Electric Industry Restructuring 1 Electric Industry Restructuring Statement of Henry M. Duque, Commissioner Statement of Henry M. Duque, Commissioner I am pleased that today we are considering two proposals for restructuring the electric industry in California. In my short time on this Commission, I have heard the strong concerns about high California electric rates from residential, commercial, agricultural, and industrial customers. I believe that reforms are needed. I commend President Fessler for sponsoring a detailed proposal that would create a wholesale-power-pool for ____________________ electric power throughout California, thereby replacing regulatory oversight with market forces.1 I commend Commissioner Knight for sponsoring a similarly detailed proposal that calls for a direct transition to a retail market, where consumers of electricity have a direct-access- ______________ market linking them to generators who sell power directly to ______ consumers.2 The thoughts contained in these proposals advance this regulatory process both by clarifying the choice that the Commission makes today and by systematically delineating many of the policy choices that the Commission must still make. I face the difficult choice of designating one of these proposals as the proposed policy decision that will become the primary focus of further inquiry, hearings, and comment. Although these proposals have many features deserving support, both the wholesale-power-pool and the direct- access-market proposals offer many additional policy proposals beyond the choice of wholesale pool or direct access market structure. These policies could have profound consequences for California s consumers of electricity and for the shareholders of Pacific Gas and Electric (PG&E), San Diego Gas and Electric (SDG&E), and Southern California Edison (SCE). I am issuing this statement because I have substantial reservations that prevent my full endorsement of several of these proposed policies. I take this opportunity to identify to the parties in this proceeding my most serious reservations. I hope that the next round of comments will provide additional information that will aid my deliberation. My concerns fall into four areas: The divestiture of the generation assets of California s investor owned utilities; (The direct- access-market proposal relies explicitly on the implementation of this step while the wholesale- 1 This statement will refer to President Fessler s proposal as the wholesale-power-pool. ____________________ 2 This statement will refer to Commissioner Knight s proposal as the direct-access-market. ____________________ Statement of Henry M. Duque on Electric Industry Restructuring power-pool proposal articulates it as an option for 2 correcting what is termed the horizontal market concentration problem. My own view is that we are not yet in a position to gauge the dimension of the power market against which the issue of concentration could be measured. I thus underscore the discussion in the wholesale-power- pool decision which acknowledges the need for further information before entertaining such significant changes with respect to the utilities asset structure.) The uncertainties arising from the Federal Energy Regulatory Commission s (FERC) extensive regulation of wholesale markets and power pools for electricity and electric transmission systems; Implementation issues concerning the sequencing, timing and operations of the wholesale-power-pool; and The consequences that specific proposed policies will have for utility shareholders, energy social policies, and the rates paid by California consumers of electricity. Is the Immediate Divestiture of PG&E s, SDG&E s and SCE s Is the Immediate Divestiture of PG&E s, SDG&E s and SCE s Generation Facilities Necessary, Prudent, or Practical? Generation Facilities Necessary, Prudent, or Practical? The largest economic uncertainties identified in the record of this proceeding are the magnitude of the costs of uneconomic power generated by investor-owned utilities and the magnitude of the costs of above-market contracts for power produced by electric generators known as Qualifying Facilities or QFs.3 When competition in the provision of electric power starts, utilities may find themselves unable to recover the cost of uneconomic generating plants or unable to pay the costs of QF contracts that offer power at rates far above market levels. These costs would become stranded -- left high and dry as the tide of competition moves out. Concerning this issue of stranded costs or transition costs (as they are called in both proposals), I have learned in my review of the record that hearings conducted by the California Public Utilities Commission (CPUC) indicate that experts can differ by tens of billions of dollars in their assessment. In my view, both the proposal for a wholesale- 3 The range of estimates included some projections that utilities could dispose of their generating assets for a net gain. If that is the case, there are no stranded costs -- there would be gains. Instead of the difficult transition problems discussed above, the CPUC would instead face the regulatory task of allocating the gains from the sales of generating plants -- a difficult but very different task. Statement of Henry M. Duque on Electric Industry Restructuring power-pool and the proposal for a direct-access-market 3 entertain regulatory policies for evaluating and collecting these transition costs that carry grave risks for Californians and utility shareholders. One regulatory action considered seriously by each proposal is to order that utilities immediately (or quickly) divest themselves of generating assets through either an auction or a spin-off. Both the proposal for a wholesale- power-pool and the proposal for a direct-access-market reason that an auction or spin-off will yield market values that enable a fair evaluation of the transition costs. Moreover, this divestiture will speed the way to a competitive market where no single participant has inordinate power. I have serious reservations concerning both the auction and spin-off strategies. I believe that because of specific market conditions that prevail at this time, each alternative will yield a value that overstates the level of stranded costs. Auctioning PG&E s, SDG&E s and SCE s generating assets at this time is unwise. The Western energy market is now glutted with generating capacity. Moreover, since no one has any experience with the new wholesale-power-pool or direct-access-market, predictions of electric prices will surely be fraught with uncertainty. The uncertainty about the prevailing prices for electricity will depress the selling price of power plants. In addition, the simultaneous sale of billions of dollars of utility generating plants could, in my judgment as a former banker, stress regional capital markets. This will result in still lower prices for the power plants. The transition costs that such an auction would yield may likely overstate the true level of stranded costs. Thus, this first step to create a competitive market for electricity could lead to regulatory-induced costs that further harm Californians who already pay electric rates that are too high. The proposal to calculate transition costs by spinning- off generating plants into a different company and observing the values of the resulting stock would have no better chance of accurately measuring the stranded costs of power plants. Since a stock price largely reflects a future earnings stream, once again the uncertainty arising from the lack of experience with either the wholesale-power-pool or the direct-access-market for electricity would depress stock values. In addition, stocks have a volatility that would introduce a large random element into their value. Once again, divestiture would likely include a regulatory-induced cost that results in an over-estimate of the underlying stranded costs. These risks of divestiture are too high for California Statement of Henry M. Duque on Electric Industry Restructuring consumers at this time. Moreover, I believe that these 4 regulatory-induced transition costs could easily consume all the benefits of the CPUC s efforts to reform how electricity is bought and sold in California. I will not support any restructuring proposal until I am sure that it will not increase rates for electricity. Both the proposal for a wholesale-power-pool and for a direct-access-market conclude that a one-time administrative process to determine the level of stranded costs for generating assets is inappropriate. In attempting to determine the level of stranded costs through an administrative process, the CPUC would face all of the uncertainties that buyers of utility assets or spun-off stocks would face. The CPUC has little expertise with auctions or stock evaluation. I concur with the analyses of both proposals that this course of action is unwise. But what about the proposed treatment for the uneconomic contracts for power that utilities entered into with QFs under the direction of the CPUC? At this time, estimates of stranded costs associated with these assets also vary by billions. Both the proposal for a wholesale- power-pool and the proposal for a direct-access-market suggest a yearly administrative true-up or evaluation process that would compensate utilities for the difference between the price of QF contractual power and the prevailing market rates, nearly identical to the practice followed today. It may ultimately be the case that the level of stranded generation costs are best assessed by an annual comparison of generation costs with market prices using the same prevailing market rates that are integral to evaluating the transitions costs arising from the QF contracts. In addition, I note that the CPUC has adopted several targeted performance-based regulatory programs that currently reward utilities for controlling costs or for improving performance as measured against a market standard. A yearly review could use prevailing market rates for electric power as an integral part of a performance-based ratemaking mechanism for generation. This mechanism could provide incentives to a utility for superior performance. This strategy to manage transition costs should speed utility generation costs to market-level prices. Finally, even if I were confident that the CPUC could accurately determine the level of stranded costs, I am reluctant to make the unprecedented decision to order divestiture of the generating assets of PG&E, SDG&E, and SCE without a legislative endorsement and the firm belief that this step is necessary. At this time, I have neither. For these reasons, I seek further comments on these matters. I especially desire comments that identify in more Statement of Henry M. Duque on Electric Industry Restructuring detail alternatives to the divestiture of generating plants 5 discussed in both the wholesale-power-pool and the direct- access-market proposals. I am particularly interested in learning more concerning performance-based ratemaking proposals that reward generating plants for improved economic performance. I also desire methods for calculating transition costs that in a given year use observed market prices for power. Do Jurisdictional Ambiguities between the CPUC and FERC Do Jurisdictional Ambiguities between the CPUC and FERC Require Resolution Before Adopting Either Proposal? Require Resolution Before Adopting Either Proposal? As I examine FERC documents and read the many filings made by parties in this proceeding, I see major jurisdictional issues that cast great uncertainty over this entire process. It appears that these issues affect both the proposal for a wholesale-power-pool and the proposal for a direct-access-market. It appears clear that if the CPUC creates a wholesale- power-pool, FERC will set the prices for the power sold through the pool. This raises a set of critical questions. Will the prices set by FERC support the pooling dispatch plans envisioned in the proposal for a wholesale-power-pool? In particular, can the CPUC reasonably assume that the FERC pool will dispatch nuclear and QF power without regard to price? Further, can the CPUC assume that FERC will honor the Diablo Canyon Settlement the CPUC considers today, the potential settlement to accelerate the depreciation of San Onofre Nuclear Generating Station, and the plans to permit recovery of the transition costs that result from existing obligations to purchase power from QFs at above market rates? Will FERC agree to the payment schedules needed to make the wholesale-power-pool operate at a common price? Moreover, since it appears that all generation assets will become dedicated to wholesale power sales, can FERC claim that the transition costs are stranded by the mechanism of the wholesale pool and thus subject to FERC authority? The proposal for a direct-access-market clearly spells out the jurisdictional issues concerning direct access or retail wheeling. As the discussion in the comments filed here and in FERC proceedings make clear, there is no bright line that currently separates transmission (and FERC jurisdiction) from distribution (and CPUC jurisdiction). Once again, I have serious questions. Does this ambiguity require resolution before proceeding to create this direct- access-market? When might we expect a clear resolution from FERC? I am interested in comments that address these questions. In particular, I desire to learn of regulatory approaches that enable California to move generation prices to market levels while California continues to honor its past commitments to power producers. I especially desire to Statement of Henry M. Duque on Electric Industry Restructuring avoid introducing regulatory uncertainties that would 6 undermine recent CPUC actions to address the high cost of nuclear facilities. In conclusion, I do not believe that Californians would gain if electric industry restructuring simply transferred the stranded cost problems of California s utilities from state to Federal regulatory forums. California can best address these problems itself. How Can the CPUC Implement these Proposals? How Can the CPUC Implement these Proposals? The proposals for a wholesale-power-pool and for a direct-access-market present two broad visions of how to achieve the goal of an electric industry dominated by markets, not regulation. There are similarities and sharp differences contained in these visions. I share the goal of each, but the vision of neither. Each proposal envisions a route that leads in the direction of this goal of an open market, but many of the steps on the implementation routes remain unclear. I need to know more about the implementation steps to which I am committing Californians. My implementation concerns embrace many issues. I outline a few of the principal ones here. To what extent must a calculation of stranded cost precede the institution of an electric market? Would it be more prudent to evaluate stranded costs only after market prices are observed? In the proposal for a wholesale-power-pool, why must all power be sold through the pool? In particular, since nuclear, QF, and hydroelectric resources will operate outside the dispatch and payment mechanisms of the pool, why cannot the wholesale-power-pool function without these resources? Since each proposal requires sophisticated metering, what problems or difficulties can the CPUC and utilities anticipate in the development of new systems of meter reading and billing? Could problems affect the speed of implementation? Does the choice of a wholesale-power-pool pre-empt, delay, or hasten a move to a retail market? What are the next steps that the CPUC should take to implement either proposal? The answers to these implementation questions will help me determine the course of action that holds the most promise for California. How Will the Implementation of Either Proposal Affect How Will the Implementation of Either Proposal Affect Shareholders of California s Utilities, California s Energy Shareholders of California s Utilities, California s Energy Policies, and Californians Electric Rates? Policies, and Californians Electric Rates? The basic goal of any Commissioner is to fulfill the duties embedded in the Public Utilities Code. Broadly speaking, the Public Utilities Code embodies statutory Statement of Henry M. Duque on Electric Industry Restructuring obligations to provide an opportunity for utility 7 shareholders to earn reasonable returns, to institute specific social programs and energy policies, and to set policies that produce reasonable rates for electricity. In meeting my statutory duties, I am mindful of the obligations of regulators to those who finance and own California s electric infrastructure. Indeed, the infrastructure made possible by those investments benefits all Californians. For this reason, I desire to know more fully how the two proposals for restructuring electric markets will affect stock and financial markets. The proposals for a wholesale-power-pool and a direct- access-market discuss in detail the social programs and energy policies that are embedded in the current regulatory system. There is little that I can add to these discussions. I will read with interest comments on the recommendations concerning these programs and policies. Concerning these proposals to restructure the electric industry, Californians want to know how the CPUC s efforts will affect their monthly electric bills. Although I share the belief in the efficiency of markets that informs both proposals released today, I note that both exempt the high- cost nuclear power of utilities and the high-priced power sold by QFs from any market test. These sources of power constitute the bulk of a utility s generating costs. Even if the rates for power from all other sources of electric power fall, I can anticipate little immediate change in California s rates for electricity. I welcome comments that describe the efficiencies these proposals will yield now and in the years to come, and comments on how these changes will affect the bills of customers. Conclusion: Will This Proceeding Yield Lower Electric Rates? Conclusion: Will This Proceeding Yield Lower Electric Rates? The CPUC began this inquiry because high rates for electricity paid by all Californians have shaken our belief in the efficacy of traditional cost-of-service regulation. Since the start of this proceeding, PG&E, SDG&E, and SCE have committed themselves to lowering rates by their own actions. This brings me to the final and most important question: How much further will the two proposed policies lower rates? May 24, 1995 San Francisco, California Statement of Henry M. Duque on Electric Industry Restructuring