SEPTEMBER 26, 2000

I am here to speak on behalf of the West Virginia Consumer Advocate Division and the National Association of State Utility Consumer Advocates (NASUCA). NASUCA is a national organization of 41 offices of utility ratepayer advocates in 39 states and the District of Columbia. NASUCA member offices operate independently from the regulatory Commission’s in their states and are designated by state law to act as ratepayer advocates. Some offices are separately established utility advocate organizations whereas others are divisions of larger departments. The West Virginia Consumer Advocate Division, for example, is a division of the State Public Service Commission. We are, however, an independent division of the Commission and have the authority to appeal any finding, decision, or order of the Public Service Commission. The response of Consumer Advocate agencies to the dramatic increase in natural gas prices depends in large part upon the way in which the states currently regulate their natural gas utilities. The regulatory model varies from state to state, of course, but I have broken it down into three general categories: 1) the traditional model 2) the retail choice model 3) the rate cap model The traditional way that states have historically regulated the prices charged by natural gas utilities was a bifurcated process. The two pieces of this process are often referred to as the base rate piece and the gas cost piece.
    
Under the traditional approach there was one proceeding, generally referred to as a base rate case, that was used to determine the level of salaries, investment in plant and equipment and profit that should be allowed in the rate charged by the utility. Base rate proceedings were typically initiated by a filing made by the utility which may occur every year, every other year or may have as long as five years or more between cases. In between each base rate case, the utility was at risk for recovery of the costs included in that portion of its rates.
The gas cost piece of the traditional rate setting approach is usually addressed in second type of proceeding which is variously called a gas cost recovery or purchased gas adjustment proceeding. In a purchased gas proceeding, the utility is permitted to adjust its rate to recover the cost of gas purchased, stored and transported on behalf of its customers. These adjustments may be made annually, quarterly or even monthly so that the utility is made whole for all of the costs its incurs in purchasing gas on behalf of its customers.
    
Under the traditional bifurcated regulatory scheme, the final price of natural gas to the consumer was composed of anywhere from 25% to 35% in the base rate piece and 65% to 75% in the purchased gas adjustment piece. Thus only 25% to 35% of the utility’s total expenses were at risk for recovery. The remaining amount was trued up through the purchased gas adjustment mechanism. I have identified three potential responses by regulators to the impending increases in gas prices under this traditional regulatory model. First, do nothing. By interfering with the price signals to consumers, regulators will inadvertently discourage conservation efforts. Conservation efforts, especially long term retrofitting measures, will of course help to keep prices lower in the future. The philosophy behind this approach is that consumers who are unable to pay their gas bills should seek assistance from other government agencies. Second, budget billing programs, where the customer is permitted to choose to pay a fixed amount throughout the year, may be modified or extended. In some states, the date for enrolling for budget payment plans may have already passed prior to widespread education efforts about the impending increases in natural gas prices. Those enrollment dates could be reopened to allow customers to choose the budget payment option. Third, regulators may want to amortize the impact of higher gas prices by shifting certain costs that would otherwise be recovered during the winter months to the summer months. Since most natural gas usage occurs during the five winter months, commissions can even out the monthly bills of consumers by deferring a portion of the impact of the price increases in natural gas until the non-heating months.
   
Some states have discarded the traditional regulation model and operate under what I have termed the retail choice model. Under this model, the state commissions continue to regulate the base rate portion of the utility’s price: the level of salaries, investments and profit. The purchased gas portion of the rate, however, is not regulated. Rather than have the gas utility buy gas on behalf of all of its customers, those customers are given the choice to buy their gas supplies from any licensed entity that it is willing to sell it to them. States that have opted for the retail choice model believe that competitive market forces from the interaction from many suppliers and many individual consumers buying and selling gas will yield lower gas prices than under the traditional regulatory model. My colleague in Ohio, Rob Tongren, the director of the Ohio Consumers Counsel is a proponent of the retail choice model. Under the Ohio retail choice model, customers may choose to continue to receive their gas purchased by their local gas utility or they can buy from a number of other suppliers available to them. The retail choice program that is operated on the Columbia Gas of Ohio system has enabled residential customers to achieve savings of 10% on their gas bills. I have identified 3 potential responses by regulators that use the retail choice model: Education, Education, Education. The idea behind the retail choice model is that regulators do not interfere in the determination of the price of gas between consumers and their suppliers. What regulators can do, however, is to provide consumers with information so that they may make informed choices. Earlier this month, the Ohio Consumers Counsel issued a press release informing customers of the expected gas price increases and telling them how they can get more information about their supplier options. The Consumers Counsel also provided some easy to implement energy saving measures that consumers can use to help lower their heating bills. A concerted effort to educate consumers as to the increases in gas prices, their options in light of those increases and energy conservation are important to help consumers manage their gas bills this winter.
    
The third regulatory model, which we have adopted in West Virginia, is to set gas utility rates using rate caps for extended periods. The rate cap approach to regulation is not a new concept: it has been used for a number of years for telephone companies. And other states have used rate caps on the base rate portion of their gas utility’s rates. What is fairly unique to West Virginia is that we have set a cap on the total gas utility rate - both the base rate and the purchased gas portions. As a result of the rate caps that we have with three of our largest gas utilities, approximately 85% of West Virginia’s residential customers will see no increase in their gas rates this winter. The rate cap approach is fairly simple, we negotiate a rate to be charged by the utility and freeze that rate for a period of three years. The utility then has every incentive to seek more aggressive and innovative ways to manage its costs. The utility is free to prosper or fail depending on their success in making business decisions. All too often in utility regulation we are faced with requests for rate increases by utilities to reimburse them for the costs of what are essentially bad business decisions. Under the rate cap approach, utility consumers keep their bargained for rate whether or not the utility is successful in holding down its costs. At the end of the rate cap period we negotiate a new rate and incorporate ongoing savings the utility has achieved into the new rate.
    
An intrinsic benefit of the rate cap approach is of course rate stability. It is our experience that utility consumers not only want their rates to be at a reasonable level, but they also want predictability. The rate cap insulates customers from the volatility in natural gas prices. Attached to this statement is a chart that demonstrates this benefit for our largest gas utility.
The relatively flat line is the purchased gas rate that was used in the first three year rate cap period which began November 1, 1995. The other line is the estimate of what the purchased gas rate would have been if we had been changing those rates on a monthly basis. When this second line is above the flat line, consumers were better off under the cap than under traditional regulation and when it is below the flat line consumers were worse off. In addition to showing the savings that the rate cap approach has achieved, which I will discuss in a moment, this chart also shows how volatile rates would have been if we did not have the rate caps in place.
   
In the first year of the rate cap, November 1995 through October 1996, residential customers saved $8.6 million. Keep in mind that West Virginia is a small state, while $8.6 million does not sound like a lot of money, it represents a savings of 10%. We achieved a 9% savings again in the second year of the rate cap, but in the third year, gas prices were lower than the rate cap by a margin of 9%. Over the entire three year rate cap period, residential customers clearly benefited from the rate cap.
    
In 1998, we negotiated another three year rate cap which was implemented in November 1998. As you can see from the chart, even though we negotiated a small reduction in rates, it doesn’t appear that we started off so well. Gas prices have been below the rate cap line for most of the period, only going above the line beginning in April this year. As all of you at this summit know, however, the futures prices for natural gas are trading today at much higher levels than any of the prices I have on the chart. Based upon the recent NYMEX futures prices, I estimate residential customers of this gas utility are going to save from $5 to $10 million per month this winter. While I am a proponent of the rate cap approach to regulating gas utilities, I recognize that the current natural gas price environment may not be the most opportune time to enter into an extended rate agreement. Just as potential home buyers may delay their decision to buy when interest rates are high, commissions may be reluctant to agree to rate caps at current rate levels. A modified rate cap that protects against upturns in prices but is still flexible enough to capture potential gas price declines may be the better regulatory approach at this time. This type of hedging is, after all, exactly what thousands of competitive gas buyers and sellers engage in to try to achieve a long term price they can live with.
    
Whatever regulatory model is appropriate for your state, clearly something must be done to educate consumers about their options and assist consumers with their natural gas bills this winter. Perhaps your state’s approach is that regulators should not interfere in the pricing of natural gas and that consumers are better assisted through other government programs. Keep in mind that the federal funding for energy assistance and weatherization programs has dropped by over 30% since 1995. If your state takes a more active role in natural gas markets, I have outlined some regulatory options that I hope are useful. Thank you.