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Power Play

Utility Deregulation Sparks Potential Cost Savings for Commercial Property Owners and Managers.

Electric power — America’s last regulated monopoly — is in transition to becoming a deregulated industry. Sometimes referred to as restructuring, deregulation of this $200 billion-a-year industry means big changes for owners and managers of commercial properties. Although all consumers potentially will benefit from electricity deregulation, large users of power will be among the first to realize cost savings. In addition, new products and services now becoming available as a result of electric energy deregulation can make buildings significantly more efficient, productive — and profitable.

The Evolution of Deregulation
Deregulation is not a new phenomenon in American business. The breakups of the telephone, trucking, and airline industries are recent examples of deregulation. But the deregulation of utilities — natural gas and electricity — has been a long time coming. Federal deregulation of the natural gas industry began during the oil shortages of the 1970s and has progressed to the point where all businesses now have the ability to choose their gas supplier. In addition to, or perhaps as a result of the introduction of competition, gas production has increased and prices have declined substantially, falling by $2.79 per million cubic feet from 1984 to 1994.

The success of natural gas deregulation has strengthened the initiative to deregulate the electric utility industry. Electricity is extremely expensive in certain areas of the country due to some states’ lack of indigenous energy supply. Costs range from 2 cents per kilowatt-hour in eastern Washington state, which has access to inexpensive hydropower, to 16 cents on Long Island, N.Y., serviced by expensive nuclear plants. But a commodity provided by a monopoly — without the price-reducing benefit of market competition — also is a factor in the high cost of electricity.

The Power of One
Under government regulation, a single entity owns and operates power generation, transmission, distribution, and customer service facilities. Consumers have no choice about who supplies their electricity. State governments define service territories, and specific utilities have the exclusive right to sell energy to all residential and business customers within that area.

Utilities were set up as monopolies in the 1920s and 1930s, based on the theory that it is more efficient for one company to build the infrastructure necessary to service a designated area than it is for several companies to do so. In return for being granted monopoly status, utilities have had an obligation to serve all customers in their designated service territories. Government oversight, provided by a state regulatory agency, ensures price and service quality protections.

While providing reliable service, a monopoly system also can be very expensive. As a result, many states, especially in the Northeast and Mid-Atlantic regions of the country, are at a competitive disadvantage vs. other low-cost energy states. Consequently, 48 states (all but Florida and South Dakota) have enacted electric utility restructuring legislation or are considering it, according to the Energy Information Administration.

Deregulation in Action
Each property’s electricity bill has three components: generation, transmission, and distribution. Generation is the making of electricity, and transmission is the system for moving high-voltage electricity from where it is generated to the distribution point for customers. The distribution system consists of the wires, transformers, substations, and other equipment used to deliver electricity to consumers from the high-voltage transmission lines.

Under deregulation, users will be able to choose the company that generates their electricity. The same set of pipes and wires actually will deliver electricity to buildings. The electric company now in place will continue to serve its areas and still will be responsible for responding to power outages and other distribution service problems.

California was the first state to open its market to electricity deregulation, beginning on March 31, 1998. Based on its experiences, the immediate benefits of deregulation are going to large power users. Power distributors — which are not deregulated — still have four years to pay off old debts and those costs, known as stranded costs, still are being passed on to consumers. Experts say at the end of the four years, savings should be more equitable. In the meantime, large power users, such as retail chains, are switching service providers to obtain significant cost savings. Ralph’s, a California grocery store chain, switched providers for its 248 stores, as have more than 800 McDonald’s outlets.

Among institutional buyers, including hospitals, schools, and local governments, aggregation is an increasingly popular cost-saving strategy. The Association of Bay Area Governments was able to pool 100 megawatts, securing an additional 4 percent reduction in energy costs, as well as enhanced billing and energy information services for the 7,000 buildings owned by its 64 member organizations.

Deregulation Benefits
With deregulation, commercial property owners and managers will have a choice of energy providers. They, like all consumers, will be able to shop around to find the best price on energy — and can add those energy savings to the bottom line.

Because of market forces, utilities will be forced to improve service and drop prices to compete with new power marketers offering to sell power for less. The savings could be substantial, with estimates on electricity rate savings ranging from 5 percent to 15 percent of a total bill.

But deregulation means more than lower power costs. In addition, utilities are creating new, full-service energy companies to compete with independent power producers and marketers in an open, deregulated market. All of these energy companies will offer products and services to help customers reduce costs and increase efficiencies.

A variety of energy management, operation, and maintenance services will be available, including the following:

Consulting. Customers will receive an analysis of strategic energy issues within the context of their relationship with their present energy suppliers. Service providers will help formulate and secure more advantageous purchasing arrangements based on this information. Engineering services, including technical consulting, oversight of specific projects, and full-service assumption of all facility operation and maintenance activities, also will be offered.

Financing. Customers wanting to upgrade equipment and reduce energy costs will have access to financing plans from their service providers. Specific services include equipment leasing and financing, energy asset acquisition, and performance-based financing. As one option, customers can finance energy equipment upgrades or expansions in part through the operational savings resulting from the improved performance of the new equipment. Energy equipment leasing or traditional financing of new energy equipment also will be offered.

Contracts. Energy suppliers will offer their customers the ability to outsource their energy management functions under long-term, customized contracts. End-use conditions, such as temperature, humidity, and light level would be mutually agreed to and the service provider would be responsible for all the energy supply, maintenance, and operation requirements necessary to meet the guaranteed conditions.

New Technologies. New generating technologies that make energy generation, transmission, and distribution more reliable and economical increasingly will become available.

The microturbine is an example of new electric generation equipment developed as a supplemental source of electricity for large operations or to supply small facilities with their total energy needs. Used during peak demand periods, this compact on-site power source can greatly reduce demand for expensive power from the local electrical grid, resulting in substantial savings.

New technologies such as the microturbine are suitable for two basic markets: remote locations, including clustered office parks, isolated towns, or transportation facilities that are removed from traditional power generation sources; and hospitals, hotels, and multifamily properties where significant thermal loads already exist, making microturbines very economical.

Also on the technology side, the North American Electric Reliability Council reports that most North American power systems are expected to be Y2K compliant by the middle of this year and expects few problems with electricity reliability when 2000 dawns.

Along with significant opportunities, however, deregulation presents property managers with several challenges. It is easy to underestimate the time, effort, and information needed to successfully negotiate in a deregulated market — and difficult to avoid becoming overly focused on commodity savings (which can range from 5 percent to 10 percent), rather than on energy efficiencies (which can save up to 20 percent).

It is essential, therefore, to select an energy service company that looks at and understands the whole picture, not just the energy component. That service company should have experience in a deregulated market, the financial stability to live up to its commitments, and offer value-added services, a variety of pricing plans, and consolidated billing. Most importantly, it must be willing to work in partnership to develop accurate, customized energy information about a property.

Re-Evaluating Energy Use
Two prime factors drive energy needs — intensity and operating hours. Beyond obviously energy-intensive industrial uses, such as steel foundries, health-care facilities stand out with high energy needs. Those needs are driven by frequent air changes required for patient comfort and safety combined with 24-hour, seven-day-a-week operation. Food sales and service, such as supermarkets and restaurants, follow closely behind.

It’s worth noting, however, that energy-intensive buildings represent a small segment of the total floor space across the country. In fact, retail stores and office buildings account for 40 percent of total floor space, so saving even a small amount in each would have a massive, positive impact on energy use, costs, and the environment.

To maximize the potential advantages of deregulation, commercial property owners and managers should analyze their energy use and work with an energy service provider to develop appropriate strategies to meet their needs efficiently. Owners and managers will need to know how much gas and electricity their building uses, for what purposes, and when. Questions to consider include:

  • Is the heating and cooling system as efficient and responsive as it could be?
  • Are lighting fixtures consuming extra kilowatts of electricity to no benefit?
  • What is the cost to power equipment, kitchens, laundry facilities, and security systems?

Local associations, trade groups, the local utility, and the public utility commission are good sources for reputable suppliers and for their competitive commodity prices.

New Opportunities
Deregulation will create new opportunities for property managers to reduce energy costs and improve related efficiencies in commercial buildings. The key to maximizing the benefits of a competitive marketplace is to partner with an energy service company that offers competitive commodity prices and has a proven track record and the financial resources to implement long-term solutions.

Frank Cassidy

Frank Cassidy is president of Edison, N.J.-based PSEG Energy Technologies, an unregulated subsidiary of the Public Service Enterprise Group that provides natural gas and electricity, as well as financial and business products. Contact him at (973) 744-2000 or frank.cassidy@pseg.com.Choosing a Service Provider Property managers should consider the following issues when seeking an electric service provider. However, before entering into an agreement, also consider the specific issues that are applicable to the particular property type.What is the company’s cost per kilowatt-hour? How does the rate schedule compare to other providers’ rates? What power sources does the company use to produce electricity? Does the contract have a minimum-usage clause? What is the length of the agreement, and does the contract stipulate a minimum time period in which electricity must be purchased? How is billing done and what are the billing options? Will the company try to sell something in addition to electricity? Is there a termination fee if service is switched? Does the company offer incentives to help use energy more efficiently? Is the service provider registered with the state’s public utilities commission or other applicable governmental entities? How long does your state give to change your mind about a service provider? Will a "free" electricity offer for a certain amount of time increase rates later? Can you receive a less expensive rate if you aggregate your properties onto one contract? Will the company assess a competitive transition charge for switching to its service? Will your negotiated rate change if commercial tenants aggregate their power needs with other businesses in their chain, leaving your contract with less purchasing power? Has the provider clearly described to you how service requests are handled and whom to contact about interruption in service? Has the company discussed the probability of potentially damaging power surges? — by Kristin Harrelson, legislative analyst of the Commercial Investment Real Estate Institute. Contact her at (312) 329-6033 or kharrelson@irem.org.

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