In the United States, restructuring activities have grown by leaps and bounds. Significant is the recent passage of legislation in Montana and Oklahoma, each of which from a national perspective has below-average electricity prices. Prior to these events, one common belief was that restructuring efforts were concentrated in only those areas with high electricity prices such as California and the Northeast. This view now has little credibility as restructuring sweeps across the country.

Reform proposals in the U.S. electric power industry have primarily, and not surprisingly, come from special interests who stand to benefit the most from a more open electricity marketplace. Another source revolves around the public-interest-type concern that regulation of utility monopolists has not benefited consumers. Regulation was established under the premise that it would keep electricity prices below what they otherwise would be. Although, throughout much of its history regulation arguably achieved this, it has failed to do so in recent years. Technological advances in the electric power industry have now made it possible and desirable to expose at least parts of the industry to competition. Restructuring activities reveal, perhaps more than anything, the growing political and economic costs of the status quo where utilities hold wide-ranging monopoly power controlled by regulatory statutes and rules.

Kansas has joined the circle of states currently contemplating what path to follow for their electric power industries. Their policy on industry restructuring hinges largely on their position on retail competition, which is synonymous with the concepts "retail wheeling" and "customer choice." These terms all refer to allowing retail electricity consumers, namely residential, commercial and industrial customers, to have the right to purchase unbundled electric services from other than the local franchised electric utility. Currently, virtually all retail consumers in Kansas purchase what can be called "bundled sales service" from the local utility, whether an investor-owned utility, rural electric cooperative or municipality. Bundled sales service combines different components or subservices -- electric energy, transmission, distribution, metering, billing, and so forth -- to retail consumers in the form of "packaged" electric service. Retail customers pay one price for this service.

Consumers who take bundled sales service currently have no choice but to buy all of the subservices from the local utility. Under retail competition, consumers would have the right to buy one or more of these subservices from a third party. As retail competition evolves over time, consumers may only purchase distribution service from the local utility with other subservices supplied under competitive conditions. In that environment, subservices may be rebundled but, unlike existing bundled sales service, retail consumers could choose among different combinations of electric services offered by available providers.

The pertinent questions for Kansas with regard to retail competition are: "How and when?" Some interest groups in the state may believe, or want to believe, that other states could follow the path of retail competition while Kansas does nothing. It seems implausible that this would happen. First, common sense dictates that the U.S. electric power industry will not be bifurcated, where some states will have open retail markets while others will not. Second, past experiences in other restructured-deregulated industries, such as natural gas and telecommunications, have shown the common pattern of competitive forces, once initiated, dispersing to all parts of the industry. Believing, for example, that competition in the electric power industry will stop at wholesale markets runs contrary to both economic theory and the recent history of other industries undergoing restructuring.

Having made an argument that retail competition is inevitable for Kansas, the question then shifts to: "What effect will it have?" Specifically, would retail competition be good for the state or would it essentially result in wealth transfers where some citizens would be better off while others would be worse off? First, viewing retail competition from a long-term perspective, it should produce positive benefits for Kansas. After adjustments by all parties, namely consumers, utilities and the Kansas Corporation Commission (KCC), retail competition should effectuate a more customer-responsive, efficient electric power industry in Kansas. Consumers should see lower prices and the availability of additional electric services, partially because of the greater incentive of Kansas utilities to restructure their costs and service offerings in accordance with consumer demands. Just as increased efficiencies in the growing of wheat in Kansas benefit the state as a whole, an improved-performing electric power industry should have the same result.

In the short term or transition period, efficiency gains would be made but wealth transfers may fall out. Some of the benefits to consumers would result from cost reductions by utilities, but other benefits may also be gained from allocating existing utility surpluses to consumers. Electricity prices should fall farthest in those areas of the state where the differences between the current (embedded) price of wholesale or generated power and the market price are the greatest. How the resultant uneconomical sunk costs are treated would significantly influence the short-term effects on consumers and utilities. For example, allowing utilities to fully recover these sunk costs would not only diminish gains to consumers, it would also discourage new entrants from accessing the marketplace and, in the process, stifle the development of competition in retail electricity markets.

The major findings of this report, conducted for the Kansas Corporation Commission, can be summarized as follows:

(1) Retail competition represents a natural and expected outgrowth of current reforms in the electric power industry. Competition in wholesale electricity markets alone will not go far enough to appease consumers, generators and marketers, and to maximize benefits to consumers.

(2) The pertinent questions attending retail competition are not "if" but "how" and "when." These are the real questions that Kansas should be addressing. Increasingly, other states are debating these questions.

(3) Good public policy requires positive benefits to society at large. While distributional effects should be taken into account, they should not drive policy. Too often we observe public policy being shaped by the political muscle of interest groups who stand to benefit at the expense of the general public. Kansas should not fall into the trap of protecting certain interests, whomever they may be, if the general public would suffer as a result. Primary consideration should be given to how retail competition would affect electricity consumers in the state.

(4) Realization of the potential benefits of retail competition requires well-founded ground rules for creating equal opportunities for incumbents and new entrants, and true competition in retail electricity markets. Anticompetitive practices shifting the potential benefits of an open retail market from consumers to producers should be avoided.

(5) The long-term benefits of retail competition are inherently difficult to measure. How utilities, new entrants and consumers would fully adjust to the new regime falls beyond anyone's comprehension, let alone precise calculation. Policymakers must resort to less stringent standards in determining the expected outcomes of retail competition.

(6) Kansas electric utilities are already preparing for the day when retail competition will arrive. Recent activities by utilities, including mergers, the open-access proposal by Midwest Energy, and the offering of discount rates to large customers, all reflect efforts to improve the competitiveness of these utilities in tomorrow's electric power marketplace.

(7) Kansas cannot be characterized as a low-cost state for which, under open markets, electricity prices would rise toward the regional average. Electricity prices in Kansas are currently above those in surrounding states. If the "regional average" theory has any validity, it would predict that electricity prices in Kansas would fall relative to those in the surrounding states.

(8) Retail competition in Kansas does not mean complete deregulation of the electric power industry. Prices of distribution services, at least for the foreseeable future, would still be subject to regulation. The KCC may also have to assume the new role of "antitrust" enforcer to help assure the avoidance of anticompetitive practices. Finally, at least during the transition period, the Commission may want to require or encourage customer education.

(9) Kansas policy on the trading of electric energy should be similar to its policy on wheat. Both electric energy and wheat can be characterized as commodities, that is, homogenous economic goods that can best be transacted in competitive markets. Kansas should look at the export of both commodities in the same light: both are good for in-state producers and for the state as a whole.

(10) Retail competition would contribute toward the efficient and equitable pricing of electricity in the state. The unbundling of electric service should make prices more transparent to consumers. Market pressures would elicit changes in existing rate designs to mitigate against subsidies and to move prices toward marginal-cost principles. Prices would be more equitable in that the price of electric service would correspond more closely to its true cost.

(11) Several intricate issues surround the implementation of retail competition. Those addressed in this report include the funding of stranded costs by what is called "securitization," FERC-state commission jurisdictional matters, anticompetitive practices, pilot programs, the meaning of "bypass" in the context of retail competition, and taxes. The complexities of these issues point to the concerted effort that would be required by various parties in the state to reach consensus.

(12) The recent Docking Institute study paints an overly gloomy picture of the effects of retail competition on rural areas. In fact, the evidence seems to point in the direction of rural areas in Kansas benefiting the most from retail competition: cooperatives' current prices seem to be most out-of-line with market prices. Incorrectly, the Docking Institute study depicts retail competition as taking wealth away from rural areas and redistributing it to urban areas. More likely, the real losers would be those utilities in the state who are unable to accommodate the demands of consumers.

The empirical analysis done for this report indicates that, for the major investor-owned plants in Kansas, one company may face the possibility of having a small amount of stranded cost. Western Resources and a combined company of Western Resources and Kansas City Power & Light would have no stranded costs, only a net benefit from competition. Under the lower market price scenario used in the analysis, Kansas City Power & Light could incur a loss when the net book value is subtracted from the net present value of the projected cash flow. No loss occurs for the company in the higher market price scenario, however, and the company is projected to have a positive cash flow in each year of the forecasted period for both price scenarios. Only one power plant in Kansas, the Wolf Creek nuclear power plant, faces the possibility of a loss in a competitive market because of the plant's investment costs. This loss is offset by the net gain of the owners' other plants. Wolf Creek's relatively low variable cost makes it one of the country's most efficient plants to operate. Consequently, the plant should be profitable for the owning companies under either scenario. In both forecasted price scenarios, all customer classes in Kansas would see lower prices from a competitive market.

Taking everything into account, the best strategy for Kansas would be, in the shortest time possible, to pass legislation that would open up the state's retail markets to competition. Legislation should specify (1) a date by which full-scale retail competition would be in place, and (2) guidelines for implementing retail competition. The KCC could be given the authority to interpret and execute the guidelines and other pertinent provisions in the new legislation. In carrying out these responsibilities, the Commission could hold a forum encouraging interested parties to reach consensus on those major issues accompanying retail competition. The forum could also be used by the Commission to acquire information on the outcomes of retail competition in other states and of any in-state pilot programs.
 
 
 
 
 
 

TABLE OF CONTENTS
 

Page

Section

Introduction 1

Background and Relevant Statistics 7

The Growing Movement to Retail Competition 17

Pressure for Change 17

Critics of Retail Competition 20

Model of Retail Competition 25

Comparison with the Status Quo 25

Comparison of a Restructured Electric Power Industry

and the Wheat Market 27

Pricing Methods 30

Effect of Wholesale Power Markets 32

Potential Investor-Owned Stranded Cost in Kansas 35

Guidelines 49

Discussion of Specific Issues 55

Jurisdictional Matters: FERC and the States 55

Anticompetitive Practices 60

Pilot Programs 63

The Meaning of "Bypass" 66

Taxes 67

Securitization 70

The Next Step for Kansas 73
 
 

Appendix: Review of Docking Institute Report 79
 
 
 
 

LIST OF TABLES

Page

Table

1 Electricity Prices by Class of Customer for Kansas Investor-Owned Utilities, 1985, 1990, 1995 10

2 Comparison of Electricity Prices in Kansas and Neighboring States by Class of Utility for 1995 12

3 Electricity Sales to Different Classes of Customer as Percent of Total Sales for 1995 15

4 Sales to Ultimate Customers by Class of Utility as Percent of Total Sales for 1995 16

5 Projected Price and Percentage Decrease from Actual 1995 Kansas Price 37

6 Power Plants Used in the Analysis 38

7 Ten Lowest Cost Plants in SPP Region 39

8 Potential Investor-Owned "Stranded Costs" for Western Resources, Inc. 41

9 Potential Investor-Owned "Stranded Costs" for Kansas City Power and Light 42

10 Potential Investor-Owned "Stranded Costs" for Merged Western Resources, Inc. and Kansas City Power and Light 43

11 Net Present Value of Cash Flow and Net Book Value for Western Resources, Inc. 45

12 Net Present Value of Cash Flow and Net Book Value for Kansas City Power and Light 45

13 Net Present Value of Cash Flow and Net Book Value for Merged Western Resources, Inc. and Kansas City Power and Light 46
 
 
 
 
 
 

INTRODUCTION

Kansas, like the other states around the country, is at the crossroads in deciding whether or not to advance the scope of competition of the electric power industry to the retail sector. Unlike wholesale market reforms, which fall under the purview of the federal government, restructuring of retail power markets will be heavily influenced by state actions. Even if federal legislation is passed requiring the opening of retail markets to competition, the states will play a vital role in deciding how retail competition will be structured and implemented.

In this report, the term "retail competition" is used instead of retail wheeling.⁽¹⁾ It refers to the situation where retail customers have been given the right to buy electric energy or other unbundled services from entities other than the local franchised utility.⁽²⁾ Under retail competition, for example, end-use customers would have the option to buy electric energy directly from power generators or from intermediaries, such as load aggregators, power marketers, or energy service companies.⁽³⁾ In a more fully-developed form of retail competition, customers would be able to choose from a wide range of services, such as metering, billing, energy management, and risk management, priced separately and opened to alternative suppliers. Under retail competition, customers could continue to purchase bundled sales service from the local utility,⁽⁴⁾ purchase their electric energy from a power exchange, with or without what are called "contracts for differences," or bilaterally with a power generator. Customers may have special meters to take advantage of real-time pricing.⁽⁵⁾

Kansas faces three choices: (1) suspend consideration of retail competition for an indefinite period, (2) initiate steps to phase-in retail competition, or (3) move immediately toward full-scale comprehensive retail competition. The first choice seems increasingly unlikely in view of the accelerated actions of other states around the country in endorsing the idea of retail competition and the political tenor in Washington, D.C. to restructure the electric power industry.⁽⁶⁾

The second choice, which can be characterized as a "moving-deliberatively approach," typifies the activities of several states. In these states, retail competition is being phased-in over a number of years, in many instances with pilot or experimental programs.

The third choice, immediate movement toward full-scale retail competition, is being carried out by a few states, notably California. These states generally have high electricity prices relative to the rest of the country, and anticipate large short-term benefits for consumers.

With retail competition unfolding across the country, it seems inevitable that Kansas will have to face the reality that doing nothing today only postpones having to do something tomorrow. If one believes this to be true, then the choice for Kansas narrows to how fast should retail competition be initiated and what ground rules should apply. The analysis performed for this report suggests that the longer Kansas waits to open up retail markets, the longer Kansas electricity consumers will have to wait to enjoy the full benefits of competition in the wholesale power market.

Good public policy demands that a governmental action should produce positive benefits for society. In the context of retail competition in the electric power industry, this means essentially that electricity consumers in the long term should benefit from being allowed to choose among alternative suppliers for the purchase of different electric services. The benefits will accrue gradually over a number of years, with longer-term gains resulting from innovations and efficiencies in new investments and new services tailored to meet customers' needs.⁽⁷⁾

Although the growing consensus among analysts is that consumers would benefit under retail competition, proper institutional mechanisms would be required. A big concern of some interest groups is that the transition period may bring costs to certain consumers and utilities.⁽⁸⁾ A major policy question for Kansas is: Should Kansas proceed with retail competition even if some utilities or consumers expect to be worse off during the transition period? This "equity" issue should be an integral part of the debate over retail competition. If, for example, some groups would be seriously injured, then, at least for political purposes, some transitory mechanisms may be required to mitigate this problem.⁽⁹⁾

This report examines the fundamental question of how retail competition will affect the electric power industry in Kansas. As a benchmark, it assumes that the wholesale power market will continue to develop in the same direction that it has over the past several years. That is to say, wholesale power transactions will increasingly be consummated under competitive conditions. We designate this scenario as the status quo against which retail competition will be assessed.

The empirical analysis performed for this study attempts to estimate the potential changes in electricity prices to retail customers and the attendant "stranded costs" when these customers are able to directly purchase electric energy in wholesale markets. Increasingly, electric utilities are taking advantage of attractive prices in wholesale markets and are passing cost savings to their customers. One may then ask: How can retail customers benefit any more than they are currently when they, instead of the local utility, purchase low-cost wholesale power? The simple answer is that much of the power sold by utilities, whether located in Kansas or elsewhere, to their retail customers is priced above the current market level. The price for this power, net of transportation and distribution costs, is based on historical embedded costs that commonly lie far above the price of power currently available in a competitive wholesale marketplace.⁽¹⁰⁾

This report also discusses the problem of forming a judgment on retail competition when its effects are inherently difficult to measure in any precise sense. This high degree of uncertainty has important implications for the Kansas Legislature. Specifically, the Legislature may not want to move immediately in implementing full-scale retail competition, in effect minimizing the costs of error if events turn out unfavorably.⁽¹¹⁾ What this implies in the context of retail competition is that an optimal strategy for Kansas may consist of pilot programs and phase-ins over a specified time period. By following this course of action, Kansas would be able to observe more of the experiences of other states (e.g., California and Pennsylvania) and retail customers would be given more time to become educated about their role in the new regime. Retail customers must become informed consumers if retail competition is to be successful. This will take time and some effort to achieve.

This report presents some general guidelines for executing retail competition in Kansas. These guidelines will help to assure that customer choice will improve the economic performance of the electric power industry in Kansas and the well-being of Kansans as a whole.

Finally, this report addresses specific issues pertaining to retail competition. They include the funding of stranded costs by "securitization," taxes, pilot programs, anticompetitive practices, jurisdiction over distribution assets, and the meaning of "bypass" in the context of retail competition.
 
 
 
 

BACKGROUND AND RELEVANT STATISTICS

Recent actions by Kansas electric utilities reflect ongoing changes occurring in the U.S. electric power industry. It should be expected that utilities in Kansas will continue to undergo restructuring and reform irrespective of the status of retail competition in the state. The electric power industry in Kansas will evolve on a course toward restructuring in line with emerging technological, political, and economic realities. As argued elsewhere in this report, the pertinent question for Kansas at this point in time is not whether retail competition will come, but when and how. A valuable lesson can be learned from the natural gas industry where competition, starting in the wellhead sector, has shifted to the other sectors of the industry.⁽¹²⁾ For any industry it is difficult to bottle up competition once initiated. The spread of competition from wholesale to retail markets seems inevitable, as it is a natural outgrowth of economic pressures exerted by market participants who want to receive the full benefits of an open marketplace.

In many ways recent actions in Kansas exemplify those in other states. Mergers, consideration of revamping the activities and structure of power pools, pressures to transmit low-cost wholesale power to end-use consumers, formation of marketing companies, cost restructuring by electric utilities, the offering of special discount rates to large customers all reflect the movement in the electric power industry toward competition.

The Southwest Power Pool (SPP), of which Kansas utilities are members, is considering whether to form an independent system operator (ISO) that would be approved by the Federal Energy Regulatory Commission (FERC).⁽¹³⁾ In recent years the SPP has expanded its membership to accommodate the increased number of suppliers in the region's wholesale power market. In response to open transmission access, in 1996 the SPP established a security plan that calls for the exchange of real-time operating information and around-the-clock security coordination performed by SPP staff. Also initiated in 1996 was a next-hour energy exchange system that allows for real-time trading of electric power.

Kansas has also seen a recent merger proposal between Western Resources, Inc. and Kansas City Power and Light.⁽¹⁴⁾ Western Resources, which is now the thirty-third largest electric utility in the U.S. in terms of sales, distributes both electricity and natural gas, owns a security company and has natural gas interests in Oklahoma.⁽¹⁵⁾ Western Resources is also actively developing power plants in China and other areas of the Far East.⁽¹⁶⁾

UtiliCorp, which operates in Kansas, has recently launched a new marketing company, Energy One, in partnership with PECO Energy. The new company will market electricity and natural gas services, as well as AT&T residential communication services and ADT home and business electronic security services. Energy One will initially function as a retail distributor; participating utilities will later serve as retail distributors or products, drawing on Energy One's national marketing identity and support. Energy One will receive revenues from franchise royalty and transaction fees from participating distributors and suppliers.

On April 30 of this year, Midwest Energy, a cooperative electric and natural gas utility and propane distributor located in Hayes, announced an experimental plan to provide customers with a choice of electric and natural gas supplies.⁽¹⁷⁾ The program, called Open Access, would provide retail customers with different service options starting in early 1998 differentiated by price, risk to consumers and other terms and conditions.⁽¹⁸⁾ The plan still requires the approval of the Kansas Corporation Commission (KCC).

Kansas utilities have, for some time, offered special discount rates to large customers.⁽¹⁹⁾ The rates are generally applicable to the incremental load of existing firms or to a new firm's entire load. These rates are frequently contained in a special contract negotiated between a utility and individual customers. Over the last several years, special discount rates have resulted in electricity prices to large customers falling relative to prices charged to smaller customers.

Table 1 shows that since 1985 industrial prices charged by Kansas investor-owned utilities have slightly fallen while prices to residential and commercial customers have slightly increased.⁽²⁰⁾ This probably in part reflects the offering of special discount rates during the period to large customers. This pattern of electricity prices reflects a national trend (although to a lesser degree) where over the last ten years industrial prices have declined by 6.6 percent, while residential and commercial prices have risen

by 13.1 percent and 6.6 percent, respectively.⁽²¹⁾ One possible outcome of retail competition would be to reverse this trend of electricity prices rising for small customers relative to large customers.

A recent article reported on the relative efficiencies of ninety-four investor-owned utilities, including three that serve Kansas.⁽²²⁾ Operational efficiencies were estimated for the period 1990-1995 using statistical techniques. Out of the ninety-four utilities, Kansas Power and Light was twenty-first, Kansas City Power and Light was thirty-fourth, and UtiliCorp United was fifty-seventh. Overall, the utilities in the study serving Kansas scored reasonably well. As the authors pointed out, high efficiency is essential for a utility to be competitive in commodity markets.

One argument heard in opposition to retail competition is that electricity prices would rise in the short term in states and regions where prices are currently low. This

position has been particularly advanced in the Pacific Northwest and the Southeast, where electricity prices are below the national average. The contention is that regional electricity prices would gravitate toward some level that exceeds the current prices in low-cost states. This belief comports with what can be called the "regional average" hypothesis. One study done for the SCANA Corporation, the corporate parent of South Carolina Electric and Gas, agrees with the concept:

Geographic aggregation. . .masks the fact that the effects of retail competition will not be distributed evenly across the country. States with low-cost generation can expect their utilities to export to higher-cost regions out of state with the possibility prices in low-price states could increase while those in high-price states could fall. . .. A low-price state that goes first is simply inviting its utility to export power up to the point where the price in-state rises to the price out-of-state (p. 61).⁽²³⁾

The legitimacy of this belief in terms of conforming to economic principles can be disputed.⁽²⁴⁾ More reliable is the prediction that those states and regions that currently have the highest electricity prices will, in the short term, benefit the most from retail competition. This is because the gap between existing prices and market-based prices, which can be used to measure the potential benefits of retail competition, is larger in those states or regions with higher electricity prices. This underlies the reason why the early interest in retail competition occurred mainly in those states with the highest electricity prices.

The question to be posed here is: Is Kansas a low-cost state for which retail competition would likely have a minimal or even adverse effect on electricity prices?⁽²⁵⁾ When comparing electricity prices in Kansas relative to those in neighboring states, the answer seems to be, no. In 1995, for example, (see Table 2), electricity prices in Kansas, as a whole, were higher than in any of the surrounding states (Oklahoma, Nebraska, Missouri, Colorado, Iowa, and Arkansas).

Another indicator that this outcome seems plausible is the large gap between the average wholesale price being paid by co-op distributors and the market-based price for wholesale power. For example, in 1996 Sunflower Electric Power Cooperative charged its all-requirements customers an average price of 6.4 cents per kilowatthour (kWh) (includes transmission costs); in contrast, Sunflower's price for nonfirm power averaged only 1.7 cents per kWh.⁽²⁶⁾ In 1996, Kansas Electric Power Cooperative charged its firm wholesale customers (most of whom were associated co-op distributors) an average price of over 5 cents per kWh, while its price for nonfirm power to investor-owned utilities averaged less than 1 cent per kWh.⁽²⁷⁾ With the apparent availability of low-cost, wholesale power, the evidence points clearly to the fact that the citizens of rural Kansas are not paying low prices for electricity. In fact, the evidence shows that they are paying high prices relative to other consumers in the state and their rural counterparts in surrounding states.

With respect to investor-owned utilities, electricity prices in Kansas are more in line with those in surrounding states (see Table 2). Oklahoma, which earlier this year passed retail-wheeling legislation, has the lowest prices (about 18 percent lower than in Kansas). Kansas Gas and Electric has the highest prices of any investor-owned utility in Kansas.⁽²⁸⁾ In 1995, the utility had an average residential price of 9.29 cents per kWh, almost 20 percent higher than the price of any of the other investor-owned utilities in the state. Kansas Gas and Electric's commercial prices were also the highest. Its industrial prices were more in line with the other utilities, leading to the speculation that it has been offering special discount rates to large customers and, in the process, allocating some of its costs to small customers.⁽²⁹⁾

In sum, it would be wrong to characterize Kansas as a low-cost state. In 1995 Kansas had the twenty-ninth lowest electricity prices in the country among the fifty states and the District of Columbia; the average U.S. electricity price was 6.9 cents per kWh while the average price in Kansas was 6.6 cents per kWh.⁽³⁰⁾ Within the state of Kansas, electricity prices vary widely with rural electric cooperatives having the highest average price and the municipalities the lowest average price.

Prices charged by Kansas investor-owned utilities as a group lie below the national average but above the regional averages. Kansas utilities such as Kansas Power and Light and Southwestern Public Service (which serves few customers in the state), have prices that are more compatible to other utilities in the region.

The above statistics suggest that under retail competition Kansas' electricity prices would not rise, according to the questionable "regional average" hypothesis, while surrounding states' prices would fall. Instead, it seems more probable that over time Kansas' electricity prices would fall relative to those in surrounding states. Such an outcome would enhance the competitiveness of Kansas' business sector and, consequently, would contribute to the state's economic development.

Sales to ultimate customers in Kansas are pretty much split among residential, commercial and industrial customers (see Table 3). Industrial customers in Kansas consume a higher percentage of statewide electricity than in Oklahoma, Nebraska, Missouri, and Colorado, but a lower percentage than in Iowa and Arkansas and for the country as a whole. This suggests that the average price of electricity in Kansas is not biased upward because of a lower mix of industrial customers (which generally pay the lowest prices).
 
 
 
 
 

Investor-owned utilities in Kansas make over 73 percent of the total sales to ultimate customers in the state (see Table 4). This is similar to the regional as well as national average (excluding Nebraska). Publicly-owned utilities and rural electric cooperatives in Kansas deliver about 17 percent and 10 percent of the total state's sales to ultimate customers, respectively. Rural electric cooperatives deliver a higher percentage of the total electricity consumed in Oklahoma, Missouri, Colorado, and Arkansas, each of which has noticeably lower prices than their Kansas counterparts.
 
 
 
 
 

THE GROWING MOVEMENT TO RETAIL COMPETITION

Pressure for Change

Pressure for expanding competition in the United State electric power industry has proliferated in recent years. This phenomenon is an outgrowth of competition in the generation sector of the industry. One lesson that we have learned from the deregulation-restructuring experiences of other industries, such as natural gas and telecommunications, is that competition, once begun, becomes difficult to contain. In the natural gas industry, for example, competition in the wellhead sector exerted great pressure to open up the pipeline and distribution sectors.⁽³¹⁾ Currently, a major activity is the liberalization of retail gas markets for all customers including residential and small commercial.

Increasingly, utilities and other market participants acknowledge the reality of competition in the electric power industry extending to retail markets. Most serious analysts and other observers of the industry agree that this movement is irreversible. Utilities have begun to develop rates and terms and conditions for individual retail services. Even utilities currently not required to offer unbundled retail services see the "handwriting on the wall." They want to be ready to compete when retail competition starts.⁽³²⁾

The push for retail competition originates from various interest groups. Independent and utility-affiliated generators want to expand their markets to include a greater number of potential buyers. Marketers want the opportunity to put deals together involving different services for retail customers. Some vertically-integrated utilities also favor retail competition. They see opportunities to sell their generation and other services outside their franchise area, while at the same time feeling confident that they can fend off competition within their service area. Last, but certainly not least, industrial customers want lower-priced electricity now being sold in wholesale bulk markets.

In sum, the movement to retail competition across the country appears robust, as different interest groups see large benefits from a restructured and more competitive electric power industry. These reforms are being driven by market forces and technological changes that ultimately will unravel existing industry and regulatory practices.

The issues and problems surrounding the implementation of retail competition in the electric power industry are well-documented and, except for the later section, "Discussion of Specific Issues," will not be examined in any detail in this report. We should note, however, that retail competition will radically change the modus operandi of industry operation, pricing and planning, and of public utility regulation itself. An endorsement of retail competition in Kansas would be a significant event that should not be taken lightly. It will lead to new institutions and major adaptations of current ones. Because the retail power sector has been so highly monopolistic and regulated, shifting to an environment where competition becomes a dominant feature would require time and considerable readjustment by everyone. The transition to an "equilibrium" competitive marketplace may cause difficulties for some and take several years to complete.⁽³³⁾ One argument can be made that the sooner the transition begins

and ends, the sooner the long-term benefits of retail competition will arrive. If the Kansas Legislature, for example, endorses the concept of retail competition, it would be good policy to "get the ball rolling" in the shortest time possible. This means more than just studying retail competition; it means developing ground rules to implement retail competition in a fashion that maximizes benefits to customers by some specified date.

Kansas may be affected by federal legislation regarding restructuring of the electric power industry. Five comprehensive restructuring bills have so far been introduced; three of them contain "date certain" provisions, one gives states the discretion to determine whether or not they want to implement retail competition, and one lifts constraints on states desiring to implement retail competition.⁽³⁴⁾ The major issues surrounding the current debate encompass jurisdictional authority, the "date certain" issue, universal service, and renewable energy.

In recent months, pressure for federal legislation has somewhat subsided in

view of the fact that states are moving faster than expected toward retail competition. Especially significant is the recent passage of legislation in Montana and Oklahoma, where electricity rates are below the national average.⁽³⁵⁾

The consensus now is that it is highly unlikely that federal legislation will be passed this year, and that the chances are not good that Congress will agree on legislation for submission to the president before adjournment of the 105^th Congress in the fall of 1998.⁽³⁶⁾ The National Association of Regulatory Utility Commissioners (NARUC) has recently issued a strategic plan predicting that federal legislation will likely not be passed before the year 2000.

Momentum in Congress has shifted toward giving states more discretion. Under this middle-of-the-road approach, states would be allowed to set dates for implementation of retail competition, with federal guidelines and standards enacted to ensure fair competition and consumer protection. Another "permissive" approach would be to remove potential federal barriers to state action along with encouraging states to consider retail competition.⁽³⁷⁾

Although federal legislation may not pass during the next year, federal legislation seems inevitable. There is wide agreement in Washington that, as a concept, consumer choice is in the public interest, and it will eventually arrive. The current debate is over how and when to get there.

One possible advantage of Kansas passing legislation before the federal government does is that Kansas legislation may be "grandfathered" by any federal action.⁽³⁸⁾ If so, Kansas could have more discretion over how and when retail competition should take place. By waiting until after federal legislation passes, retail competition in Kansas may less reflect what would otherwise be the consensus reached by the various interest groups in the state.
 
 

Critics of Retail Competition

Vocal critics of retail competition have included incumbent electric utilities who fear the loss of profits or surplus. Some investor-owned utilities have argued that revenue losses would diminish the returns from their existing assets.⁽³⁹⁾ Municipalities worry that the loss of surpluses earned from utility operations will jeopardize their fiscal integrity or force a cutback on municipal services.⁽⁴⁰⁾ Electric cooperatives fear that expanded competition in the electric power industry may result in the loss of customers and, consequently, their ability to pay back outstanding debts. In a competitive environment, firms which are able to restructure their costs and provide services that consumers want stand to gain. Inefficient firms either drop-out or merge with firms that see the opportunity to increase the earnings from the inefficient firm's assets.⁽⁴¹⁾

Kansas needs to confront the question of whether it is willing to have consumers pay higher prices for electricity in return for protecting electric utilities from competition. Certainly, the welfare of the "owners" of electric utilities represents a legitimate interest in the debate over retail competition. But it should be pointed out that the primary consideration in any discussion of retail competition or electric power industry restructuring should be given to the welfare of electricity consumers. If consumers are not expected to benefit, then little reason exists for industry restructuring. Of course, as in the case of other industries that have deregulated or restructured, consumers have benefited, but at varying levels.⁽⁴²⁾

Critics of retail competition make two broad arguments. First, unlike wholesale competition, retail competition would not benefit all end-use electricity consumers. In fact, they regard retail competition as a poor public policy, since only a small number would benefit at the expense of everyone else.⁽⁴³⁾ Second, competition in wholesale power markets will tend to maximize benefits to retail customers. As long as the utility purchases the lowest-cost or "best" available power, retail customers receive the greatest possible benefits.⁽⁴⁴⁾

Turning to the first argument, when all retail customers have the availability of different service providers they should be able to benefit, although at varying levels. Faced with new market choices, retail customers have the opportunity to lower their electricity bills and, perhaps more important, have access to a greater number of services.

Some customers may be worse off if they were previously being subsidized by other customers, for example, through faulty rate designs. Under retail competition, extant subsidies would tend to diminish over time as market pressures readjust prices toward marginal costs.⁽⁴⁵⁾

Extending market access only to some customers (e.g., industrial customers) raises the concern that utilities would have an incentive to shift costs to those customers still susceptible to the local utility's "full service" monopoly power. Broad-based retail competition would create strong forces pressuring utilities to become more efficient and more responsive to the preferences of individual customers. These outcomes are impossible to measure, ex ante, but for various reasons, are expected to occur. The evidence for this, in addition to coming from economic theory, derives from the experiences of other industries undergoing restructuring and the recent experiences of a more competitive wholesale power market. In these cases, the best analytical-empirical studies have shown that introducing more competition has a significant effect on improving the economic welfare of consumers.⁽⁴⁶⁾ These benefits stem largely from increased productive (cost) efficiencies by firms translating into lower prices and the introduction of new services.⁽⁴⁷⁾

The second argument by critics of retail competition -- customers will at best only incrementally benefit relative to wholesale competition -- is equally flawed and myopic. In the absence of retail competition, pervasive regulation of rates paid by retail customers would still continue. For example, regulators would oversee the utility's investment and purchased-power decisions in basically the same way they do today. Further, retail customers would continue to pay for a utility's past investments that are currently uneconomical. When the local utility acts as the "designated" purchaser of power, its decisions, no matter how competitive wholesale power may be, become largely immune from market discipline and, instead, subject to the judgment of regulators. This means that retail customers would continue to bear the brunt of bad decisions, thereby at most only marginally affecting the incentive of the utility to make better decisions. Retail competition would give customers the opportunity to negotiate credit and risk management instruments better tailored to their needs than the products that are generally available under regulation.

A recent article in Public Utilities Fortnightly, authored by two employees of Resource Data International, Inc., articulates this position well.⁽⁴⁸⁾ The authors summarized their argument that competition in wholesale power markets, by and of itself, will not maximize consumer benefits with the following explanation:

[T]he current bifurcated market structure does not give a utility great incentive to minimize cost other than the threat of retail wheeling. Also, market distortions are creating price trends in wholesale power markets that may be unsustainable in the long term. Utilities will not feel tremendous pressure to reduce costs, improve efficiency, and shut down uneconomic plants until retail wheeling is implemented. Only then will consumers and the U.S. economy benefit from competition (p. 11).

In sum, effective competition in the electric power industry demands more than competition in the generation/wholesale power sector; it also requires retail customers to have direct access to the wholesale market. Otherwise, prices paid by retail customers will depend on the continued regulation of a "full service" monopolist. The consequences will be the sustainability of the inefficiencies and other problems that currently exist in the electric power industry.⁽⁴⁹⁾
 
 
 
 

MODEL OF RETAIL COMPETITION

Comparison with the Status Quo

The status-quo scenario for analysis presented in this report assumes the evolving movement of wholesale power markets toward competition.⁽⁵⁰⁾ This evolution may entail the operation of a centralized market for managing generating unit commitment, and ancillary and network congestion. A Poolco-type entity, with power exchanges and transmission-network management either combined or separated, would be responsible for these activities. A spot-futures market for electricity would likely develop under such an institutional arrangement. Contracts-for-differences (CFDs), where buyers and sellers can hedge against volatile prices, would also be available.⁽⁵¹⁾

Under the status-quo scenario, it is assumed over the near term that utilities would continue to primarily sell electricity to retail customers from their own generating units at historical, embedded costs. For example, if a utility has the choice of purchasing wholesale power at 2 cents per kWh or generating power from its rate-based generating unit with an embedded cost of 8 cents per kWh, it would choose the latter. The one rationale for this assumption is that electric utilities are currently doing just that -- i.e., forgoing lower-cost wholesale power for internal generation. Although not in the best interest of retail consumers, this behavior allows utilities to continue recovering their embedded costs. Replacing internal generation with wholesale power, even when the latter is lower-cost, could jeopardize a utility's legal right (pursuant, for example, to the used-and-useful criterion) to full recovery.

The fundamental difference in the status-quo and retail-competition scenarios focuses on the market role of retail customers. Under the status quo, the utility acts as a monopoly intermediary between generators and other wholesale service providers and the retail customer. In other words, the utility acts as the "designated" agent forced upon retail customers. This arrangement per se poses no problem; the difficulty arises when the utility's interests differ from those of retail customers. In today's environment, this "interests" discrepancy is exemplified by the fact that utilities tend to favor internal generation over wholesale power, even when higher costs are passed through to retail customers.⁽⁵²⁾

Under retail competition, customers would have four options; they could

(1) continue to purchase bundled-rates service (e.g., recourse service) from their local utility, (2) negotiate a bilateral (physical or financial) contract with a generator,

(3) assign an aggregator or some kind of marketer to purchase different services, or

(4) purchase spot power directly from the power exchange or Poolco. In a fully-developed retail-competition world, other-than-local-utility services could include ancillary services, billing, metering, and information services. Retail competition does not imply that customers acquiring electric energy from another party would completely bypass the local utility. We expect, similar to the case of natural gas, that virtually all customers opting for unbundled service would continue to receive distribution service from the local utility.⁽⁵³⁾ Responsibility for maintaining the distribution system and assuring reliable local delivery service would still remain with the local utility.

In terms of regulatory intervention, under either retail competition or the status quo, price regulation of transmission and distribution services would continue. As discussed later, the FERC has sole authority over the pricing of transmission services, while states would have authority over distribution services. (The exception to this occurs in the case where a rural electric cooperative or municipality owns transmission lines that are not FERC jurisdictional.) Under retail competition, distribution services would be unbundled and priced on the basis of stand-alone cost. Some form of performance-based regulation (PBR) may be applied to give utilities a greater incentive to keep costs down.⁽⁵⁴⁾ As the sole provider of distribution service, the local utility would have an obligation to provide this service at a reliable and a safe level. Thus, its incentive to maintain the distribution system should remain unchanged.
 
 

Comparison of a Restructured Electric Power Industry

and the Wheat Market

A comparison of the electric power market and the wheat market reveals both similarities and differences. First, both electric energy (kWhs) and wheat are commodities in the sense that they are homogenous economic goods that can be transacted in competitive markets. Evidence of this is the fact that both are consummated in futures markets. Futures markets require spot markets, where short-term transactions take place under transparent-price conditions. Normally, the price will be driven to marginal cost at the level where demand equals supply. Unlike wheat, whose price is determined in the international marketplace, the price of electric energy in Kansas will largely hinge on regional market conditions.

The value of electric energy and wheat to end-use consumers depends on how these commodities are combined with other commodities and services to form a product that is directly consumed. To the consumer, for example, one kWh of electric energy at the generation level is the same as another kWh of electric energy, just as the different farmers producing one bushel of wheat are undistinguishable. But the kWh of electric energy that end-use consumers purchase or the bushel of wheat embedded in different food products, has a varying value depending on how it is bundled with other commodities and services.⁽⁵⁵⁾ Electricity consumers, for example, place higher value on electric service that is more firm and less unpredictable in terms of price. As a general rule, the more a commodity is combined with other value-added services, the greater the value consumers will place on the end-use product or service.

Relative to the wheat market, the electric power market, at least for the foreseeable future, is less conducive to competitive forces in the delivery function. Electric transmission and distribution are generally regarded (although perhaps incorrectly) as natural monopolies that will require some form of regulatory control. Under retail competition, the FERC will continue to regulate transmission services (at least for investor-owned utilities) and the state public utility commissions will continue to regulate distribution services.⁽⁵⁶⁾ In the current context, it is misleading to talk about a totally deregulated electric power industry; the current debate is over partially deregulating the industry and introducing greater competition into certain segments of the industry.

Compared to the wheat market, the electric power industry requires more centralized control of various market functions. At least that is the current thinking of most (but not all) industry experts. The view that an ISO and power exchange (as separate units or one unit), should have the exclusive right to physically manage unit commitment, ancillary services and transmission-network congestions is currently regarded by many industry observers as the most efficient modus operandi for wholesale transactions.⁽⁵⁷⁾

Finally, the question arises: How should Kansas regard electric energy as a potentially tradable commodity? Should Kansas, for example, encourage the export of electric energy to other states or other regions within the state? Certainly, in the case of wheat, Kansas farmers benefit when they are able to sell to buyers in other states and countries throughout the world. Exporting wheat from Kansas is widely regarded as beneficial to both farmers and the state as a whole.

Some critics of retail competition argue that a state with low-cost electric energy should discourage exports, reasoning that in-state electricity consumers would otherwise pay higher prices.⁽⁵⁸⁾ Such a position, however, would be detrimental to the well-being of Kansas. First, low-cost electric energy should be regarded as a resource whose value to Kansas increases with the size of the market within which it can be sold. Policymakers in Kansas would not think of restricting the market for wheat produced within the state. Why should policymakers take a different position when it comes to electric energy? From an economic perspective, any commodity or service should be sold to whoever values it the most. Not only does society as a whole benefit but producers also gain from receiving a potentially higher price or from selling more of their commodity or service. Prices to in-state consumers may or may not increase.⁽⁵⁹⁾ It can be argued that by liberalizing electricity markets in terms of allowing imports and exports, in-state electricity consumers would have access to a greater number of generators. As discussed elsewhere in this report, retail competition would provide Kansas utilities with stronger incentives to keep their costs down and to be responsive to customer demands. In sum, a policy that attempts to restrict the trading of electric energy is ill-advised, contrary to good economics and the overall well-being of Kansas.
 
 

Pricing Methods

Under retail competition, electric services would be unbundled and separately priced. Some of these services, namely those provided under competitive conditions, would ultimately be deregulated. Other services would continue to be regulated but they would probably be subject to different pricing principles from those applied today. Real-time pricing and other pricing methods applying marginal-cost principles should become more prevalent as the industry moves toward competition.⁽⁶⁰⁾

In the world of retail competition, it is expected that (1) less risks will be allocated to customers, (2) utilities will have opportunities to earn higher profits than what they do currently, and (3) utilities will be better able to "flex" their prices in response to actual market conditions. All of these outcomes are compatible with a competitive market environment.

In line with marginal-cost pricing, consumers could very well see an increase in access charges for distribution service. Higher access charges would be the result of reallocating some of the utility's fixed costs, which presumably are partially recovered today in the usage (kWh) components of utility bills. Utilities would be more constrained to recover the fixed portion of their distribution costs in a separate access charge.⁽⁶¹⁾

A two-part tariff is compatible with efficient pricing in that an access charge would recover the fixed costs of providing customer access to the distribution system, and a usage (kWh) charge would recover usage-sensitive costs.⁽⁶²⁾ Although some consumers, namely those who consume relatively small amounts of electricity, may be worse off, other customers would be better off.⁽⁶³⁾ Overall, economic efficiency would improve.

The "equity" aspect of electricity prices in a retail-competition world certainly warrants consideration by state policymakers. If all electricity consumers enjoy lower prices, then the "equity" issue becomes academic. A question may still remain if some consumers receive lower price declines than other consumers. But even here, it cannot be said that retail competition would cause some consumers to benefit at the expense of others.

The more challenging policy question arises when some retail consumers see higher prices that can be directly attributed to retail competition. As argued by some interest groups and analysts, for example, prices to small retail customers may rise subsequent to the introduction of retail competition.⁽⁶⁴⁾ On the surface, it appears that such an outcome would be inequitable: Does not an action where some customers benefit at the expense of other customers seem unfair? How can this statement be questioned?

In response, if certain customers were being subsidized prior to retail competition, then the prices in the previous regime can be characterized as inequitable. The reason for this is that these customers were not paying their share of the costs they imposed on the utility and society. If retail competition eliminates subsidies, then one could argue that prices become less inequitable, even though the beneficiaries of the previous subsidy now have to pay higher electricity prices. If some of these customers are low-income households, special consideration could be given to compensate them by creating an assistance program that offsets the higher electricity prices that they may have to pay.

Inequitable prices become more clear when cost shifting occurs. The probability of cost shifting increases by the degree of variability of competition across the different markets within which a utility sells its services. The situation where only large customers have direct access to wholesale markets would create an environment conducive to cost shifting. The utility would be inclined to allocate costs to markets where it faces less competition.⁽⁶⁵⁾ The resultant prices may be described as inequitable in the sense that "captive" customers (i.e., customers who are denied direct access) are paying for costs incurred by customers who are given opportunities to choose their supplier.
 
 

Effect on Wholesale Power Markets

Retail competition can help to bolster competitive forces in wholesale or upstream markets. The argument that retail competition should wait until wholesale markets become more competitive can be turned around: Retail competition can assist in accelerating competition in wholesale markets.

One potential problem in continuing to grant utilities monopoly power in supplying retail electric energy is that they are more likely to engage in abuses. Abuses is defined here as anticompetitive practices that reduce the potential benefits of competition to consumers. Competitively-priced generation only produces benefits to retail consumers when that power becomes available to them at a price that is not inflated because of abuses.

Customer choice would result in the unbundling of retail services. Some services, such as electric energy, would likely become subject to intense competitive pressures. The prices for these services should be transparent to retail consumers. Therefore, price inflation via anticompetitive practices such as affiliate (self-dealing) abuse would tend to financially harm the utility by eroding its sales.⁽⁶⁶⁾

In sum, the ability of the local utility to engage in anticompetitive practices such as cost shifting diminishes with the presence of stronger competitive forces "downstream." Retail competition would force the local utility to compete directly with other service providers for the business of end-use customers. Only when the utility provides lower-price or higher-quality service would it be able to compete successfully.
 
 

POTENTIAL INVESTOR-OWNED STRANDED COST IN KANSAS

This section examines the potential for stranded cost occurring as a result of a competitive generation market for investor-owned utilities in Kansas. This analysis is conducted for only the major investor-owned utility plants in the state. Stranded costs or competitive losses are defined here as generation costs that are currently recovered in utility rates, but may not be recovered in a competitive market. These potential losses may be offset by a company's competitive gains when the market revenue exceeds generation costs. These costs include both variable costs, that is, costs that vary with the amount of power produced, and capital or fixed costs invested in power-producing facilities. The method used here first estimates the future revenue stream in a competitive market based on a recent price forecast and then deducts operating, maintenance, fuel, depreciation, and taxes to estimate operating income. A net present value of the company's cash flow is then calculated and net book value of the plant is deducted to determine an estimated net increase or decrease of the firm's generation net worth in a competitive market during the period examined (1998 through 2015).

The price forecasts used in the stranded cost estimation are from the U.S. Department of Energy, Energy Information Administration⁽⁶⁷⁾ (EIA). These forecasted prices are based on marginal operating costs for multiple time periods, capacity constraints, average cost of transmission and distribution services, and consumer response to changes in price. EIA calculated two price scenarios for thirteen different regions in the country. One scenario is the "Moderate Consumer Response Case," which are average annual competitive prices based on competition-induced reduction in nonfuel operations and maintenance, general and administrative costs, and moderate consumer response to time-of-use prices. The other scenario is the "High Efficiency Competitive Case," which are average annual competitive prices based on greater reductions (than the moderate scenario) in nonfuel operating and maintenance costs, capital cost reductions, and improved operating efficiencies (lower heat rates). The price forecasts used in this analysis are EIA's projections for the Southwest Power Pool (SPP). The forecasted prices and the percentage price change from 1995 average levels are shown in Table 5. Based on this regional price forecast, Kansas customers would, overall, see a benefit from lower competitive market prices than the current average price currently paid by all customer groups.

Detailed plant level data is also used in the analysis. This information is from the Federal Energy Regulatory Commissions's Form 1, compiled and organized by the Utility Data Institute.⁽⁶⁸⁾ This includes data on steam-electric plants from more than 100 electric power companies and 481 power plants in 1995. For Kansas, detailed information was available for eight major power plants located in the state. These plants and some basic characteristics are described in Table 6. These plants account for almost two thirds of the total electric utility industry capacity in Kansas and 87 percent of the investor-owned generating capacity in the state. Together they generated approximately 84 percent of the state's total electric utility industry generation production (kilowatthours) and more than 96 percent of the state's investor-owned generation. Thus, they represent the major sources of generation by investor-owned utilities in the state. In 1995, these plants were mostly owned and operated by Western Resources, Inc. and Kansas City Power and Light.

The three largest power plants in Kansas are among the lowest total-variable-cost plants (this includes fuel, labor, and other operations and maintenance costs) in the SPP region. Of these, one is a nuclear power plant (Wolf Creek) and two are coal plants (La Cygne and Jeffrey). Of the fifty-seven plants in the SPP region, these three
 
 

plants are among the top eight lowest total-variable-cost plants in the region. Table 7 lists the ten lowest total-variable-cost plants in the SPP region. These three plants comprise almost 63 percent of the total investor-owned capacity in the state.

The methodology used here to estimate potential stranded costs, begins by first calculating market revenue based on the EIA forecasted prices, subtracting the costs of generating and delivering power to customers, and then subtracting depreciation expense and taxes. The result is either a positive operating income and net cash flow (operating income plus depreciation expense) that can be used by the company for new capital, debt service, or profit or a competitive loss, or a net operating loss. All plants

Tables 8 and 9 are the results of the analysis for Western Resources and Kansas City Power & Light, respectively. Table 10 combines both companies into one, as would occur if the proposed merger by the two companies is approved by state and federal regulators. It is assumed that the 1995 costs and the total amount of power generated at each plant will both remain steady throughout the years forecasted. While both are unlikely assumptions, these assumptions are made to be conservative and not anticipate any cost decrease or demand increase. The market revenue is calculated by using each year's EIA price forecast multiplied by the total generation. Total variable cost is the sum of fuel, labor, and other operating and maintenance costs for all plants. Transmission and distribution and administrative costs are based on a fixed proportion (33 percent⁽⁶⁹⁾) of the 1995 price for investor-owned power in Kansas and are also assumed to remain steady throughout the period. Depreciation expense is the total reported for all plants for the year (given the current book costs, at this annual rate, all but one plant will be fully depreciated by the end of the analysis period). The operating income is then calculated for each scenario by subtracting the costs from the market revenue. Taxes are then deducted based on 40 percent of the operating income (a slightly higher rate than actual reported taxes paid) and an after-tax operating income is then calculated. Net cash flow is calculated by adding back in the depreciation