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Content-Type: text/plain; charset=us-ascii Content-Transfer-Encoding: 7bit X-From: Margaret Carson X-To: Lou L Pai, Steven J Kean, James D Steffes, Martin Wenzel1, Mark Schroeder X-cc: X-bcc: X-Folder: \Steven_Kean_June2001_4\Notes Folders\Discussion threads X-Origin: KEAN-S X-FileName: skean.nsf This is a very good synopsis of how retail markets are responding to US power peaks this summer ---------------------- Forwarded by Margaret Carson/Corp/Enron on 07/31/2000 08:21 AM --------------------------- webmaster@cera.com on 07/27/2000 10:22:50 PM To: Margaret.Carson@enron.com cc: Subject: Weathering the Summer Price Volatility and Highs--How Will Retail Marketers Fare? - CERA Alert ********************************************************************** CERA Alert: Sent Thu, July 27, 2000 ********************************************************************** Title: Weathering the Summer Price Volatility and Highs--How Will Retail Marketers Fare? Author: Biehl, Behrens, Reishus E-Mail Category: Alert Product Line: Retail Energy Forum , URL: http://www.cera.com/cfm/track/eprofile.cfm?u=3014&;m=1291 , Alternative URL: http://www.cera.com/client/ref/alt/072700_16/ref_alt_072700_16_ab.html ********************************************************************** This summer retail marketers have been confronted with extraordinarily difficult market circumstances for both gas and power. So far this summer, average weekly power prices have risen above $100 per megawatt-hour (MWh) in several markets--almost double many of the standard offer levels. This differential between market prices and standard offers has made it almost impossible for retail marketers to offer customers an attractive service proposition in many areas of the United States open to competition. Similarly, in the gas market this summer (May through June) prices at the Henry Hub have averaged $3.92 per million British thermal units (MMBtu), well above the average of $2.62 per MMBtu during the same period last year. In some cases, the volatile gas and power markets this summer are proving lethal to retail marketers that chose to ride the spot markets rather than properly hedge their purchases and who lack the balance sheet strength to carry the burden. In addition, som! e retail marketers have experienced difficulty with contract fulfillment by their wholesale suppliers, even when the retailer may have felt secure going into the summer. As a result of these market conditions, a few marketers have even relinquished their customers, returning them to the utilities who are the default suppliers. Retail marketers serving these difficult markets (which include the West, PJM, and New England) are approaching the current situation with a number of different strategies, including * selling either part or all of their customer base * continuing to serve their existing customers but not renewing their contracts and planning to exit the market * turning customers back on utility service * continuing full steam ahead The irony of this situation is that high prices over the next few years may actually help increase consumer awareness about competitive energy supplies and may even cause utilities under unrecoverable price cap rates to question whether they should remain in the merchant business. Uncertainties whether retail marketers can withstand these conditions and regulators and other interested parties will tolerate a sustained period of both high and volatile prices or if instead they will step in and adjust the rules in the name of protecting retail customers. In this briefing CERA examines the question of whether one possible fallout from this summer's high and volatile energy prices will be increased consolidation among retail marketers, as retail customers (and/or businesses) begin to be actively bought and sold. We also examine the implications on retail markets of recent federal legislation supporting the legality of electronic contracts. In addition, we focus our first regional analysis on the regulatory developments and retail activity in the Northeast states and Canadian provinces--one of the most dynamic regions in terms of retail energy activity. Retail Metrics Trading Retail Customer Bases: Avenue for Building Market Share Although the impact of volatile and high energy prices this summer may be bleak for many retail players, for a new entrant and/or contrarian buyer, this could be an excellent time to pick up customers "on the cheap" and build market share. In the past month there have been three notable cases of retail energy companies buying retail customer bases from other companies--in some cases just the retail customers have been purchased and in other cases whole retail energy businesses have been purchased. Examples include * North American market entry strategy. Centrica, an energy marketing business in the United Kingdom, purchased Direct Energy, an energy marketing business in Canada that also has a joint venture with Sempra called Energy America. Through its acquisition of Direct Energy, Centrica acquired 820,000 Canadian gas customers and 27.5 percent ownership interest in Energy America, a US company that has 450,000 gas and power customers (see Table 1). In addition to gaining access to the largest retail customer base in North America, Centrica was able to buy a company with significant experience in various North American retail markets. * Gaining critical mass for an IPO. The New Power Company (a joint venture between Enron, IBM, and AOL) recently acquired over 300,000 gas and power customers from Columbia Energy Services as a way to quickly build market share before an initial public offering, for which a request has recently been filed with the Securities and Exchange Commission. * Building market share. Energy America acquired 50,000 gas customers from Titan Energy, an energy marketer in Georgia, after the latter filed for bankruptcy. In the two cases of bankruptcy, mass-market gas customers were purchased in the range of $44-$112 per customer. It appears that purchasing a base of retail customers is a cheaper form of buying market share than purchasing an entire company or division. For example, Centrica paid between $480 and $645 per customer in its purchase of Direct Energy's business. This metric is somewhat misleading, however, as the purchase of Direct Energy also included upstream gas assets. The three recent transactions join the list of retail customer acquisitions over the past year or two (see Table 1). These transactions are generally occurring for three common reasons: either as a result of a retail marketer bankruptcy (e.g., Titan Energy and Peachtree Gas), because companies are changing their strategic focus (e.g., NiSource/Columbia Energy and PG&E), or as a market entry tool (e.g., AES, Centrica, New Power). CERA expects many more players to consolidate and exit the business this year, particularly in the aftermath of the summer market. The idea that the current climate might offer a good buying opportunity for retail customers has not been lost on the market. While existing retail markets are struggling to make ends meet, the number of marketers requesting certification has increased in some places such as Massachusetts, where it is expected these new entrants will attempt to purchase other marketers' businesses. Table 1 shows extreme differences in prices paid for retail customer bases (on a total-cost-per-customer basis), since a wide variety of factors contribute to the cost of a customer and/or a retail business. CERA does not suggest that this table provides an apples-to-apples comparison on the cost of a customer. In terms of just pure customer acquisition costs there can be significant regional differences in the value of a customer owing to average use per customer and local market conditions. For example, a residential gas customer in Georgia will likely use far less gas than one in Michigan and should be valued differently as a result. Other factors such as buying habits, load size, existing contracts, and future potential growth in the market need to be evaluated to determine the proper valuation of customers. In addition, a myriad of factors can affect the value of a retail company, including what other capabilities, assets, and other factors are part of the deal, separat! e from the customer base and underlying contracts. Retail Market Share Consolidation Could Be the Trend over the Next Year Although the buying and selling of retail customers through aggregators was a common feature of Ontario gas restructuring, this tactic has not been as prevalent in the United States for two reasons. Marketers have been distrustful of the methods of acquisition of other players and are therefore skeptical about the loyalty of customers if they were to be acquired through a purchase. Additionally, many have felt that they could acquire customers at a much lower cost than by purchasing an existing customer base. This historical reluctance to buy retail customer bases seems to be changing, and will likely continue to change in the future. Over the past few years there has already been a maturation of many of these marketers and of the rules that they must obey. In addition, as larger name companies enter the retail markets, the risk associated with buying a customer base that had been acquired through questionable means has been drastically reduced. With the emergence of significant players such as Enron, Centrica, and Shell into the retail market, further customer buyouts will occur as these and other large players work to gain enough scale to make the retail business significant to their bottom line. The new breed of retail marketers may be better capitalized to play the short-run game of building market share as well as the long-run game. As a result, these players may be able to achieve scale in a market where no single company has achieved significant scale to date. In addition, many of these companies have strong wholesale marketing capabilities to support their retail marketing capabilities, inform their contracting practices, and help shield them from being on the wrong side of volatile markets. Market Developments New Law Removes the Wet Signature Barrier, but Lack of Uniform Rules Persists The regulatory requirement for retail energy marketers to obtain written ("wet") signatures from end users wanting to switch their energy service provider has posed a major cost barrier to marketers that already face high customer acquisition costs. As a result, a number of competitive energy marketers have exited markets with wet signature requirements. This cost barrier will be lowered in October when recently passed federal legislation takes effect--sparking renewed interest in the affected markets as well as guaranteeing that in the states scheduled to open, electronic customer sign-ups and transactions will be legally binding. In late June, President Bill Clinton signed into law the Electronic Signatures in Global and National Commerce Act, which will take effect October 1, 2000. This law overrides state regulatory rulings and laws that have required wet signatures. However, although the news is a step forward for marketers, the issue is not entirely cut and dried. * The Act confirms the legality of electronic transactions, while giving the states broad authority on how to implement and judge requirements for these transactions. * It stipulates that parties engaged in transactions must both agree to conduct commerce electronically. This act neither mandates electronic commerce nor allows it to be mandated if not agreed to. * The Act follows on an earlier act titled the Uniform Electronic Transactions Act (UETA), which was proposed last year by the National Conference of Commissioners on Uniform State Laws. For the states that adopted this earlier Act, the latest Congressional legislation allows them to adhere to the UETA. States that have not implemented the UETA will be under the jurisdiction of the new federal legislation, which is slightly more open to interpretation than the UETA. What does this legislation mean at the state level? Unfortunately, this Act did not come in time to have a significant impact on the states that have troubled marketers (e.g., Arizona and New Jersey). Prior to the passing of this new legislation, Arizona adopted its own version of the UETA in April. Almost concurrent with the federal legislation, New Jersey recently approved an Internet pilot program to allow marketers to use electronic signatures to switch customers beginning in September. The program will be open to 350,000 customers (10 percent of the market) and will last for six months before reevaluation by the Board of Public Utilities (BPU). However, in lieu of the federal legislation, the BPU will vote in August on lifting the program cap. It remains to be seen if either the pilot or new rules will be sufficient to lure back the marketers (e.g., KeySpan, DTE, Conectiv) that pulled out of New Jersey over the past year, citing the state's wet signature rules as one of! the primary reasons for their exit. Given the high use and ownship of personal computers in the residential market, as well as customer interest in being able to shop for suppliers over the Internet (about one third of customers surveyed in New Jersey supported Internet sign-up), we expect this recent ruling could jump-start marketing to the mass market this fall. This legislation will have the most significant impact in states that have not opened to competition or ruled on wet signatures. Although benefiting all marketers by increasing their options, this Act benefits pure e-commerce players the most. The cost of acquiring customers over the Internet can be substantially less than other forms of customer acquisition such as mail (whose costs include paper and postage) or door-to-door sales (which involves high labor costs). Since many consumers will continue to remain without Internet service for the midterm, another implication of the ruling is that it will drive further customer segmentation by different types of marketers. The implementation of the electronic signature law may signal the advent of the Internet as a favored marketing tool over the more traditional means of marketing to customer through paid advertising, direct mail, or door-to-door sales. Since the Act does not require states to accept oral communication as legally binding, many states will continue to require written or electronic signatures. "Slamming" and "cramming" remain the concern of many state regulators, resulting in rules that disallow oral transactions as a means of signing customers. The cost of acquiring customers over the Internet can be substantially less than other forms of customer acquisition such as mail (whose costs include paper and postage) or door-to-door sales (which involve high labor costs). This will help divide the retail market into players serving different customer segments. One set will continue to acquire customers that do not have Internet access through traditional methods, whereas the other set of retail players will acquire and conduct business over the Internet, typically gaining higher income customers. Though there can be little question that states will eventually have to allow marketers to transact and acquire customers over the Internet, the state-by-state rules governing electronic transactions are likely to continue to be nonstandard. Although the intent of the law as it is written is to nullify state wet signature legislation in all but a few cases, there could be some confusion over its interpretation at the state level. One area to watch will be how states interpret one of the law's few exceptions--that customers must be notified in a nonelectronic format when their utility service is being terminated. Some regulatory agencies may take that to mean that when consumers switch away from utility service, some form of communication must be sent to the consumer, and potentially a regulatory commission could require marketers to bear some or all of these costs. For more information, see the following hyperlinks: * Uniform Electronic Transactions Act (1999) (promoted by the National Conference of Commissioners on Uniform State Laws): http://www.law.upenn.edu/bll/ulc/ulc_frame.htm * Electronic Signatures in Global and National Commerce Act (signed into law by President Clinton): http://thomas.loc.gov/cgi-bin/query/z?c106:S.761.ENR: Regional Analysis--Northeast Market The attention being given to the high-priced summer market of 2000 is masking what could be seen as small steps forward for competition in the Northeast. Despite headlines about retail players exiting some markets and customers being returned to system supplies, state regulatory activity is proceeding apace this year, and there continues to be a steady influx of new players that are waiting for certification in states such as Massachusetts and New Jersey. Still, this has not been a banner year for retail activity in the Northeast (see Figure 1 and Table 2). Regulatory Front The region has more competitive retail power markets open than any other in the United States. Of the nine states in the Northeast, only New Hampshire and Vermont have not been opened to competition, although both states are moving forward to break the political impasse there. Maine and Connecticut have opened since January. Although natural gas competition got off to an early start in the region, it now lags electric access, with only New York, Pennsylvania, and New Jersey technically open to gas competition to all customers. Over the next year, the only state that is expected to take any significant step forward on the gas front is Massachusetts, as the Department of Telecommunications and Energy (DTE) is likely to rule in favor of opening the market to all customers by the end of the year. There has been a decrease in the number of customers in some utility jurisdictions that are competitively buying gas and power in the Northeast since March, particularly in Pennsylvania and New Jersey. Since March the number of customers switched to retail marketers has dropped from 612,000 to 547,000 for gas and increased somewhat for power from 680,000 customers to 801,000. Although new competitors continue to petition for the right to serve in a number of northeastern states, in a few of the newly opened access states, retailers have been slow to step forward with competitive offers. This is particularly true for offers directed to residential and small commercial customers. Wholesale Volatility Market share of retail players in the Northeast has always remained highly fragmented, and utility affiliates retain the bulk of deregulated market share. This is poised to change over the next year, as some of the early retail marketers experiencing difficulty under the current market conditions pull back, leaving room for new entrants on the sidelines. In many of the states, wholesale prices this summer dramatically exceeded the level of competitive offers in the marketplace, exceeding $100 MWh in some cases in New England. A few retailers caught without a secure supply of wholesale power were forced to return their customers to the provider of last resort service. It will be important to watch these markets in the fall to see if customers return to these marketers and/or whether the regulators adjust the rules to prohibit this kind of behavior and/or fix the rules that perpetuate this discrepancy between the standard offer and market price. Until the wave of new supply resources are built and brought online in these markets, high and volatile prices are likely to be a characteristic of this market. It remains to be seen if retailers will have learned the lessons from this past summer, however, and go into the next peak period with firm supply contracts as well as arm themselves with the marketing savvy to take advantage of customer aversion to high and fluctuating prices with offers of a stable price, while providing the marketer with a significant margin above the wholesale price. The story is similar for gas, as CERA expects strong gas prices in the Northeast to continue for the new few years, until increased supply comes into the market. High prices will continue, owing to tight storage inventories and increased demand for gas for power generation, with last winter's volatility likely to be repeated in upcoming winters. Canada The largest Canadian market in the Northeast is Quebec, as Ontario will be covered as part of our Midwest regional analysis. The Quebec gas market is the only northeastern Canadian gas or power market fully open to competition. There is no investigation into power competition in Quebec at this time. It is likely that Quebec will wait and see how opening of the Ontario power market plays out next year before taking any action, just as it watched and repeated the Ontario gas market experience. Greenfield gas distribution companies are being built in New Brunswick and Nova Scotia, which will be served by Sable Island gas supplies. The regulatory focus there is to encourage hooking customers up to gas system supplies, not necessarily to promote retail competition. **end** Follow URL for PDF version of this Monthly Briefing with associated tables and graphic. ********************************************************************** Account Changes To edit your personal account information, including your e-mail address, etc. go to: http://eprofile.cera.com/cfm/edit/account.cfm This electronic message and attachments, if any, contain information from Cambridge Energy Research Associates, Inc. (CERA) which is confidential and may be privileged. Unauthorized disclosure, copying, distribution or use of the contents of this message or any attachments, in whole or in part, is strictly prohibited. Terms of Use: http://www.cera.com/tos.html Questions/Comments: webmaster@cera.com Copyright 2000. Cambridge Energy Research Associates
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