The power of deregulation in the multifamily industry: the deregulation of utility suppliers has created options in service and pricing. Communities taking advantage of the new possibilities may find that submetering is an attractive alternative.

As deregulation was debated in the mid-1980s for the telecommunications industry, the promise was that consumers would be able to choose long distance and local telephone service providers and the price for these services would decrease. During legislative discussions both sides of the arguments were heard to the point of total confusion. It was said that the phone companies would go out of business and service levels would drop beyond tolerance, and this has occurred in some cases. On the other hand it was said that prices would drop dramatically due to competition and more aggressive telecommunications providers would emerge; this has also been the case.

Deregulation of the telecommunications industry paved the way for deregulation of other utilities, with the deregulation of power suppliers, the door has been opened for multifamily housing owners and managers, large and small, to barter energy contracts to their benefit.

In retrospect, deregulation was a painful process, but some remember "the way it was" with long distance charges of 50 cents per minute. Today long distance phone charges are typically less than a nickel per minute. Not many other products or services have decreased in cost by 95 percent in the last 15 years while the quality, access speed and available products have increased dramatically. To that end, one could irrefutably state that telecom deregulation was an unprecedented success.

Looking around the nation, states have taken a wide variety of positions. Seventeen states have some form of active deregulation program in place; six are in a suspended or delayed status; while 27 have elected not to pursue deregulation at this time.

Deregulation Background

California was the first to jump headfirst onto the deregulation bandwagon. However, the approach was to "regulate deregulation." One has to scratch one's head on that oxymoron. California wanted to offer its residents a choice of electric providers, yet it dictated what the providers could charge, as in the case of San Diego Gas and Electric, thereby forcing the utility to file bankruptcy, There were a number of other mistakes made by the utilities, the legislators and the governing authorities, but understandably so. Deregulation is a very complicated endeavor that has significant effects on all consumers. Anticipating the effects and all of the "what if's" is impossible.

California's debacle has affected the rest of the nation. Consumers are skeptical of the word "deregulation." I have sat in various state energy committee meetings over the last three years and cannot recall how many times I have heard the phrase, "California tried that and it didn't work."

Marc Treitler, General Counsel at Viterra Energy Services, who was an attorney with San Diego Gas and Electric during the early stages of deregulation, believes that California did not sufficiently account for supply and demand when planning deregulation. "It was clear to many of us in the industry that California did not consider the fact that the supply of electricity was not keeping up with the demand from California's consumers. In a regulated system, the prices would be kept artificially low, but when deregulation occurred, the prices were allowed to be driven by the market, and what resulted was dramatically increased electric rates, which reflected the insufficient supply of electricity."

On the other hand, give California credit for taking the bold step. Now we know how to improve the process. And that is exactly what the state of Texas has done. Although certainly not perfect, the Customer Choice Program in Texas works. It is the most complicated program in the country and "all eyes are upon Texas" to copy their success. So let's focus on Texas for now, where individual companies or multifamily communities can negotiate rates with energy suppliers to varying degrees.

Energy 101

But before negotiating with a provider, it is imperative to have a general understanding of how the energy market works. Retail Electric Providers (REPs), or energy, retailers, are in a very volatile business and at the mercy of others, who are sometimes one, two and even three levels up the totem pole and whom they have never met. The REPs negotiate rates with consumers based on estimated prices that in actuality fluctuate in reaction to regulation and market demand.

For example, environmental regulations are forcing reductions in the use of coal and nuclear energy as fuels to generate electricity. The advantage of these fuels has been the low cost of generation. If you want more electricity, add more fuel.

On the other hand, natural gas is a cleaner fuel, typically purchased in the summer, usually by July 1, and then stored in caves and underground caverns for use over the course of a year. Therefore, unlike coal and nuclear fuels, an energy consumer has to "guess" how much electricity will be needed for the future. If a cold spell hits a portion of the United States, energy prices can skyrocket around the country because of short supply. This happened in Texas in March 2003. A surprise ice storm hit Dallas at the same time the Northeast was experiencing weeks of frigid weather. Natural gas prices in Texas tripled over a five-day period. Wholesale electricity prices for the REP shot up from approximately $45 per megawatt to $995 per megawatt on what's called the "balancing market," a sort of short term purchasing market. That's a 2,100 percent increase in the purchase price--pretty volatile by any yardstick!

Unbeknownst to most consumers, natural gas prices have the biggest effect on electric prices. Watch natural gas prices rise and fall and usually electric prices will follow.

The best place to start negotiating prices is to place yourself in the REP's position and understand the risk involved for a REP, and realize that the REP must make a profit to stay in business, and consumers need him to stay in business. Now we're ready to buy a kilowatt of electricity.

Negotiate the Best Rate

The lack of an efficient Utility Expense Management Program can easily consume multifamily housing profitability, yet most owners and managers don't spend the time to understand how each utility market works. Without the time to learn the business, hiring an energy deregulation consultant easily can be the very best investment to make.

Most public utilities commissions regularly publish on their Web sites the electric rates of the REPs; however, nine times out of 10 the "cheapest" on the list is certainly not that--the cheapest. Usually those lists highlight the commodity (electricity) price only. When all of the costs, typically referred to as the "bundled price" or "all-in price," is revealed, the total price is very different. It seems that there are always a few REPs in every market who "low-ball" the commodity price but make up the difference in other areas. For example, some states have separate "line charges," "distribution charges," "environmental fees," etc., all of which the REP must pass on to the customer. The REP also has operating costs from overhead, sales and marketing, billing and collections, call centers, etc. While most REPs are forced to keep these to a minimum to be competitive, a few REPs actually hike these expenses and make more profit from the fees than they do from the commodity.

Are We Better Off With Deregulation?

Only time will tell the true effect of deregulation on the multifamily housing industry, its owners/managers and residents. Deregulation is blamed for high costs, blackouts, job cuts and more. However, with a little understanding of the energy market, all indicators are that we are better off. In the days of regulation, utility companies were guaranteed a return of approximately 10 percent no matter how good or bad the service while today with deregulation, the REP's margins are down to approximately 3 percent to 7 percent overall and they have to perform. You have a choice to go elsewhere.

A Dozen things to Know When Negotiating Energy Prices

1. Look for a long-term contract. If the market is down, energy prices may be quite low and the tendency is to sign a month-to-month contract where the energy price will fluctuate with the price of energy on a daily basis (remember the 2,100 percent increase). Agree to a three-year, fixed-price contract. This may be a little higher but you are insulated from spikes in the market. It's very cheap insurance.

2. Accept cancellation penalties. If you sign a one-, two- or three-year contract, the REP has to guarantee to his electricity wholesale provider that he will purchase electricity on your behalf for the entire contract period at a fixed price. If you prematurely cancel your contract, let's say six months into a three-year contract, the REP is still obligated to pay for the next 30 months of unused electricity.

3. Know the financial strength of the REP. If he goes out of business what recourse is available? From whom do you then purchase electricity and at what rate? This may be determined by the state public utility commission regulations, but ask the question of the REP during negotiations and know the options.

4. Read the fine print. Some REPs state that there is no penalty for cancellation. However, they may impose "impact fees" for cancellation. These fees are, in realty, a penalty. They may be equal to one month of consumption or the difference of the contract price verses market price for the balance of the contract. Depending on the market price at the time of cancellation, this could have the effect of a 300 percent-plus penalty. Be very careful. This is another area where a consultant could easily save 1,000 percent of their fees.

5. Understand the terminology. CSA, Continuing Service Agreement. EMA, Exclusive Marketing Agreement. CAA, Common Area Agreement. Have the REP explain how the enrollment process works. Ask the REP what is required of the apartment community's staff.

6. Understand deposit and credit check requirements. Does the REP charge the residents a deposit? Do they perform credit checks? The bad debt for REPs in the apartment industry is typically 7 percent to 20 percent. That's pretty tough when margins are 3 percent to 5 percent. Therefore most REPs will charge a deposit.

7. Ask how you can help the REP. If you can deliver door hangers for shut-off notices, or assist in disconnects if permitted by regulations, the REP has a better chance of making a profit and can keep your cast down.

8. Find out "What's in it for me?" REPs typically have programs where they discount the common area rates and possibly offer a revenue sharing plan per resident customer.

9. Check the integrity of the REP. The size of the company is not important. There are many aggressive, small companies that are backed by very large investment firms. But there are also a few that are questionable. Check their references. If you have an interest in the environment, ask if they offer "green power," but also ask how much of the electricity delivered to you will actually be "green." Many REPs outsource their sales to an aggregator who is simply a hired-gun to find customers. There are some reputable aggregators who care about your business and their reputation, bat many are looking for their payoff when they turn in a contract.

10. Understand billing. Billing with deregulation is more complicated than billing for submetering. For example, in billing deregulated energy for a single resident for one year, 64 data files are transmitted between the REP's billing company and the utility distribution company. Understand the REP's CSA and residential bill formats. Ask what reporting is available as a property owner/manager and what levels of reporting are available--property, regional, district, management company, owner, etc. Also ask if they provide summary or consolidated bills, or roll-up bills, and ask for a sample.

11. Be aware of deficiencies. Theft is a big issue. In the last year I learned of two studies by owners in the Texas market whereby the average utility cost to the owner during deregulation jumped $70 per door for the year. This was caused by deregulation deficiencies. For example, when residents move in on the first of the month, they are required to sign up for electricity. If they wait two weeks to do do, the owner still pays the bill. Require evidence of new residents that they have electric providers effective on the move-in date. Or if you have an agreement with a REP, sign residents up for electricity during the leasing process and make sure the REP can start billing residents on the day of move-in even if the market takes a week to recognize the switch. Consider allowing a special read charge if available, where the utility that reads the meters will make a special visit within a few days to get residents switched to the REP quicker. The cost for this is usually $8 to $24 but must be passed on to residents. Otherwise the account switch will average 15 days after residents move in, and guess who's paying the bill during that time--you are.

12. Submeter if possible. Make residents directly responsible for their electricity. If the property is individually metered by the old utility and the regulations allow private meters or competitive metering, put in meters, but be careful. Make sure the meter meets national utility standards (Texas PUC has a list of approved meters), and that they can be read frequently and accurately. The readings should be pushed to a common database (preferably through the Internet) with access and report generation capabilities. Many companies will install, maintain and pay for these systems. Use their money, not yours. You're not a meter expert. This solution will also eliminate the problems in items 10 and 11.

Ron Sewell, PE, is Vice President for Viterra Energy Services, Utilities Division, Atlanta. He may be reached at 678/336-2221 or [e-mail].