Assessing Electric Choice in Michigan

1. Assessing Electric Choice in Michigan Theodore R. Bolema, Ph.D., J.D.

2. Central Issues • Restructuring is generally proceeding well and should be allowed to continue • Scare scenarios are not plausible—Nothing like California • Comments on recently introduced legislation • Recommendations to enhance competition

3. Electricity Markets Residential Customers IOU Generation Transmission Grid Schools and Universities Cooperative Generation Commercial Customers Alternative Energy Suppliers Industrial Customers Transmission Generation Distribution

4. Higher Rates Among Regulated Firms Rates

5. In the Detroit Edison territory, about 20% of commercial sales and 16% of industrial sales are by alternative power suppliers In the Consumers Energy territory, alternative suppliers account for abut 7% of commercial sales and 16% of industrial sales. Very few residential sales (still subject to rate caps) are by alternative suppliers Where We Are Today

6. Electricity Sales in CMS Territory

7. Electricity Sales in DTE Territory

8. Industrial, commercial and school/university customers report savings in the 10% to 20% range after turning to alternative suppliers Some new generating capacity added or under construction Overall assessment: Transition is going well Incumbent utilities receiving transition payments Alternative suppliers are a viable option for many commercial, industrial and institutional customers Lower energy costs to pass on to customers, and taxpayers Where We Are Today (continued)

9. Nothing Like California • Consumers are being told Michigan is headed for a California-like electricity market meltdown. This is not the case. • California regulators forced utilities to divest all generating capacity and purchase all power from wholesale suppliers • California prohibited utilities from negotiating long-term contracts to ensure a stable supply at lower fixed rates • California retained regulation of retail rates which, when wholesale prices rose, forced utilities to sell power at rates far below prevailing wholesale prices • California’s restructuring process showed a fundamental distrust for the market process and was a recipe for power market ruin

10. Skyrocketing Rates? • No reason to fear skyrocketing rates due to competition from alternative suppliers • Competition means consumers can choose from suppliers and exerts downward, not upward, pressure on rates • MPSC report projected increases more on the order of 4% once rate caps are removed • If any supplier raises its rates 30%, the result would be lost sales to competitors, and probably a violation of supplier’s fiduciary duty to its shareholders

11. Incumbent Utilities Can Thrive in a Competitive Market • Michigan restructuring opens markets -- restructuring designed to rely on competition to determine market outcomes • More burdens on alternative suppliers do not help consumers and do not help incumbent utilities in the long run — they simply raise barriers to entry • Incumbent utilities have significant advantages — existing customer base, brand name, established facilities and infrastructure

12. Implications of Turning Back • All customers would face higher rates in the long run • Quality of service would deteriorate due to lack of competition • Michigan would likely lose investment in new generating capacity — Investors will not pay to build new plants

13. The Recently Introduced Legislation • Senate Bills 1331 to 1336, introduced in July of 2004, propose changes to electricity restructuring in Michigan. Although these bills call for more modest reforms than proposals previously advocated by CLEAR, this package of proposed changes is flawed. • Senate Bill 1331 would extend “transition costs” on all Michigan customers for 10 years, or until 2014, rather than ending the charges in 2007.

14. Recently-Introduced Legislation (continued) • Senate Bill 1331 also would eliminate after 2005 the requirement that incumbent utilities take back former customers at regulated rates. This proposal deserves serious consideration – current rules constitute a competitive disadvantage for incumbent utilities. • Senate Bill 1332 would require that all suppliers maintain a 15% reserve generating capacity. This requirement is wholly arbitrary and would significantly raise market entry costs. Market incentives make state-mandated requirements unnecessary. • Senate Bill 1334 would impose 10% to 20% rate reductions for K-12 schools. If choice is preserved, schools and Michigan colleges could continue to enjoy similar savings through a competitive market.

15. Recently-Introduced Legislation (continued) • Senate Bill 1333 would require that all power suppliers contribute to a subsidy fund for low-income customers. This is effectively a new tax, and other low income energy programs already exist. If subsidizing low income energy households is deemed a worthy social goal, it should be done through the General Fund rather than as a new tax. • Senate Bills 1332, 1335 and 1336 would provide state-backed financing for facility improvements. This would constitute unnecessary government interference in the energy market. Charges passed on to ratepayers would raise energy costs

16. Reform to Strengthen Competition in Electricity Markets • Although no major repeal of restructuring is warranted, changes in the direction of less government intervention could improve Michigan’s electricity market • 1. Remove requirements that incumbent utilities serve as suppliers of last resort • Not require that utilities take back customers at regulated rates • Allow firms to bid to serve as suppliers of last resort

17. Recommendations for Reform (continued) • 2. Do not require that incumbent utilities bear burden of peak-load management • Market incentives should exist for all suppliers to maintain adequate reserves without imposing arbitrary percentage requirements • Alternatives based on market incentives are also available — e.g., the state accepting bids for back-up capacity • 3. Remove all price controls • Scheduled to expire in 2006 • Distort market-based pricing

18. Recommendations for Reform (continued) • 4. End current regulatory uncertainty • Investors are understandably reluctant to risk capital investment at a time when regulatory rules are in flux • 5. If electricity welfare is to be pursued as a social goal, it should be done generally rather than selectively • Various overlapping federal, state and utility-funded programs already exist with wasteful overlap of administrative costs