theinterest of serving customers in their servicearea. This relationship between private indus-try and governments at the local or state levelis the historical arrangement for providingelectricity service. In 2000, there were 12 in-vestor-owned utilities in Texas. After SB 7, onlythe T&D services remain as regulated servicesprovided by the utilities. The operational rightsof these systems were transferred to theERCOT ISO (see below for more on the ERCOTISO) while the utilities will continue to pro-vide the expansion and maintenance, includ-

15

governments can vote to turn over this respon-sibility to the PUCT.

Non-Utility generators (NUG’s): Electricitycustomers have always had the option of pro-viding their own electrical supply. In Texas,refineries, chemical and other large industrialplants generate large portions of their ownelectricity needs. A non-utility generator is acorporation, which is not affiliated with a pub-lic or municipal utility or a cooperative, thatgenerates electricity. Federal legislation(PURPA) provides the option for some NUG’sto sell excess electricity to utilities (see Part 4 -Regulations and Policies for details). Utilitiesare required to buy this excess electricity at thecost they would incur to generate an equiva-lent amount of electricity themselves.

With the restructuring of the industry, muchof the generation in Texas has become non-util-ity generation. Utilities have created new, af-filiated generation companies that are func-tionally separated from their T&D businesses.As SB 7 preserves existing contracts, utilitiesassigned the PURPA contracts they hold withNUG’s either to the affiliated power genera-tion company (PGC) or the affiliated retail elec-tricity provider (REP).

Federal Energy Regulatory Commission(FERC): The FERC is successor to the FederalPower Commission (FPC) which was chargedwith regulating the natural gas and electricityindustries in 1938. The FPC was abolished in1977 and in its place the Department of En-ergy and the FERC were established. The FERChas jurisdiction over interstate electricity trans-actions as well as wholesale (sales for resale)electricity transactions. Its original authorityover natural gas remains in place, among otherfunctions.

Regional Reliability Councils: As a resultof the complexity of the electricity industry, re-gions have been established throughout theUnited States to ensure reliable operation ofthe electrical system. These regional reliabil-ity councils are nonprofit organizations fundedby utility and non-utility entities. The coun-cils in Texas are the Southwest Power Pool(SPP), the Western Electricity CoordinatingCouncil (WECC), Southeastern Electric Reli-

ability Council (SERC)and the ERCOT. ERCOT isby far the largest of thefour with a service areathat serves about 85 per-cent of the electrical loadin Texas (The implementa-tion of SB 7 has been de-layed in SPP, WECC andSERC territories withinTexas).

Reliability CouncilsThe need to coordinate

electrical systems in NorthAmerica arose after a seriesof major blackouts in theNortheast in 1965. TheNorth American ElectricReliability Council (NERC)was formed for “coordinat-ing, promoting and com-municating about reliabil-ity.” Most electric powersystems in the U.S., Canadaand some in Mexico aremembers of one of 10 Re-gional Reliability Councils(the state of Florida recentlybecame a separate memberof NERC). Each region ad-heres to operating rules forone of the three majorpower grids in the U.S - the Eastern Intercon-nection, the Western Interconnection and theTexas Interconnection. The Texas Interconnectionis the ERCOT region.

Utilities in each of these interconnections arecontinuously synchronized so that their sys-tems operate at the same frequency. In addi-tion, utilities communicate with each otherabout system maintenance and operation toensure that sufficient electricity will be avail-able when it is required.

Since its formation in 1970, ERCOT has op-erated as one of 10 regional reliability councilswithin the NERC umbrella organization. In1996, it became the ERCOT ISO (IndependentSystem Operator), keeping its security respon-

Energy Sources for GeneratingElectricity (cont’d)


NUCLEARNuclear energy is a non-renewable, non-fossil

fuel form of energy derived from atomic fission.

Nuclear ElectricityThe heat from splitting atoms in fissionable

material, such as uranium or plutonium, is usedto generate steam to drive turbines connected toan electric generator. Uranium is a heavy, natu-rally radioactive metallic element which has twoprinciple isotopes, uranium-235 or uranium-238.Uranium-235 is the only isotope existing in na-ture in appreciable quantities and is thus indis-pensable to the nuclear industry (which includesapplications other than electric power for civil-ian use). Uranium-238 absorbs neutrons to pro-duce a radioactive isotope that decays to pluto-nium-239, which is also fissionable. About 10 per-cent of electricity produced by Texas utilities isnuclear. Nuclear plants have been by far the mostexpensive to construct, although uranium is theleast expensive fuel to use (apart from questionsabout disposal costs). No nuclear plant has beenordered in the U.S. since 1978. The costs and po-tential hazards associated with decommissioningnuclear facilities are likely to be substantial andthe disposal of radioactive wastes from these fa-cilities remains an unresolved issue in the U.S.However, in recent years nuclear facilities haveproved to be reliable generators and the propor-tion of nuclear power consumed in all of the U.S.has grown. Nuclear generation produces nogreenhouse gas emissions. New, small scalenuclear generation technologies such as pebble-bed modular reactor are under development.

16


sibilities while adding facilitation of the whole-sale transmission market to its responsibilities.This includes administration of the ERCOTOASIS (an on-line information system for en-ergy transaction scheduling and energy ac-counting) and coordination of transmission

planning with ERCOT. Today itsrole is expanded in response to theSB 7. Under the new legislation,and with the “customer choice”mandate that came into effect inJanuary 2002, ERCOT has beengiven the responsibility to developmarket structure, infrastructure,and business processes to facilitateretail competition. The ERCOT ISO’s members in-clude participants from Coopera-tives and River Authorities, Mu-nicipals, Investor-Owned Utilities,Independent Power Marketers, In-dependent Retail Electric Provid-ers, Independent Generators, andConsumers. As of October 7, 2002,ERCOT’s Membership included147 voting and non-voting Mem-bers. The Member groups are com-prised of 44 Cooperatives andRiver Authorities, 23 Municipals,13 Investor Owned Utilities, 21 In-dependent Power Marketers, 15Independent Generators, 14 Inde-pendent Retail Electric Providers,and 15 Consumers, as well as twoAdjunct Members. Transmission systems of themembers cover 200,000 squaremiles. ERCOT members serve over12 million customers, with annual

electricity sales of 270 gigawatt hours, repre-senting 85 percent of the total load in Texas. ERCOT transmission lines extend as far northas Wheeler in the Texas Panhandle to 650 milessouth to Brownsville in the southernmost tipof Texas. The lines run from the junction of I-10 and I-20 in West Texas to the Sabine Riverbordering Louisiana, also approximately 650miles.

In addition to the 37,000 miles of transmis-

sion lines in ERCOT, there are an additional13,000 miles of transmission lines operated innon-ERCOT areas of Texas, especially withinthe SPP.

ERCOT member facilities form a single in-terconnection, located entirely within the state.The other areas are served by El Paso Electric(far west Texas), Southwestern Public Service(Texas Panhandle), South Western ElectricPower and Entergy/Gulf States Utilities (EastTexas). Two DC ties provide 800 megawatts oftransfer capability between this intrastate in-terconnection and the Eastern Interconnection.

The ERCOT operating protocols incorporatethe reliable operation and planning of the in-terconnected system. The basic element withina Regional Reliability Council is known as acontrol area. Control areas are responsible formatching electricity supply and demand on aninstantaneous basis. One or more utilities canoperate within a control area but only one isassigned the responsibility of being the Con-trol Area Operator.

Control areas are electrical systems, boundby interconnect metering and telemetry whichcontinuously regulate through automatic gen-eration control. Control areas generate and in-terchange schedules (purchases and sales) tomatch loads, and contribute to the frequencyregulation of the interconnection.

Vertically integrated utilities typically oper-ate their own control areas. In some areas ofthe country, utilities have joined together tocreate “tight power pools” which act as con-trol areas for multiple utilities and centrallydispatch all of the generating facilities in thepool based on economic criteria without regardto ownership. There are over 140 separate con-trol areas in the U.S.

There used to be nine control areas inERCOT, operated by TXU Electric, HoustonLighting & Power, Central and Southwest Ser-vices, Texas Municipal Power Pool (a combi-nation of Brazos Electric Coop and Texas Mu-nicipal Power Agency), Lower Colorado RiverAuthority, City of Austin, South Texas/MedinaCoop Power Pool, the Public Utilities Board ofBrownsville, and Texas New Mexico PowerCompany. In order to manage its tasks under

What is ERCOT ISO?

The ERCOT ISO is the nonprofitcorporation that administers the powergrid.

The ERCOT ISO serves 85 percent ofthe state’s electric load and oversees theoperation of over 70,000 megawatts ofgeneration and over 37,000 miles oftransmission lines. Texas restructured itselectricity industry, bringing “customerchoice” as of January 1, 2002. Under thenew legislation, ERCOT has theresponsibility to develop marketstructure, infrastructure, and businessprocesses to facilitate retail competition.

The ERCOT ISO is one of 10 electricreliability regions in North Americaoperating under the reliability andsafety standards set by the NERC. As aNERC member, ERCOT’s primaryresponsibility is to facilitate reliablepower grid operations in the ERCOTISO region by working with the area’sindustry organizations.

The PUCT has primary jurisdictionalauthority over ERCOT to ensure theadequacy and reliability of electricityacross the state’s power grid. A Boardof Directors comprised of marketparticipants governs the ERCOT ISO. Itsmembers include retail consumers,investor and municipally owned electricutilities, rural electric coops, riverauthorities, independent generators,power marketers, and retail electricproviders.

17

the restructured industry, the ERCOT regionhas become a single control area and theERCOT ISO has become its operator.

ERCOT is responsible for coordinating theactions of market participants and also ensur-ing that the transmission system is not over-loaded. Parallel flows and reactive power aremonitored to help accomplish this. The ISO isalso responsible for coordinating exchanges ofelectricity between neighboring control areas,although this is very limited in the case ofERCOT as there are only two interconnectswith neighboring regions. Finally, the ISO en-sures that adequate reserve electricity capac-ity is available to meet any operational or emer-gency situations.

A balanced Board of Directors, made up ofmembers from each of ERCOT’s electricitymarket groups, governs the ERCOT ISO. ATechnical Advisory Committee (TAC) consist-ing of members from each market group makespolicy recommendations to the Board of Di-rectors. Four committees assist TAC: ProtocolRevisions, Reliability and Operations, RetailMarket, and Wholesale Market. The commit-tees are assisted by numerous workgroups andtask forces. The Board of Directors hires theCEO and also appoints the ERCOT ISO’s of-ficers. These executives direct and manage theERCOT ISO’s day-to-day operations. TheERCOT ISO is organized to provide a voice forthe various groups that are ERCOT marketparticipants so that decisions on system secu-rity and market facilitation can be made in ademocratic and open atmosphere.

Beginning with the phased-in competitiveretail market Pilot Program on June 1, 2001,ERCOT’s duties are categorized into four pri-mary operations: Production Operations, Mar-ket Operations, Financial Operations, and Reg-istration.

Production OperationsThis task involves system security, planning,

and market support. These technical respon-sibilities include supporting resource and ob-ligation scheduling, real time operations, op-erations analysis, system planning, analysisand data collection. The ERCOT ISO monitors

and analyzes all of the electricity transmissioncomponents every two to four seconds for sta-tus, load, and output to maintain the reliabletransmission of electricity at every moment.The ISO has a sophisticated new technologi-cal infrastructure, called the Energy Manage-ment System, and an expanding engineeringstaff that monitors the balance between powergeneration and power demand. The ERCOTISO also keeps one eye on Texas’s future trans-mission requirements.

Market OperationsThis includes monitoring the balance be-

tween forecasted electricity power generationschedules and actual electricity demandamong all competing market participants. TheERCOT ISO estimates electricity generationand demand requirements for every 15-minuteinterval of every day. Plus, it assesses the an-cillary services required to maintain reliableelectricity production for the actual demandat any moment and procures additional ancil-lary services which are held on standby to en-sure reliability when there are gaps betweenforecasted and actual electricity usage.

Financial OperationsThis duty includes client relations, meter ac-

quisition and data aggregation, settlements,billing, business rules, registration, load pro-filing, and the renewable energy credit pro-gram management.

RegistrationThe ERCOT ISO is the centralized registra-

tion agent for both retail electric providers andmarket participants for the entire state of Texas.


Clearly, the ERCOT ISO is one of the most crucial andcentral entities in today’s restructured electricity industryin Texas.

19

History

Copyright (c) The Bettmann Archive

The electrical system we have today did notcome into being overnight. It has been builtpiece by piece over the last 120 years. This his-tory (as well as the history of other utilities andindustries) provides a useful framework forthinking about the future.

The first commercial electric power installa-tion in the U.S. was constructed in the latterpart of the 19th century. The Rochester, N.Y.,Electric Light Co. was established in 1880 andThomas A. Edison’s Pearl Street steam-electricstation began operation in New York City twoyears later. Within a year, it had 500 customersfor its lighting services. A short time later a sta-tion powered by a small waterwheel beganoperation in Appleton, Wisconsin.

The electric power industry in the U.S. grewfrom its small beginnings in less than 100 yearsto become the most heavily capitalized indus-try in the country. It comprises about 3,100 dif-ferent corporate entities, including systems ofprivate investors, federal and other govern-ment bodies, and cooperative-user groups.Less than one-third of cooperative groups havetheir own generating facilities, most being in-volved only in transmission and distribution.

Early Texas HistoryElectricity first came to Texas in 1878 with

electric arc lights that had gained attention atthe Paris Exposition. Electric lights were in-stalled in Galveston and Dallas only a few

months after Edison’s first electric system be-gan operation in New York City. By 1890, elec-tricity was available in several Texas cities.Hundreds of small electric companies werecreated and generators were built especiallyto power ice plants, trolley systems, and cot-ton gins. These specialized power generatorswere often extended to surrounding homesand businesses to be used only at night. Forexample, power lines from trolleys were sim-ply connected to homes from lines runningalong the street.

Early electricity use was largely confined toTexas cities where factories and other largeelectric users were located. The cost of servingrural areas was prohibitive due to the miles oflines that would be needed. While many citieshad two or more companies competing forcustomers, rural areas went unserved. In 1935,the Rural Electrification Act was passed by theU.S. Congress which provided low interest,long-term financing that would bring electric-ity to farmers and farming communities inTexas and other states.

In 1934, the Lower Colorado River Author-ity was chartered to develop flood control, hy-droelectric and related services. Other feder-ally financed hydroelectric plants followed onthe Colorado, Brazos and Red Rivers. Theseplants sold power to rural cooperatives to pro-

OverviewHistory

Edison’s Pearl Street Steam Electric Station–1882

Electric power systems in the U.S.and Texas were established firstin urbanized areas where

enough customers existed to support de-velopment. Electrification was extendedto rural areas through special state andfederal programs that subsidized infra-structure development.

The early electric power industry wasquite competitive, with companies com-peting to build systems and add custom-ers. Regulated, private monopoly fran-chises evolved as a way of ordering in-dustry development.

Regulation began at the state levelthrough public utility commissions, thefirst of which was formed in Massachu-setts in 1885 to regulate natural gas.Emergence of large holding companiesthat controlled many local utilities ledto the federal Public Utility Holding

Company Act (PUHCA) in 1935which restricted the size and scopeof these businesses.

Electricity arrived in Texas in1878 and by World War II nearlyall of the state was electrified. OurPublic Utility Commission was notestablished until 1975, a time ofupheaval in the industry as worldoil prices soared and the long-timetrend of declining electricity costsreversed.

The electric power industry inTexas and the U.S. today faces anew challenge as competition in-creases and customers seek outnew options and choices.

Thomas Alva Edison

20

History

vide electricity to rural areas. In 1937, the TexasLegislature passed legislation to match the U.S.REA for the formation of rural electric coop-eratives.

By the end of World War II, almost all ofTexas was electrified. Electricity use grew rap-idly after the War with prices dropping fromas high as 15¢ to only 4¢ per kilowatt hour. In1942, the Texas Interconnected System (TIS)was informally organized among utilities tohelp meet heavy wartime demand for electric-ity. Even though not as simple to operate asseparate island systems, the interconnectionsin the early TIS were single lines making in-terchange of electricity relatively easy tohandle, predict and understand.

Public Utilities: A U.S. Private/PublicModel

The Public Utilities Holding Company Act(PUHCA) of 1935 provided the basic structureof the current U.S. electrical industry. The Actlimited the size of electric holding companiesthat owned utilities and required that theseutilities serve integrated, contiguous territo-ries. In addition, technological constraints lim-ited the distance that electricity could be trans-

mitted. These two factors – PUHCA require-ments plus technological limitations - yieldeda utility model in which electric power wasowned widely by many companies and wasoperated under close government regulation.(The reader can refer to Part 4 on Regulationand Policies for details on U.S. federal ap-proaches and issues.)

The idea of private ownership with publicoversight had emerged in the early part of thecentury for many services in the U.S. includ-ing the telephone, transportation and energy.For electricity, as with these other industries,the general philosophy was that only one elec-tric service provider was needed for an areaor there would be duplication of generatingfacilities and power lines, resulting in wasteand inefficiency. Private companies weregranted exclusive franchises to serve desig-nated geographic areas. This monopoly privi-lege bore an obligation to serve all customerswithin a service area. In return, companies hadthe opportunity to earn a reasonable rate ofreturn (profit) as determined by the PUCs. Thisprivate/public model is unique to the U.S. (al-though Canada had a similar model in somelocations) and was introduced at a time when

The amount of electricity consumedin Texas has increased by more thanfive times in the past 30 years. How-ever, the rate of growth has droppedsubstantially, a pattern similar to therest of the United States. Growthrates have declined from above 12percent in the 1960s to levels of 2to 3 percent in the last 10 years.

Source: U.S. EIA.

Texas Growth in Consumption of Electricity1965 to 2000

Annual Growth Rate(3 Year Rolling Average)

ElectricityConsumption

21

History

widespread communication, transportationand energy services were seen as critical foreconomic growth and to bind the nation. Othercountries also recognized the importance ofthese services, but instituted governmentallyowned and operated programs.

Forces for Change in the U.S.Until the 1960s, the electric utility structure

provided services at a relatively low cost. Util-ity owners and investors were generally satis-fied with the rate of return on new plants aswell as the ability to pass on most costs of op-erations and maintenance (O&M) for oldplants. They could also increase profits on ex-isting facilities through technological innova-tions and efficiencies. Consumers were gener-ally satisfied since they were guaranteed ser-vice and the technological improvements keptthe cost of service low or declining as demandgrew for electricity.

Earlier in 1935, the Federal Power Commis-sion (FPC) had asserted its jurisdiction over thewellhead price of natural gas sold in interstatecommerce. Through various pricing methods,the FPC set prices so low that new productionwould not meet demand. This caused curtail-ments and high prices in the U.S. interstatemarkets.

In the late 1960s and early 1970s, variouseconomic and technological factors affected

utilities. America’s growing dependence onimported oil combined with production quo-tas instituted by a cartel, the Organization ofPetroleum Exporting Countries (OPEC), led torapid energy price increases. Inflation andhigher interest rates followed. Larger powerplants were being built that could produceelectricity at much lower O&M costs but alsoat much higher construction costs. The con-struction of larger plants, high interest ratesand inflation led to increases in consumer rates.For the first time, consumers on a large scalewere faced with increasing service costs forelectricity while companies were beingsqueezed by rising costs and interest rates.

In 1965, a massive power outage in the north-eastern U.S. plunged 33 million people intodarkness. For the first time since electricitybegan its rapid growth in the U.S., the atten-tion of most Americans was focused on elec-tricity. A continuous, reliable source of electric-ity had become vital to the nation’s economyand security.

In 1967, the FPC determined that the elec-tric industry must take steps to increase reli-ability and reduce the potential for such black-outs. In 1968, the North American Electric Re-liability Council (NERC) was formed as theelectric industry’s voluntary response to theneed for increased reliability. Almost everyelectric utility now belongs to NERC.

1878Electric arc

lights installedin Texas

1882Houston Light

& Powerformed

1875

1880

1885

1890

1895

1900

1905

1910

1915

1920

1925

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

1885Fort Worth

Electric Light andPower formed

1913First high

voltage line inTexas

1932Technologyfor naturalgas use in

boilers

1942Texas

InterconnectSystem

1965Northeast

poweroutage

1968NERCformed

Lignitepower

plants inTexas

1973OPEC

oilembargo

Nuclearplant

constructionbegins in

Texas

1979ThreeMile

Island

1935Rural

ElectrificationAct

1935PUHCA

1937Rural

cooperativescreated in

Texas

1975Texas Public

Utility RegulatoryAct

PublicUtilityCommissionof Texascreated

1978PURPAPIFUANGPA

Timeline of Electricity Events in Texas and the U.S.(see Regulations & Policies–A Closer Look for details on regulatory actions)

1970ERCOTformed

Firstnuclearplantopenedin Texas

1993Texasdebateonresourceplanning

1992EnergyPolicy

Act

1995Texas

introduceswholesale

competition

1996ERCOT

ISO

1996FERC

Orders888/889

1999Texas

SB 7

Calif.EnergyCrisis

2001Califsuspendsrestructuring

2001TexasPilot

Program

2002Retail

Choicebegins

inTexas

1999FERCOrder

2000

2002FERC

proposesStandardMarketDesign(SMD)

Recent Timeline1990 to 2002

22

History

During the 1970s, large industrial and com-mercial customers were the first segments ofthe economy to look for alternatives to utility-provided electricity. They sought legislationwhich would allow them to obtain electricityfrom other sources. Residential customers andconsumer groups complained to elected offi-cials who began to review utility rates more

carefully. Cost increases were more frequentlydisallowed when officials believed that utili-ties were not incurring costs in a prudent man-ner.

Legislators were also pressured by utilitieswho believed that they had a contract whichallowed them to recover costs they incurredin providing services to the community. Utili-ties argued that if they were not allowed torecover costs, this jeopardized their financialstanding, could force bankruptcy and therebyendanger the provision of this basic commod-ity.

Parallels for Electric Power in TexasTexas was affected by many of the same

forces as the utility industry in the rest of thecountry. During the 1950s and 1960s more elec-trical appliances entered the consumer marketand the economy was strong. In Texas, newhomes were being built with air conditioning

and units were added to existinghomes. Annual growth in demand av-eraged 10 percent during this time. Theadvent of large, more efficient powerplants reduced prices further to 2¢ perkilowatt hour for residential custom-ers. The rapid growth of electricity usewas fairly constant until the early1970s, when high fuel prices from thecrisis in world oil markets, environ-mental concerns and a slowing U.S.economy resulted in reduced growth.While many other utilities in the U.S.struggled with rising fuels costs, Texaswas blessed with an abundance ofnatural resources - oil, gas and lignite- and natural gas became the fuel ofchoice for electricity up through the1960s. In the 1970s, in the heavily regu-lated U.S. natural gas market, the per-ception grew that there was a shortageof natural gas, a perception madeworse by widespread curtailmentsduring the winter of 1976. In actualfact, regulatory distortions had createda situation in which inadequate sup-plies of natural gas were being devel-oped. Because natural gas prices were

controlled in the interstate markets by the FPC,but largely unregulated in the intrastate mar-kets in locations like Texas, more gas was be-ing sold in the intrastate markets leading toshortages elsewhere (even though prices didnot reflect this situation). Erroneously, stateand federal laws were passed which prohib-ited the construction of new gas-fired base loadpower plants. Utilities in Texas and elsewheremoved to diversify their fuels to include coal,lignite, and nuclear power.

Texas also followed the drive in the U.S. toincrease reliability after the 1965 blackout. In

Power Plants Opened in Texasby Size of Plant, Year Opened and Fuel

Megawatts

0

1000

2000

3000

4000

5000

6000

7000

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Natural Gas Coal/Lignite Nuclear

23

History

1967, the Texas Interconnected System (TIS)developed more formal agreements to handleadministrative as well as planning and opera-tional activities. In 1970, the ERCOT wasformed out of the TIS. And in 1975, the PublicUtility Commission of Texas (PUCT) was es-tablished to oversee statewide issues that werenot addressed by regulation at the local level.Texas was the last state to establish such a com-mission. The main issues for the PUCT werefuel diversification and increased rates for elec-tricity.

Regulators and utilities felt they had a solu-tion which would address these issues simul-taneously. The solution was the constructionof large lignite and nuclear power plants,which would take advantage of expected lowergeneration costs (through economies of scale)for larger facilities. Between 1971 and 1988, al-most 15,000 megawatts of lignite and bitumi-nous coal plants were built. In the late 1980s,two nuclear facilities were built: South TexasNuclear Project (HL&P) and the ComanchePeak nuclear facility (TXU Electric).

In 1979, the Three Mile Island nuclear plantin Pennsylvania suffered a serious accidentwhich caused public outcry for more stringentregulation of nuclear power. Constructioncosts began to increase along with increasedO&M costs for all nuclear facilities. As con-struction costs increased, utilities asked for andreceived rate increases to recover these costsas well as inflation-driven increases for oper-ating and maintenance. Consumer complaintsled to even greater scrutiny of rate increases.

When nuclear plant construction was com-pleted, some utilities proposed rate increasesexceeding 50 percent. The PUCs examinedeach request on a case-by-case basis, disallow-ing some and approving others. Utility creditratings in some cases were downgraded andsome came close to or declared bankruptcy, asin the case of El Paso Electric Company. By theearly 1990s most of the ratemaking issues as-sociated with nuclear power were resolved.However, also by the 1990s, growth in electric-ity consumption in Texas had declined sharply,ranging from one to three percent per year incontrast to the more than 10 percent per year

in the 1960s.

Restructuring andRe-regulation inthe U.S.

Since the 1960s,much has beenlearned about publicutility industries inthe U.S. Many as-sumptions that weremade when the cur-rent utility industrystructure evolved inthe 1930s - not just forelectricity but alsonatural gas, tele-phones and otherpublic utility services- are being challengedby changes in tech-nologies and resultingchanges in industrystructure. In a nut-shell, markets movedahead of public policyand we are in the pro-cess of adjusting pub-lic policy to fit new re-alities.

The most influentialchange has been thegrowing role for com-petition in the deliv-ery of services. Thishas been a generaltrend in the U.S. sinceairline and bankingderegulation wereproposed in 1975 andfor the electric power industry it has beenmarked by three characteristics. One is theimpact of technology change. Improved de-signs for gas-fired turbines and computer in-formation technologies that allow real-timemanagement of systems and market transac-tions have had a tremendous impact on theelectric power industry. The second character-istic is the introduction of entrepreneurial busi-

Status of State Electric IndustryRestructuring Activity (EIA, July 2002)

Twenty-four states and the District of Columbia(D.C.) have either enacted enabling legislation orissued a regulatory order to implement retailaccess. Dark gray colored states are active in therestructuring process, and these states have eitherenacted enabling legislation or issued a regulatoryorder to implement retail access. Retail access iseither currently available to all or some customersor will soon be available. Those states are Arizona,Connecticut, Delaware, District of Columbia,Illinois, Maine, Maryland, Massachusetts,Michigan, New Hampshire, New Jersey, New York,Ohio, Oregon, Pennsylvania, Rhode Island, Texas,and Virginia. Clear colored states are not activelypursuing restructuring. Those states are Alabama,Alaska, Colorado, Florida, Georgia, Hawaii, Idaho,Indiana, Iowa, Kansas, Kentucky, Louisiana,Minnesota, Mississippi, Missouri, Nebraska, NorthCarolina, North Dakota, South Carolina, SouthDakota, Tennessee, Utah, Vermont, Washington,Wisconsin, and Wyoming. A medium gray coloredstate signifies a delay in the restructuring processor the implementation of retail access. Those statesare Arkansas, Montana, Nevada, New Mexico,Oklahoma, and West Virginia. California is the onlylight gray shaded state because direct retail accesshas been suspended.

Restructuring Active

Restructuring

Restructuring Suspended

Restructuring Not Active

24

History

nesses, often a consequence of technologychange, seeking to enter existing industriesprotected by regulation. These includenonutility generators of electricity and powermarketers, and they are equivalent in effect tostart-up airlines, the array of electronic bank-ing services, long-distance and wireless serviceproviders and independent marketers of natu-ral gas. The third characteristic is the value-seeking behavior of customers, in particularthose who purchase services in large enoughquantities to exert influence - large industrialand commercial enterprises. These character-istics – technology change, new entrants andconsumer value - have been at work in everyindustry affected by restructuring and re-regu-lation in the U.S.

Analogies for restructuring the electricpower industry in the U.S. include telephonesand natural gas. In all three industries, the un-derlying principle for historic change is thatof “open access.” Open access is not a new idea.Contract carriage for natural gas pipelines wasdebated when the 1935 U.S. Natural Gas Actwas passed (giving the FPC regulatory author-ity over interstate gas markets). With open ac-cess, telephone lines, natural gas pipelines andelectric wires become like toll highways. Anyservice provider can access the highway asmay any customer. In this way, competition canbe fostered even though the grids - telephonelines, pipelines and electric wires - remainmanaged as physical monopolies. The devel-opment of sophisticated information technolo-gies is a major factor in making open access areality.

At the national level, electricity restructur-ing is progressing in similar fashion to naturalgas, the most immediate predecessor industryto experience transformation (although tele-communications transformation continues toevolve). Natural gas restructuring is also animportant factor in the drive to restructure theelectric power industry. Open access and un-bundling for the natural gas industry has beena key element in development of gas-fired non-utility power generation. Since the gas indus-try already had experience with creation andimplementation of information systems to

manage competitive sales of gas and with thirdparty marketing, it was a natural transition forthe industry to also participate in buildingthese skills for electric power. These sharedskills have led to a strong “convergence” be-tween the natural gas and electric power in-dustries.

As for gas, the FERC has ordered that openaccess be implemented for interstate transmis-sion and wholesale power transactions, whichdirectly affects the wholesale electricity mar-ket (bulk sales for re-sale to retail customers).Also as with natural gas, certain types of in-formation must be made widely available withcommon standards for information platforms.Finally, utilities must separate or “unbundle”their transmission and marketing functions,much like the interstate natural gas pipelineshave done, so that a competitive third partymarketing industry can evolve and to ensurefair, nondiscriminatory access to transmission.

It is up to the individual state legislatures todetermine the extent to which these initiativesshould be extended beyond the FERC’s juris-diction, to both large and small retail commer-cial and industrial customers and individualhouseholds, and to wrestle with the details ofimplementation.

Restructuring and Re-regulation inTexas

In the early 1990s, Texas began examiningrestructuring the electric power industry.These have included measures designed topromote jobs and economic growth by ensur-ing low cost electricity. Almost all electricityconsumed within the state of Texas is gener-ated in the state and because of this it has beenexcluded from interstate commerce provisions.This has allowed Texas to operate differentlythan other states.

The FERC has the authority to regulate thetransmission of electricity only in interstatecommerce. In 1992, the U.S. Energy Policy Actor EPAct authorized creation of exempt whole-sale generators (EWGs). In 1995, Texas SenateBill 373 (SB 373) was enacted to restructure thewholesale electric industry and EWGs were au-thorized. The law required utilities to provide

State Initiatives onElectricity

Restructuring

ArizonaPhase in customerchoice between 1/99and 1/01. Recentdecision to reconsiderretail competition.

CaliforniaOn 3/31/98 beganoffering retail choice toall customers of thethree largest utilities.Stranded cost recoveryand related pricingissues forced somecompetitors to exit themarket. Price spikes ofSummer 2000 led to thesuspension ofrestructuring.

ConnecticutAccess to competitivesuppliers for 35 percentof consumers by 1/00(with a ten percent ratereduction) and for allconsumers by 7/00.Utilities to sell non-nuclear generationassets by 1/00 andinterests in nucleargeneration by 1/04 -first State to requiredivestiture of nuclearassets. 5.5 percentrenewable portfoliostandard.

DelawareA phase-in of retailcompetition for largecustomers in Conectiv’sservice territorybeginning on 10/1/99and ending on 4/1/01;a residential rate cut of7.5 percent for Conectivcustomers and a ratefreeze for co-opcustomers.

cont’d on page 25

25

unbundled transmission service ona non-discriminatory basis and es-tablish an ISO. The PUCT autho-rized the ERCOT ISO, to be opera-tional by July 1997. A Senate In-terim Committee on Electric Indus-try Restructuring was also formedin 1997. The Committee continu-ously met with stakeholders to for-mulate the restructuring bill forTexas.

In May 1999, Texas Senate Bill 7(SB 7) was passed to restructure theelectric industry allowing retailcompetition. Base rates (excludingfuel) have been frozen for threeyears, and a six percent reduction(price-to-beat) has been requiredfor residential and small commer-cial consumers for five years oruntil REPs affiliated with incum-bent IOUs lose 40 percent of theirconsumers to competition. Utilitiesunbundled their integrated busi-nesses into three separate catego-ries - generation, transmission anddistribution, and retail electric pro-vider - and are limited to owningor controlling no more than 20 per-cent of the installed generation ca-pacity within ERCOT. SB 7 also re-quires an increase in renewablegeneration and 50 percent of newcapacity to be natural gas-fired.Following a pilot test, retail compe-tition started on January 1, 2002(more information on SB 7 and theTexas Electric Choice program canbe found in Part 4 - Regulations andPolicies).

History

District of ColumbiaRetail competition in2001. Eight electricitysuppliers and threeaggregators certified,but only two suppliersand one aggregatorproviding service. Asof 11/01, 3.1 percent ofcustomers,representing morethan 40 percent ofdemand switched.

IllinoisAs of 1/1/01, allcommercial andindustrial customerseligible for retailaccess, and residentialcustomers eligible in5/02. 12 percent ofComEd’s eligiblecustomers - half of thecompany’s load -switched.

MaineRetail competition by3/00. A market sharecap of 33 percent forlarge IOUs in oldservice areas.Divestiture ofgeneration assets by3/00. 30 percent ofgeneration fromrenewable energysources.

MarylandThree percent ratereduction forresidential consumers,funding for low-income programs,disclosure of fuelsources by electricsuppliers, recovery ofstranded costs througha nonbypassable wirescharge, and a three-year phase-in forcompetition beginningin 7/00 and completedby 7/02.

State Initiatives (cont’d)

MassachusettsRetail access and ratecuts of ten percent by3/98 and another fivepercent 18 monthslater. Divestiture ofgeneration assetsencouraged.

MichiganRetail choice for allcustomers by 1/02.Five percent ratereduction, frozen atleast until 12/31/03.Rates for large C&Iconsumers cappedthrough 2003, andsmall businessconsumers’ ratescapped through 2004.

New HampshireFive percent ratereduction on 10/01/2000 for residentialcustomers. The fullreduction of 15.5percent. Residentialrates capped for threeyears, and businessrates for two years.PSNH to divest itsgeneration assets byJuly 2001, and operateas a T&D utility,regulated by the PUC.

New YorkRetail choice to bephased in beginning inearly 1998 on utility-by-utility basis.

New JerseyAll consumers to shopfor their electricsupplier by 8/99; fivepercent immediate ratediscount, and tenpercent over the nextthree years. Recoveryof utilities’ strandedcosts through a wirescharge paid byconsumers.

OhioRetail choice on 1/1/01 with five percentresidential ratereductions and a ratefreeze for five years.15 percent of eligiblecustomers switched in2001.

PennsylvaniaOne-third customerchoice by 1/1/99;two-thirds by 1/1/00;final third by 1/1/01.As of 7/1/01, 591,596customers wereparticipating inelectricity openmarkets, while in 4/01, 787,846 customerswere participating.

Rhode IslandIn 7/97, the first stateto begin phase-in ofstatewide retailwheeling (forindustrial customers).Retail access forresidential consumersby 7/98.

VirginiaCreation of a regionaltransmission entity by1/1/01; deregulationof generation by 1/1/02; phase-in ofconsumer choicebetween 1/1/02 and1/1/04; rates cappedthrough 7/07 for thosewho remain with theincumbent utility.

For more and updated

information:

www.eia.doe.gov/

cneaf/electricity/

chg_str/regmap.html

27

Regulations & Policies

Overview

In its early history, electricity was generatedand used locally. A local utility sold nearly allof the electricity it generated to customerswithin the same community. Therefore, statelegislators gave regulatory authority to munici-palities while rural electrical systems operatedunder little or no direct state regulation. Al-though there was considerable federal regula-tion that developed, in Texas this localizedview of regulation did not change until 1975.

The major changes in electric power regula-tion occurred in the 1930s, the 1970s and theearly 1990s. In 1935, the Public Utility Hold-ing Company Act (PUHCA) strengthened stateregulation of electric power and caused thebreak up of large holding companies that hadcome to dominate the market. In 1978, severalfederal energy bills were passed under the Na-tional Energy Act which included new obliga-tions for utilities. States were given primaryresponsibility for much of the implementation.In 1992, the Energy Policy Act (EPAct) and ac-tions by federal agencies encouraged addi-tional competition in the wholesale electricpower market.

In Texas, the Public Utility Regulatory Act(PURA) was passed in 1975, creating the Pub-lic Utility Commission of Texas (PUCT). TheCommission had the primary responsibility ofmaintaining rates and services that were fairto consumers and utilities. The Commission’sinitial responsibilities included establishingservice areas, certifying generation and trans-mission facilities and setting service standards.The four primary functions of the Commissionhave been rate-setting, certification of facilities,monitoring of regulated utilities for compli-ance with Commission rules and assisting theresolution of consumer complaints againstutilities.

Today, electric power systems are intercon-

nected, crossing state and even nationalboundaries. Over the last 20 years, federalregulations have moved toward allowing morenon-utility companies to participate in the elec-tric power business. There remains some un-certainty as to what roles federal and stateregulators should play in controlling thesenew, competitive markets.

However, two issues are emerging. One isthe extent to which regulators act as marketfacilitators, and thus have responsibility forproviding and overseeing appropriate rules forcompetitive activity. The second, more recentissue is regulatory oversight of energy trad-ing and marketing. These activities are essen-tial to properly functioning natural gas andelectric power markets. They help to link buy-ers and sellers, to “clear” market imbalances(moving energy from places where there isexcess supply and therefore lower prices tolocations where supplies are tight and pricesare higher) and to manage the price risk vola-tility inherent in natural gas and electric poweronce they are subjected to competition and

Development of federal elec-tric power regulation andpolicy has been a long, com-

plex process led by world eventsthat changed perceptions aboutand, consequently, the behavior ofenergy markets. Of particular im-portance was the disruption ofMiddle East oil supplies in the ‘70sand the ensuing crisis atmospherewhich led to sometimes conflictingfederal initiatives. Results have in-cluded growth in electric powergeneration by non-utility busi-nesses and elimination of federalprice controls on natural gas well-head production.

Federal actions in the ‘90s havebuilt on these ‘70s changes. Thenatural gas industry was restruc-tured to encourage competition ininterstate pipeline transmission,making it easier to use of naturalgas for electric power. In the EnergyPolicy Act of 1992, Congress en-couraged competition in wholesalebulk power, meaning that powerexchanges between marketers, utili-ties, non-utility generators and oth-ers could take place, introducing

competitive pricing in the sale ofelectricity for re-sale to retail users.FERC has been implementing thismandate with Orders 888 and 889in 1996 and Order 2000 in 1999.

Regulation at our state level isfairly recent. In 1975 Texas becamethe last state to establish a publicutility commission. Basic functionsof the PUCT have not changedmuch, but the ways of implement-ing its responsibilities have beeninfluenced by national trends - at-tention to energy efficiency andconservation, market-based strat-egies and response to federal ini-tiatives for wholesale market com-petition. The PUCT had to focus onretail competition as well sinceSenate Bill 7, passed in 1999, re-structured the electric power in-dustry in Texas and allowed allcustomers retail choice startingJanuary 1, 2002.

Regulation &Policies:A Closer Look

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become commodities. However, energy trad-ing and marketing are complex, fast-movingactivities. During 2001 and 2002, questionshave arisen about the transparency associatedwith trading and marketing operations, cor-porate reporting on these operations and theadequacy of the market structures being de-signed by policy makers, regulators and indus-try to ensure that trading and marketing areundertaken without abuse. All of these issuesare posing new challenges for U.S. electricpower industry restructuring efforts, and forU.S. energy policy in general.

Non-UtilityParticipants

Identified in MajorFederal Legislation

Non-UtilityGenerator (NUG)

A general term encom-passing all electricitygeneration that is notsolely owned by utili-ties and generally notsubject to rate regula-tion (includes IPPs,QFs and EWGs).

Independent PowerProducer (IPP)

A non-utility powergenerating companythat is not a qualifyingfacility (QF).

Qualifying Facility(QF)

A generator or smallpower producer thatmeets ownership, op-erating and efficiencycriteria established byFERC pursuant toPURPA; and has filedwith FERC for QF sta-tus.

Exempt WholesaleGenerator (EWG)

A type of power gen-erator identified by theEPAct which, unlikeQFs, is not required tomeet PURPA’s cogen-eration or renewablefuels limitations. Utili-ties are not required topurchase power fromEWGs. FERC is autho-rized to order utilitiesto provide transmis-sion service to EWGson a non-discrimina-tory basis comparableto their own use ofthese facilities. FERCorders 888/889 ad-dress this issue.

The Role of Federal Regulation ofElectric Power

What began as a novelty in the 1880s was,by the 1920s, a necessity for modern society.At the turn of the century, following ThomasEdison’s blueprint, the electric power indus-try consolidated into large holding companiesthat controlled local utilities. Local utilities hadalready begun to buy competitors and neigh-boring companies.

By 1927, there were 180 holding companiesoperating in the U.S. The number of operatingcompanies had decreased from more than6,300 to less than 4,500. By 1932, the eight larg-

1978National Energy Act

Five bills designed to respond to the crisis in worldoil markets. Other actions were included in theNational Energy Plan.

Powerplant and IndustrialFuel Use Act (PIFUA)

Prohibited the use of natural gas in new electricutility boilers and some industrial boilerapplications. Certain geographic areas wereexcluded due to air pollution concerns if coal andoil use were increased.Public Utility Regulatory Policy Act (PURPA)

Established Qualifying Facilities (QF’s) as a newentrant to the electrical generation market. QF’scould build smaller generation facilities free fromPUHCA regulation. Utilities were required to pur-chase electricity from QF’s at the utilities’ avoidedcost (the cost the utility would incur to generatethe equivalent amount of electricity).

Natural Gas Policy Act (NGPA)Initiated a process of phasing out federal controlson wellhead prices of natural gas, which resultedin increased gas supplies and lower prices. Thecombination of PURPA and NGPA stimulatedgrowth in gas-fired non-utility power generationcapacity.

History of Federal Regulation of the Electric Utility Industry

1935Public Utility Holding Company Act (PUHCA)

Title I: Provided for the Securities & Exchange Commissionto break up large holding companies which had becomeprevalent in the utility industry.Title II: Extended to the Federal Power Commission theauthority to regulate wholesale power sales by electric utili-ties. Utilities were allowed to charge prices based on thecost of operation while allowing for a reasonable return ontheir investment in capital.

Federal Power ActThis part of PUHCA allowed the Federal Power Commis-sion to regulate transmission of electricity across stateboundaries (interstate commerce). It also allowed FPC toregulate wholesale trade of electricity (electricity sales des-tined for resale).

Rural Electrification ActThis act provided low interest loans (primarily to electric-ity cooperatives) to ensure that electricity was provided torural farm areas. This led to the rapid growth of coopera-tives that served rural areas.

1920Federal Water Power Act

The Federal Power Commission (FPC)was established to oversee licensingof hydroelectric power on federallands. FPC later became the FederalEnergy Regulatory Commission(FERC) which regulates many activi-ties of electric utilities.

29


est holding companies controlled 73 percentof the investor-owned electric power business.Electric Bond & Share, a subsidiary formed byGeneral Electric, was the largest, owning elec-tric systems across the United States, includ-ing Texas, and in foreign countries as well.

PUHCA - 1935In 1935, Congress moved to limit the size of

these holding companies through passage ofthe Wheeler-Rayburn Public Utility HoldingCompany Act (PUHCA). This act requiredutilities owned by a holding company to servean integrated, contiguous territory. Over thenext ten years, PUHCA forced the realignmentof holding companies across the nation. For ex-ample, Electric Bond & Share Company wasrequired to divest of some of its utilities.

PUHCA authorized the Securities and Ex-change Commission (SEC) to closely regulate

the financial and corporate activities of hold-ing companies with utilities that operated inmore than one state. The Federal Power Com-mission (now FERC) regulated rates, terms andconditions on the wholesale trade of electric-ity and transmission between states (interstatecommerce). The wholesale market was mostlya small, localized activity that operated on avoluntary basis. PUHCA specifically excludedpower generation and local distribution fromits regulation.

The 1970s: Energy Crisis and PolicyIn 1973, Arab oil producers embargoed sales

to consuming countries in retaliation for poli-cies pursued by the U.S. and other countriestoward the Middle East. The embargo gaveOPEC, formed in 1960 when world oil priceswere low, effective control of world oil prices.The U.S. plunged into a period of extreme un-

1990Clean Air Act Amendments (CAAA)

This act seeks to reduce annual sulfur dioxide (SO2)

emissions by 10 million tons by the year 2000 fromthe 1980 level and to reduce annual nitrous oxides(NOX) emissions by 2 million tons by the year 2000from the 1980 level.

1992Energy Policy Act (EPAct)

This act created a new class of generators called Exempt Whole-sale Generators (EWG’s) who could generate electricity andsell it at market based rates free from PUHCA regulations. Utili-ties which owned transmission facilities are required to pro-vide services to EWG’s and other facilities on a comparablebasis to their own transmission access. Utilities are also requiredto provide information on the availability of transmission andconstraints on their system. Under EPAct, FERC allowed utili-ties to sell their electricity at market based rates if they openedtheir transmission system up to competition (open access).

1996FERC Orders 888 and 889

These rules issued by the Federal Energy RegulatoryCommission implemented the intent of the EPAct tocreate a competitive, wholesale, bulk power market.Utilities under FERC regulation must providenondiscriminatory open access for transmission tothird parties, functionally unbundle theirtransmission and marketing functions and createinformation systems so that open access can befacilitated. Individual state legislatures and PUCs areresponsible for open access at the retail level (salesfor resale to ultimate consumers).

1999FERC Order 2000

FERC’s third initiative to grid regionalization, Order2000, calls for the voluntary creation of RTOsthroughout the U.S. FERC wants to bring alltransmission systems owned by regulated IOUsunder regional control in order to eliminate theremaining discriminatory practices, meet theincreasing demands placed on transmission systemsand achieve fully competitive wholesale powermarkets. If Order 2000 can be successfullyimplemented, the U.S. grid will transform from asystem owned and controlled mostly by verticallyintegrated utilities to a system owned and/orcontrolled by a few unaffiliated RTOs.

30


certainty and discord with respect to energy(thought to be no longer cheap or plentiful)and energy policy. Also during the 1970s, FPCregulation of gas prices led to perceptions ofinadequacy of gas supplies and to high pricesin intrastate markets where FPC regulationsdid not constrain prices.

Federal actions, in par-ticular the five-bill Na-tional Energy Act thatemerged from the CarterAdministration’s NationalEnergy Plan, emerged inresponse during the crisisatmosphere. The NationalEnergy Act includedPIFUA, PURPA and theNGPA, all described be-low. Taken together, theselaws sent confusing andcontradictory signals fornatural gas and electricity,which were to have pro-found impacts on the elec-tric power industry andplay a role in the eventualrestructuring of both in-dustries. Also as part ofthe National Energy Plan,the Department of EnergyOrganization Act in 1977created that agency andestablished the FederalEnergy Regulatory Com-mission to replace the Fed-

eral Power Commission created in the 1920Water Power Act.

PIFUA - 1978The Powerplant and Industrial Fuel Use Act

(PIFUA) of 1978, passed at the same time asPURPA, prohibited the use of natural gas innew utility power plants (except in areas likeLos Angeles where increased use of coal or oilwould make air pollution problems worse).Similar restrictions were placed on certainlarge industrial boilers. The Act also prohib-ited use of natural gas in existing electric powerplants starting in 1980, but this limitation was

removed in 1981.PIFUA emerged out of widespread concern,

following sharp natural gas curtailments in theeastern U.S. in 1976, that there were real physi-cal shortages of natural gas. In fact, as notedabove, federal control of wellhead prices fornatural gas, which affected the price of gas inthe interstate market, was later found to be theroot cause of gas shortages in the 1970s. Be-cause gas prices were artificially low in theinterstate market, but higher in the unregu-lated intrastate markets, there was no incen-tive to place gas into the interstate pipelinesystem. In addition, because gas prices wereheld down by price controls at a time of rapidprice rises in other fossil fuels, there was noincentive for producers to explore and drill forgas. PIFUA was an outcome of these policy dis-tortions and contributed greatly to the devel-opment of coal and nuclear power generationcapacity in the U.S. and Texas.

PURPA - 1978The Public Utility Regulatory Policies Act

(PURPA) almost directly countered PIFUA inimplementation. Under PURPA, regulated andnon-regulated utilities were required to con-sider eleven different rate design standards todetermine if they were appropriate for imple-mentation. These standards included such con-cepts as time-of-day rates, cost-of-service pric-ing, interruptible rates, prohibition of declin-ing block rates and lifeline rates.

Two of the primary purposes of PURPA were(1) to encourage energy efficiency through ex-panded use of cogeneration and (2) to create amarket for electricity produced from renew-able fuels and fuel wastes. PURPA stipulatedthat all utilities engaged in the distribution ofelectricity were required to offer to purchaseelectricity produced by certain qualifying co-generation and small power production facili-ties that used renewable fuels. These facilitieswere called “QFs” - qualifying facilities. Utili-ties had to offer to purchase electricity fromQFs at a price that reflected the avoided costs.These were costs the utilities would have in-curred if they had constructed new facilitiesand generated the electricity themselves. QFs

For the first time since1935, non-utility powergenerators wereencouraged by federalpolicy to produce and sellelectricity. PURPApromoted this byrequiring utilities topurchase power fromqualifying facilities (QFs).

Although PIFUAprohibited use of naturalgas for power plants,PURPA actuallystimulated gas-firedgeneration from non-utility generators.

31


could use some of the electricity they producedto serve the electrical load of host industrial orcommercial facilities, such as refineries, andsell the excess back to the utility, or sell theirtotal output to the local utility. QFs also typi-cally produced or “cogenerated” steam, whichwas sold to the host facility. QF owners weregiven exemptions to the PUHCA making itpossible for a large number of non-utility com-panies to enter the electric generation business.

The paradox of PURPA was that it helped tostimulate growth in gas-fired power genera-tion, which utilities then purchased under con-tract even as they were prohibited from usinggas as a boiler fuel in their own facilities. Natu-ral gas today accounts for most (more than 40percent) of non-utility power generation in the

U.S. In Texas, 92percent of ournon-utility pro-duction wasnatural gas-fired in 2000.

NGPA - 1978The Natural

Gas Policy Act(NGPA) was in-tended to re-move the distor-tions associatedwith federalcontrol of well-head natural gas

prices. The NGPA was the most contentiousof the National Energy Plan elements and, asa result, the most complex and cumbersome.Federal oversight of natural gas prices, alreadyan arduous task, was made even more so bythe many categories of gas pricing created inthe phase-out approach taken with the NGPA.The bottom line, however, was that federalprice controls would end in 1985. It did nottake until 1985 for the effects of the NGPA tobe fully comprehended. A surge in explorationand production activity in the U.S. as a conse-quence of phased out price controls revealedthat natural gas was indeed plentiful. A“bubble,” the excess of deliverable supply over

demand, almost immediately appeared, de-pressing natural gas prices. In spite of claimsto the contrary, the bubble persisted, lendingeven stronger support to new thinking aboutthe natural gas resource base in the U.S. Morerecently, the faster depletion of gas reservoirsand an inability to add significant amounts togas reserves despite increased drilling, com-bined with higher demand mainly caused bynew gas-fired power generation, have startedto raise concerns about the adequacy of gas re-source base. These new opinions about thenatural gas resource base in the “Lower 48” –the contiguous states – combined with newenergy security concerns in general has trig-gered new interest in developing natural gassupplies in Alaska and northern Canada andin importing increasing amounts of natural gasin the form of liquefied natural gas or LNG.

Federal Policy After the 1970sWhat were the combined effects of the

PIFUA, PURPA and NGPA along with otherelements of legislation enacted by Congress atthe height of the 1970s energy crises? Naturalgas was removed from the domain of electricutility boiler fuels but at the same time its useby non-utility generators (NUGs) was encour-aged. Utilities were forced to add coal andnuclear capacity while cheaper capacity wasbeing developed by NUGs. Policies were en-acted on the premise that natural gas wasscarce while at the same time federal price con-trols, the source of the scarcity, were being dis-mantled. As changing market conditions, newpolicy initiatives and new thinking emergedregarding competitive markets for energy inthe U.S., the 1970s laws were altered or re-pealed: PIFUA was repealed in 1987, naturalgas wellhead price decontrol under NGPA wasaccelerated and finalized in 1989 through theWellhead Decontrol Act. While PURPA re-mains on the books, it is being subsumed bynew initiatives around the country and in Con-gress.

In the U.S. and other countries, explorationfor oil spurred by the higher prices engineeredby OPEC production quotas revealed that pe-troleum was abundant. As crude oil supplies

Federal energy policiestoday support greaterreliance on marketactivities. They alsoseek to encourageefficiency anddiversity in fuelsources andresponsiveness toenvironmental issues.

32


surged into the early 1980s, world prices col-lapsed. Natural gas prices remained low rela-tive to oil, supporting rapid growth in non-util-ity power generation. The electric power in-dustry became one where the utilities held ex-pensive capacity, built to ensure long-term fueldiversity, that had been installed at consider-able financial risk; where non-utility genera-tion (particularly from lower cost gas-firedturbines) grew rapidly; and where fuel com-petition in a low price environment increasedoverall. Public policy attention became cen-tered on two issues, environmental protectionand encouraging competition.

Clean Air Act Amendments - 1990Combustion of fossil fuels - coal, oil and

natural gas - result in emissions of various sub-stances that can pose a variety of environmen-tal and health-related problems. The sub-stances targeted most heavily in environmen-tal regulation are the emission gases from fuelcombustion. Sulfur dioxide (SO

2) and oxides

of nitrogen (NOX) are precursors to acid rain

deposition because,under the right set ofconditions, they re-act with otherchemicals in the at-mosphere to formsulfuric acid and ni-tric acid, respec-tively. NO

X is also a

major contributor toground level ozone.Carbon dioxide

(CO2) is colorless, odorless and nontoxic but

contributes to a “greenhouse effect” as it accu-mulates in the atmosphere and causes infra-red radiation reflected from the earth to be-come trapped.

With respect to combustion emissions, in-creasing concerns about air quality led to pas-sage of the Clean Air Act in 1963 with substan-tial amendments in 1970. (The 1970 amend-ments are commonly referred to as the CleanAir Act). In 1970 the Environmental Protec-tion Agency (EPA) was empowered to set en-forceable air quality standards. In 1971 the EPA

established the New Source Performance Stan-dards (NSPS) that directly affected new ormodified coal-fired utility boilers. The stan-dards were revised in 1979, but the most strin-gent revision came about with the Clean AirAct Amendments of 1990 (CAAA). The CAAArequired a 10 million ton reduction in SO

2 emis-

sions and a 2 million ton reduction in NOX from

1980 levels. The reduction in SO2 was set to

occur in two phases, one that began in 1995and another that began in 2000. The CAAA alsocreated an innovative tradable emissions al-lowance program that led to a market for SO

2

emissions. The concept is that older utilitiesfaced with higher marginal costs for additionalSO

2 reductions could purchase their allow-

ances in an open market from utilities (ornonutility generators) that produce less thantheir allowed emissions. Older facilities thatare very expensive to retrofit could also be shutdown, creating the opportunity for operatorsto sell all of their allowances in the open mar-ket. Consequently, vigorous activity in “emis-sions trading” has resulted, enabling a moreefficient allocation of responsibility for pollu-tion control.

The CAAA also left utilities with a varietyof options for meeting environmental stan-dards. One is to use natural gas which yieldslower emissions of targeted pollutants. Utili-ties can also use lower sulfur coal, use blendedcoals or co-fire gas and coal. Utilities can usedifferent combustion technologies to reduceNO

X or employ environmental equipment to

reduce emissions before they are released intothe atmosphere. The advantages for naturalgas under the CAAA coupled with the EPActprovisions for non-utility generation and lownatural gas prices meant that most new gen-eration capacity has come, and continues tocome, from NUG’s using natural gas turbines.

EPAct - 1992Like the National Energy Act in 1978, the

Energy Policy Act of 1992 (EPAct) was con-cerned with energy efficiency and availability.Also like the 1970s, the EPAct emerged out ofcrisis, or perceived crisis, again associated withdisruptions in Middle East oil supplies but this

Utilities are the second largestsource of CO

2 emissions in Texas.

While no regulations currentlyrestrict CO

2 emissions, the Clean Air

Act Amendments of 1990 requiremonitoring and reporting.

33

time within the context of the 1991 Gulf Warstemming from Iraq’s invasion of Kuwait. Thepush for an energy bill continued even afterworld crude oil prices fell swiftly after surg-ing during the confrontation. The legislativeinitiatives accompanied a U.S. Department ofEnergy study, National Energy Strategy (NES),

which the DOEwas asked to pre-pare by thenPresident Bush.As with the Na-tional Energy Act,the EPAct wasjust as conten-tiously debated. Itcontained provi-sions directed to-

ward increasing U.S. energy options as wellas language supporting more competitive en-ergy markets.

For electricity, the EPAct represented an his-toric rethinking of the electric utility industryand how it should be regulated. It increasednon-utility participation in electric power thathad started with the PURPA, and it reformedthe PUHCA to encourage a competitive whole-sale market for electricity.

The EPAct created a new category of inde-pendent power producers called exemptwholesale generators (EWGs). These genera-tors were not required to meet cogenerationor renewable fuels limitations in PURPA. Utili-ties were not required to purchase electricityfrom EWGs. However, utilities were requiredto provide transmission access to EWGs forwholesaling their power. In effect, EPAct pavedthe way for FERC’s actions on open access forwholesale transmission and, indeed, EPActencouraged the FERC to move forward withopen access for electricity (as well as to con-tinue to fine tune the open access environmentcreated for natural gas on interstate pipelinesin 1992).

FERC Orders 888/889 - 1996With Orders 888 and 889, the FERC imple-

mented the intent of Congress implicit in theEPAct, to create a competitive, wholesale, bulk

power market. All utilities within the FERC’sjurisdiction were required to open their wiresand provide nondiscriminatory access to allthird parties at comparable rates, terms andconditions. They had to provide both networkand point-to-point service. The FERC has areciprocity requirement that publicly ownedutilities and co-ops, which are outside of FERCjurisdiction, and who take advantage of openaccess among the utilities that FERC regulates,must also provide comparable service. TheFERC allowed recovery of stranded costs at-tributable to its rulemaking as long as theywere demonstrated to be legitimate and veri-fiable, with recovery obtained by charging ei-ther an access charge or exit fees for bulk us-ers that elect to leave a utility’s service. Impor-tantly, stranded costs in the wholesale markethave not been nearly as large as the potentialstranded costs associated with retail access, anissue for state PUCs.

As noted in the previous sections Part 1 -Facts on Texas Electric Power and Part 2 - His-tory, under Orders 888/889 only transmissionand marketing must be functionally un-bundled and utilities must provide informa-tion systems for access to facilitate third partyaccess.

FERC Order 2000FERC’s third initiative to grid regionalization

is Order 2000 issued in December 1999, whichcalled for the voluntary creation of regionaltransmission organizations (RTOs) throughoutthe U.S. FERC wants to bring all of the trans-mission systems under regional control in or-der to eliminate the remaining discriminatorypractices, meet the increasing demands placedon the transmission system, and achieve fullycompetitive wholesale power markets. If Order2000 can be successfully implemented, thetransmission system will transform from aloosely interconnected system owned and con-trolled mostly by vertically integrated utilitiesto a system owned and/or controlled by a fewunaffiliated RTOs or “transcos” (independentfor profit or not-for-profit transmission compa-nies) with decisions to add (or remove) trans-mission capacity made through those entities.


For electricity, theEPAct represented anhistoric re-thinking ofthe electric utilityindustry and how itshould be regulated.

34

According to Order 2000, an RTO must beindependent from market participants; haveappropriate scope and regional configuration;possess operational authority for all transmis-sion facilities under its control; and have ex-clusive authority to maintain short-term reli-ability (The FERC has been less specific withregard to transcos).

To achieve these goals, an RTO must admin-ister its own tariff; employ a transmission pric-ing system that will promote efficient use andexpansion of transmission and generation fa-cilities; create market mechanisms to managecongestion; monitor markets to identify designflaws and market power; operate a single OpenAccess Same-Time Information System (OA-SIS); and serve as a supplier of last resort forall ancillary services required in Order 888 andsubsequent orders among other functions.

During late summer, 2001, the FERC putforth a more assertive view, suggesting that itwould encourage formation of only four RTOs:Northeast, Southeast, Midwest and West. In ex-plaining its vision with regard to the four-RTOmodel, the FERC often mentioned ERCOT asa separate regional grid. However, many op-tions are available to ERCOT with regard topossible combinations that could be made withsurrounding RTOs as well as remaining inde-pendent. Subsequent to the FERC’s proposalfor four RTOs, administrative hearings andmediations have attempted to address con-cerns across the numerous stakeholders in allof the affected areas, including consumergroups and representatives. As these meetingshave progressed, local concerns as well as is-sues associated with the formation of the RTOs(like transmission asset ownership, RTO struc-ture and “governance” and congestion pricing)have resulted in a view that a larger numberof RTOs may initially exist as various ap-proaches for managing the many issues areexperimented with.

FERC is expected to reach its final recom-mendations regarding the formation of RTOsin 2002. Meanwhile, some utilities and exist-ing ISOs are already forming associations tocoordinate the operations of their transmissionsystems. For example, after the PJM (Pennsyl-

vania-New Jersey-Maryland) ISO and Mid-west ISO (or MISO) announced they wouldmerge their operations in early 2002, the Ten-nessee Valley Authority (TVA), the nation’sbiggest public power producer, agreed to con-nect its 30,000 megawatts of generation with anetwork that spans 20 Midwest and Southweststates and one Canadian province. Southeastutilities Southern Co. and Entergy Corp. alsoagreed to join the grid formed by the combi-nation of the MISO and Southwest Power PoolInc. (SPP). Together, the four groups own oroperate 150,000 miles of transmission lines andprovide power for an area covering 1 millionsquare miles. Nevertheless, these deals do notnecessarily imply that merged areas or opera-tions will be handled in the same manner asintended in FERC’s RTO proposal.

As the debate regarding RTOs progressed,the FERC issued on July 31, 2002 a “notice ofproposed rulemaking” (or NOPR) on standardmarket design (SMD). The intent is to harmo-nize rules across the RTOs in order to create aseamless, larger national grid and market. TheFERC also hopes that the SMD proposal willhelp solve numerous issues and conflicts thathave arisen from electric power restructuringefforts. However, the SMD proposal is verylarge, complex and contentious. As of thisedition, it is not clear whether, and in whatform, FERC’s initiative will be implemented.

National Energy Policy Since EPActDuring 2000 and early 2001, a crisis atmo-

sphere once again prevailed in the U.S. Thiswas triggered by several events.

• After a severe collapse, worldwide oil pricessurged, a result of efforts by OPEC to regaincontrol of the global oil market. Prices havesince moderated, after peaking at $35 perbarrel in nominal terms, a level not seensince the Persian Gulf War.

• Surging demand for natural gas, in large partdue to the increased use of natural gas forelectric power generation, and rising oilprices led to prices for natural gas never be-fore seen in the U.S. Natural gas pricespeaked well above $10 per thousand cubic


35

feet, in nominal terms, at Henry Hub inSouth Louisiana, the main trading point fornatural gas in North America. This meantprices in excess of $40 per thousand cubicfeet at “citygates” like Chicago, where natu-ral gas from interstate pipelines enters localgas utility distribution systems.

• With both oil and natural gas prices rapidlyrising, with accumulated demand for elec-tric power in the U.S. at an all time high –the result of an unprecedented eight-yeareconomic boom, with problems surfacing inmany electric power restructuring programsundertaken by the states (in particular inCalifornia) and with fundamental problemsrevealed in electric power transmission(critical capacity shortages and severe con-gestion), electric power prices in the youngnational wholesale market reached levelsthat resulted in political responses from bothstates and the U.S. Congress. At one point,electric power trading at the California-Or-egon border reached $10,000 permegawatthour. The situation in Californiawas acute, with chronic shortages, rollingblackouts and a high degree of conflict re-garding causes, appropriate actions and fed-eral and state policy and regulatory respon-sibilities and responses.

• Terrorist attacks on September 11, 2001 thatdestroyed the World Trade Center in NewYork City and a part of the U.S. Departmentof Defense’s Pentagon headquarters inWashington, D.C. lent new urgency and newattention to U.S. energy security. These con-cerns have become exacerbated as the “waron terrorism” became complicated by ten-sions surrounding a possible war in Iraq. Thebusiness failure in December 2001 of EnronCorp., long one of the most innovative andaggressive advocates for competitive energymarkets and wholesale energy trading in theU.S. and worldwide, cast a new light onemerging electric power structures in theU.S. Enron’s collapse has had repercussionsthroughout the natural gas and electricpower industries as FERC, SEC and Con-gressional and state investigations intoEnron’s activities, and those of other energy


traders and generators of electricity, haveadded new uncertainties.

To address new U.S. energy security concerns,encourage development of diverse energy sup-plies and infrastructure, deal with environmen-tal and conservation initiatives and attempt toprovide some direction for emerging competi-tion in electric power, the White House unveiledin Spring 2001 a National Energy Policy (NEP)document. Congressional action on the NEPsince that time has resulted in legislation pro-posed in the House and Senate that must bereconciled through House-Senate conference ifany new, final energy legislation is to emerge.As of this edition of the Guide, no final legisla-tion has been achieved. The FERC is continu-ing its investigations into electricity market fail-ure in California and reviewing problems inother states and regions. The myriad of investi-gations and inquiries on energy trading activi-ties have raised questions about whether andhow oversight should be conducted for energytrading operations and practices. Among thestates, Texas is regarded as a key barometer forelectricity restructuring.

36

Regulation ofElectric Power inTexas

Policy changes at the federal level have hada tremendous impact on the Texas electricpower industry since its inception. To betterunderstand the current system of electric util-ity regulation in Texas, and the impact of fed-eral initiatives over the years, a brief descrip-tion of how the Texas system has evolved ishelpful.

As described in the beginning of this chap-ter, electric utilities developed to serve a par-ticular business and grew to serve a town orcommunity. A utility sold all the electricity itgenerated to a local market. As a result, in theearly 1900s the state legislature enacted stat-utes that granted the authority to regulate ratesand services to local municipalities. Over theyears, utilities expanded their operations to

provide service to manymunicipalities and devel-oped integrated systemssuch that electricity gener-ated at one point on that sys-tem might be consumed at adistant location on the sys-tem. The concept of localregulation did not changeuntil 1975. And so, prior to1975, municipalities regu-

lated electric rates and services within theirmunicipal boundaries while residents of ruralareas had relatively little regulation.

Public Utility Regulatory Act (PURA)1975

In 1975, the 64th Texas Legislature passed thePublic Utility Regulatory Act (PURA) whichcreated the Public Utility Commission of Texas(PUCT). The Commission was authorized toregulate the electric, telephone, water andsewer services in Texas. The legislature foundthat these utilities operated as monopolies andwere not subject to normal competitive forces.

The use of regulation was established as theappropriate means for utility operations anddevelopment. The Commission was given theresponsibility for assuring rates, operations,and services that are just and reasonable to con-sumers and utilities. In 1986, the agency’s ju-risdiction over water and sewer utilities wastransferred to the Texas Natural Resource Con-servation Commission, which is now called theTexas Commission on Environmental Quality(TCEQ). The PUCT now regulates the electricutilities, electric cooperatives (only wholesaletransmission), river authorities and 58 localtelephone companies. Municipal utilities arenot governed by the PUCT, but are subject toservice area certification by the Commission.

The Commission’s initial duties focused onestablishing each utility’s service area, certifi-cation of facilities and setting just and reason-able service standards. The Commission wasalso charged with holding hearings on pro-posed utility rate changes, monitoring themanagement and affairs of public utilities,monitoring compliance with PURA andagency orders and rules, and investigatingpublic utility mergers and sales of property.

The Commission’s function and responsibili-ties have undergone several legislative changessince 1975. In 1983, the 68th Legislature madeseveral changes to the PURA including requir-ing electric utilities to file a notice of intent withthe PUCT before building new generatingplants and to prove to the agency that they hadconsidered other reasonable resource alterna-tives. In addition, the Legislature encouragedutilities to use alternative fuels, required theCommission to develop a long-term statewideenergy forecast to be used in certification pro-ceedings for generating plants, and requiredthe agency to conduct management audits ofeach utility under its jurisdiction at least onceevery 10 years.

Legislative Changes in 1995In 1995, the Texas legislature made several

changes to PURA that would help develop acompetitive wholesale electric market.Changes to PURA included exemption ofpower marketers and EWGs from the


In 1975, the Public UtilityRegulatory Act (PURA) waspassed by the Texas legislature.PURA forms the basiclegislative authority for thePUC of Texas.

37

Commission’s rate regulation, partial rate de-regulation of electric cooperatives distribution,deregulation of wholesale rates of certain riverauthorities, development of an integrated re-source planning process, flexible pricing forwholesale and retail sales, open nondiscrimi-natory wholesale transmission service, andrepeal of the requirement to conduct the man-agement audit every 10 years. Although the basic activities of the PUCT didnot alter much during its 20 years of existence,how the PUCT had gone about its responsibili-ties had been heavily influenced by nationaltrends and strategies adopted and sharedamong all PUCs in the U.S. One of these trendshad been the emergence of integrated resourceplanning (IRP) as a strategy for improving util-ity planning and reducing costs to customers.IRP or least-cost IRP, as it was sometimes called,was a process in which PUCs were heavily in-volved in decision making both before and af-ter the fact. Utilities were required to make“prudent” investments and prudence reviewswere often used as an after-the-fact mechanismfor regulatory oversight. IRP evolved across thestates in response to the large costs associatedwith new generation capacity additions, espe-cially for nuclear facilities.

Similarly, demand side management (DSM)evolved in response to utility investments andconcern about energy efficiency and conserva-tion. DSM was generally a component of IRPand encouraged utilities to consider gains fromconservation and efficiency improvementsbefore undertaking new investments. Both IRPand DSM had been controversial, generatingextensive debate about whether they createdreal benefits in excess of the costs associatedwith these policies. They had, nevertheless,affected how all PUCs undertook their basicactivities.

Another area influencing PUC operations inthe U.S. had been the notion of incentive ratemaking. Interest in developing rate structuresthat were more market oriented and less dis-torting to the behavior of regulated utilities aswell as their customers had grown in the U.S.PUCs in every state have been looking at newways of setting rates. Finally, a last area influ-

encing the Texas PUC is the general trend to-ward more efficient government operations.

Also in 1995, the Texas legislature made sev-eral changes to PURA that are particularlynoteworthy and were in response to the EPAct.These include the following.

Senate Bill 373 (SB 373) was enacted to re-structure the wholesale electric industry andauthorize EWGs. Power marketers are busi-nesses that sell but do not generate or trans-mit electricity. These businesses and EWGswere not defined as utilities in PURA and wereauthorized in SB 373 to sell only wholesaleelectric power in Texas. Power marketers andEWGs could be affiliated with a public utilityand could sell power to that utility. However,they were required to register with the Com-mission and comply with reporting require-ments.

SB 373 also required utilities to provide un-bundled transmission service on a non-dis-criminatory basis and establish an ISO. ThePUCT authorized the ERCOT ISO to be opera-tional by July 1997. Utilities that own or oper-ate transmission facilities had to providewholesale transmission access at rates, terms,and conditions that were comparable to theirown use of their system. The PUCT could re-quire utilities (including municipal utilities) toprovide access to transmission services to an-other utility, a QF, an EWG or power marketer.

Except for river authorities, wholesale rateswere not deregulated, but a utility could re-quest wholesale tariffs that were less than ap-proved rates, but more than the utility’s mar-ginal cost approved by the regulatory author-ity (either the PUCT or city government). ThePUCT had interpreted PURA such that thecosts for these discounted rates could not becharged to other customers.

The PUCT had an IRP process and a state-wide plan, as required in PURA. Starting in1996, utilities were required to file an IRP ev-ery three years. If a utility needed to acquirenew electricity sources, a competitive biddingprocess was required that included differentsources of electricity. The utility itself or an af-filiate could also bid, but an independent bidevaluator was required by the PUCT’s substan-


38

tive rules based on PURA. Nongenerating utili-ties had to follow this same process if theywished to increase their supply more than 25percent or acquire more than 70 megawatts ofnew power from a supplier. There were alsorequirements for consumer participation in de-veloping the utility’s IRP.

River authorities and electric cooperativeswere deregulated to some extent in 1995. Cer-tain river authorities had wholesale sales toany purchaser within the authority’s servicearea. River authorities could also create a cor-poration to sell electricity to any wholesale pur-chaser in the state and the corporation wouldnot be treated as a public utility by PURA. Elec-tric cooperatives providing retail electricity atdistribution voltages could become exemptfrom rate regulation. This required a majorityvote by voting members. Flexible retail ratescould then be adopted (without Commissionapproval) which were as low as the lowestmarginal costs of any of the cooperative’swholesale suppliers.

A utility could offer flexible retail pricing,

with retail tariffs orcontracts that were lessthan their approvedrates. These rates hadto be greater than theutility’s marginal cost,as approved by theirregulatory authority(either the PUCT orcity government).

LegislativeActivity in 1997and SB 7 In 1997, the Texaslegislature considereda number of bills thatwould have restruc-tured the electricpower industry inTexas to allow entitiesother than local utili-ties to sell electricity ina retail market. One billsupported by the Texas

governor, the PUCT and investor owned utili-ties was introduced late in the legislative ses-sion but the session adjourned prior to actionon the bill.

Following adjournment, the Senate InterimCommittee on Electric Utility Restructuringwas created to study issues and report back tothe Senate before the next legislative sessionwhich began in January 1999. The seven-mem-ber committee conducted hearings around thestate to gather information and better under-stand concerns of citizens and interested par-ties. The committee also visited other states inthe U.S. as well as other countries that wereexperimenting with electricity restructuringand more competitive markets. The TexasHouse State Affairs committee also studied re-structuring issues and held hearings.

By the close of the 1997 session, several is-sues emerged that affected the final formula-tion of Senate Bill 7 (SB 7), including the fol-lowing:• Cost savings to consumers. There were con-

siderable concerns about whether small


ERCOT Competitive Market Participants

Source: ERCOT, The Market Guide, February 22, 2001

39

(mainly residential) consumers would beable to benefit immediately with retail com-petition. Most of these concerns stemmedfrom the allocation of stranded costs and im-plications of stranded cost recovery on elec-tricity prices. It was feared that without ad-equate, broad-based competition, cost sav-ings from restructuring might not beachieved to offset stranded cost charges. Ac-cordingly, SB 7 allowed for all net, verifiable,nonmitigated stranded costs to be recoveredthrough a competition transition charge(CTC). Stranded costs, however, did not turnout to be a problem. In fact, ”stranded ben-efits” were created in 2000 and 2001 due tohigh natural gas prices leading to highpower prices and sustained value of coal andnuclear facilities – which many had expectedto decline in worth in a competitive market.The ability for residential users to fully ben-efit from retail choice remains a concern.

• Property tax losses to counties, municipali-ties and school districts. In some parts of thestate, there were (and still are) concerns thatsavings or other benefits (such as economicgrowth) from retail competition will not ex-ceed lost property tax revenues as a resultof write downs on utility assets (strandedcosts). The most sensitive arena for debatewas the structure for public school fundingin Texas, which many thought might needto be revisited if economic benefits from elec-tricity restructuring were to be achieved.Accordingly, SB 7 included mechanisms forreimbursement through the System BenefitFund. So far, however, school districts havebenefited through their new buying powerachieved through aggregation as providedin SB 7. For example, as of this writing, En-ergy for Schools Aggregation (142 school dis-tricts) saved $39.3 million and Texas Asso-ciation of School Boards (180 school districts)saved $30 million per year. Cities and localgovernments are also benefiting. For ex-ample, the City of Houston is saving $32million, the Public Power Pool (46 local gov-ernments) is saving $36 million, the CitiesAggregation Project (71 cities) is saving $10million, and the South Texas Aggregation

Project (40 cities) is saving $4.3 million peryear.

• Role of co-ops and munis. Many small co-ops and munis were concerned about the vi-ability of their businesses in more competi-tive electricity markets. While these organi-zations would benefit from the flexibilityand savings that could be achieved as theylooked for competitive suppliers of electric-ity, co-ops and munis that were next to largeIOUs and that were not able to provide thelowest cost transmission and distributionservice would face competitive pressure. Al-though, with unbundling as stipulated in SB7, competition from regulated wires busi-nesses would not have been a major prob-lem, munis and co-ops were given the op-tion to opt out of retail choice. Thus far, nomuni has chosen to offer retail competition,and only two co-ops expressed interest buthave not formally offered retail competitionyet.

• Market power of IOUs. Some policy mak-ers, regulators and independent providers(generators and marketers) were concernedthat the larger IOUs would be able to exerttoo much market power with retail compe-tition. This concern was addressed in SB 7by requiring unbundling of generation, T&Dand retail activities by the state’s IOUs and,more importantly, by limiting the affiliatedretail electric provider (REP) to a six percentdiscount for five years or until the affiliatedREP loses 40 percent of its customers.

• Management and function of the ERCOTISO. Throughout the U.S., as well as in Texas,there was (and still is) considerable debateabout the FERC’s ISO (and now RTO) con-cept. The major arguments are: whether ISOsand RTOs should be structured as for-profitor non-profit entities; how they should begoverned and whether industry stakehold-ers will have too much influence; whetherfor-profit “transcos” (companies that pro-vide open access transmission) are better formarket facilitation; whether the ERCOT ISOor RTO will perform reliably in a fully com-petitive market; and what the ERCOT ISO/RTO structure should be (for example,


40

whether there should be multiple control ar-eas). The decision was made to structureERCOT as a non-profit ISO with a stake-holder board representing all market partici-pants, operating as a single control area, andresponsible for physical reliability of the sys-tem (see Part 2 for details on ERCOT).

• Increased transmission access to ERCOT.This is a contentious,long-term issue. Mak-ing ERCOT less of an“island” in the nationalgrid would have sub-stantial impacts on ex-isting industry stake-holders, especially theIOUs and large NUGs.Given the potential forincreased integrationof North Americanelectric power markets,however, increasedtransmission accessinto and out of ERCOTis probably inevitable –as market participantsseek to take advantageof larger regional mar-kets and connections.How much transmis-sion capacity will be re-quired, where that ca-pacity is to be located,at what cost for devel-opment and how thecost for new transmis-sion capacity is to be al-located across the mar-ketplace remain key is-sues.After the lengthy in-

vestigation period, SB7 was passed in May1999. As discussed ear-lier, utilities must un-bundle into three sepa-rate categories: gen-eration, regulatedtransmission and dis-

tribution and retail electric provider (REP), us-ing separate or affiliated companies. Utilitiesare limited to owning and controlling not morethan 20 percent of installed generation capac-ity within ERCOT. Retail competition startedon January 1, 2002. Rates were frozen for threeyears, and a six percent reduction from this fro-zen rate was required for residential and smallcommercial consumers. This will remain the“price-to-beat” for five years or until the REPaffiliated with the incumbent utility loses 40percent of its consumers to competition. The bill requires a reduction of nitrogen ox-ides (NO

X) and sulfur dioxide (SO

2) emissions

from “grandfathered” power plants over atwo-year period. The law also requires an in-crease in renewable generation of 2,000 mega-watts by 2009 and 50 percent of new capacityto be natural gas-fired. A pilot program open to customers in thestate’s IOU service territories was set to beginretail competition by June 1, 2001. Enrollmentbegan in February 2001. A high level of inter-est in participating in the retail choice pilot pro-gram by nonresidential customers requiredmost of the IOUs to conduct lotteries to choosethe five percent of their customers who wouldbe allowed to choose their electricity supplier.The residential participants were selected ona first-come, first-serve basis. However, theofficial opening of the pilot program was de-layed twice (from the original date of June 1 toJuly 31) due to computer system problems ex-perienced by the ERCOT ISO, which is incharge of recording customer switches from ex-isting utilities to new retail providers.

No new retail provider offered service in ar-eas served by Southwestern Electric Power Co.and Entergy Gulf States during the pilot pro-gram and, subsequently, no customers have re-quested service by an alternative supplier. In2001, legislation delayed retail choice in thearea covered by the Southwest Power Pool inthe Texas Panhandle until 2007. The PUCT alsoaccepted a settlement to delay implementationof retail access in East Texas. These delays willaffect customers of Southwestern ElectricPower Co. in Northeast Texas, a few custom-ers of Southwestern Public Service Co. in the


Highlights of SB 7 and Texas Choice Program.

Senate Bill 7• Utilities must unbundle into three separate

categories: generation, regulated transmis-sion and distribution and retail electric pro-vider, using separate or affiliated companies.

• Utilities are limited to owning and control-ling not more than 20 percent of installedgeneration capacity within ERCOT.

• Generators are required to reduce their ni-trogen oxide and sulfur dioxide emissionsfrom “grandfathered” power plants over atwo-year period.

• Generators must more than triple theamount of power generated from renewableresources such as wind by January 1, 2009.

• ERCOT is defined as the ISO, responsiblefor coordinating the actions of market par-ticipants and ensuring system reliability.

• Municipals and cooperatives are not af-fected by the law, unless they choose to opentheir territories to competition.

Texas Choice Program• Retail competition started on January 1,

2002.• A six percent reduction from 1999 rates is

mandated for residential and small commer-cial consumers (<1 MW). This will remainthe “price-to-beat” until 2005 or until the af-filiated REP loses 40 percent of its consum-ers to competition.

• Companies are allowed to adjust their ratestwice a year due to fluctuations in the priceof natural gas.

• As of July 2002, more than 40 companies arecertified as REPs; 12 REPs are actively pro-viding service to residential customers and24 REPS are actively providing service tonon-residential customers across Texas.

• As of July 2002, almost 100 companies arecertified as aggregators; 28 are actively pro-viding service to residential customers and46 are actively providing service to non-resi-dential customers. Others are self-servingentities for associations, restaurant chains,churches and so on.

41


Panhandle and customers of Entergy withinthe Southeastern Electric Reliability Council.Reasons cited include the lack of regionaltransmission organizations (RTOs), no retailelectric suppliers and wholesale electricitymarkets in these areas that are not yet com-petitive.

It is early in the competitive era and theERCOT region is blessed with comfortable re-serve margins. As a result, the competitivemarket in Texas has not experienced majorproblems as many feared after the Californiacrisis. However, delays with the start of thepilot program, ERCOT’s difficulties with han-dling the switching data, withdrawal of REPssuch as Shell and NewPower, news of poten-tial gaming in congested zones, changes in theERCOT board, concerns regarding Provider ofLast Resort, or POLR, rules (See Part 5 - MajorIssues) and the like have been frustrating forthe market participants.

Nevertheless, as of November 2002, 48 com-panies are certified as REPs by the PUCT. Ac-cording to the Texas Choice web site, 12 REPsare actively providing service to residentialcustomers and 23 REPs are actively providingservice to non-residential customers acrossTexas. Also, as of November 2002, more than130 companies are registered as aggregatorswith the PUCT; 32 are offering service to resi-dential customers and 50 are offering serviceto non-residential customers. Others are self-serving entities for associations, restaurantchains, churches and so on.

Not all of these companies are active in allparts of the ERCOT region. Currently, depend-ing on the location, residential customers havethree to nine REPs and six to 14 products fromwhich to choose. Customers in most populatedurban locations such as Houston and the Dal-las-Ft. Worth area have more choices. For ex-ample, according to PUCT data, in Reliant(now CenterPoint) and TXU (now Oncor) ter-ritories there are nine REPs offering up to tendifferent products.

As of September 2002, about 456,000 custom-ers had requested a retail switch. Given thatthere are more than nine million customers inERCOT (eight million residential), these num-

bers are not very large, especially consideringthat the switch statistics include customerswho may have switched more than once.CenterPoint (mostly Houston) has the largestpercentage of residential customers served bynon-affiliated REPs, with six percent. CPL hasseen about 11 percent of its small commercialcustomers switch to a non-affiliated REP.However, when it comes to large customers(with peak demand of one megawatts orlarger) that are not eligible for PTB, the switchrate is more than 80 percent in all territories.Overall, 40 to 50 percent of the load seem tohave switched in ERCOT.

Meanwhile, improvements in ERCOT’s com-puter systems and in communications betweenERCOT and other market participants’ systemsincreased the success rate for customer switch-ing from 50 percent in early February to morethan 90 percent in early June. Remaining prob-lems include lost switches, rejected switches,switches done outside ERCOT protocoltimelines, and usage data transfers, whichleads to billing problems.

When price-to-beat (PTB) is compared withDecember 31, 2001 rates, the annual potentialsavings to residential customers is estimatedto be about $1 billion. Since some retail offersare below PTB, savings are likely to be higher.In addition, when savings to school districts,city governments and commercial and indus-trial (C&I) customers are considered, total sav-ings are estimated in billions.

C&I customers switch actively to new retailproviders, most often through energy servicecontracts that offer lower prices with associ-ated incentives for energy efficiency and con-servation. On the residential side, technical is-sues continue to delay switching and REP se-lections by new move-ins, frustrating newplayers in the market. Also, the PUCT contin-ues to examine broad and important marketissues such as transmission congestion, creditrisk of REPs, generation adequacy (see Part 5 -Major Issues), POLR rules, lack of competitionin non-ERCOT areas and consumer protection.

Basic PUCT Activities Before SB 7While numerous changes were made to the

42


Comparison of PUCT Activities Before and After Senate Bill 7

Certification

Rate-setting

Monitoring

Assisting Customers

Overall

Before

IOUs needed CCNs for genera-tion as well as T&D assets.

Responsible for setting electricityrates for IOUs.

Monitored activities of IOUs.

Resolution of complaints regard-ing service quality, bill payments,etc.

Fostering wholesale competition.

After

CCNs are now required for newgeneration units and new transmis-sion lines (consistent with ERCOTsystem assessment).

Responsible for setting rates forT&D services.

Monitors market activities of avariety of market participants.

Same plus educating the publicabout retail choice.

Fostering wholesale and retailcompetition.

PURA, the four basic activities of the PUCTdid not change substantially between 1975 and1995. These four basic activities include certi-fication, rate-setting, monitoring regulatedutilities for compliance with statutes and Com-mission rules, orders and service standardsand assisting consumers in resolving com-plaints against regulated utilities.

Before a regulated utility could provide ser-vice to an area or construct new facilities (gen-eration or transmission), it needed to obtain acertificate of convenience and necessity orCCN from the PUCT (the Texas Constitutionprohibits non-exclusive franchises). Prior to1996, two hearings were required, one for anotice of intent (NOI) and a second for theCCN. The hearings would identify the optionsthe utility had considered for meeting thearea’s electrical needs. The action would needto be in compliance with the utility’s longrange energy forecast for its service area. TheNOI process applied only to generating facili-ties but it was repealed in 1995 with the enact-ment of the Integrated Resource Planning (IRP)provisions. In 1996, utilities started to includenew facilities in their IRP. In the case of a trans-mission line, the PUCT is required to take ac-tion within one year. Other actions or improve-ments have no time limit.

The PUCT was responsible for setting elec-tricity rates outside of city limits for investor-

owned utilities, electric cooperatives and riverauthorities. City governments had the respon-sibility for rate setting inside city limits. Thesecases, however, were usually filed with bothcity government and the PUCT and cities gen-erally utilize the PUCT process. Any appealsof city rates were consolidated into a singlePUCT proceeding. The PUCT also reviewedappeals of municipal utility rates where cus-tomers were served outside of the city limits.

The PUCT set rates by determining a utility’srevenue requirements and rate design. Rev-enue requirements were the amount requiredto cover reasonable and necessary operatingexpenses plus any new investment while pro-viding an opportunity for the utility to earn areasonable return (profit) on the utility’s capi-tal investments. In its determination, the PUCTneeded to decide what was allowed to be in-cluded in a utility’s rate base - the capital as-sets and expenditures incurred by utilities. Es-tablishing what was to be included in the ratebase was actually one of the most difficult as-pects of regulation in any state. In setting rates,the PUCT considered management quality,operational efficiency, and conservation anddemand-side management activities. The ratedesign included the ways that revenue require-ments were spread among the various typesof customers.

The PUCT monitored regulated utilities toensure that they com-plied with legislative re-quirements and Com-mission policies, rules,orders and service stan-dards. In addition, thePUCT monitored utilityearnings and conductedmanagement audits ofthe utilities.

The PUCT helpedwith consumer com-plaints against regu-lated utilities. The con-sumer affairs office re-sponded to inquiriesand complaints from thegeneral public. In addi-

43


tion, the office assisted consumers in resolv-ing specific problems they might have experi-enced with regulated electric utilities.

Basic PUCT Activities After SB 7As a result of all of the changes brought

about by SB 7, the work of the PUCT is chang-ing. As competition emerges, the large ratecases that consumed the agency in the past aregiving way to more sharply focused proceed-ings aimed at protecting competitive marketsand Texas customers.

In late 1999 and early 2000, the Commissionadopted rules on service reliability, distributedpower generation, utility codes of conduct, re-newable energy, and the requirements for un-bundling utility operations. Beyond 2002, thePUCT will continue to regulate rates but onlyfor transmission and distribution service as thegeneration side is separated from the wiresbusiness. The Commission will continue to en-force rules on quality of service, customer pro-tection, market power and reliability. ThePUCT will also continue regulating utilities inareas of Texas where competition has not yetbegun.

SB 7 also repealed PURA Chapter 34, whichrequired the Commission to implement IRPprograms. This repeal is generally well re-ceived by the market participants as many be-lieve that SB 7 allows the market to determineresource planning and continues to encouragerenewables and DSM services as intendedoriginally by the IRP programs. On the trans-mission side, the ERCOT ISO evaluates the sys-tem and puts out reports about the need fornew facilities. T&D utilities that are willing toinvest in new facilities will have to show thattheir plans are consistent with ERCOT’s assess-ment.

SB 7 also requires the PUCT to develop aconsumer education program to inform con-sumers, including low-income and non-En-glish-speaking consumers, about changes inthe provision of electric service and about thecustomer choice pilot program. The four-yeareducation campaign, beginning in fiscal year2001, will be designed to provide customerswith the information necessary to make in-formed decisions relating to the source andtype of electric services available.

45

Major Issues

Overview

Consumer IssuesAll of us are electricity consumers and, as

such, are familiar with issues that directly af-fect us. For most people this comes down tothe cost (our monthly bills) and reliability (dowe get our electricity all or most of the time).However, other consumer issues arise aschanges occur in the electric power arena.These issues have been described as large ver-sus small consumers; or industrial versus resi-dential consumers.

Small Consumers and ResidentialCustomers

There are many more residential consumersthan any other customer class - more than eightmillion Texas households. In 2000, these cus-tomers purchased 37 percent of Texas electric-ity and paid 45 percent of the total electric bill.

Customers with special needs and problemsinclude low-income households, renters andmultifamily households, and the elderly. Thesegroups have received special consideration byutility regulators and electric utilities in theform of rate setting, weatherization programsand special programs that allow other custom-ers to contribute to the cost for those less ableto pay.

The Monthly BillSmall consumers cost utilities more per cus-

tomer to serve. In Texas, the primary issue forthese customers is their total electric bill, notthe rate. This has to do with the customer’scontrol over their own expenses. If bills in-crease quickly for reasons beyond their con-trol, residential customers are dissatisfied.Residential consumers, and many small busi-nesses, prefer predictable costs that fluctuatewithin a certain range and that change rela-tively little over time.

Major ElectricPower Issues

Many of the issues facing theelectric power industry arepresent in day-to-day op-

erations and are taking on addedimportance as the industry becomesmore competitive. Some of theseinclude consumer issues, environ-mental concerns, economic develop-ment, financing, integrating non-utility generation into the Texas andU.S. energy mix, stranded costs, fi-nancial performance, and the regu-latory process.

In Texas we have many differentcustomers, and each group of cus-tomers has different needs and re-quirements. Smaller customers, likehouseholds, need electricity to meetbasic requirements of lighting, heat-ing and cooling. We are accustomedto receiving our electricity on de-mand, but our bills tend to be some-what higher than for the U.S. as awhole because of the amount ofelectricity we use for summer cool-ing. Low income and rural custom-ers have particular sets of problemsin terms of service and ability to pay.Large users, businesses and facto-ries, always want lower energyprices to be more competitive. Largecommercial and industrial custom-ers had more supply options thanhouseholds until retail choice wasintroduced with SB 7 starting Janu-ary 1, 2002. Now, we can all chooseour electricity suppliers.

Energy, in general, is vital to eco-nomic development in the U.S. andTexas. Electricity has played a role

both in our overall quality of lifeand in the performance of theeconomy. However, although en-ergy is important, it is just one fac-tor among many that influences thepace and direction of economic de-velopment. It may be desirable forenergy markets to be as accessibleand competitive as other marketsthat provide inputs to economicdevelopment.

Environmental protection is in-creasingly important in the U.S.,and the electric power industry isaffected by our preferences forcleaner air, higher efficiency use ofenergy and other values. An arrayof options exists for use of cleanerfuels to generate electricity, espe-cially renewable energy sourceslike solar and wind, for new tech-nologies that continue to reduce thegeneration cost of electricity andfor more flexible electricity systemsthat can serve a variety of customerneeds and encourage conservation.

Finally, introducing competitioninto the electric power industry hasposed a host of issues for both utili-ties and non-utility generators. Fi-nancial implications, transmissionaccess and pricing and the muchdiscussed “stranded cost” problemare some of the issues being con-sidered.

ReliabilityReliability is also a major concern for all cus-

tomers. Although outages are familiar to cus-tomers, their expectations are that such out-ages will be quickly remedied, unless there areunusual circumstances such as major stormsor natural disasters.

Obligation to ServeAn important issue affecting the small con-

sumer more than other customer groups is the“obligation to serve” issue. As part of the“regulatory compact” between utilities and thestate of Texas, utilities had an obligation toserve all consumers on demand. This meanthaving the capability to bring electricity to

46

Major Issues

current and fu-ture customersas it is needed.After SB 7, elec-tricity supply isc o m p e t i t i v e .While the wirescompanies arestill regulatedand obligated toprovide servicein their territo-ries, customerscan be firstdropped to aprovider of lastresort (POLR) ifthey fail to paytheir bills. If they

fail to pay POLR bills, their service can be ter-minated. There are provisions for protectingthose who cannot afford to pay. A consider-ation for consumers is how expensive powerprovided by POLRs might be.

Social ConcernsIn Texas, as elsewhere in the U.S., the almost

universal availability of electricity for every-one has been built into our regulatory system.For low-income households, electric utilityprograms have been created to help assure thatelectricity is available at as low a cost as pos-sible.

Of the 20.8 million people in Texas in 2000,roughly 16 percent lived in poverty, an esti-mated 825,000 households that use electricity.This population and those living on fixed in-comes are less able to afford increases in elec-tricity costs. Under the System Benefit Fundprovision of SB 7, about 500,000 low incomecustomers are receiving discounts.

Renters and Rental HousingOf the eight million residential customers,

almost 37 percent are renters. Most rental unitsare now individually metered, but renterhouseholds have little control over the choiceof appliances or energy savings improvementsthat could be used to better manage electricity

costs. In addition, income levels in rentalhouseholds typically are lower than the aver-age household.

Consumer ProtectionAlthough all electricity customers need con-

sumer protection provisions, small consumersare more likely than large industrial or com-mercial electricity customers to lack the re-sources or capabilities to adequately protectthemselves. Over the years, consumer advo-cate groups have emerged in all of the statesto intervene in the regulatory process on be-half of small customers.

Rural IssuesTexas is a big state, with huge swaths of ru-

ral areas that are remote from electric powerfacilities that serve large cities and towns. Forthis reason, it was important to consider theeffect of restructuring on the rural areas of thestate. The Rural Electrification Act of 1935 ineffect pioneered the concept of universal ser-vice - the concept that electricity was a funda-mental commodity to which all citizens shouldhave access. Today, even though some coop-eratives are large and serve suburban metro-politan areas, most rural customers still receivetheir services from cooperative systems. Co-operatives face similar risks as utilities in acompetitive environment, but since they op-erate as non-profit entities they may face ad-ditional challenges from a changing electric-ity market. In recent years, financial resourcesincluding federal funds for co-ops started todecline. As discussed in Part 4, co-ops wereallowed to opt in retail choice and, thus far,only two co-ops are expected to participate inretail competition.

Large Electricity ConsumersCost and economic competitiveness are key

issues for Texas industrial and large commer-cial customers that consume large amounts ofelectricity. These customers have considerableleverage in the electricity market. They are rela-tively easy to serve, their loads are more pre-dictable and they sometimes have the optionof generating their own electricity (e.g., cogen-

2000 Electric Bills in TexasCompared with U.S. averages

Percent Higher than U.S. Avg.

Percent Lower than U.S. Avg. Source: U.S. EIA

31.9%

-21.8%

12.6%

17.9%

-2.3%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

Residential Commercial Industrial Other Total

47

Major Issues

eration). Large customers also have strong in-centives to increase efficiency and reduce theirconsumption of electric power. With retailchoice, most C&I service contracts includethese benefits.

Cost IssuesTexas industrial customers enjoy a cost ad-

vantage of roughly five percent over the aver-age U.S. industrial customer (4.42¢ per kWhversus 4.64¢ in 2000). However, electricity costsare a significant factor for many Texas indus-tries and they believe that lower rates may bepossible. As a result, competition and accessto alternative sources of electricity are impor-tant issues for these customers.

Economic CompetitivenessTexas industrial and commercial activities

must compete in an international marketplace.Opportunities for lowering electricity costs canimprove the competitive status of Texas indus-tries, as well as attract new industries to thestate. While rates are lower in Texas than otherlarge states, it is overall costs that are impor-tant. Texas and U.S. industries enjoy a distinct

cost advantage overmany of our interna-tional trading part-ners (see table of in-ternational electricityprices for industry),but global competi-tive forces are drivingother countries topursue policies thatlower industrial elec-tricity costs.

ReliabilityWith the advent of

and increasing reli-ance on electroniccontrols and informa-tion systems, the re-liability of electricpower plays a largerrole. Even small out-ages (less than a sec-ond) can disrupt industry processes, addingto the cost of production and operation.

Sample of Worldwide Electricity Pricesfor Industrial Users

Year U.S. $/kWh

Japan 0.143Germany 0.057Spain 0.056OECD 0.063Turkey 0.079OECD Europe 0.065Netherlands 0.061United Kingdom 0.064France 0.047United States 0.046Australia 0.056Texas 0.044Sweden 0.034Canada 0.038Mexico 0.042

Note: OECD = Organization for Economic Coop-eration and DevelopmentSource: International Energy Agency

199919991999199819991998199919991998200019972000199719941999

Population

1959 Level = 1.0

1959 to 2000Growth of U.S. Electricity Generation, Population and the Economy

.0

48

Major Issues

Self GenerationLarge electricity users sometimes have the

option of generating their own electricity. Thispotential affects the relationship between in-dustry and utilities, especially when self-gen-erators want to sell their excess power to theutilities. Industrial cogeneration, the majorityof self-generation, provides fuel efficiencies perkWh that are about double conventional gen-eration. Also, investment costs per kWh for co-generation are usually one-half to three-fourthswhat they are for conventional electricity gen-eration.

Economic DevelopmentHow important is electricity to economic de-

velopment in the U.S.? The answer is “very,”but in a surprising way. Electricity growth isdriven both by household growth and growthin the overall economy, as measured by GrossDomestic Product (GDP).

Growth in the electric power industry in theU.S. is influenced both directly and indirectlyby population growth and general economicperformance. The direct effects come from de-mand for electricity as households are addedor we add new appliances or businesses andindustries expand. The indirect effects comefrom the contribution that electricity makes toour life-styles and quality of life and technol-ogy development.

At the same time, electricity has been an es-sential input for industrial and economic per-formance in the U.S., although there are otherthings that are equally or more important.Much of the improvements in productivity isdue to increased automation and computeriza-tion, which depend on reliable supply of elec-tricity. When both household and economicgrowth is taken together, they account for mostif not all of the net growth in the U.S. electricgeneration capacity.

Texas accounts for almost eight percent ofthe U.S. GDP and about eight percent of totalU.S. population. The relationships betweenelectricity growth, population growth and gen-eral economic performance are similar to thenation as a whole. Like the U.S., electricity in

Texas is a factor in economic performance, butnot the only one. Electricity costs are impor-tant, but so are the costs for land, labor, mate-rials, transportation and other factors. Employ-ment in electric utility services, the most eas-ily obtained measure of jobs linked to the elec-tric power industry, is only about one-half per-cent of the state total nonfarm employment -quite small. However, we also have jobs tiedto companies that provide equipment, materi-als and services to the electric power industry,and jobs in electric power services outside ofthe utility companies themselves. Texas has agrowing number of businesses that indepen-dently market, broker and manage the provi-sion of electricity to industrial and commer-cial customers all over the U.S. Finally, Texaselectric utility companies and independentgenerators and marketers are engaged in de-veloping and managing electric power all overthe world, although these activities are beingcut back due to current financial problems ofthe industry and problems in some regions ofthe world, like Latin America.

The link between electricity and economicdevelopment can play a role within the stateof Texas as cities and regions compete for busi-ness and job growth. Electricity costs varywidely, and are influenced by a number of fac-tors. For example, electricity from nuclear gen-eration or electricity service to remote locationscan result in higher costs. When it comes towhere businesses or people locate withinTexas, however, electricity cost is just one ofmany factors that are evaluated.

Environmental and Energy PolicyIssues

Environmental concerns are a prominentpart of every industry today and electric poweris no exception. Coal and lignite are taken fromunderground and strip mines. Natural gaswells are drilled to provide fuel to generateelectricity. Power plants that use fossil fuelsemit pollutants that are subject to state andfederal regulations. Transmission lines arespread across the state, affecting human andnatural environments. These activities aremonitored and regulated, but because of the

49

Major Issues

size and scope of the industry there will con-tinue to be concerns about electric power andits environmental effects.

Fuel Choices => environmentalPower plants use various fuels that are

linked to problems like acid rain, urban ozone,global warming and waste disposal. Each fuelhas environmental advantages and disadvan-tages. Coal, one of the lowest priced fuels, re-quires considerable treatment of emissions tomeet environmental standards and its use trig-gers concerns about global warming. Naturalgas, a more expensive fuel, burns cleaner thancoal but can contribute to ozone formation inurban areas. Wind and solar power which re-quire relatively high capital costs, produce nodirect emissions and have virtually no fuelcost, but they can be unsightly or impact wild-life. Nuclear power plants emit no combustiongases but have raised the issue of long-termdisposal of spent fuel and are a focus for secu-rity post September 11.

Coal and lignite were the fuels used to gen-erate about 37 percent of Texas electricity in2000. Almost 52 percent was from natural gaswith about ten percent from nuclear power.Less than one percent was from hydroelectricpower or renewable fuels (wind, solar, or bio-mass). Some predictions call for electricity fromcoal to increase over the next 20 years. Texasuses more coal for electricity than any otherstate in the U.S. with the possible exception ofOhio. However, 27 states generate a greatershare of their electric power from burning coal.

In 1971, natural gas dominated the state’selectricity production, generating 99 percentof all electricity. But in response to natural gasprice volatility related to a perceived naturalgas shortage, public policy mandated that utili-ties eliminate the use of natural gas even inexisting plants and use alternative fuel sourcesfor future generating needs. Utilities in Texasin the 1970s began to diversify their fuelsources using coal and nuclear power (see Part4, Regulations and Policies).

It is important to note that natural gas domi-nates generating capability among Texas utili-ties - 71 percent versus 20 percent for coal in

early 2002. These ratios represent a significantchange since 1997 when gas accounted for 61percent and coal for 30 percent of capacity. Coaldominated the amount of electricity actuallygenerated - 49 percent versus 37 percent fornatural gas. With the anticipation of restruc-turing, much more gas-fired generation capac-ity has been built since 1998-99, eventuallyleading gas to be the dominant fuel both forcapacity and generation.

Air Pollution => environmentalAcid rain, urban ozone, particulate emis-

sions and global warming are the four primaryair pollution concerns for the electric powerindustry (also see Part 4, Regulations and Poli-cies, for our discussion of air pollution issuesassociated with electricity in the 1990 Clean AirAct Amendments) although emissions of sub-stances such as mercury especially from coal-fired plants will likely receivemore attention. The EPA Emis-sions Trend Report shows thatfor 1995, Texas electric powergeneration accounted for 43percent of sulfur dioxide (SO

2)

emissions (associated with acidrain) and 21 percent of oxidesof nitrogen (NO

X) emissions (as-

sociated with ozone formation).However, with natural gas in-creasing its share in power gen-eration and implementation ofacid rain programs, overall SO

2

emissions from power genera-tion declined about 20 percent between 1997and 2001. Texas also reduced its NO

X emissions

by 16 percent between 1990 and 2000.Another emission from combustion of fossil

fuels is carbon dioxide (CO2). Although not

officially considered a pollutant, there are con-cerns that it may contribute to global warm-ing. In 1999, CO

2 emissions from utilities ac-

counted for 33 percent of Texas CO2 emissions

(U.S. EPA website yosemite.epa.gov/oar/g l o b a l w a r m i n g . n s f / c o n t e n t /emissionsStateEnergyCO2Inventories.html).

Power plants contribute relatively little toemissions of volatile organic compounds

50

Major Issues

(VOCs - associated with ozone formation andmainly produced by vehicles and industrialoperations), carbon monoxide, nitrous oxide(a greenhouse gas and oxide of nitrogen), ormethane (a greenhouse gas). Because of effec-tive control devices, power plants contributerelatively little to the problem of particulates.

Acid Rain: Acid rain refers to precipitationwhich has a high acidity level that poses a riskto human and ecosystem health. SO

2 emissions

from burning coal (or any fuel containing sul-fur) reacts with water vapor and becomes anacid. The acids may mix with water, fall to theearth, or combine with dust particles. Thesemay damage plants, marine life, or humanhealth, including increasing mortality rates ofhumans. SO

2 is subject to federal and state air

quality standards.Urban Ozone: Power plants produce a sub-

stantial portion of NOX as a product of com-

bustion. These oxides react with VOCs in thepresence of sunlight to produce ozone. Ozonehas various nonfatal effects on human healthand some types of vegetation. NO

X and VOC

emissions are subject to federal and state airquality standards.

Global Warming: Background or naturalgreenhouse gases keep the earth’s temperaturewithin a certain range by capturing part of thesun’s heating effect within the earth’s atmo-sphere. Some fear that enhanced global warm-ing will result from increased levels of CO

2 and

other greenhouse gases in the atmosphere,leading to increased temperatures, changes inprecipitation and other harmful effects. CO

2

and NO2 are two greenhouse gases produced

by fossil fuel (coal, natural gas, and petroleum)power plants.

Natural gas has much higher hydrogen con-tent than coal. As a result, it has about 60 per-cent of the carbon content of coal and, as such,produces less CO

2. According to the EPA, in

2000, coal-fired units produced almost twiceas much CO

2 as non-coal units in Texas despite

the fact that gas-fired power accounted for 52percent and coal-fired power for only 37 per-cent of total generation. Nationwide, CO

2 emis-

sions from coal-fired units account for nearly80 percent of total CO

2 emissions associated

with power generation.Particulates: Although power plants contrib-

ute relatively little to this problem, particulatesare the subject of increasing concern for theimpacts on human health. Particulates are as-sociated with other pollutants, such as SO

2

from power plants, and are likely to be subjectto future air pollution control strategies. TheEPA has recently adopted new standards forfine particulates (PM

2.5). Monitoring equip-

ment has been installed to determine if Texaslocations are in violation of these standards.

Transmission Lines and Stations => environmentalDevelopment of new transmission lines, ex-

pansion of existing lines, and construction ofnew distribution facilities is often met withpublic resistance. Environmental concerns arepart of the reason given for this resistance.

Transmission lines may require intrusion onnatural areas, be visible from scenic areas orintrude on residential neighborhoods. Theymay destroy or disrupt wildlife habitat. Solarand wind power facilities supported by envi-ronmental groups have faced similar public re-actions.

There has been ongoing public concernabout the health effects of high voltage powerlines. The National Research Council (1996) hasfound that there is “no conclusive and consis-tent evidence” that electromagnetic fieldscause any human disease or harmful healtheffects. Despite these findings, this issue willlikely continue to be an environmental andhealth concern for the general public.

Related Energy Policy Issues =>environmental+energy

Environmental concerns are also linked toenergy issues such as the use of alternativefuels to generate electricity and energy effi-ciency. Alternative fuels are defined in differ-ent ways, but are often simply alternatives toconventional fuels. There are usually environ-mental or energy-related benefits associatedwith alternative fuels. For example, natural gasused as a transportation fuel is considered analternative that can be cleaner than conven-tional gasoline, but natural gas for power gen-

51

Major Issues

eration is not considered to be an alternativefuel (it is considered by many to be a cleanerfuel, however).

Alternatives for power generation includehydroelectric power, solar electricity, wind en-ergy, biomass energy and geothermal power.The fuels for each of these are available at littleor no cost; they are often renewable fuels; andthey may produce little if any direct emissions.Proponents argue that the environmental costsof conventional electric power are not reflectedin the cost of electricity produced. If these costs(externalities) were included, alternative fuelelectricity could be very competitive (see TexasRenewable Energy Resource Assessment, July1995, Texas Sustainable Energy DevelopmentCouncil).

Hydroelectric power is produced as watermoves from a higher to lower level and pushesa turbine. Texas has about 471 megawatts ofinstalled hydroelectric capacity which pro-duced about 0.4 percent of Texas electricitygeneration in 2000. Considerable oppositionexists to developing more hydro power, notonly in Texas but throughout the U.S.

Solar electric power can be producedthrough various technologies. Costs have de-clined substantially and in some applications,solar electricity is economically competitive.Texas has good solar resources available to alarge portion of the state; the best resources,

however, arenot near majorpopulated ar-eas. Solar pan-els and largesolar arraysface environ-mental andcommunity op-position similarto placement ofother largeelectric power

facilities.Wind energy technology is available today

at competitive prices (advanced wind tur-bines). Wind resources are fairly site specific.The best areas include the Texas Panhandle,

Gulf Coast and areas in the Trans-Pecos regionof west Texas. With the requirement of renew-able power in SB 7, there has been increasedinterest in wind power. Today, there are morethan 1,000 megawatts of wind power capacityin Texas as compared to about 50 megawattsin 1997, and more capacity is expected.

A key consideration for wind and solar re-source development is that the areas of bestpotential in the state are far from urban popu-lations. Transmission access is one of the ma-jor impediments to developing these fuelsources for widespread use.

Biomass energy is produced from conversionof plant and animal matter to heat or to achemical fuel. It encompasses the widest rangeof technologies including converting garbageto methane, burning materials to produce heatto generate electricity and fermenting agricul-tural wastes to produce ethanol. Biomass re-sources from urban waste are more availablein populated areas of Texas, while agricultural-based fuels are strongly associated with rain-fall distribution as well as agricultural produc-tion. Many biomass energy approaches rely onrenewable fuels. Because of the differences inthese technologies, it is difficult to generalizeon the environmental issues associated withthem.

Geothermal power relies on the heat energyin the earth’s interior. Texas has a variety ofgeothermal resources, mostly located in theeastern half of the state and some along thewestern portion of the Rio Grande. Most re-sources could not be used for electricity pro-duction. However, heat from these resourcescould be used as a substitute for heat from anelectrical source. The economics and environ-mental effects of such applications limit theirviability.

While the benefits of cleaner, alternative en-ergy sources for electricity are appealing, theydo pose operational considerations for themanagement of electricity services. For onething, they are “intermittent” power sources(the sun does not shine at night, the wind isvariable), and peak availability of alternativeenergy sources does not always coincide withpeak demand. Options like solar and wind

52

Major Issues

cannot provide consistent power production,in contrast to the coal and nuclear facilities thatare usually used for “base load” (the units op-erate continuously providing a consistentpower base). Many solar technologies tend tobe implemented in conjunction with naturalgas turbines. In addition, both solar and windrequire large amounts of acreage when de-ployed for large-scale power generation andextensive use of materials (steel and otherproducts) that require considerable energy toproduce.

Technological advances are such that somesuccess in integrating wind-generated electric-ity has been achieved. Likewise, hydro facili-ties provide a readily available power reserve(interrupted only by periods of extremedrought). Solar poses more of a problem, be-cause some form of storage is required. Scien-tists are experimenting with a variety of stor-age solutions, like letting daytime heat accu-mulate in fluids like molten salt so that tur-bines can continue to operate after sunset.However, it will be some time before the eco-nomics of utility-scale renewable technologies

become favorable.The operating costof new natural gasturbines hasdropped by half ormore during thepast decade, so thatelectricity frommost renewable en-ergy technologies isusually 150 to 400percent more ex-pensive than natu-ral gas-fired tur-bines with therange dependentupon the age of gasturbine and theprice of natural gas(Comprehensive Re-view of the NorthwestEnergy System, De-cember 1996). Thecost of wind power,

however, has fallen significantly to about fourcents per kWh within the last decade and costsare expected to drop another 20 to 40 percentover the next ten years.

What many renewable technologies (andsome small scale technologies like natural gasmicroturbines and fuel cells) do offer are op-tions for users in remote locations or localizedsolutions for energy demand. An isolated com-munity can distribute electricity to its residents“off-grid” (meaning that there does not haveto be a connection to a transmission system).Or, excess power from location-specific gen-eration, including cogeneration, can be distrib-uted “on grid.” Distributed and off-grid gen-eration bear significant implications for the fu-ture.

Energy Efficiency and Conservation =>environmental+energy

Energy efficiency and conservation are twosides of the same environmental and energypolicy coin. The impacts of the environmentalissues discussed above are all reduced by sim-ply using less electricity. New electricity de-mand is met through energy savings ratherthan the provision of more electrical power.

Energy efficiency usually applies to techno-logical improvements that reduce electricityneeds, such as more efficient electric motors,low energy lighting and automatic sensors thatturn lights off in unoccupied spaces, improvedinsulation and high efficiency refrigeration.Cogeneration can provide an energy efficientmeans to sequentially produce both power anduseful thermal energy (steam/chilled water)from a single fuel. Technology improvementshave substantially increased fuel efficiency andlowered capital costs during the last decade.

Reduced energy use also includes changesin operations and behavior that result in lesselectricity consumption. These include strate-gies such as shifting industrial and commer-cial processes to off peak hours, or using elec-tric power at night to chill water that wouldthen be used to cool buildings during the day,offsetting other demands for electricity.

Utilities have implemented energy efficiencyand conservation efforts through programs

Hypothetical Energy Savings fromEfficiency Improvements

Year 2010

This analysis shows an estimate of thepotential for saving 36 Gigawatts ofelectric energy through demandreduction.

Source: Texas Energy for A New Century, TexasSustainable Energy Development Council, August1995

Customer Savings in$Billions

Gigawatts $billions/yr

Energy Savings in Gigawatts

53

Major Issues

called demand-side management (DSM). Likeother DSM programs around the U.S., utilitiesin Texas helped customers to reduce electric-ity use by providing energy audits and infor-mation on energy saving appliances and hab-its (“bill stuffers”). Other initiatives used insome states include offering rebates to custom-ers who install energy saving appliances, com-pensating utilities that reduce electricity loadthrough efficiency programs by allowing themto earn a higher rate of return or encouragingcustomers to reduce peak-period demand (i.e.,installing devices such as trips on swimmingpool filter motors that reduce a customer’s loadduring daily peaks in demand).

Utility spending on DSM programs in theU.S. increased from about $900 million in 1989to almost $3 billion in the mid-1990s. In con-trast, DSM spending in Texas decreased dur-ing the 1990s (Senate Interim Committee on Elec-tric Utility Restructuring, 1998). Some estimatesare that increased efficiency in Texas could re-place all projected increases in electricity de-mand in the residential and commercial sec-tors, and that efficiency could offset 43 percentof total projected energy demand. These esti-mates are probably high, given that not all sav-ings may be technically or economicallyachievable.

The drive to encourage efficient use of elec-tricity has had a powerful impact not only inthe U.S. but worldwide. Historically, the mostactive use of DSM applied to utility operationshas been in California, the Northwest andNortheast. However, with market restructur-ing and retail competition, utility DSM effortshave largely been phased out. Nevertheless,SB 7 has an energy efficiency provision thatrequires each utility to provide incentives suf-ficient for REPs to acquire additional cost-ef-fective energy efficiency equipment equivalentto at least ten percent of the utility’s annualgrowth in demand.

Many economists argue that if costs and ben-efits are correctly measured, electric utilitiesmay be spending much more on efficiency pro-grams than the value of benefits obtained. In-deed, one of the main arguments for electric-ity restructuring has been the encouragement

of new demand side technologies with newbusinesses to provide these technologies in themarketplace. Strategies like marginal pricing,which force customers to pay more of what itactually costs to provide electricity, may bemore effective for rationing electricity use.REPs in locations where retail choice is allowedprovide an array of energy efficiency services,including inspection of the site for potentialenergy savings, installation of energy efficientequipment and insulation, monitoring of en-ergy usage, and so on. If retail choice becomesmore widely adopted, REPs may provide moreof these services to a wider range of custom-ers, including residential users.

With the growing attention to efficiency andconservation, new businesses have emergedand existing ones have grown creating numer-ous opportunities. These businesses includeeverything from companies that research, de-velop and manufacture energy saving devices(like lighting and building materials, auto-matic/remote thermostat controls, advancedreal-time meters, storage devices, etc.) to thosethat provide independent audits and informa-tion services. REPs can definitely benefit fromcommercialization of these technologies andare actively pursuing some in Texas. Thus,energy efficiency can generate economic ben-efits in a competitive environment.

Financing and OperationsTo generate over $233 billion in annual rev-

enues from U.S. electricity sales and nearly $21billion in Texas alone has required big invest-ments. Likewise, policies to make the electricpower industry more competitive have big fi-nancial and operational impacts on these in-vestments.

Electricity Investments and TechnologyTransmission and distribution costs have

been most heavily impacted over the years byinflation (which affects the cost of labor andmaterials), interest rates (which affects thecosts for utilities to borrow money), dealingwith environmental concerns (costs associatedwith environmental studies and mitigation)and other factors. In contrast, the costs associ-

54

Major Issues

ated with generation have generally declineddue to technology improvements, includingthose for alternative electric energy sources,and lower costs for conventional fuels.

The impact of technology innovations hashad a significant impact on generation costs.Improvements in natural gas turbine designhave made gas much more competitive withcoal. New turbines are essentially jet enginesthat use a pressurized mixture of gas and airto spin the turbine. New “combined-cycle” tur-bines take excess heat generated from the gasturbine and use it to power a conventionalsteam turbine. This combination has pushedturbine efficiencies beyond 50 percent, andcontinued improvements are expected in com-ing years. New turbine designs are relativelycheap, modular and can be brought on-linequickly. Gas derived from coal or biomass canalso be used to drive combined-cycle turbines.Turbines using higher pressures and efficiencygains in performance are improving rapidly.

Because of the development of turbine tech-nologies and improvements in alternative en-ergy technologies (mainly in solar panel andwind turbine design), the costs for electricitygeneration from natural gas (so long as fuelcost do not rise appreciably) and alternativefuels are on a downward trend, while flexibil-ity and ease of installation are on an upwardtrend. Where investments of billions of dollarswere a matter of course for nuclear and coalfacilities, it is likely that the financial require-ments of the electric power industry in the fu-ture, including Texas, will be much different.It is clear that for the electric utilities, especiallythose that have invested heavily in coal andnuclear facilities, the advent of cheaper, moreflexible turbine design and generation alterna-tives means that competitive pressure every-where in the electric power industry is likelyto increase.

The Challenge of IntegratingAs noted previously, because ERCOT is a

separated grid, much of the Texas electricpower industry has not been subject to regu-lation by the FERC. But FERC actions on anumber of issues have impacted both PUCT

and power industry decisions. If, as expected,ERCOT becomes increasingly linked to sur-rounding portions of the U.S. grid, FERC ac-tions will grow in importance to the Texasmarketplace.

Non-Utility GenerationIn Part 4 - Regulations and Policies, a revo-

lution in the U.S. electric power industry wasdescribed, fostered by the PURPA and later theEPAct. Non-utility generation has played a sig-nificant role in reducing costs of technologiesfor natural gas, solar and wind generation.However, the process of integrating non-util-ity capacity has posed a significant challengeto utilities and PUCs. Under PURPA, whichencouraged the growth of non-utility genera-tors, non-utility generators that meet definedconditions must be classified as “qualifyingfacilities” (QFs). Power purchases from QFswere based on the cost that utilities wouldavoid in not building new generation capac-ity. The complex issues of making this systemwork have been evident in Texas and the restof the nation.

Shift to Competitive BiddingUnder PURPA, utilities had an obligation to

buy power from QFs (if capacity was neededand the price was lower than the utilities’avoided cost). This made it possible for a largenumber of non-utility companies to enter theelectric generation business as owners of QFs.The regulations governing QF procurement ina number of states forced utilities to buy toomuch QF capacity at too high a price. In re-sponse to this problem, many states shiftedfrom the administrative determination ofavoided cost-based prices, at which utilitieshad to buy all QF power that was offered (ifcapacity was needed), to competitive biddingprograms in which utilities estimate their ca-pacity needs and then put these needs out forcompetitive bids. As QFs’ business expanded,industries and interest groups argued that thisprocess should be opened to all potential elec-tricity suppliers, not just QFs. They argued thatutilities’ most effective role was as portfoliomanagers for retail customers (principally resi-

55

Major Issues

dential and small commercial). Within this role,utilities would examine all sources of genera-tion - QFs, non-QF independent power pro-ducers (IPPs), DSM (conservation), third-partyutility suppliers and utility-owned generation.They would then choose the most cost-effec-tive power mix. However, after SB 7 un-bundled old utilities into separate generation,T&D and retail entities, existing PURPA con-tracts are transferred to either affiliated PGCsor REPs.

Use of Antitrust LawsQFs were covered by PURPA, but IPPs’ sales

or sales by utilities with excess capacity weresubject to FERC regulation at the wholesalelevel and outside of ERCOT. The ratemakingprinciples were consistent with the regulationof a legal monopoly franchise and prudent in-vestment standards, but incompatible with theQFs’ contracts or for IPPs’ speculative marketentry.

Some wholesale customers complainedabout being captive to regulated tariffs of thelocal utility. They wanted the option of acquir-ing bulk power from other utilities. In anyevent, municipal distribution companies re-quired access to the utility’s transmission gridto “wheel” generation to the distribution sys-tem and to integrate dispersed generating fa-cilities.

At the time PURPA was enacted, utilitieswere not required to provide transmission net-work access. FERC could order “wheeling”only if it did not affect competitive relation-ships. Wholesale customers turned to antitrustlaws to get access. Municipal utilities used thenuclear power licensing process to open uptransmission systems on reasonable and non-discriminatory terms and conditions. Munici-pal and cooperative utilities also brought suitsunder antitrust laws to obtain access to “es-sential” transmission facilities. Once utilitiesbegan offering transmission service to somewholesale customers, FERC used its authorityto bar undue discrimination to extend theseservices to others. By the mid-1980s, distribu-tion utilities were able to meet much of theirrequirements from competing suppliers, rely-

ing on their host utility as a backup.The wholesale market in Texas developed at

a rapid pace since 1995. Significant participa-tion by new entrants and the opportunity forfuture entry helped establish a healthy whole-sale market, which is expected to increase thechances for success of the retail competitioninitiated by SB 7.

Emergence of Coordination MarketU.S. utilities, including those in Texas, have

routinely engaged in hourly energy exchanges,using low cost electricity from a generator inone control area that might otherwise havecome from a more costly generator. Over time,the range of products available in the coordi-nation markets has also expanded. Longer du-ration contractual arrangements emerged andvertically integrated utilities came to rely onmedium term capacity and thereby defer newgeneration construction. These longer termcapacity and energy contracts were signifi-cantly different from the very short term coor-dination arrangements from which theyemerged. This coordination market grew dur-ing the 1970s and 1980s in response to grow-ing regional differences in marginal operatingcosts and supply/demand balances. A majorreason is that FERC did not apply rigid cost ofservice formulas to regulate these rates (seepage 59 for a description of cost of serviceratemaking).

FERC’s Role Integrating Non-Utility GenerationIn 1988, FERC began to reconsider its pric-

ing regulations in an effort to encourage entryof IPPs (not QFs) into the electricity sector andto encourage utilities with excess capacity tosell it to third parties under long term con-tracts. As a result, IPPs and unregulated util-ity-affiliates making power sales outside oftheir retail service territory have had little dif-ficulty obtaining market-based pricing author-ity from FERC.

During this time, the FERC accommodatedentry of power brokers seeking to arrangepower transactions between sellers and pur-chasing utilities with such transactions havinga minimum of regulatory obligations. Utilities

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Major Issues

and utility affiliates seeking market-based pric-ing authorization to sell in or near their ser-vice areas are required to provide adequate“open access” transmission service to otherbuyers and sellers. This is the essence of theFERC’s Orders 888 and 889.

Absent statutory authority to require utili-ties to provide nondiscriminatory transmissionservice prior to the EPAct, FERC began to en-courage utilities to “voluntarily” file open ac-cess transmission tariffs. FERC then condi-tioned its approval of mergers between verti-cally integrated utilities on their filing of openaccess transmission tariffs and the availabilityof market-based pricing.

Then FERC placed a ceiling on the price thata utility could charge for transmission serviceto third parties. This price was equal to theaverage embedded cost of transmission facili-ties per megawatt of system peak load. Thepolitical and regulatory difficulties of build-ing major new transmission facilities are gen-erally thought to cost more than the revenuesfrom selling temporarily excess transmissioncapacity.

A study by FERC showed that the cost oftransmission is highly dependent on the volt-age used. Since capacity increases with thesquare of the voltage, the use of high voltageupgrades effectively reduces cost. The FERChas been encouraging the formation of RTOswhich would take responsibility for (1) re-gional transmission facility planning, (2) theprovision of information about transmissioncapacity and costs, and (3) ultimately, compre-hensive regional transmission service pricing.FERC provided the details of RTOs in Order2000, discussed in detail in Part 4.

Major FERC Policies on Transmission AccessMajor actions which have affected transmis-sion access include the following:• Requiring utilities to publish detailed infor-

mation about the availability of transmissioncapacity on their systems and related oper-ating characteristics of their bulk power fa-cilities.

• Expanding the range of transmission ser-vices that utilities must be prepared to offer

from point-to-point service to a full range ofservices that are “comparable” to servicesthat the integrated utility provides to itself.

• Allowing wholesale customers to file for“generic” tariffed transmission service evenin the absence of a specific buyer and a spe-cific seller.

• Encouraging the formation of RTOs to dealwith transmission planning, operations, andpricing issues on a comprehensive regionalbasis.

Unfinished FERC BusinessThe FERC has increased transmission access,

but has much left to do with regard to trans-mission and ancillary services pricing. Theseissues are especially important in the U.S.where many transmission owners operate por-tions of the synchronized AC system in whichproperty rights are poorly defined and associ-ated external and “free ride” problems are ram-pant.

Control areas are responsible for balancingloads and resources, maintaining frequencyand voltage, providing spinning reserves, dis-patching in response to transmission con-straints, providing emergency support andcoordinating operations with interconnectedcontrol areas. Based on Order 2000, FERC hasbeen working on an RTO model that wouldaddress these issues.

Transmission owners are also getting readyby establishing industry standards in coopera-tion with FERC so that when the RTOs areformed, they can be operated reliably and ef-ficiently in a consistent manner at least withineach region.

How existing FERC policies get imple-mented, and how the FERC’s unfinished busi-ness get done, are contingent on resolution ofthe FERC’s SMD proposal (see Part 4 - Regu-lations and Policies).

Related Generation Cost IssuesGeneration costs are being driven down by

technological advances, lower fuel costs (notguaranteed to last) and competition, but elec-tricity rates vary widely around the U.S. andbetween wholesale and retail markets. This ap-

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Major Issues

parent disparity can be understood by consid-ering changes in electric power policy.

First, the U.S. added nearly 100,000 MW ofnuclear capacity during the 1970s and 1980sto meet growing base-load demand and in re-sponse to state and federal laws and policiesthat dictated fuel diversification. In manycases, nuclear capacity was much more costlyto build than anticipated. In spite of fears thatnuclear units would not operate at high reli-ability levels, capacity factors for nuclear unitshave been trending up. Where once many ex-perts believed that nuclear units would be con-verted to other fuels, the outlook for contin-ued operation of nuclear units is more opti-mistic.

Next, currently there is substantial excessgenerating capacity in many parts of the U.S.due to slower growth in demand and rapid ex-pansion of NUG capacity. The price of genera-tion services in the wholesale market reflectsthis excess capacity and is often below the long-run marginal cost of expansion.

Third, utilities in some areas of the country(especially California and the Northeast) wererequired to purchase too much QF capacity attoo high a price under long-term take-or-paycontracts. These costs have been borne largelyby retail customers.

Fourth, utility energy conservation programsthat provide subsidies to customers to use elec-tricity more efficiently have both reduced de-mand for electricity and led to higher prices.Utilities have been allowed by regulators topass through the costs of DSM programs orrecapture expenses through higher rates of re-turn.

Finally, as mentioned before, efficiency im-provements of combined cycle natural gas tur-bines have significantly reduced long-runmarginal electricity costs. The abundant sup-ply and low prices for natural gas throughoutthe U.S. for much of the last decade was highlyvisible in the emerging wholesale electricitymarket. As a result, electricity prices acrossmuch of the U.S. were generally influenced byaccessibility to natural gas or natural gas-firedwholesale power although in parts of the coun-try prices are still dominated by either coal

based (Midwest) or hydro based (Northwest)generation. Recent spikes in the price of natu-ral gas, which may reflect changing fundamen-tals with respect to natural gas supply anddeliverability, may diminish the cost advan-tage for gas-fired power.

In a nutshell, most of the base load nuclearand coal capacity added during the last twentyyears was done to ensure service to retail cus-tomers. These investments have been found tobe prudent. Today, these long term investmentsmay seem questionable, but recall from Part 4,Regulations and Policies, that utilities wereconstrained to fuels other than natural gas.

“Stranded Costs” or “StrandedBenefits”? The debate about retail wheeling in the U.S.and Texas largely has been about whether toextend the FERC’s policy of open access in thewholesale market down to the retail level. Themajor issues centered on who would pay forgeneration and generation-related financialcommitments that might not be fully recover-able when public policy was changed to allowfor electricity to be sold at unregulated mar-ket prices. These commitments included in-vestments in power plants, long-term powerpurchase and fuel obligations and other coststhat were deferred for future recovery, all ofwhich were reviewed by regulators, found tobe reasonable and prudent and have been in-cluded in rates.

Many utilities, regulators, legislators andconsumers were concerned about whether acredible mechanism could be found to pay forthese stranded costs in the transition to morecompetition. Industrial customers and someindependent suppliers and marketers hopedthat utility shareholders would pay for a largefraction of these costs. Utilities and power gen-erators, however, agreed with FERC Order 888,which states “[t]he recovery of stranded costsis critical to the successful transition to a morecompetitive market.” A reasonable opportu-nity to recover stranded costs was believed tobe consistent with honoring past commit-ments, including the regulatory compact ofproviding service to all customers in exchange

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Major Issues

for a reasonable opportunity to earn a reason-able return on investments that state PUCsfound to be prudent and subsequently in-cluded in rates. Many representatives of smallretail customer interests opposed retail wheel-ing because they were concerned that the bur-den of stranded costs would be shifted to “cap-tive customers” who would then be unable totake advantage of retail competition opportu-nities.

Many proponents of retail wheeling haveviewed it as an opportunity to get utilities outof the “taxation by regulation business” andfocus their attention on producing electricityas cheaply as they can. While this has appealto some, it must be recognized that state andmunicipal governments receive substantialrevenue from utility sources, such as gross re-ceipts taxes, local and state franchise taxes,property taxes and sales taxes.

As states began to move forward with com-petition, a critical question was “how big is thestranded cost problem?” It was not easy todefine. In the mid-1990s, estimates fromMoody’s Investors Service ranged widely, from$100 billion to $300 billion for the U.S. and from$1 billion to $10.3 billion for Texas. The PUCT’sReport to the 75th Legislature (January 1997) es-timated a range of a negative $3 billion(stranded benefit) to $22 billion (stranded cost).The Senate Interim Committee 1998 report es-timated that stranded costs range from a nega-tive $9.8 billion to $18 billion. The range ofstranded costs is dependent on several factors,including the projected market price of elec-tricity, the projected cost of fuel, what assetsare included, whether only wholesale compe-tition or both wholesale and retail competitiontake hold and the isolation of stranded costsas opposed to other costs associated with thetransition to greater competition. For example,the PUCT calculated stranded costs at $1 bil-lion in 1998, $3.7 billion in April 2000, -$1.5billion in August 2000 and -$2.2 billion inspring 2001 with the last two estimates reflect-ing benefits.

The FERC, having jurisdiction over mostwholesale rates, ruled in Order 888 that fullrecovery of prudently incurred wholesale

stranded costs will be provided by customersseeking other generating service providers. Asnoted above, the FERC viewed stranded costrecovery to be essential for successful transi-tion to open access. Retail stranded cost deter-minations were to be made by state PUCs andlegislators, although the U.S. Congress consid-ered pursuing legislation that would impacthow much of the cost would be born by share-holders versus ratepayers. Most states, includ-ing California and Texas, adopted a competi-tion transition charge (CTC) for the recoveryof stranded costs when they passed restruc-turing legislation. In Texas, the CTC was origi-nally set at $0 by the PUCT because the mar-ket values of assets were greater than theirbook value (as indicated by the estimates ofstranded benefits provided earlier). In Califor-nia, however, CTC caused problems for utili-ties that were not allowed to pass fluctuationsin wholesale prices on to their retail rates untilthey fully recovered their stranded costs. Utili-ties which recovered their stranded costssooner were able to adjust their retail ratesduring California’s crisis, at least until the rateswere refrozen by the State Legislature.

It is important to note that not only utilitieswere impacted by the transition to greater com-petition. Many NUGs undertook the risk ofdeveloping facilities under contract terms thatwere thought not to survive in more competi-tive markets.

Today, the issue of stranded costs has fadedsomewhat as assets once thought to be vulner-able to market competition have retained theirvalue. In particular, nuclear and large coal-fired power generation plants proved to becritical to the U.S. power system as demandsoared during 2000-2001. The switch fromstranded costs to stranded benefits also wasdue in part to high natural gas prices leadingto high power prices.

Financial Performance of UtilitiesUnder regulated rates, the utility industry

has traditionally been considered as a safe andreliable investment target. Many feared thatthe electric utility industry would experiencenegative financial impacts from the transition

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Major Issues

to competition. Certainly, bond and equitymarkets discounted the utility sector on thebasis of increased competition and the cost oftransition. For example, the Moody’s InvestorServices estimate of stranded costs also notedthat the industry’s current equity was $165 bil-lion. This makes the low stranded cost estimate60.6 percent of equity and the high estimate181 percent of equity, a huge impact for utili-ties. Reflecting the uncertainties created by theintroduction of competition, Standard & Poor’sCorporation downgraded four public powerentities and two public power projects (all inCalifornia) in 1996. In 1997 and 1998 more than20 utilities were downgraded. After the Cali-fornia crisis and the collapse of Enron, moreutilities as well as IPPs and power marketerswere also downgraded. Enron’s problems cre-ated the belief that most companies, especiallytrading/marketing firms and IPPs, have beencarrying too much debt to finance power plantsand/or their trading activities.

Nevertheless, revenues for the U.S. indus-try as a whole rose from $198 billion in 1993 to$233 billion in 2000. Historically, about 17 per-cent of total revenues has been retained as netoperating income; about 14 percent has been

paid in taxes; and al-most 60 percent hasbeen used to coveroperating and main-tenance expenses. As California’senergy crisis and theimmediate impact ofthe Enron’s bank-ruptcy fade, manypower companiesare returning to moreconservative growthand earnings fore-casts. Some are re-ducing their depen-dence on volatiletrading activities andthey are diversifying,especially into natu-ral gas. Integratedutility companies ap-

peared to be doing much better than IPPs inthis new environment until recently. Increasedscrutiny of debt loads incurred by utilities asthey created and expanded their non-regulatedbusinesses has led to growing credit problemsfor IOUs in Texas and across the U.S.

Issues in the Regulatory ProcessThe way in which we have regulated utili-

ties in the U.S. has long been an issue. Texashas not been immune to the consequences ofour particular regulatory system. Some oppo-nents of retail choice want to maintain the util-ity as an entity that has a “public service obli-gation fulfilled with private sector efficiency.”In the U.S. we have relied on regulators to serveas a substitute for competitive efficiencythrough rate regulation reviews of utility costsand by disallowing costs that are not prudent,necessary or efficient. With SB 7, Texas un-bundled the integrated utilities. As a result,generation and retail have become competitivebusinesses that are not subject to rate regula-tion. Rates for access to the T&D network,though, remain regulated by the PUCT.

The traditional method of regulation hasbeen “cost of service ratemaking” (already

Dow-Jones Averages for Utilities1971 to 2002

(through Nov. 11, 2002)

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Major Issues

mentioned in this chapter and in Part 4 - Regu-lations and Policies). To determine a utility’srevenue requirements, PUCs must determinethe “allowable” operating costs of a utility (e.g.,maintenance and other operating costs) andthe “capital related” charges. The latter is the“rate base” upon which a utility is allowed torecover depreciation, interest costs and the costof capital associated with equity investmentsin transmission and distribution facilities.(Note that the FERC also has traditionally usedcost of service ratemaking for interstate pipe-lines and electric utility transmission facilities.)

Most of the controversy over rates in ratehearings turns on which operating costsshould be “allowed,” which should be “disal-lowed” because they are unnecessary, whichcapital investments should be included in therate base and what, in the end, the appropri-ate “fair rate of return” or “just and reason-able rate of return” on investment should be.

PUC hearings provide a framework for theregulatory process. PUCs may penalize a util-ity for incurring unnecessary operating costsor for making “inefficient” investments. Whilethe rules governing these decisions may bevague and subject to controversy, PUCs acrossthe U.S. follow very similar practices in evalu-ating the financial and accounting informationthat is reported by utilities.

One of the major criticisms levied againsttraditional cost of service or “cost plus” ratemaking is that it provides poor incentives forcost minimization, in particular because a biasmay be created in favor of capital expenditures.Some have speculated that because utilitiesearn more revenue as the rate base grows, theyhave historically emphasized capital expendi-tures rather than more efficient ways of deliv-ering services. Evidence of this is mixed.

An area that had been especially targeted inthis regard is nuclear energy. Many controver-sies occurred in Texas over the inclusion ofnuclear facility costs in utility rate bases andthe extent to which customers should becharged. The PUCT conducted fully litigatedprudence reviews of nuclear and other plantconstruction expenditures and, where appro-priate, imprudent costs were disallowed, re-

sulting in recovery only of prudent expendi-tures in rates.

Cost of service rate making is in the processof changing as other methods of regulatingutilities become more widely used and, ofcourse, as it becomes limited to T&D servicein restructured markets including Texas. Ingeneral, PUCs (and the FERC) are moving to-ward “market-based pricing” in regulatory de-cision making. Incentive rate making, pricecaps and other techniques are increasinglyused as regulators strive to make utilities andtheir customers more responsive to market dy-namics and encourage efficient use of re-sources.

In addition, with the restructuring of the in-dustry, the PUCT no longer deals with the re-view of generation projects although new T&Dfacilities will still have to be subject to rate ad-justments. But, as ERCOT will provide theguidelines for the type, capacity and locationof new T&D facilities needed, the review ofproposals for these projects should be morestraightforward.

Another big issue has been rate design. Utili-ties typically have a large number of tariffsavailable to customers that fall into differentsize and voltage classes. Marginal costs to servesmaller customers (typically residential andcommercial) are different when compared withother classes of customers. This reflects the factthat smaller customers take power at lowervoltages, require costly low-voltage distribu-tion investments and have low load factors.Marginal costs to serve very large customerstend to be low reflecting the fact that they takepower at high voltages and have higher loadfactors. Increasingly, U.S. utilities are offeringlarger customers time-of-day rates and inter-ruptible rates.

Because the marginal costs of providing elec-tricity service to a variety of customers undera variety of conditions are different, there hasbeen considerable debate about how regula-tors and utilities should set prices. The evi-dence on this is mixed. As electricity systemswere built, it helped to have large volume cus-tomers on the system which allowed utilitiesto more easily and economically extend ser-

61

vice to smaller customers. This became moredifficult to do as the U.S. industry has had torespond to global competition and as indus-trial customers came to enjoy many more elec-tricity supply options.

In addition, regulators used to prefer pric-ing schemes to benefit small users that did notaccurately reflect the cost of serving differentsize customers. This caused large users to payrates larger than the marginal cost of servingthem. This preference has played a role inpushing industrial users toward non-utilityoptions for electricity. The gap between resi-dential and industrial rates has grown over theyears, reflecting a gradual move toward pric-ing electricity service to more accurately reflectthe marginal cost of providing power to all cus-tomers as well as changing fundamentals in

Major Issues

the electric power industry.Regulators, including those in Texas, strive

to avoid price distortion subsidies. However,some price distortion is always possible (anartifact of regulation as a substitute for com-petition). With the start of retail choice at allcustomer levels, REPs are expected to providecompetitive market prices, more reflective ofmarginal costs of serving each customer type,and hence remove potential price distortions.At the same time, the PUCT is relieved of theburden of designing rates for different cus-tomer types, and reviewing and monitoringthese rates. In today’s competitive market, thePUCT’s most important task is to ensure thatconsumers are protected against potentialmarket power practices.

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Future Trends

What lies ahead for the electric power indus-try in Texas and the U.S.? If the recent past isprologue, then we can be assured that the in-dustry will continue to become more competi-tive and that some changes will take place (per-haps extreme, perhaps not). Electricity will re-main an important component of our dailylives, perhaps increasingly so as we movedeeper into the Information Age. And there issure to be conflict about how to best provideelectricity to all users, how best to facilitateconsumers’ desires for choice and how to man-age all of this while protecting the environmen-tal and social values that are important to us.

We can strive to consider what the future willhold in today’s decision making, but that isoften not possible. Looking back at the historicchanges in telecommunications, airlines, truck-ing, banking and natural gas, there are manythings that could have been done differently.Perhaps the best we can do is to watch the keytrends and try to anticipate the actions of to-day with the needs of tomorrow. Here are fourkey trends to watch in the electric power in-dustry in Texas and the U.S.

Technology ChangesThe electric power industry has often been

criticized as a “low technology” industry, butnothing could be farther from the truth. In thisdocument we have discussed a number of tech-nologies that are vastly changing the way elec-tricity is produced, delivered and priced. Wehave learned in the U.S. that we have an enor-mous capacity to research, develop and deploynew technologies that make our lives betterand push our economy forward. Future expec-tations for electric power should be no differ-ent, but the outcomes may take a differentform. Utility spending on R&D may be affectedby increased competition, but new R&D ar-rangements are likely to emerge.

Texas’ recently restructured electric powerindustry provides for one of the most ad-vanced competitive electricity markets in theU.S. with even the smallest customers having

the choice of their retail electricity providers.The restructuring bill in Texas (SB 7) calls for2,000 megawatts of new renewable generationcapacity to be added by January 1, 2009 - larg-est requirement to date by any state. Severalhundred megawatts of new wind power ca-pacity have already been built in West Texas.This environment is very conducive for Texasto become a center of innovation in energytechnologies. In addition, the long history ofthe energy industry in the state created a so-phisticated community of energy suppliersand users. The state also provides a favorableinvestment environment for startup busi-nesses. Finally, organizations such as the Hous-ton Technology Center, STARTech Foundationand The Austin Technology Incubator as wellas the PUCT are working together towards thegoal of establishing Texas as a national energytechnology center.

New Generation TechnologiesIn addition to the advances in natural gas

turbine design, new ways to achieve cleancombustion of coal and fuel oil and improve-ments in alternative energy technologies, thereare technologies on the horizon that may com-pletely change the industry. Often discussedare fuel cells, which use electrochemical reac-

OverviewFor more than 100 years, elec-tricity has been developed andelectric service provided using

a public-private model of a regu-lated, private franchise monopoly. Aswe consider altering this model,what can we expect?

Technology will not remain static.New developments, encouraged bymore competitive markets, willemerge to change how electricity isprovided and change our lives as aresult. Financial pressures will growas competition increases, but creativesolutions will arise to spur energy en-trepreneurship.

The electric power industry is re-organizing in response to thesetrends, and this pattern will continue.The landscape for electric powerprobably will look very different inthe future than it does even today or

did in the 1930s.The changes evident in Texas

and the U.S. today are taking holdaround the world, creating chal-lenges for many societies and eco-nomic opportunities for our ownindustries.

Since the early development ofthe electric power industry in theU.S., we have witnessed the powerof society to adapt and move for-ward with new technologies. Thecentral question today is whetherwe will lay the right policygroundwork for what the futureholds. To do this, we all need to beas well informed as we can be.

Future Trends

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Future Trends

tions - like automotive batteries - to produceelectricity. Auto manufacturers are aiming tohave first models with these batteries availableby 2005. Most promising are fuel cells that canuse natural gas as feed stock for producing hy-drogen. Fuel cells are smaller and modular andcould be used to power individual buildingsor neighborhoods with none of the noise andunsightliness of traditional generating stations.Fuel cells, improved solar technologies andother developments may lead to a “decentral-izing” of electric power systems, allowingsmall scale applications and resolving manyof the potential reliability problems that cus-tomers fear. HARC as well as others aroundthe world are testing home fuel cell units.

Further into the future, economic nuclearfusion technologies may finally be achieved.Unlike nuclear fission, fusion is the combina-tion of atoms to produce heat. Fusion is a longsought technology that holds tremendouspromise of clean, renewable energy, if it canbe achieved. Pebble-bed modular reactor(PBMR) technology (still based on fission), onthe other hand, may yield its first commercialreactor by 2007. PBMR reactors are fuelled byseveral hundred thousand tennis-ball-sizedspheres, known as pebbles, each of which con-tains thousands of tiny “kernels” the size ofpoppy seeds. As compared to pressurized-water reactor (PWR) technology used in morethan half of the world’s existing reactors,PBMR reactors are smaller and can be builtfaster. Proponents also argue that they are saferand cheaper. Both claims are challenged bycritics.

Given the abundance of coal resources in theU.S. and the recent concerns about natural gasresource base and prices, there is an increas-ing interest in technologies that may help lowerthe emissions from coal-fired generation. To-day, more than half of the nation’s electricityis generated from coal, but many plants arenearing retirement. Older plants with higheremissions will need to be replaced. Neitherrenewable nor gas-fired generation may besufficient to substitute for all of the coal-firedcapacity. The development of clean coal tech-nologies is one of the goals of President Bush’s

National Energy Policy. The Department of En-ergy has been running a program on these tech-nologies and there are an increasing numberof utilities and generators who are looking intothem.

Microturbines, solar power (either as largecollector farms or photovoltaic cells on build-ings), ocean power (using either the tidal cur-rents of waves) are other technologies that arebeing watched closely by the investor commu-nity.

Many of these technologies discussed hereare not new. All are dependent on favorableeconomic and market conditions. A benefit ofcompetition is that it will accelerate introduc-tion of new technolgies.

Transmission, Distribution and StorageTechnologies

As electricity travels over the transmissiongrid, much of it is lost (sometimes upwards of10 percent). This is because the materials typi-cally used in transmission wires can only with-stand a certain amount of heat. New, super-conducting materials may change that. At re-search centers around the world, including theTexas Center for Superconductivity at the Uni-versity of Houston, scientists are developingnew materials that can withstand levels of heatand stress beyond anything achievable withtraditional metals. These materials, if they canbe economically developed for applicationslike electricity transmission, will dramaticallyreduce the amount of electricity that must begenerated and allow electricity to be efficientlytransported over long distances. Experimentswith short-distance high voltage lines that usesuperconducting materials have produced en-couraging results.

For electricity to be more easily managed,new ways of handling electricity are neededthat take advantage of superconducting mate-rials and devices. One such technology is theuse of superconducting devices for instanta-neous management of electric power. Re-searchers the Houston Advanced ResearchCenter have studied small superconductingswitches and much larger superconductingenergy storage devices for transmission en-

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Future Trends

hancement applications. HARC (with a privateand public sector consortium and the State ofTexas) has examined the technical and eco-nomic feasibility of applying these technolo-gies to constraints in the Texas transmissionsystem. Such devices would enable variouspower management services such as stabilityenhancement, increased transmission capacity,voltage and frequency control and other qual-ity enhancements for a transmission companyor utility.

In a recent conference on energy technolo-gies held at the University of Houston bySTARTech and Houston Technology Center,several participants, including investmentbankers and venture capitalists, identified stor-age technologies as the “holy grail” of all en-ergy technologies. In particular, flywheel tech-nology seems to be most advanced. A Texascompany, Active Power, developed the firstcommercially viable flywheel energy storagesystem and has distribution deals with com-panies such as Caterpillar, GE and Invensys.

Information TechnologiesThe sophistication of electronic information

systems is one of the most important factorsin the drive to restructure industries like natu-ral gas pipelines and utilities and electricitytransmission and utilities. These informationsystems have removed many of the barriers tocommon carriage by allowing real-time man-agement of energy flows and exchanges.

Electronic bulletin boards and software sys-tems required by the FERC for pipeline trans-portation and electricity transmission includeinformation on capacities, prices, transactionsand other variables. This information is nec-essary to facilitate a properly functioning mar-ketplace. It also facilitates the development of“secondary” markets so that holders of excesscapacity on pipelines or transmission grids canrelease or resell that capacity. This preventsmany of the kinds of disruptions and short-ages that have posed serious problems in thepast.

Finally, the advent of information systemsfor natural gas and electricity has supportedthe growth and effectiveness of new busi-

nesses, independent third party marketers ofgas and power. These companies - they maybe entirely unaffiliated or they may be“nonjurisdictional” or unregulated affiliates ofgas pipelines or gas or electric utilities - act asintermediaries in a complex marketplace. Us-ing electronic information, they are able topackage services and build flexible arrange-ments and contractual terms between suppli-ers of gas and electricity and end users.

The development of electronic informationsystems has been one of the most importantfactors in the re-conceptualization of what con-stitutes monopoly in gas or electricity service.These tools have enabled the separation of thecommodities, gas and power, from the physi-cal systems used to deliver them to custom-ers. The result is that the scope of regulationcan be narrowed to the physical systems,where before it applied to both the systems andthe commodities (which were not commodi-ties since there were not separate markets forthe exchange of gas and electricity). This hasbeen a critical step in the evolution of both thenatural gas and electricity industries.

FinancingTechnological change and adaptation need

to keep up with changing consumer prefer-ences in the type and delivery of energy sys-tems. This will mean continued financial pres-sure on the electric power industry. Two areasare worth watching: how the industry willraise capital and how the industry and its cus-tomers will protect themselves against risk anduncertainty.

Capital Needs and ResourcesFinancial capital will continue to be required,

especially for research and development onnew energy technologies and for the new sys-tems that will be necessary to manage electric-ity production and flows in a more competi-tive environment. Large companies and utili-ties will continue to draw from internal sources(cash flow) and be able to access national andworld capital markets. But how will smaller,entrepreneurial enterprises compete for fund-ing in a deregulated/restructured world, and

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one in which government funds will be in-creasingly scarce?

One solution will be to access equities mar-kets through public offerings. Energy relatedofferings have grown rapidly over the years,and the interest in technology-based enter-prises should help to support a healthy capi-tal market for energy entrepreneurs. Anothersolution will be capital provided by major com-panies seeking to enter niche markets with aneye to the future. Financial resources may bedirected to start-up companies or large orga-nizations may joint-venture to establish theirown new product lines. Solar power has ben-efited already from these trends.

After the California crisis and the collapseof Enron, the issue of financing new genera-tion plants has gained a new perspective. Inthe competitive environment, new generationcapacity has been built mostly by IPPs (orNUGs) that usually did not have the same as-set ownership as integrated utilities. As de-mand continued to increase in the 1990s andincreased volatility in electricity prices pro-vided decent returns for gas-fired peakingplants, these companies did not have any prob-lems using project financing. Especially afterthe collapse of Enron, Wall Street analysts andrating agencies began to pay closer attentionto these companies’ balance sheets (as well asthose of many other energy companies). IPPs,for the most part, were found to carry highdebts with respect to their equity. As a result,credit ratings of some IPPs were downgradedto “junk” status. Companies are now restruc-turing and some will likely continue buildingpower plants, but financing conditions in thefuture may be less favorable.

Small scale and rural energy needs in Texascould be financed using a familiar strategy,establishment of special utility districts. Morethan any other state, Texas has allowed the useof special districts to support development.Bond financing through these districts hastypically provided for water and sewer infra-structure, but they could also be used for en-ergy infrastructure. The economic crisis suf-fered by Texans after the 1986 crash in worldoil prices caused many municipal utility dis-

tricts to go into default. However, the mecha-nisms subsequently put into place ensure bet-ter reporting and financial solvency.

Risk ManagementWhen gas and electricity become commodi-

ties, they also become subject to considerablevolatility in pricing. In the case of electricity,this is complicated by the diurnal or daily pat-terns of electricity use and the need for pric-ing to reflect fluctuations in demand and sup-ply. Risk management has emerged as a pow-erful, though often not well understood,mechanism for managing volatility.

Risk management encompasses the array offinancial instruments and the strategies usedto implement them. Futures contracts, options,derivatives and swaps are some of the instru-ments that risk managers use. The basic prin-ciple is to separate the sources of risk in orderto deal with them in a systematic way. For ex-ample, an electricity supplier or consumer whois concerned that the price today may be higheror lower than what it will be at some time inthe future, an important source of risk, canenter the futures market to hedge against ei-ther possibility.

Risk management is not new. Ancient civili-zations used futures contracts for grains andother traded goods. In the U.S., we have longhad futures markets for agricultural commodi-ties, minerals like copper and, since the early1980s, oil. Natural gas and electricity are rela-tive newcomers. As risk management instru-ments have become both more sophisticatedand more complex, problems have arisen re-cently for both suppliers and customers, someso serious that firms experienced liquidity cri-ses or bankruptcy. The issues, however, lie notwith the instruments but when they tend tobe used speculatively. Too often, firms attemptto use risk management instruments to supple-ment income generation rather than strategi-cally to reduce exposure in commodities mar-kets. For example, Enron’s collapse is usuallyassociated with the company’s aggressive useof these instruments in their flagship tradingoperation and the aggressive accounting prac-tices employed in recording the value of these

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trades.When risk management instruments are

used correctly, however, they are a powerfuland important tool for both suppliers and cus-tomers in more competitive energy markets.For example, the inability of California utili-ties to engage in long-term contracts forcedthem to buy continuously from the spot mar-ket in order to comply with their “obligationto serve.” Combined with the retail rate freezeand hence the inability to pass on wholesaleprice fluctuations to customers, Pacific Gas &Electric had to file for bankruptcy and a statebail-out was needed to prevent Southern Cali-fornia Edison from doing the same. If the utili-ties were allowed to manage their price riskthrough long-term contracts (which is what theDepartment of Water Resources did for thestate), these problems could have beenavoided.

During the incredible summer 1998 heatwave, some electric power contracts soared tothousands of dollars per megawatthour. Thisevent triggered a surge in defaults among in-dependent power marketers, shut downs oftrading risk management operations (includ-ing at least one large utility), and a great dealof worry among consumers, regulators, policymakers and some suppliers that this was aportent of what competitive markets would belike. However, after extensive investigations,it appears that a root cause was lack of trans-mission access that would have caused capac-ity shortages in key regions (especially theMidwest) to be resolved. The lesson - risk man-agement practices for electric power needwork, but they are no match for non-competi-tive bottlenecks.

Industry ReorganizationThe previous sections capture another im-

portant trend in the U.S., and again Texas isnot immune. The dramatic changes in technol-ogy and financial pressures stemming fromcompetition are forcing a fundamental reorder-ing of the utility industries. This is being mani-fest in the convergence of utility industries andresulting merger and acquisition activity ascompanies seek new strategic partnerships and

critical mass.

Convergence of Utility Industries: What Happened tothe One-Stop Shop?

If a householder or business receives cabletelevision, telephone and fax, data connection(the Internet), electricity, natural gas and wa-ter and sewer services then is it unlikely tothink that one organization could supply anycombination or all of these needs? That wasthe question driving strategic planning in theutilities industries as electric power restructur-ing unfolded. It came as utilities positionedthemselves to grow in new directions and withnew markets, as competition across industrylines increased, as consumer preferences (in-cluding the desire for convenience) changedand as providers sought to make the most oftheir infrastructure investments and billingand data processing capabilities.

One of the most important lines of conver-gence for Texas has been between natural gasand electricity. Changes in the U.S. electricpower industry are likely to have profoundconsequences for natural gas suppliers, pipe-line companies and marketers, all of which areimportant businesses for the Texas economy.At least for the foreseeable future, customerswill continue to require both gas and electric-ity. Direct use of gas is more efficient for heat-ing and may be also for cooling, but gas can-not drive a home computer (yet)!

Some of the rationale for convergence stemsfrom industry trends. The first companies toenter the power marketing business were thosethat already had gas marketing expertise. In-deed, the electric power industry has gainedmuch experience from natural gas firms al-though today we have retail choice in electric-ity but not yet in gas. Another important fac-tor is that gas has been the fuel of choice formeeting most of the growth in electricity de-mand. This is due to the highly favorable costfor combined cycle units for new capacity ad-ditions. While low heat rate (high efficiency)combined cycle units are used for base loadalong with coal-fired and nuclear units, highheat rate (low efficiency) gas-fired steam plantssupplied the peak load. As a result, the mar-

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ginal cost of power has been closely related tothe price of natural gas. It is also much easierand cheaper to turn a gas-fired plant on andoff than a coal-fired plant. Daily use of gas byelectric utilities fluctuates just as daily use ofelectricity does. And marketers can move gasand electricity interchangeably from one loca-tion to another, reducing price differentialsacross energy types and regions. Industry ex-perts often refer to “gas by wire,” meaning thatcustomers can receive natural gas in the formof gas-fired electric power. Similarly, custom-ers can receive “power by pipe,” choosing totake gas directly. Lastly, as already noted, natu-ral gas and electricity overlap at the end userlevel. A householder can, for instance, choosea natural gas clothes dryer or an electric one,and a single firm could profit from either de-cision whereas competing ones could not.While our future fuel mix for electricity willdepend on relative fuel prices, many compa-nies are gambling that gas will have a com-parative advantage and are building strategiesaround the synergies between gas and electric-ity.

All of these complex forces led to the idea ofa “one stop shop” for energy, or the “Btu store.”Customers would be able to secure all of theirenergy needs, whether it is gas, coal, oil, elec-tricity or an alternative, from one organization.The one stop shop would consolidate billingand marketing, creating many additional effi-ciencies. Companies pursuing this strategybelieved that it would lead to a critical mass inthe marketplace, allowing them to packagemany different kinds of customers in manydifferent locations, generating revenues inmultiple ways from the same assets.

Countering the idea of the one stop shop wasthe notion that as energy systems became moredecentralized, niche markets would dominate.In this view of the future, large companies thatoffer many different services would not nec-essarily have an advantage over those thatnarrowly defined their scope and carefully tar-geted their customer audiences. These compet-ing views of the future lent an extra set of chal-lenges and another layer of complexity to elec-tricity restructuring.

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So where do things stand today? Most of thecompanies aggressively pursuing strategies tooffer multiple products and services to endusers have either postponed, dismantled orshelved their business concepts or the compa-nies themselves were subsumed in mergersand acquisitions. Spanning the “last mile” toend users to combine energy and informationproved to be more difficult and expensive thanpreviously realized. The collapse of technol-ogy and telecommunications companies, thelatter of which (along with many utilities andnatural gas pipelines) had invested in a vastsurplus of fiber optic cable capacity, has post-poned indefinitely the concept of multipleproducts. Aggressive development of gas-firedpower generation capacity has left surpluses(a good thing for end user prices) althoughretirement of old gas-fired units started to de-plete the surplus. Financial constraints andscrutiny for the host of companies pursuingnew business models has delayed innovationwhile these organizations work to improve fi-nancial reporting, deal with related issues andrespond to increased regulatory oversight, andthe potential for further exertion of regulatoryauthority.

Mergers, Acquisitions and CombinationsThe efforts of companies to position them-

selves for the future led to merger and acqui-sition (M&A) activity beyond anything previ-ously experienced in the utility industries. In-vestors once looked to the utilities for safe ha-vens from stock market cycles and steady divi-dends as a consequence of the regulatory com-pact - that in exchange for their investments,utility companies were given an opportunityto earn a reasonable return. M&A activitychanged investor perceptions and expectationson an almost daily basis. From 1992 to April2000, 35 M&As were completed between IOUsor between IOUs and IPPs. Twelve additionalmergers have been announced and are nowpending stockholder or Federal and State gov-ernment approval. The size of IOU mergers,in terms of value of assets, is also increasing.Between 1992 and 1998, only four mergerswere completed in which the combined assets

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of the companies in each merger were greaterthan $10 billion. More recently, eight mergerscompleted in 1999 or 2000, or pending comple-tion, each have combined assets greater than$10 billion.

A second category of M&A activity includeselectric utilities and natural gas companies.Increased competition pressured these entitiesto combine operations in order to become moreefficient, to diversify products, to share exper-tise and experience in energy markets, and totake advantage of the growing use of gas-firedpower plants. From 1997 through April 2000,23 such mergers involving companies withassets valued at $0.5 billion or higher have beencompleted or are pending completion.

In its Policy Statement for reviewing publicutility mergers, the FERC demonstrated thatit will more closely scrutinize the impact ofmergers on competition in the wholesale elec-tric market. While the Policy Statement nar-rows the focus of the FERC’s inquiry, it in-creases antitrust review by adopting the analy-sis outlined in the Department of Justice/Fed-eral Trade Commission’s 1992 HorizontalMerger Guidelines. Using those Guidelines,the FERC will assess the increase in marketconcentration, requiring a hearing for thosemergers exceeding certain thresholds. ThePolicy Statement, however, adopts the Guide-lines’ generic threshold levels rather thanhigher levels, suggested by many industry ex-perts that are more appropriate for the electricutility industry. Accordingly, many mergersmay not pass initial screening, at least as tosome products during some time periods, andwill be set for hearing. Apart from the FERC’sauthority, the focus of review will be at the statelevel. PUCs will likely face considerable activ-ity from intervenors either opposed to or infavor of proposed M&As or combinations.

In states where the industry restructuringcalled for the unbundling of integrated utili-ties into generation, T&D and retail market-ing companies, competitive pressures and newmarket realities are leading companies to lookfor ways to cut costs as well as gain competi-tive advantage. In this environment, in lieu ofa full M&A or combination, firms may seek

strategic alliances, partnerships or joint ven-tures not only with traditional industry play-ers but also with technology firms, marketingoutfits and such that allow them to developand market services. In any case, the corpo-rate landscape has already changed consider-ably, and will continue to do so.

GlobalizationWhile the changes in Texas and the U.S. may

be overwhelming, we are not alone. Aroundthe world, reliance on markets to provide en-ergy services has been a growing trend. Com-panies in Texas and elsewhere in the U.S. haveplayed a critical role in providing technologyand financial capital as countries seek to liber-alize energy markets and reduce governmentownership and control of energy services. Ourenergy companies have discovered that theirskills and expertise at home are transferableelsewhere, speeding the transition to interna-tionalization.

The current, agonizing changes in the energymerchant businesses – wholesale trading andmarketing and IPP activity – along with finan-cial disruptions and setbacks in regions likeSouth America where these companies havebeen active has introduced a new turn of eventsin international activity. Many U.S. companiesrecently have shut down their operations over-seas and focused back on the U.S. markets, inpart because they did not realize the gains theyexpected in the restructured markets of LatinAmerica and Europe. In part, this is becausethese markets have become quite competitive,which put pressure on prices, and hence onreturns. Another, larger factor has been thedifficulty of building sustainable markets incountries where governments still retain heavyinfluence in their energy sectors.

Canada most closely parallels the U.S. expe-rience. The two countries have moved in closeunison, with Canada often in the lead to restruc-ture the natural gas pipeline industry and en-courage greater competition among natural gasutilities. Although in Canada natural gas re-serves are considered provincial crown assets,in both countries exploration and productionis carried out by many competing companies.

Recent EventsTexas Companies

Credit rating issuesimpact the majorIOUs’ exposure aswell as the “energymerchants” withtotal in the billionsof dollars.

Reliant Energyseparates intoReliant Resourcesand CenterPointEnergy.

Enron declaresbankruptcy.

Enron’s tradingbusiness acquiredand subsequentlydownsized by UBSWarburg.

NewPower goes outof business.

AEP transfers twoof its REPs ( WTURetail Energy andCPL Retail Energy )to Centrica.

Shell quits the retailmarket.

Other Events

PG&E declaresbankruptcy.

National Grid Group(power-transmission)acquisition ofLattice (gas-pipeline) in UK.

E.ON (Germany)acquisition ofPowergen (UK).

Exelon Corp.acquisition of SitheNew EnglandHoldings.

Constellation EnergyGroup acquisitionof NewEnergy fromthe AES Corp.

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Canada and the U.S. comprise a commonmarket for gas trade. Electricity trade alreadyexists between the two countries and there arepossibilities for this activity to increase. Cana-dians, watching U.S. electric power restructur-ing, began to mimic and again in some casesto lead the process. Alberta and Ontario havebeen the two most active provinces. AlthoughAlberta appeared prone to experiencing prob-lems similar to those of California in the earlydays of reform, its market is now fully func-tional.

Of great interest was how the huge provin-cial crown companies, Ontario Hydro and Hy-dro-Québec, would be treated with regard tothe prospects for privatization. Ontario Hydrowas broken up and mostly privatized after therestructuring of the sector in 1998. Its HydroOne Inc. subsidiary remained wholly-ownedby the provincial government until recent ef-forts to privatize it. The Communications, En-ergy and Paperworkers Union of Canada andthe Canadian Union of Public Employeesstopped the sale of Hydro One in April 2002.The Ontario Superior Court of Justice ruledthat the government does not have legal au-thority to relinquish public control of the cor-poration, by offering its shares for sale to pri-vate investors. In addition, price caps wereplaced on electricity prices in October 2002,essentially halting reform. There is little re-structuring activity in Québec and Hydro-Québec remains a powerful integrated utilitywith significant exports to the U.S. and increas-ing activity worldwide.

Western Europe is moving in a similar di-rection taken by the U.S. and Canada. Britainactually has been much more aggressive inrestructuring its electricity sector than we havein the U.S. But state ownership of utilities wascommon practice in Europe. This system hadto be dismantled before other steps could betaken to introduce competition. The EuropeanCommunity (EC) has formulated directives toliberalize member country electricity markets,with a goal of achieving 30 percent of the mar-ket open to competition by independent powersuppliers in ten years. The EC has also issueddirectives to liberalize natural gas markets. On

November 25, 2002, energy ministers frommember countries announced that retail mar-kets for electricity and gas will open by July2007.

The issues in Western Europe include sensi-tivities to sovereign preferences (countries inwhich state-owned monopolies dominate elec-tricity and natural gas service are trying to pro-tect these enterprises) and concerns about en-ergy security (Europe has been much more vul-nerable to supply shocks than we have, energyprices are higher and domestic reserves ofnatural gas are not significant outside theNorth Sea). Many of the same consumer, envi-ronmental and financial issues that we see hereprevail in Europe.

In emerging markets, the commitment to freemarket energy is much more variable and theresults will be much more difficult to predict.In Latin America, Chile and Argentina havebeen the leaders in encouraging privatizationand private investment in electricity and natu-ral gas (as well as other economic sectors),while Mexico and Venezuela, characterized bytheir rich natural resource endowments, havemoved more slowly and unevenly. Brazil, be-cause of its size and population will be closelywatched. Opportunities for wheeling electric-ity exist between the U.S. and Mexico, betweenMexico and Central America and within the“Southern Cone,” which includes Argentina,Chile, Brazil and smaller countries in theMercosur free trade region. Economic collapsein Argentina in 2001-2002 and repercussionsthroughout the region have slowed both re-forms and investment.

The story is similar in Asia, South Africa,Central and Eastern Europe and the FormerSoviet Union. In all cases, much of the impe-tus for restructuring markets comes from gen-eral economic reforms, the need for private in-vestment to build infrastructure and create jobsand the need to generate good will among theindustrialized countries.

All emerging markets face similar con-straints. Their economies traditionally havebeen highly centralized and dominated bygovernment intervention and ownership. Cor-ruption and poverty are pervasive. Prices tend

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to be controlled by the governments so thatdistortions and inefficient use of energy arerampant. Political and financial instability re-main a problem. Social backlash to reform ini-tiatives is always a possibility as witnessed inArgentina and the myriad of market issuesfaced in the U.S. these past two years have hadglobal repercussions. Nevertheless, in spite ofthese enormous constraints, even the most dis-advantaged nations seem at least interested intrying to adapt to the prevailing trends. Almostsurely, at some point in the future, countriesthat make the effort to embrace market prin-ciples and private sector participation in en-ergy development will enjoy the payoff. Manycountries from Eastern Europe to SoutheastAsia continue with their restructuring effortsbased on these expectations.

ConclusionsIs there a reason to be optimistic? The an-

swer is a resounding “yes.” Will change in theTexas and U.S. electric power industries bedifficult? The answer is also “yes.” However,if people are well-informed at all levels - sup-pliers, customers, policy makers, researchers -then we have a better chance of making thebest decisions that we can.




713/743-4634Fax 713/743-4881

[email protected]

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Appendices

Basic Economic Principles .................................................... 74

Glossary................................................................................... 77

Further Readings .................................................................... 83

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To understand the electric power industryin Texas, and the issues we face, it helps to befamiliar with a few economic terms.

MarketThe U.S. is a “mixed economy,” meaning that

we depend on private markets for the provi-sion of goods and services but with govern-ment involvement. A “market” is simply thefree interaction between many buyers and sell-ers, exchanging information about price andcost. It can be a place, like the New York StockExchange or the Chicago Board of Trade. Or, amarket may be more diffuse, encompassingmany institutions and places as well as therules that actors follow, like energy markets.

A market is like a bidding process wherebuyers disclose the amount they are willing topay for a good or service while sellers disclosethe amount they are willing to accept. This pro-cess is called “price discovery” and it is veryimportant to the proper functioning of a mar-ketplace. Adam Smith, generally regarded tobe the father of modern economic thought,described the process of price discovery in TheWealth of Nations, published in 1776, to be likean “invisible hand.”

For markets to function properly, it is neces-sary to have “property rights,” meaning thatthere is a recognition of ownership, and legaland institutional protection for property rights.In this way, when buyers and sellers engagein contracts for the purchase and sale of goodsor services, it is clear who owns the good orservice, who is taking title to the good or ser-vice, that there are laws protecting the sanc-tity of the contract and that, if there were a dis-pute, the parties would be able to seek a fairremedy. Finally, for markets to function prop-erly, resources — particularly labor and capi-tal inputs exclusive of land — must be mobilewith no or few barriers to mobility.

Marginal CostThis is one of the most important criteria in

guiding the behavior of firms and individualsin a properly functioning marketplace. Once afirm has accumulated all of the inputs neces-sary to produce a good or service — land, la-bor, machinery, etc. — the per-unit cost to pro-duce a small increase of the good or service isthe “marginal cost” faced by the firm. In aproperly functioning marketplace, the pricethat buyers discover they must pay shouldequal the marginal cost faced by the seller.When that happens, the right information isbeing communicated and the market “clears,”that is, there is no shortage or surplus. In theutility industries, not all customers are thesame. In addition, marginal costs vary in theshort run and long run, by season and duringthe day (even minute-by-minute)

The marginal costs for utilities to serve resi-dential customers are often higher than for cus-tomers that use larger volumes of electricity.Think of it this way. Let’s say that in order toadd 10,000 kWh of residential load a utilitycompany has to hook up 100 households. Ithas to spend more to do this (install moremeters, set more billing services, etc.) than itdoes to add one new 10,000 kWh customer.

Economies of ScaleSome industries tend to be dominated by

monopolies because of the technical nature ofthe industry. The utility industries — electric-ity, gas, telephone, water and sewer — are ex-amples. Once a company has the transmissionand distribution systems to bring electricity tocustomers, it is much cheaper (the marginalcost is much lower) for that company to addcustomers than for a competing company tobuild new, duplicate facilities and provide ser-vice to those same new customers. In otherwords, the existing utility company can addmany more customers and generate muchmore output than the amount of new inputsthat may be required. This is called “economiesof scale.”

Economies of scale create “barriers to entry.”The high costs that new firms face to enter anindustry relative to the sunk costs (costs that

Basic EconomicPrinciples

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cannot be recovered if the firm stops operat-ing) that existing firms have already made aresuch that potential new entrants may be dis-couraged. Technology change can alter theserelationships. For instance, electricity genera-tion is no longer considered an activity withmonopoly attributes. It is relatively easy fornew competitors to enter the power genera-tion industry. Advantages of high efficiency,new generation plants may outweigh benefitsfrom existing generators that have some econo-mies of scale.

Profit and Producer SurplusAll businesses desire to earn a “profit.” Profit

is basically the difference between all costsfaced by a firm and the revenue that the firmgenerates from sales. Producers face a mini-mum price at which they are willing to selltheir goods or services. The market price isusually higher than the minimum, because ofwhat consumers are willing to pay — compe-tition among consumers “bids up” the price.The difference between what the producer iswilling to take in order to at least break evenand what consumers are willing to pay is calledeconomic rent or “producer surplus.” It is adifferent concept than profit, because it takesinto account the dynamics of a competitivemarketplace.

Consumer SurplusLikewise, consumers are willing to pay a

price for a good or service that is generallymore than what they actually end up payingin the marketplace. This is because competi-tion among sellers “bids down” the marketprice. The difference between what consum-ers are willing to pay and what they actuallypay is “consumer surplus.”

Market Failure and Welfare LossAs discussed above, both producers and con-

sumers have a surplus when the market clears,or is in equilibrium. “Welfare” for the societyas a whole is equal to the sum of producer sur-plus and consumer surplus.

The equilibrium is efficient if the economy’sscarce resources are being used to yield the

largest possible value (or, lowest possible cost).Changes in market conditions, however, canshift the market to an inefficient equilibrium.Then, we have loss of welfare.

“Market failure” is a general term used todescribe a wide range of reasons for the mar-ket to yield an inefficient equilibrium.

For example, sellers may accumulate toomuch power, with the ultimate situation be-ing one of monopoly (only one seller). In thiscase, part of consumer surplus is transferredto the producers. Markets may also fail becausebuyers accumulate too much power, with theultimate market power being the case of onebuyer (monopsony). In this case, producer sur-plus is transferred to the consumers.

Alternatively, markets may fail because of“information asymmetries,” meaning that oneside has more information than the other andcan use that to an advantage.

There may be social costs of producing agood or service other than the private costs andthese social costs may not be reflected in themarket price. This is called an “externality,”and it is the typical situation for many envi-ronmental issues. For example, the social costof air pollution in terms of health and safetyeffects are above and beyond the private costassociated with the activity that generates pol-lution, whether it is driving a car or operatinga power plant.

Markets can fail because property rightsbreak down or are impossible to determine. Forexample, how do we decide who owns thestock of fish in the world’s oceans? Or, howdo we best manage the production of a natu-ral resource like petroleum? These are called“common pool” problems because the bound-aries are arbitrarily established.

When market failure happens, the prices thatwe see for goods and services are not what theywould be if the market was functioning prop-erly, and consequently we suffer a loss in so-cial welfare.

Government FailureWhen government steps in to regulate mar-

ket failure, either real or perceived, this oftencreates a new and different set of problems,


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sometimes worse than the market failure itself!This is called “government failure.” It happensbecause it is difficult, indeed impossible, forgovernment to know what prices should beand how to correct the price distortions thatarise from market failure.

Utility RegulationRegulation is most often an attempt to re-

capture welfare loss (in this case, lost consumersurplus from monopoly provision of utilityservices) and transfer it back to consumers bysubstituting regulatory oversight for competi-tion. However, this is a difficult thing to do.The tradition of utility regulation in the U.S.rests on the granting of franchise monopolylicenses, in recognition that economies of scaleexist, and control of monopoly power via theallowed rate of return or profit that a utilitycan earn. In return for the opportunity to earna just and reasonable rate of return, the utilityis obligated to serve all customers within itsfranchise service area. In practice, utility regu-lation is very expensive because of the amountof time and cost incurred by utilities in sup-plying information and for regulators to evalu-ate the information and make a determination.In addition, regulation has often been used togenerate welfare gains for specific groups ofcustomers.


ContestabilityEconomists have learned that in industries

characterized by monopoly there are interme-diate solutions between a competitive market-place, which may not be achievable becauseof the tendency for monopoly power to de-velop for technical reasons, and regulation ofmonopoly franchises. The most powerful ideais that of “contestability.” Simply put, mo-nopoly power may be more constrained thanit would appear to be because of the potentialfor competition to develop and for new en-trants to contest the existing monopolist.Knowing that there is a potential for competi-tion, the monopoly supplier may actuallycharge a price for the good or service that isclose to the price that would be realized in aproperly functioning, competitive market-place.

In the utility industries, the idea ofcontestability is most easily put into practicewhere large users are concerned. Because ofchanges in technology that allow competingsuppliers to emerge and the volumes that largeusers take, giving them some influence in themarketplace, competition can easily emerge.In the electric utility industry, this is the casewith nonutility generators and the growingwholesale market for electricity. The notion ofcontestability has led to a new regulatory phi-losophy that the amount of market failure dueto monopoly can be limited by reliance on com-petition everywhere possible, reducing theamount and cost of regulation to society.

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GlossaryAffiliate

a. An Entity who directly or indirectly owns or holds atleast five percent of the voting securities of anotherEntity; or

b. An Entity in a chain of successive ownership of at leastfive percent of the voting securities of another Entity;or

c. An Entity that has at least five percent of its voting se-curities owned or controlled, directly or indirectly, byanother Entity; or

d. An Entity that has at least five percent of its voting se-curities owned or controlled, directly or indirectly, byan Entity who directly or indirectly owns or controls atleast five percent of the voting securities of anotherEntity or an Entity in a chain of successive ownershipof at least five percent of the voting securities of an-other Entity; or

e. A person who is an officer or director of another entityor of a corporation in a chain of successive ownershipof at least five percent of the voting securities of anEntity; or

f. An Entity that actually exercises substantial influenceor control over the policies and actions of another En-tity; or

g. Any other Entity determined by the PUCT to be an Af-filiate;

Aggregator: A person joining two or more customers,other than municipalities and political subdivision cor-porations, into a single purchasing unit to negotiate thepurchase of electricity from retail electric providers.Aggregators may not sell or take title to electricity. Retailelectric providers are not aggregators.

Ancillary Services: Those services, described in Section6 of the ERCOT Protocols, necessary to support the trans-mission of energy from Resources to Loads while main-taining reliable operation of transmission provider’stransmission systems in accordance with Good UtilityPractice. May include load regulation, spinning reserve,non-spinning reserve, replacement reserve and voltagesupport.

Annual Transmission Planning Report: A report pre-pared at least annually by ERCOT, as required by thePUCT rules, regarding the status of the ERCOT Systemincluding identification of ERCOT System existing andpotential Congestion, which includes identification of cur-rent and recommended construction of Transmission Fa-cilities.

Balanced Schedule: An Energy and Ancillary Serviceschedule submitted to ERCOT by a Qualified SchedulingEntity that consists of projected interval Obligations andprojected interval Supply, and that includes Qualified

Scheduling Entity Obligations for Transmission and Dis-tribution Losses. A Balanced Schedule must have aggre-gate Supply equal to aggregate Obligations, by SettlementInterval.

Balancing Energy: Balancing Energy represents thechange in zonal energy output or demand determinedby ERCOT to be needed to ensure secure operation ofERCOT Transmission Grid, and supplied by the ERCOTthrough deployment of bid Resources to meet Load varia-tions not covered by Regulation Service.

Bilateral Contract: A direct contract between the powerproducer and user or broker outside of a centralizedpower pool or power exchange.

Btu (British Thermal Unit): A standard unit formeasuring the quantity of heat energy equal to thequantity of heat required to raise the temperature of 1pound of water by 1 degree Fahrenheit.

Bundled Utility Service: All generation, transmission,and distribution services provided by one entity for asingle charge. This would include ancillary services andretail services.

Capacity: The amount of electric power delivered orrequired for which a generator, turbine, transformer,transmission circuit, station, or system is rated by themanufacturer.

Cogenerator: A generating facility that produceselectricity and another form of useful thermal energy(such as heat or steam) used for industrial, commercial,heating, or cooling purposes. To receive status as aqualifying facility (QF) under the Public UtilityRegulatory Policies Act (PURPA), the facility mustproduce electric energy and “another form of usefulthermal energy through the sequential use of energy,” andmeet certain ownership, operating, and efficiency criteriaestablished by the Federal Energy RegulatoryCommission (FERC).

Combined Cycle: An electric generating technology inwhich electricity is produced from otherwise lost wasteheat exiting from one more gas (combustion) turbines.The exiting heat is routed to a conventional boiler or to aheat recovery steam generator for utilization by a steamturbine in the production of electricity. This processincreases the efficiency of the electric generating unit.

Commercially Significant Constraint (CSC): A constraintin the ERCOT Transmission Grid that is found, throughthe process described in Section 7 of the ERCOT Protocols,to result in Congestion which limits the free flow of energywithin the ERCOT market to a commercially significantdegree.

Competitive Retailer (CR): Municipally Owned Utilityor an Electric Cooperative that offers Customer Choiceand sells electric energy at retail in the restructured electricpower market in Texas; or a Retail Electric Provider (REP)as defined in 25.5 of the PUCT Substantive rules.

Competitive Transition Charge: A non-bypassable chargelevied on each customer of a distribution utility, includingthose who are served under contracts with non-utility

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suppliers, for recovery of a utility’s transition costs.

Congestion: The situation that exists when requests forpower transfers across a Transmission Facility elementor set of elements, when netted, exceed the transfer capa-bility of such elements.

Congestion Zone: A grouping of busses that create a simi-lar Shift Factor on CSCs.

Control Area: An electrical system, bound by intercon-nect (tie line) metering and telemetry, which continuouslyregulates, through automatic generation control, its gen-eration and interchange schedules to match its systemLoad, regulates frequency, and meets all applicable Con-trol Area requirements.

Direct Current Tie, DC Tie: Any non-synchronous trans-mission interconnections between ERCOT and non-ERCOT electric power systems.

Dispatch: The act of issuing Dispatch Instructions.

Dispatch Instruction(s): Specific command(s) issued byERCOT to QSEs or TDSPs during the course of operatingthe ERCOT System.

Distribution Losses: The difference between the energydelivered to the Distribution System and the energy con-sumed by Loads connected to the Distribution System.

Distribution Service Provider: An Entity that owns andmaintains a Distribution System for the delivery of en-ergy from the ERCOT Transmission Grid to the Customer.

Distribution System: That portion of an electric deliverysystem operating at under 60 kilovolts (kV) that provideselectric service to Customers or Wholesale Customers.

Divestiture: The stripping off of one utility function fromthe others by selling (spinning-off) or in some other waychanging the ownership of the assets related to that func-tion. Stripping off is most commonly associated with spin-ning-off generation assets so they are no longer ownedby the shareholders that own the transmission and dis-tribution assets.

Electric Cooperative

a. A corporation organized under Chapter 161, Texas Utili-ties Code, or a predecessor statute to Chapter 161 andoperating under that chapter;

b. A corporation organized as an electric cooperative in astate other than Texas that has obtained a certificate ofauthority to conduct affairs in the State of Texas; or

c. A successor to an electronic cooperative created beforeJune 1, 1999, in accordance with a conversion plan ap-proved by a vote of the members of the electric coop-erative, regardless of whether the successor later pur-chases, acquires, merges with, or consolidates with

other electric cooperatives.Electric Service Identifier (ESI ID): The basic identifierassigned to each Service Delivery Point used in the regis-tration and settlement systems managed by ERCOT oranother Independent Organization.

Emergency Electric Curtailment Plan: A plan which pro-vides an orderly, predetermined procedure for maximiz-ing use of available Resources and, only if necessary, cur-tailing demand during electric system emergencies whileproviding for the maximum possible continuity of ser-vice and maintaining the integrity of the ERCOT System.

ERCOT Region: The geographic area under the jurisdic-tion of the PUCT that is served by TDSPs that are notsynchronously interconnected with electric utilities out-side the state of Texas.

ERCOT System: The interconnected combination of gen-eration, transmission, and distribution components in theERCOT Region.

ERCOT System Load: The sum of all HVDC intercon-nections and Generation Resources metered at the pointof its interconnection with the ERCOT System at any givenpoint in time.

ERCOT Transmission Grid: All of those TransmissionFacilities which are within the ERCOT Region.

Futures Market: Arrangement through a contract for thedelivery of a commodity at a future time and at a pricespecified at the time of purchase. The price is based on anauction or market basis. This is a standardized, exchange-traded, and government regulated hedging mechanism.

Hedging Contracts: Contracts which establish futureprices and quantities of electricity independent of theshort-term market. Derivatives may be used for this pur-pose.

Independent Power Producers: Entities that are also con-sidered nonutility power producers in the United States.These facilities are wholesale electricity producers thatoperate within the franchised service territories of hostutilities and are usually authorized to sell at market-basedrates. Unlike traditional electric utilities, IndependentPower Producers do not possess transmission facilitiesor sell electricity in the retail market.

Load: The amount of electric power delivered at any speci-fied point or points on a system.

Load Profile: A representation of the energy usage of agroup of Customers, showing the demand variation onan hourly or sub-hourly basis.

Load Serving Entity: An Entity that provides electric ser-vice to Customers and Wholesale Customers. Load Serv-ing Entities include Retail Electric Providers, Competi-tive Retailers, and Non-Opt In Entities that serve Load.

Market-Based Pricing: Electric service prices determinedin an open market system of supply and demand underwhich the price is set solely by agreement as to what abuyer will pay and a seller will accept. Such prices couldrecover less or more than full costs, depending upon whatthe buyer and seller see as their relevant opportunitiesand risks.

Market Participant: An Entity that engages in any activ-ity that is in whole or in part the subject of these Proto-cols, regardless of whether such Entity has executed anAgreement with ERCOT.

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Market Segment: The Segments defined in Article 2 ofthe ERCOT Bylaws. The segments are:

a. Independent REPs,

b. Independent Generators,

c. Independent Power Marketers,

d.Investor Owned Utilities,

e. Municipals,

f. Cooperatives, and

g. Consumers.

Merit Order: The ranking of Resources as a direct func-tion of the monetary bid from those resources.

Metering Facilities: Revenue Quality Meters, instrumenttransformers, secondary circuitry, secondary devices,meter data servers, related communication Facilities andother related local equipment intended to supply ERCOTsettlement quality data

Municipally Owned Utility (Muni): A utility owned, op-erated, and controlled by a municipality or by a nonprofitcorporation, the directors of which are appointed by oneor more municipalities.

Net Generation: Gross generation minus station auxilia-ries or other internal unit power requirements meteredat or adjusted to the point of interconnection at the Com-mon Switchyard.

New Renewable Facilities: Renewable energy generatorsplaced in service on or after September 1, 1999. A NewFacility includes the incremental capacity and associatedenergy from an existing Renewable Facility through re-powering activities undertaken on or after September 1,1999.

Non-Opt In Entity (NOIE): An Electric Cooperative orMunicipally Owned Utility that does not offer CustomerChoice.

Non-Spinning Reserve Service (NSRS): A service that isprovided through utilization of the portion of off-line gen-eration capacity capable of being synchronized andramped to a specified output level within thirty (30) min-utes (or Load that is capable of being interrupted withinthirty (30) minutes) and that is capable of running (orbeing interrupted) at a specified output level for at leastone (1) hour. Non-Spinning Reserve Service (NSRS) mayalso be provided from unloaded on-line capacity thatmeets the above response requirements and that is notparticipating in any other activity, including ERCOT mar-kets, self-generation and other energy transactions.

North American Electric Reliability Council (NERC):The national organization that is responsible for estab-lishing standards and policies for reliable electric systemoperations and planning, or its successor.

Obligation: Total Obligations scheduled by a QSE thatare comprised of energy Obligations and Ancillary Ser-vices Obligations where:

· Energy Obligations = Load + losses + energy sales +energy exports; and

· Ancillary Services Obligations = ERCOT allocated An-

cillary Services Obligations (which may be self-arranged)+ Ancillary Services sales (to ERCOT or to other QSEs)

Open Access: A regulatory mandate to allow others touse a utility’s transmission and distribution facilities tomove bulk power from one point to another on a nondis-criminatory basis for a cost-based fee.

Out of Merit Order (OOM): The selection of Resourcesfor Ancillary Services that would otherwise not be selectedto operate because of their place (or absence) in the bid-ding process for that service.

Outage: Removal of a Facility from service to performmaintenance, construction or repair on the Facility for aspecified duration.

Parallel Path Flow: Electricity flows over transmissionlines according to the laws of physics. As such, the powergenerated in one region may flow over the transmissionlines of another region, inadvertently affecting the abil-ity of the other region to move power.

Postage Stamp Allocation: The pro rata allocation ofcharges (or payments), which spreads to designated, En-tities based on a pro rata share (of actual or estimatedconsumption).

Power Generation Company: An Entity registered by thePUCT that:

1. generates electricity that is intended to be sold at whole-sale;

2. does not own a transmission or distribution Facility inthis state other than an essential interconnecting Facility,a Facility not dedicated to public use, or a Facility other-wise excluded from the PURA definition of “electric util-ity”; and

3. does not have a certificated service area, although itsaffiliated electric utility or transmission and distributionutility may have a certificated service area.

Power Marketer: An Entity that:

1. Becomes an owner or controller of electric energy inthis state for the purpose of buying and selling the elec-tric energy at wholesale;

2. Does not own generation, transmission, or distributionFacilities in this state;

3. Does not have a certificated service area; and

4. Has been granted authority by the Federal EnergyRegulatory Commission to sell electric energy at market-based rates or has registered as a power marketer.

Price-to-Beat (PTB): The bundled rate a Retail ElectricProvider that is affiliated with an Entity required to un-bundle its electric services, and offer Customer Choice,must charge to residential and small commercial Custom-ers upon initiation of Customer Choice, as further de-scribed in Section 39.202 of PURA and PUCT rules.

Provider of Last Resort (POLR): The designated Com-petitive Retailer as defined in the PUCT Substantive Rulesfor default Customer service, and as further described inSection 15.1, Customer Switch of Competitive Retailer.

Pumped Storage Hydroelectric Plant: A plant that usu-

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ally generates electric energy during peak-load periodsby using water previously pumped into an elevated stor-age reservoir during off-peak periods when excess gen-erating capacity is available to do so. When additionalgenerating capacity is needed, the water can be releasedfrom the reservoir through a conduit to turbine genera-tors located in a power plant at a lower level.

Qualified Scheduling Entity (QSE): A Market Participantthat is qualified by ERCOT in accordance with Section16, Qualification of Qualified Scheduling Entities andRegistration of Market Participants, to submit BalancedSchedules and Ancillary Services bids and settle paymentswith ERCOT.

Rate Base: The value of property upon which a utility ispermitted to earn a specified rate of return as establishedby a regulatory authority. The rate base generally repre-sents the value of property used by the utility in provid-ing service and may be calculated by any one or a combi-nation of the following accounting methods: fair value,prudent investment, reproduction cost, or original cost.Depending on which method is used, the rate base in-cludes cash, working capital, materials and supplies, anddeductions for accumulated provisions for depreciation,contributions in aid of construction, customer advancesfor construction, accumulated deferred income taxes, andaccumulated deferred investment tax credits.

Reactive Power: The product of voltage and the out-of-phase component of alternating current. Reactive Power,usually measured in megavolt-amperes reactive, is pro-duced by capacitors, overexcited generators and othercapacitive devices and is absorbed by reactors,underexcited generators and other inductive devices.

REC Program: The Renewable Energy Credit trading pro-gram, as described in Section 14, Renewable Energy CreditTrading Program, and PUCT Subst. R. 25.173.

Replacement Reserve Service: A service that is procuredfrom Generation Resource units planned to be off-line andLoad acting as a Resource that are available for interrup-tion during the period of requirement.

Resource: Facilities or Load capable of providing or re-ducing the need for electrical energy or providing Ancil-lary Services to the ERCOT System, as described in Sec-tion 6, Ancillary Services. This includes Generation Re-sources and Loads acting as Resources.

Resource Plan: A plan provided by a QSE to ERCOT in-dicating the forecast state of Generation Resources or in-dividual Loads each acting as a Resource, including in-formation on availability, limits and forecast generationor Load of each Resource.

Responsive Reserve Service: Responsive Reserve consistsof the daily operating reserves that are intended to helprestore the frequency of the interconnected transmissionsystem within the first few minutes of an event that causesa significant deviation from the standard frequency.

Retail Electric Provider (REP): A person that sells elec-tric energy to retail Customers in this state. As providedin PURA §31.002(17), a Retail Electric Provider may notown or operate generation assets. As provided in PURA

§39.353(b), a Retail Electric Provider is not an Aggregator.

Scheduling Process: The process through which sched-ules for energy and Ancillary Services are submitted byQSEs to ERCOT as further described in Section 4, Sched-uling.

Settlement Interval: The time period for which a MarketService is deployed and financially settled. For example,the currently defined settlement interval for the Balanc-ing Energy Market Service is 15 minutes.

Settlement Meter: Generation and end-use consumptionmeters used for allocation of ERCOT charges and whole-sale and retail settlements.

Spinning Reserve: That reserve generating capacity run-ning at zero load and synchronized to the electric sys-tem.

Stranded Benefits: Benefits associated with regulatedretail electric service which may be at risk under openmarket retail competition. Examples are conservationprograms, fuel diversity, reliability of supply, and tax rev-enues based on utility revenues.

Stranded Costs: Prudent costs incurred by a utility whichmay not be recoverable under market-based retail com-petition. Examples are undepreciated generating facili-ties, deferred costs, and long-term contract costs.

Supply: Total supply scheduled by a QSE that iscomprised of Energy Supply and Ancillary ServicesSupply where:

• Energy Supply = Resources + energy purchases +energy imports; and

• Ancillary Services Supply = Resources + AncillaryServices purchases (including purchases throughERCOT) + Ancillary Services imports

System Benefit Fund: The fund established by the PUCTto provide funding for Customer education programs,programs to assist low-income electric Customers; andthe property tax replacement mechanism provided by Sec-tion 39.601 of PURA.

System Congestion Fund: ERCOT’s accounting fundfrom which payments for resolving Congestion are dis-bursed and to which ERCOT credits Congestion-relatedreceipts from QSE’s representing Loads.

System Operator: An Entity supervising the collectiveTransmission Facilities of a power region that is chargedwith coordination of market transactions, system-widetransmission planning, and network reliability.

TDSP Metered Entity: Any Entity that meets the require-ments of Section 10.2.2, TDSP Metered Entities.

Technical Advisory Committee: A subcommittee in theERCOT governance structure reporting to the Board ofDirectors as defined by the ERCOT bylaws.

Total Energy Obligation: The total energy Obligation fora Qualified Scheduling Entity during a Settlement Inter-val, including the energy from the Balanced Schedule andintegrated energy of instructed Ancillary Services.

Total Transmission Capacity: The maximum power that

Glossary

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may be transferred across a transmission corridor whilemaintaining reliability of the ERCOT System.

Transmission Access Service: Use of the TDSP’s Trans-mission Facilities for which the TDSP is allowed to chargefor the use through tariff rates approved by the PUCT.

Transmission Congestion Right (TCR): A financial hedgeagainst the cost of 1 MW flowing across a particular Com-mercially Significant Constraint, in a single direction, for1 hour.

Transmission and/or Distribution Service Provider(TDSP): An Entity that owns or operates for compensa-tion in this state equipment or Facilities to transmit and/or distribute electricity, and whose rates for TransmissionService, distribution service, or both is set by a Govern-mental Authority.

Transmission Facilities: The following Facilities aredeemed to be Transmission Facilities:

1. Power lines, substation, and associated Facilities, op-erated at 60 kV or above, including radial lines operatedat or above 60 kV.

2. Substation Facilities on the high side of the transformer,in a substation where power is transformed from a volt-age higher than 60 kV to a voltage lower than 60 kV or istransformed from a voltage lower than 60 kV to a voltagehigher than 60 kV.

3. The direct current interconnections with the SouthwestPower Pool (SPP), Western System Coordinating Council(WSCC), Comision Federal de Electricidad, or other in-terconnections.

Transmission Losses: Difference between energy inputinto the ERCOT Transmission Grid and the energy takenout of the ERCOT Transmission Grid.

Transmission Service Provider: An Entity under the ju-risdiction of the PUCT that owns or operates Transmis-sion Facilities used for the transmission of electricity andprovides transmission service in the ERCOT Transmis-sion Grid.

Wholesale Customers: Non-Opt-in entities receiving ser-vice at wholesale points of delivery from an LSE otherthan themselves.

Zonal Congestion: Congestion that can be resolved bydeployment of Balancing Energy Services by CongestionZones, including CSCs and any Operational Constraintsunderlying or essentially parallel to CSCs.

This glossary is based on glossaries available atwww.ercot.com and www.eia.doe.gov. For more defini-tions, please refer to these sites.

Glossary

83

Andrews, Clinton J., editor. 1995. RegulatingRegional Power Systems . Westport, Conn: Quo-rum Books.

Bradley, Robert L., Jr. 1996. The Origins ofPolitical Electricity: Market Failure of PoliticalOpportunism? Energy Law Journal 17: 59-102.

Brennan, Timothy J., et al. 1996. A Shock to theSystem: Restructuring America’s Electricity Indus-try. Washington, D.C.: Resources for the Future.

Dismukes, David, Allan Pulsipher and Kim-berly Dismukes. March 1996. Restructuring theElectric Utility Industry: Implications for Louisi-ana: Phase I: Background and Overview. BatonRouge, Louisiana: Center for Energy Studies,Louisiana State University.

Enholm, Gregory B. and J. Robert Malko. 1995.Reinventing Electric Utility Regulation, Vienna.Virginia: Public Utilities Reports, Inc.

Energy Information Administration. March2002. Inventory of Electric Utility Power Plantsin the U.S. 2000 .

Energy Information Administration. January2002. Electric Sales and Revenue 2000. Washing-ton, D.C.: U.S. Department of Energy.

Energy Information Administration. December2001. Annual Energy Outlook 2002. Washington,D.C.: U.S. Department of Energy.

Energy Information Administration. August2001. Electric Power Annual 2000, Volume I,Washington, D.C.: U.S. Department of Energy.

Energy Information Administration. October2000. The Changing Structure of the Electric PowerIndustry 2000: An Update. Washington, D.C.:U.S. Department of Energy.

Energy Information Administration. 1995.Performance Issues for a Changing Electric PowerIndustry.

ERCOT. February 22, 2001. The Market Guide .

ERCOT. circa 1990. ERCOT: The Texas Connec-tion for Reliable Electricity . Austin, Texas:ERCOT.

ERCOT. September 1993. The ERCOT Bulk Elec-tric System: What It Is and How It Works. Aus-tin, Texas: ERCOT.

Flavin, Christopher and Nicholas Lenssen.1994. Power Surge. New York: W. W. Norton &Company, Inc.

Foss, Michelle Michot and Gürcan Gülen. Sum-mer 2001. Electricity Industry Restructuring inTexas: A White Paper (available atwww.powertochoose.org).

Foss, Michelle Michot. September 17, 1996.Energy Utility Deregulation: Implications for Cus-tomers. Presentation to Federal Reserve BankFacilities Managers Conference. Richmond,Virginia.

Foss, Michelle Michot, Pratt, Joseph A., Conine,Gary, Stone, Allen and Robert Keller. May1998. North American Energy Integration: TheProspects for Regulatory Coordination and Seam-less Cross-Border Transactions of Natural Gas andElectricity. IELE White Paper.

Foss, Michelle Michot. Unpublished manu-script. U.S. Natural Gas in the 21st Century: Ad-justing to the New Reality. University of Hous-ton, dissertation.

Fuldner, Arthur H. 1996. Upgrading Transmis-sion Capacity for Wholesale Electric Power Trade,Worldwide Web: <http://www.eia.doe.gov/cneaf/pubs_html/feat_trans_capacity/w_sale.html>

Gee, Robert W. and Kenton C. Grant. 1995.Regulation in the Lone Star State, from Rein-venting Electric Utility Regulation by Enholmand Malko. Vienna, Virginia: Public UtilitiesReports, Inc., 273-285

Further Readings

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Gervais, Marc . July 1993. Electricity Supply andDemand into the 21st Century. Washington, D.C.:U.S. Council for Energy Awareness.

Gülen, Gürcan and Michelle Michot Foss.Forthcoming. Electricity Restructuring in theU.S. A Status Report. IELE White Paper.

Gülen, Gürcan. October 2002. A ComparativeLook at Capacity Schemes. IELE Working Paper,presented at the 2002 USAEE Conference inVancouver.

Gülen, Gürcan. June 2002. Demand SideResponse and Dynamic Pricing. IELE WorkingPaper. Versions published in the Proceedingsfor the 2002 IAEE International Conference inAberdeen and USAEE Dialogue.

Gülen, Gürcan and Michelle Michot Foss. June2002. Mean Reversion and Volatility in EnergyPrices: Implications for Policy. IELE Working Pa-per, presented at the 2002 IAEE InternationalConference in Aberdeen.

Hoecker, James J. October 4, 1994. NewDirections for the Electric Industry: A View ofEmerging Competition. Presentation to theEdison Electric Institute and Western CoalCouncil (St. Louis).

Hoffman, Matthew. 1994. The Future of Elec-tricity Provision. Regulation 1994(3): 55-62.

Hogan, William. May 2000. RegionalTransmission Organizations: Millenium Order onDesigning Market Institutions for ElectricityNetwork Systems. Working Paper. Harvard Elec-tricity Policy Group.

Hogan, William. November 17, 1994. Reshap-ing the Electricity Industry. Presentation to theFederal Energy Bar Conference (Washington,D.C.).

Joskow, Paul L. and Richard Schmalensee.1983. Markets for Power. The MIT Press: Cam-bridge, Mass.

Joskow, Paul. 1994. Competition in the U.S. Elec-tric Power Sector: Some Recent Developments.MIT, Center for Energy and EnvironmentalPolicy Working Paper 94-008. October.

Kozloff , Keith Lee and Roger C. Dower.December 1993. A New Power Base: RenewableEnergy Policies for the Nineties and Beyond. Wash-ington, D.C.: World Resources Institute.

Lower Colorado River authority. 1995. Electric-ity 101, Austin, Texas: LCRA.

Adib, Parviz and Candice Clark. August 1996.Regulatory Reform, Texas Style: The Electric andTelecommunications Industries. Texas BusinessReview, University of Texas Bureau of Busi-ness Research.

Public Utility Commission of Texas. June 18,2002. Presentation to the Electric Utility Re-structuring Legislative Oversight Committee.

Public Utility Commission of Texas, MarketOversight Division. December 2000. ProjectNo. 22209. 2000 Annual Update of GeneratingUtility Data.

Southern States Energy Board. April 1996.Emerging Competitive Issues Relating to the U.S.Electric Utility Industry: A Primer.

Texas Comptroller of Public Accounts.December 1996. Deregulation Sparks: Electricindustry faces overhaul in new era of compe-tition. Fiscal Notes. Austin, Texas.

Texas Sustainable Energy DevelopmentCouncil. August 1995. Texas Energy for a NewCentury. Austin, Texas: Texas Sustainable En-ergy Development Council.

Texas Legislature. May 1999. Senate Bill 7.

TU Electric. undated. The Pathway of Power.

U.S. Federal Energy Regulatory Commission.April 24, 1996. Fact Sheet: Electric Utility Re-structuring.

Further Readings

85

Virtus Energy Research Associates. July 1995.Texas Renewable Energy Resource Assessment.Austin, Texas: Texas Sustainable Energy De-velopment Council.

Vogel, Carole. April 18, 1996. Texas Transmis-sion Access and Pricing Rules. Presentation forthe Natural Gas Association of Houston. Hous-ton, Texas.

Vu, Mia. December 12, 1996. Convergence ofGas and Electricity Markets. Presentation to theInternational Association for Energy Econom-ics-Houston Chapter (Houston).

WEB SITES:www.powertochoose.orgwww.puc.state.tx.uswww.ercot.comwww.ferc.govwww.eia.doe.govwww.epa.govwww.gulfcoastpower.orgwww.aect.net

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