Anticipating Electricity Deregulation in Leases

At both the federal and state levels, the electric industry is undergoing profound changes as a result of deregulation, the effects of which are only beginning to be known. It will take a few years before the impact of deregulation is sorted out. Until then, there will be uncertainty and confusion for electricity consumers as they survey the new competitive landscape to find which offers from competing service providers make sense. Estimates of savings as a result of deregulation vary widely, but are often projected to range from ten percent to fifty percent savings. In a typical office building, electricity constitutes almost a third of its operating expenses and usually is the single most significant operating expense. With respect to malls and other retail establishments, over $5 billion is paid to utilities annually to cover electric heating and lighting costs.

In Maryland, the General Assembly in its 1998-99 session restructured the state's regulation of electric supply service to provide for a competitive market starting for commercial users on July 1, 2000. After that date, supply service as well as some collateral services such as billing and metering will be unregulated, and commercial classes of electricity users will be free to shop for electric supply service.

The deregulation of the electricity markets will give landlords and tenants opportunities to shop for electricity among a range of providers offering an array of products and services. As a result, leases negotiated in anticipation of electric service deregulation need to address some of the expected changes in the marketplace. Perhaps the largest issue will center around control -- that is, who will control the choice of electric service providers. Although experts can't agree on the amount of saving that deregulation will bring, there is a consensus that the greatest potential for savings will come about through the pooling of electricity loads or "aggregating" such loads. By aggregating electricity loads, consumers can take advantage of size to demand the greatest price concessions from service providers.

For landlords, the place to start is with a review of existing leases to see whether and to what extent such leases have limits on the ability of the landlord to purchase electric service for its tenants. Older leases may name the local utility as the service provider and therefore may have inadvertently locked in that utility as the only source of electric service.

For new leases, some of the considerations which a landlord should consider are as follows:

1. The landlord should retain the right to select the electric service provider.
2. The landlord should have the right to switch service providers at any time during the term of the lease.
3. The landlord should seek to be held harmless from any liability for service interruptions.
4. The tenant should grant the landlord access to tenant's premises for the installation of cabling, lines, risers, and other wiring as an electric service provider may reasonably require.
5. The landlord should have authority to pass through to tenants any fees, costs or expenses associated with stranded cost charges, exit fees, equipment installation, maintenance or repairs.
6. The landlord should be able to maintain controls over the tenant's introduction of additional electricity-consuming machinery or equipment.
7. The landlord should maintain the right to require individual metering of each tenant to monitor tenant usage and consumption.

From the tenant's prospective, a large tenant will want to maintain its ability to contract directly with electric service providers. Even smaller tenants who are part of a chain or are a branch of a national or regional organization may want the flexibility of aggregating their service requirements. Alternatively, middlemen or "aggregators" are forming for the purpose of aggregating demand from smaller users. In negotiating with landlords over these rights, tenants should keep in mind that to the extent a tenant retains its right to negotiate directly with an electric service provider, it is depriving its landlord of the ability to aggregate that tenant's service demand with other tenants. The issues which a tenant should keep in mind are as follows:

1. Tenant may wish to preserve the option of independently contracting with a service provider or using whatever service the landlord procures.
2. The landlord should allow the tenant's service provider to install in the landlord's building whatever lines, wires, risers and other equipment as are reasonably necessary to service the tenant.
3. To the extent landlord installs improvements to the premises which do not benefit the tenant (because the tenant has its own electric service provider), then the landlord should not be able to pass the improvement costs on to the tenant.
4. If the tenant chooses to allow its load to be aggregated with other tenant loads, the tenant should require the landlord to procure the best available rates.

The deregulation of electric service is a highly dynamic area of the law. The transition to a deregulated environment in Maryland will occur over a period of years, starting this summer. During this time, owners, landlords, managers and tenants will need to focus more closely than has ever been required before on some of the issues discussed here. Lease clauses which touch on these issues will need to anticipate this transition period and the brave new world which deregulation will bring.

Matthew L. Kimball is a partner in the firm's Real Estate Department, and is the co-author of the text "Property Manager's Guide to Commercial Real Estate Law" recently published by the BOMI Institute. For additional information please contact him at 410-783-6354 or mlkimball@niles-law.com.