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June 1, 2001

Update on Texas Deregulation: 
Myriad of Issues Converge as Pilot Kicks Off 

By Will McNamara
Director, Electric Industry Analysis 

[IMAGE]The City of Dallas has become another of Texas' major customers to 
take advantage of the savings available in the state's emerging competitive 
electric market. The city has signed an electricity contract with AES 
NewEnergy. Under the terms of the contract, AES NewEnergy will provide 
electricity to approximately 100 service accounts located at municipal sites 
throughout the city that are currently served by TXU Electric. The city of 
Dallas, one of the nation's largest cities, has a population of more than 1 
million people. 

Analysis: The date at which Texas customers will begin to receive power from 
new suppliers under the state's electric pilot program has been pushed back 
to mid-July, but today marks the start of when new suppliers begin turning in 
their bid forecasts to the Electric Reliability Council of Texas (ERCOT). 
Full electric competition begins in Texas on Jan. 1, 2002. Thus, it's a good 
time to do an assessment of the many interesting dynamics that have emerged 
in the Lone Star State, some of which might pose unique challenges to the 
state's electric market. As Texas continues to prepare for full competition, 
its electric pilot program is getting off to a rather slow start (at least on 
the residential side), an ongoing debate about incorporating Texas into the 
national transmission grid continues, and ERCOT defends itself against claims 
that the state should be "closely watched" this summer. At the same time, Pat 
Wood, the state's highest-ranking utility regulator, marks his departure from 
Texas to assume a position with FERC. 

In previous columns, I've established the main points of Texas' restructuring 
plan (see 3/6/01 IssueAlert at www.scientech.com/rcifor a review). As 
incumbent utilities in Texas are allowed to create unregulated energy 
providers that can compete outside their traditional service territory, an 
interesting game of musical chairs is taking place among the various 
incumbent competitors. For instance, Dallas-based TXU is positioning itself 
to hold on to its North Texas customers while expanding into Houston, while 
Houston-based Reliant attempts to retain its base in Houston while moving 
into Dallas. At the same time, new competitors (AES NewEnergy among them) 
have moved into the state, attempting to get a jumpstart on securing 
customers during this pilot phase. At last count, 19 regional electric 
providers have registered with the Public Utility Commission of Texas (PUCT) 
to provide power to Texas customers. Also worth noting is the fact that, 
after much speculation, I recently confirmed that AEP has indeed registered 
as a retail electric provider (REP) in Texas under the name Mutual Energy, 
representing approximately one million customers. 

First, let's look at the electric pilot program. After issuing a recent delay 
in the start date for the pilot (originally slated for June 1) to ensure that 
computer systems were running effectively, those Texas customers 
participating in the pilot should start receiving power from new providers in 
mid-July. State officials had high hopes that most of the 5 percent of the 
state's electric customers eligible to participate in the pilot would select 
a new electric provider. However, at last count, fewer than 15 percent of the 
261,000 residential customers that are eligible have signed up since 
enrollment in the pilot began Feb. 15 (this represents about 1 percent of 
TXU's residential customers and 3 percent of those currently served by 
Reliant).  

The pilot officially ends when full competition begins. Fears arising from 
the national coverage of the California situation appear to be dissuading 
Texas residential customers from participating, along with general apathy 
about electric service. Also at play is a 6-percent discount that residential 
and small business customers receive from their incumbent utilities, which 
may lower the incentive for these customers to seek out a new provider. 

While Texas residential customers appear hesitant (or apathetic) about 
electric competition, the state's large industrial and commercial customers 
are eagerly embracing the opportunity to sign on with a new electric 
provider. There are about 2,000 large electric users in the state (defined as 
those businesses that consume more than 1 MW of power at peak usage). 
C_customers have filled up many of the slots available in the pilot program 
for their customer classes, and naturally appear to be generating the most 
competition in the state.  

Within this space, AES NewEnergy is gaining momentum. In addition to its 
contract with the city of Dallas, NewEnergy also secured a deal with H-E-B, 
one of Texas' leading retail companies with 280 stores in the state. AES 
NewEnergy is a subsidiary of AES Corp. (NYSE: AES), which controls more than 
64,000 MW in 32 countries. Formed in 1995, AES NewEnergy claims to be present 
in "very state where a competitive energy market is emerging." I spoke with 
representatives from the city of Dallas regarding their selection of AES 
NewEnergy among other providers, including those based in Texas. 
Interestingly, NewEnergy was the only REP that responded to the city's bid. 

Another large deal was recently announced between Cinemark USA, which 
operates movie theaters around the state, and TXU. Under the contract, TXU 
will provide energy services to 22 Cinemark theaters outside of its 
traditional North Texas service territory. Unlike the city of Dallas, which 
only received a bid from one REP, comparative price was a factor in 
Cinemark's selection of TXU. 

Whether or not Texas should be forced to join the nation's transmission grid 
is a debate that has been heating up over the last few weeks. Ironically, 
although President Bush usually supports free market forces, he reportedly is 
considering a mandate that would force ERCOT into becoming interconnected 
with the nation's two other transmission grids, the Western Interconnection 
and the Eastern Interconnection. Presently, ERCOT stands independent from the 
other two grids and wants to keep it that way. However, because Texas is 
generally thought to have excess power, it is now being considered that the 
Lone Star State should be made to export some of that supply to power-starved 
California. Presently this is not possible due to the fact that ERCOT has 
limited interconnections to surrounding power pools. 

This is not the first time that this issue has been tossed around. While 
President Bush was still governor of the state, the Public Utility Commission 
of Texas (PUCT) studied the option of linking Texas to the other grids and 
found that it would be cheaper for the state to remain disconnected. However, 
as the issue of FERC's oversight over regional transmission organizations 
gains momentum, the Bush administration may overrule Texas' current 
sovereignty over its transmission system. Further, the debate on this issue 
is related to the policy of eminent domain in the Bush administration's 
energy plan, which would give FERC the power to buy state property for the 
construction of interstate transmission lines. 

However, the question of just how much excess generation Texas might have to 
give to California has come into question over the last several weeks. The 
North American Electric Reliability Council (NERC) sparked the controversy 
recently when it issued a report identifying a number of areas in the United 
States that should be "watched closely" this summer due to supply concerns. 
In the same report, NERC also mentioned that Texas should be watched closely, 
but out of concern about the state's pilot program rather than supply 
deficiencies. ERCOT immediately disputed NERC's claim, reiterating the 
state's oft-repeated contention that it is more than prepared for competition 
and in fact has a 17.9 percent reserve power margin. In addition, Texas 
officials point to the fact that, since 1995, 22 new plants have started 
operations in the state, generating 5,700 MW. By the time competition begins 
fully in January 2002, 15 more plants and 10,000 MW are scheduled to come 
online. Nevertheless, in response, NERC stood behind its assessment, which it 
based on two possible ramifications of the summer's pilot. NERC is concerned 
that as Texas consolidates 10 control areas into one and 5 percent of the 
state's utility customers switch to new providers as is hoped by the state, 
this could take a toll on transmission capability. 

Another challenge facing Texas is the shrinkage of its regulatory commission. 
As noted, Pat Wood has now officially left his post as chairman of the PUCT 
to become a FERC commissioner. Wood's departure leaves only Brett Perlman as 
the sole PUCT commissioner, something that concerns many stakeholders as a 
number of final decisions on rules that will govern Texas' electric market 
are still pending. Texas Gov. Rick Perry has made no announcement as to when 
Wood might be replaced on the PUCT (along with Judy Walsh, who left the 
commission last January).  

Moreover, the fact that the state's pilot program has not attracted a large 
number of residential customers is not surprising. Texas may not have a 
strong competitive residential market for some time, considering the 
6-percent discount for residential and small business customers that was 
included in the state's restructuring plan. Rather, the competitive C_market, 
which is where the largest savings can be obtained anyway, may be the true 
test of the success of Texas' competitive market. This determining factor, 
along with the state's ability to retain a strong power supply, ultimately 
will decide the fate of Texas' electric industry. Because the vast majority 
of the new generation in Texas is fueled by natural gas, there are also some 
related concerns about competitors being able to beat the fixed rates of 
utility REPs if natural-gas prices remain high. However, despite these 
factors, Texas is clearly gearing up for competition and pursuing 
deregulation in its own independent fashion. The eyes of the energy industry 
remain fixed on Texas as the state-which by the way will reportedly soon 
become the largest state in terms of megawatts generated-continues its 
attempts to distance itself from the national debate that has somewhat 
tainted electric deregulation. 

An archive list of previous IssueAlerts is available at
www.scientech.com


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