Descriptive Text of Value Chain Step
In our power markets value chain, load serving entities (or LSEs) represent the organizations that directly server retail electric customers. As with other value chain steps, the mapping of firms to activities is not simple: some firms may participate in multiple steps of the value chain. Therefore, this step represents the conceptual role of serving retail load, which might be handled by companies that do nothing else (e.g., retail choice companies in Texas), by companies that are completely vertically integrated (e.g., Pacific Gas & Electric), or companies that pick and choose what elements of the electric power business they want to participate in (e.g., Sempra).
The defining factor, therefore, is that LSEs represent electric demand in the power system as we view it in our value chain. The core activity of an LSE is to aggregate load on behalf of many customers and make appropriate arrangements in wholesale markets to meet that load. LSEs typically are responsible not only for procuring electricity for their retail customers, but also for procuring various capacity reservations as necessary to guarantee reliable operation of the system. LSEs may do this through organized wholesale markets, bilateral contracts, direct ownership of resources, or any combination thereof. See, for example, California ISO’s definition of a load serving entity within their territory.
In addition to the basic aggregation and procurement functions, LSE’s typically:
- Own and operate the physical distribution system, a physical network of hardware that serves as a bridge between the transmission system and individual retail customers
- Establish rate schedules for types of customers
- Measure customer use and bill customers
- Plan for growth
- Plan for contingencies
- Manage risk (operational and financial)
Risk management is a particularly important LSE activity. Because customers are quite sensitive to sudden and unexpected price variations, and because governmental regulatory agencies also pay close attention to such variation, LSEs typically implement sophisticated hedging plans that allow them to smooth out price variation, isolating their customers from sudden changes that might occur in the wholesale “spot” market. These hedges come in many forms, including medium- and long-term contracts for electrical energy or for fuel (including firm contracts and options) as well as direct ownership of generating resources.
Though most LSEs perform all the above functions, the actual form of the LSE can vary.
Investor-Owned Utility (IOU): The traditional (and still the most common) form of LSE in the United States is the vertically integrated investor-owned utility. Such firms participate in all aspects of the power markets value chain, including generation, transmission, and load aggregation. These firms operate for-profit and have legal monopolies in their service territory. In trade for their monopoly status, they have an obligation to serve all customers in their territory, and are subject to economic regulation — their governing bodies, typically, a state or local public utilities commission (PUC) dictate how much they can earn. IOUs typically earn money in two ways. One is by marking up their energy costs, and the other is by earning a return on all investment that the IOU has made, at a rate set by the PUC. The sum total value of all investments, depreciated appropriately over time is called the ratebase. In some jurisdictions such as California, utilities earn a return only on their ratebase, and are not able to earn profit on energy sales. The intention is to make utilities indifferent to how much energy they sell, but instead care about the overall satisfactory service as defined by the governing PUC.
Publicly-Owned Utility: An alternative structure to the IOU is the publicly owned utility (POU). These operate much like an IOU in most respects, except that are typically non-profit and owned by the local government or the ratepayers themselves. See, for example, the California Energy Commission’s comparison of IOUs and POUs across a variety of functions and metrics. Municipally Owned Utilities or Municipal Utility Districts (MOUs or MUDs) are operationally similar, but are sometimes listed separately in statistics.
Community Choice Aggregators: Community choice aggregators (CCA) are a relatively new type of LSE, coming into effect with the Utility Restructuring Acts of 1996 and 1997 of Rhode Island and Massachusetts. CCAs are also legal in Ohio, California, Illinois, New Jersey, and New York. CCAs aggregate load and make bulk purchases and investments to support that load, but generally do not provide billing or own the distribution system, instead relying on a pre-existing IOU for those services. Essentially, a CCA exists as an overlay on all or part of an IOU service territory, and customers who avail themselves of a CCA will see their energy costs as a separate line item on a bill furnished by the incumbent IOU. A utility service territory may be large and as a result, utilities must account for a large and heterogeneous range of customer preferences when purchasing power or planning investment; CCAs represent smaller and more homogeneous areas, and so, in theory, can better match the preferences of the local area. For example some CCA’s might be chartered to purchase only “green” energy (e.g., Marin Clean Energy) whereas others may be asked to find the very cheapest power available (e.g., some of the options formed under the Rhode Island Energy Aggregation Program). Figure DI.1 depicts the hybrid structure of CCA between municipal utility and IOU.
Figure DI.1 Structure between IOU, MOU and CCA
Source: NREL blog post https://www.nrel.gov/technical-assistance/blog/posts/community-choice-aggregation-cca-helping-communities-reach-renewable-energy-goals.html
Energy Services Companies (ESCOs) and Electric Service Providers (ESPs): These companies typically target large industrial power users and either procure power on their behalf (ESPs) or assist customers in reducing their energy use (ESCOs). ESCOs may also make (or suggest) investments in the physical plant of their customers to reduce the cost of meeting their electric needs. Some companies can perform both types of activities. ESPs may not exist in some territories because retail load is barred from the wholesale market.
LSEs are typically monitored and/or constrained by governing bodies, though the details of these relationships vary widely. In most situations, an IOUs must be responsive to various entities such as a local or state public utility commission (PUC), state energy commission, local or state air board, and federal entities, such as the Federal Energy Regulatory Commission, or FERC (though FERC’s purview is generally on the wholesale market side only). Because POUs and CCAs are theoretically directly accountable to the ratepayers (for example, with boards elected by citizens or ratepayers), they may not be subject to some layers of regulatory oversight. Additional details on the policy environment are included in the Strategic Conditions section.
Figure DI.2 Structure of Vertically Integrated Utilities
Source: Figure 2.1 from Pacific Northwest National Laboratory (2002)