Imagine a company that made pens and pencils and the executive team of that company earned a total compensation of $2 million annually. That company could sell its pens very cheaply if it allocated all of its executive compensation costs to the pencil side of the business. In fact, it might be able to sell pens so cheaply that it would prevent any other pen companies from gaining a meaningful market share. The pencil business would be a different story. It would likely face fierce competitive pressures and would likely be run out of business — unless of course, the company had a monopoly on pencils and faced no competition.

As crazy as that sounds, that is exactly how utilities in competitive retail energy markets set prices for default electric and gas service. Default service customers are only charged the cost of the electrons or gas molecules and in some instances, some modest costs that are incurred for procuring the commodity or other minor incidental expenses. Across the entirety of the US, there is not one utility default service provider that appropriately allocates indirect costs to default service. Of course, the list of utility resources that are utilized to provide default service is quite lengthy and includes, but is certainly not limited to, billing personnel and systems, customer service personnel and systems, finance and accounting personnel and systems, regulatory personnel and executive personnel.

“NARUC cost allocation guidelines advocate that a portion of the costs for those internal resources should be allocated to default service at the higher of cost or market value”

NARUC cost allocation guidelines advocate that a portion of the costs for those internal resources should be allocated to default service at the higher of cost or market value. For twenty years, utilities and regulators have ignored this guidance and the practical realities of pricing business products or services. As a result, distribution rates are too high and default service rates are too low in these markets. Unlike the pencil manufacturer mentioned above, the distribution companies don’t need to allocate costs away from distribution to maintain their competitiveness — they are monopolies. The utilities use the monopoly power to subsidize the default service rates and as a result, competitive suppliers are at a significant competitive disadvantage.

For those who want to learn more about this issue and its unfair and negative impact on consumers and retail energy suppliers, I have written a more detailed article here.

Frank has worked in competitive energy markets since their inception as a consultant to utilities navigating restructuring and as a direct market participant once the markets opened. After more than twenty years in the industry, he launched Electric Advisors Consulting, in the fall of 2015. His focus is assisting clients with energy market issues – regulatory, strategic and business. His clients include energy market participants and end-use consumers.

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