BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA Order Instituting Rulemaking on the ) Commission's Proposed Policies ) Governing Restructuring California's ) R. 94-04-031 Electric Services Industry and ) Reforming Regulation ) ) Order Instituting Investigation on the ) Commission's Proposed Policies ) Governing Restructuring California's ) I. 94-04-032 Electric Services Industry and ) Reforming Regulation ) OPENING COMMENTS OF INDUSTRIAL USERS ON BLUE BOOK POLICY ISSUES (ROUND III) I. Introduction In the next two rounds of comments, the Commission turns its attention to the basic components of the fully competi- tive electricity market which is the focus of the Blue Book vision. Industrial Users1/ believe the Commission's disposition of the wholesale market and direct access issues presented will 1. The Industrial Users intervenor group is comprised of Airco Industrial Gases; Air Liquide America Corpora- tion; Air Products and Chemicals, Inc.; Amoco Chemical Company; Anheuser-Busch Companies; The Chevron Compa- nies; Dow Chemical USA; Eastman Chemical Company; Ford Motor Company; General Motors Corporation; Hughes Air- craft Company; Kimberly-Clark Corporation; Libbey- Owens-Ford Company; Liquid Carbonic Industries; Nabisco, Inc.; New United Motors Manufacturing Company (NUMMI); Owens-Corning Fiberglas Corporation; Praxair, Inc. and Steelcase, Inc. 1 largely determine the success or failure of the effort to imple- ment that vision. With respect to the role of the wholesale market, In- dustrial Users share the view of many stakeholders that a compet- itive wholesale market, by itself, will not produce the benefits the Commission seeks to bring to California via the restructuring process. Those benefits will not materialize until market prices are subjected to the ultimate test of the vast pool of buyers which only direct access can bring into play. Accordingly, direct access is the indispensable element of the blueprint for attainment of the Commission's OIR goals. With respect to the form and structure of the wholesale market, Industrial Users believe that robust wholesale competi- tion abounds and that the institutions and mechanisms required for the transition to direct access are already in place. Ac- cordingly, the Commission's appropriate course in the wholesale sector, by and large, is to forego any regulatory action and to leave to market forces the development of any additional market structures or mechanisms. Indeed, were it to heed the advice of some stakeholders to design and impose entirely new wholesale market structures, the Commission would not only delay the imple- mentation of direct access, but would also run the risk of under- mining rather than enhancing competition. That conclusion is amply supported in the comments al- ready presented in both the Yellow Book and Blue Book proceed- ings. Compelling testimony in support of the "hands off" ap- proach to the wholesale market was also presented by several par- ties, including Pacific Gas and Electric Company (PG&E) at the recent hearings (July 13-15, 1994) of the House Subcommittee on Energy and Power. Industrial Users strongly urge the Commission to forge its wholesale market policy in the light of the persua- sive comments offered by PG&E and a broad range of other parties. 2 The ultimate challenge for the Commission in this context is to jettison the outdated and ineffective "central planning" mode and to entrust the further development of the competitive electricity market to the competitive forces already at work. II. Discussion A. A Competitive Wholesale Market, Though an Important Component of the Restructured Electric Services Indus- try, Will Not By Itself Assure Attainment of the Com- mission's OIR Goals. The Assigned Commissioners' Ruling of July 8, 1994 frames several questions for Round III of the Commission's re- structuring policy deliberations. Among the issues posed is the question "whether the development of a competitive wholesale market alone is sufficient to meet the objectives of the Commis- sion." Ruling, p. 2. This question unavoidably anticipates the issue of the role of direct access in the implementation of the Commission's vision, the subject of the not-yet scheduled Round IV. Industrial Users will reserve the bulk of their comment on direct access for that next round. However, it is essential, even for the purposes of the Commission's Round III review of wholesale market issues, that this threshold question be ad- dressed. Several stakeholders in this process, most notably, Southern California Edison Company (Edison) and San Diego Gas and Electric Company (SDG&E), contend that the Commission should, indeed must, intervene to superimpose a new government-mandated wholesale power pool. These parties propose the Commission at- tend to the creation of elaborate wholesale market structures before committing to anything at all on the demand side of the market. 3 Industrial Users urge the Commission to reject the counsel of these parties. Their suggested wholesale market changes will not in fact bring the necessary rate relief to Cali- fornia's electricity consumers. To the contrary, such relief will materialize only when there is a valid market test of the prices the utilities pay for their purchased and generated power. Further, that market test will become a reality only when consum- er choice comes into play via direct access. These fundamental principles are borne out in the les- sons of the restructuring experience in the natural gas industry. In the late 1970s and early 1980s, there was abundant competition at the wellhead among the producers selling gas but, for all practical purposes, pipelines were the only purchasers. In that framework, consumers did not receive the benefits of true compe- tition. Such benefits were denied because pipelines had little incentive to reduce their purchase costs. There was also no com- petitive market test or frame of reference to allow a regulator to determine if the prices paid by pipelines were reasonable. The key ingredient lacking in that phase of natural gas restructuring was the element of direct access. As the FERC made open access an increasingly real alternative beginning in the early 1980s, the prices paid by consumers for natural gas began to fall -- not only for the customers exercising their access rights but also for those who continued to buy pipeline-purchased gas as local distribution company (LDC) customers. This occurred because direct access provided a market test of pipeline purchas- ing practices. The ability of other parties to purchase gas at prices lower than those paid by pipelines created a real incen- tive for pipelines to reduce their costs. In the absence of open access, that kind of competitive pressure simply did not exist. Despite this experience in natural gas markets, some would have the Commission believe that California's electric 4 utilities do not need a market incentive to minimize their pur- chased power costs. Rather, they suggest that as long as the wholesale market is competitive, the utilities will always act in the best interests of their customers. The shaky and illusory character of that premise is painfully clear in the fact that the rates of California's investor-owned utilities are among the highest in the nation. It is simply not enough to concentrate on further improvements in the one area of the electricity industry where competition is already a reality while ignoring the need to foster demand-side competition, the only source of the market test that will assure lower electricity prices and rates. As stated in the July 13, 1994 testimony of the Electricity Con- sumers Resource Council (ELCON) before the House Subcommittee on Energy and Power: [T]he establishment of a wholesale-only electrici- ty market will not in any way assure economic benefits for ultimate customers. As long as buy- ers in wholesale markets know that their customers are captive, they have neither the motivation to purchase the lowest cost power, nor the incentive to pass through the benefits of competition to ratepayers. . . . Direct access is necessary to assure both an efficient and effective wholesale market and benefits flowing through to ultimate customers. Testimony of Dr. John A. Anderson (ELCON Executive Director), pp. 34-35. Addressing the wholesale market pool proposals advanced by other parties to this proceeding, PG&E expressed a similar view before the House Subcommittee: Because of the high level of efficiency and coor- dination which already exists, we believe that im- posing a government-mandated power pool would not provide additional efficiency benefits for consum- ers. Under the most advanced and complex propo- sal, even if new benefits could exist, real, wide- spread consumer benefits from the creation of a wholesale pool would start to accrue only after a major investment is made in time-of-use metering and other hardware. It would seem to require a 5 suspension of reality to believe that a regu- lator mandated, designed and approved whole- sale pool would be more economically effi- cient than customer choice under direct ac- cess. In short, a new wholesale pool may simply have the effect of delaying for many years consumer choice and the consumer bene- fits which can result from beginning an or- derly transition to direct access today. Testimony of PG&E Executive Vice-President Robert D. Glynn, Jr., pp. 5-6.2/ In sum, the already adequately developed wholesale market is not sufficient in itself to foster full competition. The key ingredient still to be supplied is direct access. It is that facet of the restructured industry and regulatory framework which should become the primary focus of the Commission's efforts in this proceeding. B. The Commission Should Leave to the Market Itself the Further Development of the Already Highly-Competitive Wholesale Market. Attainment of the goal of a fully competitive electric- ity market requires a large number of players on both the supply side and the demand side of the market. To California's great good fortune, robust competition is already up and running on the supply side of the market. As stated by PG&E's witness in the recent hearings before the House Subcommittee on Energy and Power: 2. The course of action advocated by ELCON and PG&E is consistent with a basic restructuring guideline offered by Dr. Philip R. O'Connor in last year's Yellow Book proceedings. Testifying at the Commission's May 25, 1993 full panel hearing, Dr. O'Connor testified: "[T]he focus ought to be on flowing through competitive forces from those segments of the market where there is competition or can be competition to those segments of the market where there isn't." Transcript, pp. 11-12. 6 We agree that wholesale competition is a desirable first step and, in fact, we believe that such a market already exists in the West. We are already blessed with one of the most fully functioning and open wholesale pooling infrastructures in America -- the Western Systems Power Pool. PG&E and about 30 other entities, including brokers, independent power producers, and municipal utilities, recently filed to create the Western Regional Transmission Association, which will further enhance system planning, coordination and operation. Testimony of PG&E Executive Vice President Robert D. Glynn, Jr., p. 5. The Commission itself has recognized the extensive com- petition in today's wholesale electricity market. As stated in the OIR: Many of the institutional and contractual arrange- ments, financial instruments, and information sys- tems necessary to support direct access and retail competition in the electric services industry al- ready exist, and continue to develop, just as they have in the natural gas and telecommunications in- dustries. OIR, p. 15; emphasis added. The burgeoning competition addressed in these state- ments surely will continue to develop in the years ahead. Equal- ly certain is the fact it will do so without this Commission's intervention. Indeed, the central issue here is the importance of allowing the market participants themselves to devise and develop any necessary structures or mechanisms rather than for the Commission or any other external entity to simulate competi- tion. However tempting the opportunity to influence the develop- ment of the market, whether in reliance on the experience in other countries or various projections of the "perfect" market structure, there is more potential mischief than good in such an approach. A broad range of parties have commented to that effect in the restructuring proceedings to date. For example, Pacific 7 Power and Light Company (PP&L), a well-versed participant in wholesale electricity markets, comments: Pacific Power believes the Commission should take pains to avoid being prescriptive in establishing any form of market. Freed of regulatory con- straints, an efficient market can be expected to develop in response to market forces. Opening PP&L Comments (Round I), p. 3. PP&L's comments were echoed in PG&E's testimony before the House Subcommittee on Energy and Power. Addressing the im- portant role of marketers and brokers and the need for financial hedging mechanisms in the restructured electricity market, Mr. Glynn testified: The market must be allowed to develop with minimal regulatory prescription. This will occur once direct access becomes a reality. Glynn Testimony, p. 5; emphasis added. In his testimony before the Subcommittee, Dr. Anderson of ELCON observed in similar fashion: ELCON's understanding of the proposals for a wholesale-only market suggests that similar prob- lems would be forthcoming through the improper implementation of the U.K model in the United States. In a broader sense, proposals such as these actually are trying to force the design of the market. But markets can't be created as such. They will evolve only if people and government let them happen. Anderson Testimony, p. 34. In sum, the competitive wholesale market component of the restructured electric services industry is a fait accompli. There is no need for regulatory intervention as wholesale market institutions and mechanisms continue to evolve. To the contrary, any attempt to intervene in the process could seriously set back the implementation of the Commission's OIR vision. 8 III. Conclusion On the basis of the foregoing, Industrial Users urge the Commission to adopt a policy of restraint in addressing the wholesale market component of the new industry structure. The required wholesale market competition is already at hand and will continue to develop as the restructuring process goes forward. Attainment of the Commission's Blue Book goal ultimately hinges on the Commission's disposition of the direct access issue, and it is that issue that should now occupy the Commission's atten- tion. Indeed, an inexorable logic and momentum underlies the need to focus on direct access and retail competition. As inci- sively stated by Commissioner Knight in his July 14, 1994 address to members of the California Manufacturers Association: In my mind, those that think that the Commission can, in the words of Dr. Michaels at our first full panel hearing in L.A. 'quarantine competi- tion' to the wholesale market, seriously underes- timate market forces and their relentless attack on artificial market barriers. . . . Text enti- tled "A Commissioner's Perspective", p. 23. Respectfully submitted, Philip A. Stohr Ronald Liebert Downey, Brand, Seymour & Rohwer Attorneys for Industrial Users EAST-105474.1 9