The electric industry is in transition and some jurisdictions are reconsidering the role of the utility and private enterprises offering products and services to customers. New companies are offering services and products, including energy efficiency, demand response, and distributed generation, among others that provide more information, which allows customers to make sound, personalized choices about how they use electricity.

As these markets emerge, new rules of the road will be needed—similar to when the electric industry restructured in many states to create competitive supply options. Given that the utility functions as the gatekeeper to the customer and may also want to compete in offering these services, it is important to create codes of conducts that regulate the behavior of the utility and its competitive entities. Codes of conduct act as the blueprint of what utilities should and should not be able to do. They protect the competitive market so that a variety of businesses can compete fairly to drive down prices and offer customers the products and services they want.

When utilities offer competitive services, this poses challenges for regulators. The utility is a regulated entity, but the energy services company is not, or is only lightly regulated. Where competitive behavior is allowed, it is important that state public utility commissions create and enforce strict codes of conduct and oversee the separation of the utility and its affiliate to ensure a fair and free marketplace. The rest of this post provides a brief overview of the options for achieving this. A more detailed examination of the issues is available in Power Sector Reform: Codes of Conduct.

Separation of the Distribution Company from the Competitive Entity

If an electric distribution company (EDU) does wish to enter the energy services market, a number of steps must be taken to ensure that it does not have an unfair advantage. When creating a new competitive arena in which a regulated utility participates, separation between the regulated entity and its competitive arm is critical. This can be accomplished in three ways:

• Divestiture–Requires the distribution company to spin off a competitive business enterprise in order to ensure that the competitive business has no competitive advantage by virtue of its association with the EDU. It removes all financial incentive for any kind of favoritism or sharing of costs or information.
• Corporate Separation–Requires the EDU to separate its competitive enterprise from its regulated enterprise by creating a separate affiliated company. The EDU and the new affiliate both are part of the same parent or holding company.
• Functional Separation–Maintains the competitive arm within the EDU as a separate division with its own accounting system, staff, and services. It relies on a “Chinese wall” to eliminate the flow of commercial information between the two divisions.

Corporate separation is the middle ground because it allows the company’s shareholders to get into the business, but it does not obligate utility customers to get involved in the risks, positive or negative. And it has clarity of regulatory oversight compared with functional separation.

Codes of Conduct

Some basic areas of anti-competitive conduct should be avoided when an EDU enters a competitive energy or energy-related services market. A code of conduct set forth as part of the state utility commission’s rules is the best way to establish permissible and impermissible conduct between an EDU and its affiliate or division, depending on whether there is corporate or functional separation.

While the rules to prevent anti-competitive behavior can be detailed, there are basic principles that govern the establishment of the rules:

1. Discrimination in providing access to essential services should be prohibited.
2. There should be no sharing of competitive information among affiliates or divisions.
3. Cross-subsidization by the EDU to benefit the competitive enterprise should be prohibited and carefully monitored by regulators.

Specific elements that should be part of a code of conduct include:

• Nondiscrimination provisions;
• Information sharing limitations and disclosure requirements;
• Equal treatment of affiliated and nonaffiliated entities e.g., separate corporate identification and logo;
• Separate books and record-keeping;
• A bar on cross-subsidies on the transfer of goods and services, meaning that transactions for goods and services between the EDU and the affiliate should be at market prices and not based on embedded costs;
• A bar on sharing facilities, equipment, and costs;
• A bar on joint purchases;
• Limitations on corporate support; and
• A bar on shared employees.

Regulatory Oversight

Regulatory oversight and the exercise of jurisdiction over the codes of conduct and the competitive market is critical to its success. Note, there is a distinct difference between price regulation and the regulation of conduct. Many deregulated businesses, such as the airline industry, have free rein in establishing prices based on what the market will bear but are still regulated as to the terms and conditions of service.

Several requirements that will help a state public service commission oversee the successful separation of the EDU and the affiliate include regularly filed compliance plans, compliance audits, a complaint procedure with a log of those complaints, and penalties for infractions.

Corporate separation and codes of conduct are potentially tricky issues requiring commission oversight, although they are not within the traditional realm of regulatory oversight. Setting up clear guidelines and a detailed code will help to ensure a smooth transition, and a fair and robust market.