KEMA PANEL TOPIC - GROWTH AND INNOVATION IN C&I MARKETS

Opening RemarksThere are currently 19 states that allow commercial and industrial customers to purchase electric generation from suppliers instead of the local regulated utility. However, the smaller the customer is in terms of usage, the more limited their options are when choosing an electric supplier.

One necessary step in growing innovation in C&I markets is to assure that all C&I customers have a real opportunity to shop. This is accomplished by correcting skewed pricing in some utilities that make it difficult for suppliers to offer competitive products to certain classes of C&I customers.

Another solution, which has been very effective in getting small commercials to shop in Ohio, is opt-out municipal or governmental aggregation where groups of small businesses act as an aggregated buying group, providing suppliers the ability to serve them at a lower cost of acquisition. Currently, about 65% of commercial customers representing over 80% of the commercial load in the Ohio Edison, Toledo Edison and The Illuminating Company service territories are being served by competitive electric generation suppliers due mainly to opt-out governmental aggregation. And we’re seeing interest from communities in the other Ohio utility jurisdictions.

One of the largest barriers to shopping in the C&I markets is a narrow-minded view regarding how to supply electric generation service. Recent actions by the New Jersey legislature and Maryland Public Service Commission about providing regulated generation service from the utilities will result in customers subsidizing new generation. And some might argue that in these cases, new generation will be built whether it’s needed or not. This subsidization and state selected generation service will only create barriers to ensuring that the market delivers innovative and cost-effective generation supply to customers – which would most certainly lead to fewer customer options and higher prices over the long term.

Similarly, recent filings and public statements by certain utilities in Ohio indicate a strong interest in reregulating the Ohio markets despite evidence that suggests customers have benefited in Ohio markets. Interestingly, the argument has moved toward the need for more jobs in Ohio that could result from the construction of regulated generation. And in this economy, a position of increasing jobs tends to get the attention of local politicians. Along with this new regulated generation comes additional shopping barriers, such as non-bypassable generation based charges that customers pay whether they get their generation from the utility or a supplier.

Simply stated, competitive markets work. This is clearly proven by the levels of shopping in many Northeast states as well as here in Texas, which (according to the 2011 Scope of Competition Report in Electric Markets of Texas) has the lowest electric rates in the nation with customers in the Dallas and Houston areas paying less than those in Washington State. I’m confident that markets, not regulatory mandates, will deliver more options and lower prices to customers in the future. Our best opportunity to meet the nations future energy needs is through the innovations, efficiencies and productivity improvements offered by competitive markets.

Commercial Switching and how it might differ from residential and industrial Commercial customers come in a range of sizes and vary widely on their understanding of electric shopping. . Commercial accounts can be anywhere between a small office or storefront that uses less electricity than most homes, up to a large hospital that uses more power than most industrial accounts.

The real question is not how switching differs based on customer size, but rather based on the utility’s different rules among customer classes. For example, large customers, whether commercial or industrial, tend to have hourly default pricing. Because these customers tend to enjoy the budget certainty of a fixed price product that is readily available in the retail market, switching levels for large customers are consistently above 90% across most competitive markets Since smaller C&I accounts typically have a fixed price default Price to Compare, their levels of switching is tied closely to how current market prices compare to the default service price. In times of escalating market prices, customers return to the utility default as it is a cheaper option, while during times of falling market prices switching levels increase.

From a supplier’s perspective, smaller commercial customers tend to be more like residential customers in terms of their default utility service option as well as their cost to acquire. And much like residential customers, small commercial customers tend to be less educated about choice, are often times apathetic about competitive suppliers and don’t think the savings are worth the effort of comparison shopping.

As mentioned in my opening remarks, one very effective way to fight consumer apathy toward savings is through opt-out municipal aggregation. States that have legislation that allows some form of opt-out aggregation today include Ohio, Connecticut, New Jersey, Maryland and Illinois. However, only Ohio has put the specific rules in place to allow opt-out municipal aggregation to be implemented.

What products are working/not working in the C&I markets

It is our experience that the majority of contracts signed in the C&I market are simple fixed price full requirements products. These are the easiest for customers to understand, provide budget certainty, and do not place any volumetric risks on the customer. More sophisticated customers with flexible energy consumption patterns and the manpower to monitor power prices have found value in variable priced programs that might include both a block and index portion of their load. The customer assumes more risk in exchange for a lower initial price or the perceived ability to get lower pricing.

However, as anybody who has dealt in these markets knows, a year’s worth of savings can be erased in a day or two of peak pricing. So it’s critical for customers who choose more sophisticated products to have solid risk management capability to monitor market fundamentals and technical trends. These customers will also need to track regulatory and legislative activity, or have a very good supplier that provides these things as value-added services to the commodity sale.

Beyond pricing options, we’ve seen interest from customers in demand response programs where they can receive compensation for flexibility to reduce load. The question becomes whether to sign up to the RTO program or whether there could be more benefit in negotiating that value in their deal with their electric generation supplier.

We’ve seen certain customers with stronger sustainability mandates express interest in building their own wind farms and/or solar arrays and in a long-term commitment from their supplier to acquire either the output or the RECs from the renewable facility. However, we’ve found that very few C&I customers are willing to pay extra for green energy.

How does power innovation compare to natural gas markets

In comparing power innovation to natural gas markets, we find both similarities and differences. And I think we can learn from the history of natural gas in deregulated markets since they’ve been at it for much longer. Electric utilities can learn from the transition that gas utilities have made in removing the artificial barriers that prevent customer shopping. From a generation perspective, both industries are facing challenges with environmental concerns. But with the recent events in Japan with its nuclear facilities and our country’s desire to wean itself off foreign oil imports, I have to believe that both energy sources are considered to be important sources in the U.S. energy future.

All of that being said, there are legitimate differences in innovation. Whenever there is complexity, there is opportunity. Because the power markets are more complex (for example, electric prices are hourly versus gas markets being mostly daily, gas can be stored easily, and there are a larger number of devices that use electricity) ,it would seem that there are more opportunities for power market innovation than natural gas.

For instance, opportunities for power market innovation lie in the fact that power can be generated in a variety of ways, offering opportunities around how you package each one of the generation sources to create consumer products. The obvious packaging is relating to selling/developing green power. And as other alternate electric generation sources mature, suppliers will start to offer additional products around the generation technologies. Once storage technologies becomes more viable, you’ll see new products develop out of this capability as well. And as I indicated, there is significantly more opportunity for in home/facility product offerings since just about everything runs on electricity.

PA examination of FE merger and impact on competition

The merger of FirstEnergy and Allegheny Energy was certainly an interesting process. There was concern by some parties that the PA markets would become less competitive as a result of the merger but we’ve seen the opposite. Shopping in all of FirstEnergy’s PA utilities is growing and is attracting non-affiliated suppliers. West Penn Power, a former Allegheny Power utility, along with FirstEnergy’s Met-Ed and Penelec utilities are seeing residential and small commercial shopping for the first time. On a side note, Penn Power’s latest default supply plan was folded into the existing Met-Ed and Penelec plans. We think it would be positive if the 4 FirstEnergy utilities in question – Met-Ed, Penelec, Penn Power and West Penn Power – would adopt a single set of rules and processes to make it easier for competitive retail suppliers to cost effectively acquire customers.

Another interesting part of the merger was that during the process, a group of competitive suppliers proposed that FirstEnergy’s PA utility companies be required to implement certain aspects of the Texas retail model, while limiting the competitive affiliate (that being FirstEnergy Solutions) from participating as a supplier in either the POLR load or proposed retail customer auction. In my view, placing limits on any affiliated supplier in PA from participating in the markets is the more egregious anti-competitive behavior. The focus should be on the rules that prevent utility affiliates from getting preferential treatment from the utility on either the wholesale or retail front.

As a final note, one of the outcomes of the merger is that the PA PUC has indicated its intent to open a statewide investigation into Pennsylvania’s retail electric markets to ensure that a properly functioning and workable competitive retail market exists. And since PA has done a great job of assuring fair competition to date, I’m cautiously optimistic that the statewide investigation will achieve that same objective.

Are the markets getting saturated with no new states opening up; how do we think about it Certain customer classes have been saturated for quite a while. For example, large C&I shopping in the Duquesne Light territory has been above 90% since the mid-2000s. Suppliers have reacted as one would expect, by targeting smaller and smaller accounts. Recent activity in the residential sectors of New Jersey, Maryland, Pennsylvania and Illinois supports this notion, as many of the offers are from retail suppliers that traditionally target medium and large C&I customers.

Another trend we’re seeing is that suppliers are becoming more adept at implementing takeaway campaigns…and in some cases using questionable tactics like misrepresenting to customers the T&Cs in existing supplier contracts. In Ohio, we’ve seen competitors suggest things like “you can switch since they probably wont’ charge you the cancellation fee that’s in your contract”.

But I firmly believe that the small commercial market is not saturated and still offers good opportunities for suppliers. But utilities will need to remove artificial barriers to shopping in which case we think there could be 20% more shopping in the small commercial customer class in some utilities.

One of the more daunting barriers to shopping is created when utilities design a variety of non- bypassable charges to help pay for new generation build in competitive states. And most often, the small commercial and residential customer is saddled with the bulk of those costs through skewed rate design. We continue to believe that the best outcome for customers in creating shopping opportunities and savings is to let the market send the signals for new generation build and have stockholders, not customers, bare the risk of building new generation.

An additional barrier created by some utilities lies in how they set up their consolidated billing rules for suppliers.

It would also be helpful for utilities to offer suppliers a variety of billing options, such as purchase of receivables, bill ready, rate ready and percent off the PTC to increase suppliers’ ability to innovate products around their billing flexibility.

Finally, lowering threshold where customers will receive hourly pricing for default service instead of a fixed price will spur additional switching. A fully developed functional market like New Jersey still has an hourly threshold of 1,000 kW (being reduced to 750 kW starting June 1), while a relatively new entrant in ComEd has a 100 kW threshold. And again, the trend indicates that the lower the threshold, the higher rate of customer shopping.

Impact of DR, EE, renewables, etc.

We’re starting to see trends with C&I customers around energy efficiency, including:o Facility benchmarking to establish a starting point for project justificationo Customers taking advantage of energy rebates and tax breakso Large interest in EnergySTAR for benchmarking and measurement and verification of

energy efficiency projectso Many facilities working on lighting conversion programso Large interest in greenhouse gas reporting or understanding carbon footprint

Because of the rollout of advanced meters, one question yet to be answered and currently being discussed at the FERC and RTO level is whether dynamic retail pricing can achieve the same objectives as wholesale full LMP priced demand response. PJM has started to look at whether dynamic retail pricing is complementary or competitive with wholesale demand response.

As it relates to renewables, we’re seeing spotty interest from larger C&I customers. Some larger customers are building solar and wind farms on their properties. Others have asked us to enter into long-term PPAs for renewable output to help finance the project.

And of course, there is the ongoing debate about the impact of these variable renewable resources on the power grid and its reliability as generation resources that can be counted on. The debate begs the question about the impact of large scale storage on the successful development of renewable resources like solar and wind. Coupled with demand side solutions like DR and EE, cost-effective large scale storage could be one of the keys to quicker adoption of renewable resources.

Keep in mind that state renewable portfolio standards were set up in a way that did not include much integrated resource planning, Much more engineering needs to be completed to determine the real cost of certain sustainability solutions and their long-term viability as solutions that large blocks of customers may adopt.

How do business models differ for competitive suppliers with generation vs. those without FirstEnergy Solutions’ family of companies owns approximately 21,000 MW of generation, making us the second largest owner of deregulated power in the United States. Because of our status as a generator/retailer, you would be correct in assuming that we believe there are advantages to owning generation as a supplier. But at the same time, you’d probably hear non- generation suppliers talk about the advantages of not owning generation.

So without suggesting who’s right, I believe that both can be very competitive in the markets for different reasons. Evidence is that non-generators have been successful in POLR auctions.Those also serving the retail markets typically are aligned with a generator or commodity group of large financial institutions. One difference is that non-generators could have more concern with collateral obligations relating to their short positions, which will be impacted further by the final results that come from the proposed financial reforms that are part of CFTC / Dodd-Frank. At the same time, some generators struggle with the discipline that non-generators have out of necessity since they rely on partners or the market for their generation supply. Generators also need to worry about if/when to idle plants because they don’t clear the market and the additional costs to comply with environmental regulation – costs that are not directly felt by non-generator suppliers.

, I tend to think that pricing differences, if any, will show up in the risk premium that each would include in their price quotes since a generator may look at swing and shopping risk a little differently than a supplier without generation.

What role does service innovation play (consolidated billing, basis management, etc.) Service innovation can be important for customers who need help managing their usage and price risk. FirstEnergy Solutions has an energy consulting business that helps customers in these areas. Much of the innovation comes in the form of the way in which you might help customers manage their energy consumption data, which then helps them better manage their energy spend. We’ve seen these kinds of services play a more important role for multi-site facilities, especially when those sites cross multiple utilities in multiple states, some deregulated and some still fully regulated.

The obvious challenge for suppliers is finding those innovations that appeal to customers, and this is particularly challenging when dealing with small C&I customers. Unlike large C&I accounts where relationships are cultivated and customer needs explored, there is rarely an actual human interaction between retail suppliers and smaller customers, and providing innovative products to this group may be difficult.

How does investment by wires companies in advanced metering and grid automation impact innovation

At this point in the markets where FirstEnergy Solutions operates, this is largely a theoretical discussion, as smart grid deployment is just beginning with many of the programs rolling out over an extended period. And even where utilities are more aggressive about their implementation schedules for smart grid, most utilities will prioritize work around grid automation. This is because it will typically have more line-of-sight benefits to their operations than will advanced meters, which generally provides the capability for customers to have more control over their energy consumption.

But once advanced metering and grid automation projects near completion, suppliers can be in a position to analyze a customer usage patterns and offer a variety of time-of-use products and services so that it feels to the customer like the product was designed specifically for that customer…one to on marketing. And as mentioned in my discussion on demand response, RTOs are considering the impact that variable pricing capabilities of retail service providers that will be created by advanced meters, will have on wholesale demand response. Keep in mind that the customers’ objective will be to manage and reduce its energy bills. However, some have expressed customer privacy concerns, which brings into question how much data a supplier will be able to receive, and how they will be able to use it in the future. The full benefits of smart meters will not be available if generation suppliers do not have access to the data to tailor products and services.

What are some of the regulatory differences that impact innovation and C&I shopping Regulatory consistency is the single most important factor that impacts innovation and C&I shopping. Not all states have shown a real commitment to advancing competition, and the supplier community has responded accordingly. And although we don’t agree with every ruling from state commissions, we believe that the Pennsylvania Public Utility Commission has done an admirable job over the past several years in advancing the choice marketplace. They have generally provided a more positive experience for shopping customers while encouraging suppliers to come into the market and compete. Now the Public Utilities Commission of Ohio has its work cut out with at least two utilities trying to rewind the clock to reregulate the state, or at least their jurisdictions. This kind of uncertainty is not what suppliers want to hear when they’re faced with decisions to invest their time and effort to winning customers in the state.Suppliers need to decide whether to get licensed with state commissions, perform all the necessary EDC testing and establish a sales office, and suppliers are less willing to do these things in a state where the regulatory wind changes direction every few years.

But specific regulatory differences that not only impact innovation but impact whether suppliers will want to play at all include:

1. The threshold where the hourly priceis established. Customers are much more likely to shop when they don’t have a default Price to Compare, which means the lower that the hourly threshold is set, the more customers will shop.

2. Making a customer’s Price to Compare easily identifiable to customers and suppliers is key to the shopping experience. Large portions of power procured in spot market purchases that are subject to quarterly true-ups can swing the PTC wildly from quarter- to-quarter, making it difficult for suppliers and customers to estimate an offers savings.

3. States with overly restrictive sales and marketing rules limit the ability of suppliers to offer innovative products. There needs to be a balance between offering the appropriate consumer protections and allowing suppliers the flexibility to market innovative products.

Commissions that have a specific office dedicated to increasing competition, such as the Office of Retail Market Development in Illinois or the Office of Competitive Market Oversight in Pennsylvania, have allowed all of the stakeholders to have a voice and come to a consensus on the best way to implement changes that lead to innovation and increased shopping.