May 01, 1999

Electric Deregulation (1999, 13:03)

By Portia Owen Morrison and Christopher J. Townsend

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For decades it was thought that the public would be best served if a single electric utility had authority to be the sole provider of electricity in a given geographic region. Regulation was instituted to assure that utilities would not take unreasonable advantage of their monopoly status. But federal and state policymakers now question the wisdom of continuing the current system of regulating electric utility monopolies. There is a growing perception that portions of the electric utility business could and should become competitive, and this perception is becoming a reality across the nation as states enact electric deregulation legislation.

The deregulation of electric utilities will create many opportunities for real estate lawyers to help clients profit from the various options created by this new legislation. To take full advantage of these options, however, clients will have to change their perception of electric utilities. For example, clients may be surprised to learn that utilities are no longer the only entities that supply electricity, much less provide metering or billing service. Clients should no longer think of utility bills as fixed costs. Rather, utility costs are variable and can differ greatly, depending on the supplier. Knowledgeable, well advised clients will be in a better position to take advantage of these emerging opportunities.

Electric Deregulation Legislation

Many state legislatures, fearing federal preemption, are currently considering whether the public could benefit through reduced regulatory oversight and restructuring of the electric industry. Approximately 13 states have already passed electric deregulation legislation, including Arizona, California, Illinois, Maine, Massachusetts, New Hampshire, Pennsylvania and Virginia. Other states--Maryland, Michigan, New Jersey, New York and Vermont--have issued comprehensive regulatory orders. Almost every other state is considering the issue either in its state house, before its utility commission or both.

The term "electric deregulation" is actually a misnomer. In fact, the process should be referred to as "electric re-regulation." Similar to the "deregulated" telephone industry, the regulated electric utility will still own and operate the wires, but alternate suppliers will be able to "transport" electricity over the utility's wires. These new suppliers of electricity will likely be regulated to some extent at both the state and federal levels. Additionally, most parts of the traditional electric utility structure will

continue to be regulated. The Federal Energy Regulatory Commission will continue to regulate the transmission system (the "big wires"), and state public utility commissions will still regulate the distribution system (the "little wires"). As a result (for better or worse), the reliability of the "delivery services" provided by the electric utility will not change. Electric deregulation legislation merely allows customers to buy electric generation, billing and metering services from suppliers other than their local utility. Nevertheless, by choosing alternative suppliers for these services, customers can realize substantial savings.

Impact of Electric Utility Deregulation

As public utilities enter this new era of deregulation, real estate clients of all sorts will face numerous opportunities to profit. In fact, opportunities are already available for real estate owners and users to realize savings on their utility expenses--savings that can flow directly to the bottom line. At no other time has a greater opportunity existed for customers to reduce their electric utility costs substantially, both locally and nationally. Owners and managers of investment property portfolios, manufacturing and other operating companies with multiple facilities and franchised businesses all are well situated to benefit from the deregulation of electric utilities. Some customers are already realizing savings of 5-15%, depending on how much electricity they use. This can translate into hundreds of thousands of dollars for the largest energy users.

Building owners and tenants must prepare for these new choices. Real estate lawyers can assist their clients in regulatory and administrative proceedings, in negotiating new purchase and supply arrangements with utilities and other suppliers and in negotiating and drafting new lease and easement provisions. There also will undoubtedly be a significant increase in litigation involving public utilities, which will require counsel to be familiar with a variety of public utility regulatory issues.

Utilities and other providers are also gearing up to distinguish themselves in new ways. They will be attempting to woo customers with offers of equipment repair, consolidated billing, special metering systems, financial risk management and other new services. They will be offering rewards, alternative rate structures, pricing incentives and perks as a way to build client loyalty and name recognition. Each of these offerings will carry with it unique risks and rewards, which clients will need assistance in evaluating.

As the electric utility industry deregulates (or re-regulates), there will be a number of ways in which various types of customers will be able to reduce their utility expenses. Some of these opportunities will be available nationwide, but others might be available only in specific states.

Nationwide Opportunities

* Aggregating. Entities with locations throughout the country should consider a national strategy to take advantage of the phase-in of deregulation of the electric utility industry. National companies that do not want to take the time to learn the intricate details of deregulation legislation or special rate offerings will primarily benefit by aggregating their demand. By aggregating their facilities with others, multi-site consumers can achieve significant savings that will increase profitability and provide major marketing opportunities.

Aggregating, or purchasing as a buying group, is similar to bulk purchase. As in almost all negotiations, the theory is "the bigger the better." All types of real estate clients may look into forming alliances for the purpose of buying electricity. Many tenants will likely choose to purchase electric power and other services through their landlords. Nevertheless, some businesses with multiple locations, including retailers and franchisors with nationwide market power, may wish to purchase electricity independent of their landlords. Other consumers will form coalitions or join associations or "buying groups" and aggregate their usage to achieve maximum

negotiating power.

* Partnering. Another option currently available on a national basis is partnering with a national energy marketer or alternative retail electric supplier. The current catchphrase is "outsourcing the customers' utility usage." Essentially, a client may hire another company to come in and act as energy manager for all of the client's facilities. If given authority by the client, a manager can obtain all of the necessary information to propose and institute a number of innovative pricing options. The box above includes information that an energy manager will need from a client. Partnering with an energy manager can be used in combination with aggregating the demand of numerous facilities as an overall power purchase strategy.

State-by-State Opportunities

In addition to the nationwide opportunities, recent developments in particular states may present further opportunities for real estate clients. As stated earlier, electric deregulation legislation has already passed or is being considered in most states. Each bill or comprehensive regulatory order presents its own set of benefits. One obvious benefit is the opportunity for immediate rate reductions or "shopping credits" for customers that choose an alternative supplier. Additionally, as electric utilities "unbundle" their rates, customers will be able to pick and choose which services they desire. Customers will face a myriad of options for metering, billing, lighting services and financial risk management.

Because many states are actively considering electric deregulation legislation, customers can shape the landscape for deregulation by becoming involved in those legislative debates. In Illinois, for example, the Illinois Retail Merchants Association, the Building Owners and Managers Association of Chicago and the City of Chicago were able to negotiate specific legislative provisions to benefit their constituents.

Even in states that have not yet enacted legislation, traditional options such as participating in "experimental" rates, negotiating for a special contract with the local utility or exploring on-site generation may prove fruitful for some clients. With the advent of "micro-turbine" generators, even smaller commercial customers should examine the economics of installing a mini power plant on site to provide at least some of the electricity needs of the facility. These generators are usually fueled by clean burning natural gas, allowing the customer to be in the enviable position of pitting the local natural gas utility against the electric utility. Additionally, for clients that have been frustrated by electric outages, on-site generation can provide a more reliable source of electricity.

To prepare for competition, many utilities are offering pilot programs intended to stimulate the development of a competitive market. One experimental rate that might be available is a "real-time pricing" rate. Real-time pricing rates reflect electricity price fluctuation as demand increases and decreases throughout each day. The Illinois Commerce Commission recently approved real-time pricing rates for each Illinois electric utility. Similar rates have been adopted throughout the country. Customers with equipment that they can shut down during "peak" daytime hours or customers that have installed on-site generation can benefit greatly under these rates.

Utilities are more willing than ever to offer special deals to retain or attract individual customers. Although these deals may require the approval of the state utility commission, utilities are often authorized to offer economic development rates or discounted rates based on a particular customer's competitive options. Clients should be aware that many options are already available, even in states that have not yet adopted electric deregulation legislation.

Specific Issues for the Real Estate Industry

Tenants, owners and managers of real estate will have a range of options to consider in preparing for these new opportunities. Electric costs for real estate facilities represent a considerable part of total operating expenses, and reductions in costs or other efficiency savings can have a substantial effect on a landlord's income or a tenant's expenses. Often the interests of the owner must be reconciled with those of the tenant.

Some of the issues facing commercial landlords are:

* the extent to which a landlord will be able to provide or resell electric utility services to tenants;
* the extent to which a tenant will have the right to choose its own provider; and

* the extent to which an electric service provider will have the right to gain access to individual tenants.

As building owners and tenants gain greater freedom to bargain for electric services, their legal advisors must ensure that leases, easements and other real estate documents permit them to take full advantage of deregulation.

Landlord as Electric Service Gatekeeper

Electric deregulation offers landlords two methods to assert control over the electric service providers for their buildings. First, building owners may be able to take responsibility for distributing electric service to their tenants by retaining ownership of or purchasing the electrical conduits, meters and other distribution facilities that are located on their property and in their buildings. In these situations, the owner would be the customer of the utility or other supplier and would be free to contract with its tenants for the prices, terms and conditions of service. Of course, the owner would also be responsible for maintaining the internal distribution system.

Second, landlords might be able to aggregate their tenants and purchase electricity in bulk on their behalf. In some jurisdictions, landlords are already permitted to contract with tenants to purchase electric energy and other services on their behalf and to resell and redistribute the services to tenants, regardless of whether the building owner has acquired ownership of the electrical facilities on its site. These agreements would enable landlords to aggregate the total electricity demand of their tenants and negotiate discounted rates from outside service providers. A building owner would act as an electric service provider on the same footing as other independent companies that generate and distribute electric power and other services.

Both of these options give landlords the opportunity to better manage their buildings and make them more profitable.

Tenant Choice of Electric Service Provider

Under most deregulation plans, a tenant's right to choose its electric service provider stems mainly from the tenant's power to contract. Lease terms might require a tenant to take service from the supplier that the landlord designates or permit the tenant to contract directly to purchase power and other services from outside providers. Unless leases provide otherwise, deregulation legislation likely will allow tenants to buy electric power and associated services from whomever they choose. A provider's ability to gain access to tenants is contingent on two factors: (1) whether the provider can negotiate a contract with the tenant to deliver power or other services; and (2) whether the land-lord owns and controls access to the property's electrical distribution facilities. Building owners may be able to restrict access to electric risers and underground utility corridors that they own outright or that are subject to easements permitting the landowner to control access.

Real Estate Documents to Take Advantage of Deregulation

A landlord wishing to reap the benefits of deregulation above all should remain flexible enough to adapt to a quickly changing market. A landlord should adjust new leases to avoid disputes over a tenant's right to choose the electric service provider. In addition, developers and owners should reserve easements for utility purposes generally, rather than granting exclusive easement privileges to a specified provider. The following areas deserve the attention of property owners as electric utility deregulation spreads across the country.

New Leases

Landlords that want the flexibility to resell and redistribute electricity or to aggregate their tenants' demand and purchasing power to select an alternate provider must reserve those rights in their lease documents. The lease should state that the landlord has the right to select the property's electric service provider, to act as the primary energy aggregator to contract for power on the tenant's behalf and to switch providers at any time. To allay tenant fears of possible cost increases, the landlord might consider capping its rates at any time at the amount the local utility then charges under its published rates. A landlord should remove any lease references to a specific electric provider.

If a tenant's electricity is separately metered, the tenant will probably want to retain the right to purchase its own power and other services. Where the tenant has sufficient bar gaining power to insist on control, the landlord should require its written consent before the tenant switches from the incumbent utility company to another provider. Some reasonable conditions to the landlord's consent include that:

* the electric supplier will pay all costs of installing wires and equipment and reimburse the landlord for expenses that the landlord incurs as a result of the supplier's work in the building;

* the electric supplier will pay the landlord for space used and provide the landlord with continuing access to the space where the supplier has set up its equipment;

* the electric supplier must be licensed and reputable and agree to follow all building rules;

* the electric supplier will provide proof that it can pay for potential damage to the property;

* the landlord may reject the electric supplier if the building does not have enough space in its risers for the supplier's wires; and

* the electric supplier will do all its installation and other work under the landlord's supervision.

Distribution Facilities and Easement Areas in New Developments

Deregulation legislation typically permits public utilities to impose a cost recovery factor on customers to recoup investments previously made (with the assumption of continued monopoly status) in assets, such as power plants, that are no longer useful in a competitive market. During the early years, much of the potential initial savings from deregulation will be absorbed by the utilities' imposition of these "stranded cost charges" on customers, regardless of whether the customers elect to switch suppliers. Distribution costs, as opposed to generation costs, however, comprise most of the average commercial customer's electric bill. These costs are not affected directly under the terms of most deregulation legislation. In newly constructed projects, real estate developers may have the unique ability to avoid the utility monopoly on distribution by retaining control of access to the project's utility customers rather than following the typical pattern of paying to install the project's utility distribution systems and then "contributing" those systems to the local utility.

The automatic grant of an exclusive easement to the local utility should be a thing of the past. Developers should, in all events, avoid exclusive arrangements with specified utilities, including alternative service providers. Developers should declare and dedicate easements for utility purposes in general. Developers rarely, if ever, should grant easements in favor of a specific provider.

Developers should also consider retaining control over the electric distribution systems for themselves. This ownership could create a new profit center, separate and apart from the real estate development, surviving the sell-off of lots as a continuing revenue source after construction cost recovery. A developer could set up a separate entity to design, construct, finance and manage the electric distribution system or, as an alternative, the developer might consider contracting out the system's operation to an alternative supplier.

Flexibility in Agreements with Alternative Service Providers

Because it is difficult to tell how quickly prices will decline during the first few years of electric deregulation, short-term contracts may produce the most benefits by allowing purchasers the freedom to take advantage of future discounts. Additionally, landlords should consider requiring an alternative provider to hold the landlord harmless for liability arising from brownouts or other service problems.


The deregulation of the electric utility industry undoubtedly will present new opportunities for real estate lawyers and their clients. Landlords, tenants and developers will face new and complicated issues. Lawyers should be careful to preserve their clients' options so as to permit maximum benefit from the various associated risks and rewards.

Relevant Information for Energy Managers

* Location of each facility
* Name of local electric utility

* Electric bills from the last 24 months

* Half-hour usage data from the electric utility

* Description of unique electric fixtures or usage patterns

* Name of local natural gas utility

* Natural gas bills from the last 24 months

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