COMMISSIONER P. GREGORY CONLON'S COMMENTS REGARDING THE ELECTRIC RESTRUCTURING PROPOSAL AT THE COMMISSION'S MAY 24, 1995 MEETING Today's proposal represents a vision of the future of the electric industry in California and the steps needed to achieve that vision. This vision provides a transition that moves us from a highly regulated electric market with one natural monopoly towards a market having many different electric generation suppliers. This competition should result in long-term price reductions for all of California's consumers. It should also significantly increase the choice that consumers have to better control their energy usage and to be satisfied that they are getting the best prices. Today's proposal represents an evolutionary process that continually moves us toward that goal. To briefly summarize our proposal, we advocate establishing a central "pool", beginning on January 1, 1997, run by an independent party, that would serve as a central forum for all energy suppliers to compete against each other to meet California's electric demand. California's investor owned utilities would be functionally separated into transmission, distribution, and generation functions. Each utility's transmission services would be open on a non-discriminatory basis to all energy generators. This ensures that all generators can compete fairly against each other to meet California's energy needs. This competition between energy suppliers should promote competition and reduce cost. Our proposal recognizes the need to work cooperatively with the Federal Energy Regulatory Commission (FERC) to resolve jurisdictional boundaries. Our proposal also addresses the issue of the recovery of stranded costs, and stranded benefits, that may result in a movement towards a competitive marketplace. In our original proposal issued almost 15 months ago, known as the "blue book", the Commission proposed providing consumers with greater choice in choosing their electric generating source. The Commission called this option "direct access". Many consumers in our public hearings also voiced their interest in greater choice as well. Although still committed to the goal of direct access for all consumers, the results of the Commission's hearings and investigations over the past 15 months have shown that a number of issues still must be resolved before this can happen. Our proposal, however, will provide electric consumers with essentially the same amount of choice and flexibility through a combination of "Virtual Direct Access" and "contract- for-differences." Virtual Direct Access allows consumers to better control their energy usage and the price they pay. It consists of equipping customers with real-time meters that allow them to track, and be billed for, their energy usage hour-by- hour. Combined with the publicly available price information from the pool that our proposal also will establish, customers can tell what their hourly energy costs and usage will be and adjust accordingly. The proposal would phase in real-time metering to all consumers within 6 years starting on January 1, 1997. "Contracts-for-differences", also allowed under our proposal, are financial contracts that consumers can sign with energy producers, marketers, or brokers. These contracts will allow end-users to lock-in fixed energy prices if they desire. Thus, customers are given increased flexibility to control their overall energy costs by either buying power from the pool at hourly prices or signing up for longer term contracts at fixed prices. Thus consumers are allowed to control their overall energy costs by constructing a portfolio of short-term energy purchases from the pool, long-term fixed price purchases through contracts-for-differences, and at the same time conduct appropriate energy conservation and load-shifting investments. In order to further promote competition in the wholesale portion of the electric industry, today's proposal establishes a single pool that would act as a marketplace to match energy supplies with energy demand. This pool would operate in much the same way that the New York Stock Exchange provides a ready-made marketplace for the trading of stock to occur. This central, organized "pool" that would run by an Independent System Operator (ISO) that would be independent from any of the utilities. This pool would 1) act as a central marketplace for parties wishing to buy and sell electricity 2) establish a market-clearing price for all electric energy based on an auction 3) dispatch all electric generation resources in an economically efficient manner and 4) ensure and maintain system reliability. The competition between all electric generators trying to sell their power into this central pool should result in lower prices for energy. The pool would provide all energy users with transparent prices that reflect the variation in electric prices that occur both hourly and seasonally. The pool would also take into account transmission constraints in dispatching power. Unlike many other commodities, there is a greater need for central coordination and control in the electric system due to the need to maintain system reliability and to match electric load with demand on an almost instantaneous basis. This central pool system is similar in many respects to the system that the United Kingdom chose when it restructured its electric industry. Participation in the pool would be required for California's three investor-owned utilities (Southern California Edison, San Diego Gas & Electric, and Pacific Gas & Electric). It is hoped for that California's municipal electric utilities (such as the L.A. Department of Water & Power or Sacramento Municipal Utility) would voluntarily want to join the pool in order to receive its economic benefits. Combined with out-of- state utilities and independent energy providers, we hope to see increased competition in the electric generation sector. Today's proposal would change how today's electric utilities would be organized. The generation, transmission, and distribution functions of each investor-owned utility would be separated into different functional units. Our proposal also asks for comment on whether each of these functions should be put into separate independent subsidiaries. Under our proposal; o The distribution function would remain under Commission regulation and continue to provide local distribution services to all consumers; o The transmission function would offer open and non- discriminatory access to all energy providers under FERC- approved tariffs; and, o Each utility's generation function would also be separated. These actions, combined with FERC's recently announced open- access transmission rules, should ensure that transmission services are available on a non-discriminatory basis to all energy providers. This will eliminate the concern that existing utilities have used their control of the transmission system to limit access to competing generators. An open transmission system has been anologized to the effect that freeways and the Interstate Highway system have had in promoting competition and reducing prices by improving the movement of goods between areas, Today's proposal anticipates similar changes in the electric industry. Under the proposal, it is suggested that each of California's investor-owned utilities will voluntarily choose to set up separate transmission subsidiaries and then combine them into a single joint venture that would operate an integrated transmission system throughout California. The proposal would continue to honor any already existing wholesale transmission contracts. There is a valid concern, however, that the current investor-owned utilities may have significant market power in electric generation in any pool that is established, particularly given transmission limitations. This has been a problem with the operation of the United Kingdom's pool. Accordingly, our proposal asks for comment on the need to have each utility divest itself (either through a spin-off or sale) of a sufficient portion of their generation assets (excluding nuclear and hydroelectric power plants) in order to ensure a competitive marketplace. Ideally, the results of this divestiture would meet both FERC's and the Department of Justice's criteria for what constitutes a competitive marketplace. Transition Cost Recovery The blue book stated the Commission's proposal that the utilities should retain a reasonable opportunity to recover all past prudently incurred expenses that they made under their traditional obligation to provide utility service. The blue book proposal identified that some of these costs were "uneconomic" in today's more competitive environment and proposed to collect the costs of these "uneconomic assets and obligations" through a Competitive Transition Charge (CTC). The proposal identifies three different type of transition costs that need to be collected; (1) the costs of uneconomic utility assets; (2) above-market prices paid to third-party power producers under long-term QF contracts and (3) regulatory assets such as deferred taxes. The full cost of regulatory assets and the portion of QF contract costs that are above market rates will be classified as transition costs and collected yearly through the CTC charge. Uneconomic utility-owned assets are expected to consist primarily of each utility's nuclear power plants. In order to mitigate the amount of CTC that would need to be collected, the proposal bundles each utility's high-priced nuclear and low-priced hydro assets together. The proposal asks for comments on if this provides sufficient recovery of the utility's uneconomic nuclear costs or if additional CTC recovery is needed. For the utility's fossil-fueled and geothermal assets, the proposal would provide a floor and ceiling on the rate-of-return that the utility could make for any of these power plants. Our initial proposal is to use the utility's authorized rate of return with a floor and a cap of 150 basis points in either direction. If a utility is required to sell off any of its power plants in order to address market power concerns, the difference between the plant's sale price and its book value will be used to determine the level of CTC. Stranded Benefits Today's proposal reaffirms California's commitment to the continued funding of social programs (such as low-income ratepayer assistance) and energy efficiency programs. These programs are proposed to continue and to be funded by a surcharge on electric bills. The proposal also envisions working with the Governor's Office, the Legislature, and all interested parties to evaluate future funding mechanisms for these programs if necessary. Energy diversity through the use and development of renewable energy is also maintained by requiring that a portion of any new energy demand is met through the use of these energy sources. The following briefly describes the proposed steps that will lead to increased competition and reduced rates. 1. Establishment of open, non-discriminatory access to all transmission services as recently proposed in FERC's NOPR. 2. Separation of the existing vertically-integrated utility into separate functional units for generation, transmission, and distribution. 3. Establishment of a "pool" (or central marketplace), no later than January 1, 1997, that would set the market- clearing price and carry out the economically-efficient dispatch of all electricity. 4. All California investor-owned utilities would join the pool. California's municipally-owned utilities and other out-of-state utilities encouraged to join to receive the pool's benefits. 5. Comment on the need to address market power in the generation of electricity through the disaggregation of each utility's non-nuclear and non-hydro generation into several separate entities. 6. Develop methods to ensure recovery of each utility's reasonably incurred economic costs and obligations that may now become uneconomic due to increased competition. 7. Work with Governor's office, State Legislature, and all interested parties to achieve our recommendations for the continuation of social programs, energy efficiency programs, and energy diversity and renewable energy goals currently being carried out by the utilities. 8. Real-time metering capability for all customers phased in over the next six years. 9. "Virtual Direct Access" for all customers. Customers know their hourly energy usage and its hourly price. Contracts for differences allow customers to enter into financial contracts with generators, marketers, and brokers to lock in fixed prices. 10. Direct physical, bilateral contracts between end-use consumers and generators allowed once the Commission has resolved all jurisdictional, market power, and transition cost issues, not sooner than January 1, 1999. Bi-Lateral Contracts Why not move on directly towards bi-lateral contracts immediately? As stated, allowing bi-lateral contracts raises a number of issues that need to be resolved first. Secondly, I believe that allowing bi-lateral contracts too early would allow for the benefits of competition to be gained solely by large users. I believe that it is better to have all energy providers bidding into the pool. This should keep the pool price lower than it otherwise would be, thereby benefitting all other consumers. Virtual Direct Access, combined with contracts-for-differences can provide the same benefits that large users desire. Conclusion We are looking forward to making a final policy decision in the next few months so we can get the pool started, hopefully no later than January 1, 1997. This will allow for consumers to enjoy the benefits of virtual direct access and contracts-for- differences as we phase in the use of real-time metering. Hopefully, we can then move on to allowing direct physical bilateral contracts between parties sometime around January 1, 1999. Real-time metering should be available to all consumers by January 1, 2003.