Texas tries to prove electricity deregulation can work

Lone Star State embarks on a free-market power plan. Other states watch, with California on their minds.

Last year was a grim one for US energy markets.

From the rolling blackouts in California to the collapse of industry giant Enron, the playing field - and the players - changed substantially in a mere 12 months. In both cases, regulatory lapses have come in for a good share of the blame.

After California's debacle, many states put deregulation on hold. But through it all, supporters of free-market experimentation stood fast. Electricity markets could benefit from greater competition, they held, if only the right plan existed.

Now, just a few months after California backpedaled on deregulation, Texas is embarking on its own journey into the free-market energy arena.

To supporters, it's the closest thing to the "right plan" any state has come up with yet. Consumer advocates, however, see no guarantees that Texas will succeed where California failed.

But with the experiment beginning for 4.7 million homes and businesses this month, states from Arkansas to Nevada are watching from the sidelines and, no doubt, searching for a success story.

"After the blackouts in California and the collapse of Enron, the year 2001 was a disaster that set us back at least five years," says Ken Malloy, who heads the Center for the Advancement of Energy Markets in Burke, Va., which favors deregulation. "It really showed us that states better be in this for the long haul."

While Mr. Malloy won't say the Texas plan is perfect, he believes it is easily the best plan in the nation.

First of all, the oil-rich state will not have the supply problem California did.

By breaking its implementation into two phases, it was able to ensure supply would be in place first. Wholesale markets were demonopolized in 1995, luring competitors to the state. Since then, 39 new energy plants have been built, with more in the works. (California had not built a new plant in over a decade.)

That gives Texas a nice supply cushion, says Terry Hadley, spokesman for the Texas Public Utilities Commission (TPUC) in Austin. The supply of electricity in the state currently exceeds demand by 23 percent.

In addition, lawmakers here did not mandate price caps. California had a cap that forced utilities to sell to consumers at a set price while buying power on a volatile wholesale market. That drove many companies into bankruptcy when fuel costs skyrocketed.

But regardless of the Texas safeguards, convincing leery consumers will be the hardest part. California's bailout is still fresh in their minds. As is the bankruptcy of Enron - one of the foremost champions of deregulated energy.

To build consumer confidence in the plan, an immediate price reduction of 6 percent went into effect Jan. 1 - and many suppliers cut prices even more because natural-gas prices have fallen so far.

But the price cuts may not bode well for competition among retail suppliers. It is already causing some angst among new entrants, who are not regulated and can charge whatever they want.

"New companies have complained that rates are too low for them to compete," says Janee Briesemeister, a senior policy analyst at the Consumers Union in Austin. Some may drop out altogether, she says, harming competition in the long run.

In addition, of the 41 new retailers that are vying for a piece of the energy pie, only a handful serve residential customers.

For their part, many customers don't know they have a choice, and only perhaps 25,000 have signed up for a switch. Supporters say those numbers will rise slowly.

The pattern is common to the more than 20 states that have enacted energy-deregulation plans. Only a tiny percentage of their populations have switched energy providers. Even in relatively successful states such as New York and Pennsylvania, the percentage of switchers has only been in the single digits.

Texas is entering the deregulation process at a good time: Fuel is cheap and the benchmark for success is low. But skeptics remain unconvinced.

"Texas has a lot of things going for it right now. It could take two to three years for problems to crop up - but I suspect they will," says Richard Rosen, executive vice president of the Tellus Institute, a research and consulting organization in Boston. "The question is: What will happen when supply and demand tighten up?"

He says there has yet to be any convincing evidence that energy deregulation benefits ratepayers. As the Lone Star State tries to provide proof, one thing appears certain: A Texas-size failure could set deregulation back indefinitely.