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 ) on the Commission's Proposed Policies ) Governing Restructuring California's ) I.94-04- 032 Electric Services Industry and ) Reforming Regulation ) COMMENTS OF MAGMA POWER COMPANY ON THE ROLE, STRUCTURE AND EFFICACY OF COMPETITIVE WHOLESALE MARKETS Karen K. Edson Karen M. Peterson Edson + Modisette 1303 "J" Street, #770 July 26, 1994 Sacramento, CA 95814 ii TABLE OF CONTENTS Page I. Introduction and Executive Summary 1 II. Enhancement of the current wholesale market does not preclude implementation of retail wheeling but is a necessary step. 2 III. Existing wholesale arrangements are insufficient to achieve a truly competitive wholesale power market. A. State and regional wholesale power markets have only begun to organize and are not yet functioning. 3 B. The CPUC should support and encourage FERC approval of WRTA and full participation by California utilities. 4 C. The CPUC should immediately begin the process of requiring utilities to divest their generation assets. 5 D. The CPUC should begin immediately to unbundle generation, transmission, and distribution rates; apply the market price of generation to the identification of stranded costs; and allocate stranded costs between consumers and utilities. 6 E. The Commission should identify those policy programs that will be retained under the new market structure and determine how they will be achieved. 7 IV. The Commission should reject mandatory pool proposals. A. Buyers and sellers should be free to enter commercial arrangements suited to their individual needs. 7 B. Limitations of a mandated pool system are emerging in the U.K. 9 C. Allowing buy/sell arrangements outside of a pool serves as a "check" on pool pricing and dispatch protocols. 9 D. The competitive market is self-correcting. 10 E. Neither the potential for market abuses nor the need to require utility divestiture are eliminated by the creation of a mandatory pool. 11 F. Mandating a power pool would result in a regulatory system as cumbersome and confining as past regulatory schemes. 13 V. Conclusions 14 i 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 ) on the Commission's Proposed Policies ) Governing Restructuring California's ) I.94-04- 032 Electric Services Industry and ) Reforming Regulation ) COMMENTS OF MAGMA POWER COMPANY ON THE ROLE, STRUCTURE AND EFFICACY OF COMPETITIVE WHOLESALE MARKETS I. Introduction and Executive Summary Magma Power Company is a California-based company and one of the largest geothermal power developers in the world. The company is committed to supporting development of a competitive regional power market in the West which properly accommodates the need for diversity from renewable resources in the power generation system. Magma has actively supported efforts to create the Western Regional Transmission Association (WRTA), and its participation in this proceeding is further evidence of its commitment to creating new competitive opportunities in the electric power industry. 1 Magma urges the Commission to proceed systematically in its effort to develop a competitive electricity industry in California, whether the ultimate market is limited to wholesale transactions or also accommodates retail transactions. In either case, there is much to be done to ensure that: (1) consumers benefit from lower electricity costs, (2) competition in the generation market and movement of power over the transmission system are fair, regardless of the ownership of generation, (3) policies provide for resource diversity through continued competitive renewable resource development, and (4) California regulation is minimized to permit competitive markets to work. As requested, these comments focus on the steps Magma believes are necessary to reach a competitive wholesale generation market and the company's opposition to proposals for a mandated power pool. The company will address issues regarding retail wheeling in the next round of comments. II. Enhancement of the current wholesale market does not preclude implementation of retail wheeling but is a necessary step. The Commission should not assume that taking the necessary steps to develop a competitive wholesale power market precludes development of a retail power market. One does not preclude the other. Even if the Commission elects to develop and implement a retail wheeling program, there will be the need for a large, competitive wholesale power generation market to serve many if not the vast majority of California consumers. In any case, the 2 first logical step in the Commission's program is to develop a functioning, competitive wholesale market system. Thus, in identifying in these comments the steps that are necessary to implementation of a competitive wholesale power market, Magma does not presuppose whether or not retail wheeling will be part of the future market paradigm. At the same time, Magma has attempted to recommend steps which do not preclude such an outcome. III. Existing wholesale arrangements are insufficient to achieve a truly competitive wholesale power market. A. State and regional wholesale power markets have only begun to organize and are not yet functioning. Non-discriminatory transmission access for independent power producers does not exist in today's market. Only with the Biennial Resource Plan Update projects will there be significant movement of independently generated power other than by utility affiliates between and through California utility service territories. Moreover, the difficulty of obtaining transmission agreements hampers independent power access to municipal utility and out-of-state markets. Although the Energy Policy Act of 1992 (EPAct) clearly promotes the development of regional wholesale power markets, pricing policies and reforms are only now being developed. The first regional transmission group application by the Western Regional Transmission Association (WRTA) is still pending at 3 FERC. The agency only recently articulated its "comparability of service" standard for pricing transmission service to third parties and remains in the midst of its investigation of wholesale transmission pricing issues. Until these efforts mature, independent power producers will be left unable to compete even in a wholesale power market let alone a retail market. Magma recognizes that these issues are further complicated by questions of state v. federal jurisdiction. In addition, some parties to this proceeding prefer lengthy federal deliberations to relatively speedy state deliberations. That does not change the need to resolve these critical matters, however. While it may be tempting, as noted in comments by the cities of Burbank, Glendale, and Pasadena, to implement a California program which ignores FERC pricing jurisdiction by limiting the CPUC program to retail pricing issues, the result would be a piecemeal program that distorts the California market, fails to achieve competitive market benefits for all California consumers, and frustrates efforts to achieve a competitive retail power market. B. The CPUC should support and encourage FERC approval of WRTA and full participation by California utilities. While still tentative, critical progress has been made in recent years to opening up the West's regional power market to wholesale competition. Most notable among recent accomplishments is the development of the Western Regional Transmission Association (WRTA). A description of WRTA prepared by PacifiCorp clearly summarizes the association's purposes: 4 An RTG provides a prospective transmission user with a process that will result in a transmission service contract even when bilateral discussions between a transmission provider and a transmission user break down. Information sharing and coordinated planning will create an environment for collaborative action and minimization of disputes. Dispute resolution process (sic) provides a mechanism for enforcing the service obligation accepted by the RTG members. By using regional resources and established regional practices, the RTG is expected to lower the cost and reduce the time necessary to bring transmission service requests to completion. An RTG such as WRTA is an appropriate vehicle for development of fair and open transmission access in that it minimizes government intervention in the marketplace and avoids the jurisdictional issues implied by other access schemes.1 Further development of the WRTA holds promise for fulfilling many of the elements necessary for healthy wholesale market development, as recognized by the CPUC in its April 20th OII/OIR Proposal. Magma notes, however, that one of California's key players -- Southern California Edison Company (SCE) -- is not a member. In addition, WRTA has not yet been approved by the Federal Energy Regulatory Commission (FERC). Commission support and encouragement could significantly strengthen WRTA's development. C. The CPUC should immediately begin the process of requiring utilities to divest their generation assets. In today's market, total freeing of the transmission system would not achieve a truly competitive generation market given the 1The Commission's authority to establish a wholesale pooling mandate, for example, appears highly uncertain given that the Federal Power Act clearly gives the F.E.R.C. authority to regulate wholesale transactions. 5 enormous conflict of interest that exists with utility purchasers also competing to build power plants, sell power, and earn a return on investment. This is why so many consumer interests have joined independent power producers in calling for utility divestiture of their generation assets. Divestiture would, in addition to eliminating an obvious conflict of interest and the need for heavy-handed market regulation, establish a benchmark for defining utility stranded costs. Both are essential objectives in either a wholesale or retail market. D. The CPUC should begin immediately to unbundle generation, transmission, and distribution rates; apply the market price of generation to the identification of stranded costs; and allocate stranded costs between consumers and utilities. Magma agrees with the Division of Ratepayer Advocates that the Commission should begin as soon as possible to unbundle current electric rates to provide market signals for the full range of electric generation, transmission, and distribution services. Such information is critical to the separate transmission and generation service choices that must be made in a wholesale market. Also critical is the identification of uneconomic utility assets as is development of policies governing the allocation of these costs between consumers and utilities. How these costs are collected may change in the event that retail wheeling is implemented, these initial steps remain essential 6 under either wholesale or retail wheeling. Unless these steps are taken, the CPUC will fail to create a competitive wholesale market or to lower electricity costs for California consumers. E. The Commission should identify those policy programs that will be retained under the new market structure and determine how they will be achieved. The Commission has already entertained separate comments on whether and how the State's social and environmental policies should be maintained in a restructured market. Parties have submitted a variety of comments on the importance of resource diversity through continued renewable resource development as well as the reasons for maintaining Low Income Ratepayer Assistance and other programs through a charge on all electricity consumers. Given the diverse nature of these programs, the array of constituencies affected by them and existing mandates, the Commission must begin now to identify those programs that will be retained under the new market structure. Magma believes that State policy objectives can be implemented under either a wholesale or retail market structure; the means to achieve them simply changes. IV. The Commission should reject mandatory pool proposals. A. Buyers and sellers should be free to enter commercial arrangements suited to their individual needs. In responding to the question of what type of market institutions and arrangements the Commission should establish to 7 foster a more competitive industry, several parties including SCE and San Diego Gas & Electric Company advocate creation of a mandatory Pool. The proposals are similar in concept to the centralized wholesale pool devised and implemented in the United Kingdom in which all electricity trading is centralized in a single arena and in which individual transactions may be enhanced via contracts for differences. Magma opposes creation of a mandatory pooling structure. A successful competitive market structure requires buyers and sellers to be free to enter commercial arrangements suited to their individual needs. A mandated Pool, whether in the context of a wholesale competitive market or as an institutional underpinning of direct access, unnecessarily restricts free market activity by creating essentially a single reference price for electricity and tying all transactions to a single arena. Magma agrees with the New York Mercantile Exchange's (NYMEX) position that the Commission should seek to implement a structure that gives market participants' the freedom to negotiate terms, conditions, and price. That is not to say that pooling is undesirable. Pooling will likely emerge as the result of market participants' needs and the physical constraints/opportunities on the transmission system just as the Western States Power Pool and the New England Power Pool (NEPOOL) emerged within the traditional vertically integrated industry. 8 Indeed, it is possible that several types of pools would emerge in a competitive market serving both a clearing function and providing price reference information. Pooling, for example, could easily emerge to facilitate short-term or spot transactions. By providing near-term and real-time reference prices, such a sub-market would likely be an integral aspect of system stability. In addition, renewable generation pooling could facilitate sellers or buyers' meeting continuing diversity requirements, as recommended by Magma. The balance of Pool versus non-Pool trading, however, would depend upon the needs of buyers and sellers in the marketplace. B. Limitations of a mandated pool system are emerging in the U.K. The market limitations resulting from a mandated Pool system are currently being scrutinized in the U.K. and reforms to allow trading outside the Pool are under active consideration. After several years of experience, U.K. officials now recognize that in a structure in which a central pool is the only means for trading electricity, efficiency opportunities may be lost: It is possible that, if trading were allowed outside the Pool (e.g. in bilateral contracts), individual generators and customers could develop more efficient or less uncertain patterns of running plant and pricing electricity than the Pool presently achieves. Non-Pooled trading could be less complex and time consuming than trading through the Pool. Or such trading might result in avoiding Pool charges which at present can be in excess of the costs individual users actually impose on the system, or are levied for services which are not needed by some.2 2"Consultation on Pool Reform," U.K. Minister for Energy, March 3, 1994, p. 3. 9 C. Allowing buy/sell arrangements outside of a pool serves as a "check" on pool pricing and dispatch protocols. Freely negotiated commercial transactions outside of pooling arrangements not only increase market flexibility but also serve as a "check" against pool pricing and protocols. This valuable function is explicitly recognized by U.K. regulators currently engaged in Pool reform: The ultimate sanction against Pool arrangements that do not work efficiently to deliver what buyers and sellers want is the ability to leave the Pool and develop other trading arrangements. ...If buyers and sellers had more choice, this would have a salutary effect on the development of Pool procedures that are more responsive to the needs of customers.3 In a mandated pool system, "checks" on the efficiency of pool bidding (i.e. gaming of bid regimes), price outcome, and dispatch protocols would be extremely limited because market participants are not offered alternative means to effect transactions and pricing independent of the pool may simply not exist. This flaw in the mandated pooling approach is fatal. In a reform effort in which the primary goal is to reduce costs and lower rates, implementing a system in which pricing emerges as the result of administratively-determined pooling rules applicable to all transactions provides no assurance that the pricing protocols are resulting in the most efficient prices and transactions possible. D. The competitive market is self-correcting. 3"Pool Price Statement," July 1993, Office of Electricity Regulation, p. vi. 10 In arguing for a mandated pool (such as its "POOLCO" proposal) and against a market structure in which buyers and sellers are free to negotiate bilateral transactions, Edison asserts that by "exploiting market imperfections to their profit, brokers, marketers and other such middlemen will degrade system reliability.4 Magma disagrees with Edison's conclusion and does not share its apparent pessimism regarding the ability of markets to respond to foreclose such results. The opportunistic profit taking at the expense of less sophisticated buyers and sellers described by Edison is possible in any market, including a mandated pool. This is a characteristic of market development per se. In a free market, however, participants are able to adjust their behavior to preclude opportunism as they become more knowledgeable and sophisticated. As a result, inefficiencies or price distortions resulting from such opportunism are fleeting. In sum, the specter that brokers will destabilize system reliability erroneously assumes that buyers, once bilked by an unscrupulous middleman, will allow themselves to be subject to such scheming and manipulation over and over again. The Commission should look to the evolution and successful functioning of existing commodity markets (e.g., heating oil, natural gas, unleaded gasoline, etc.) rather than to Edison's analogy to thinly-capitalized charter tour operators for evidence 4See: June 8, 1994 Response of Southern California Edison Company (U338-E) To Order Instituting Rulemaking and Order Instituting Investigation Dated April 20, 1994, pp. 26-31. 11 that such markets are self-correcting as they mature. E. Neither the potential for market abuses nor the need to require utility divestiture are eliminated by the creation of a mandatory pool. Opportunities to exploit the market are more problematic under mandatory pooling than under a market-based system. For example, activities such as price manipulation and running plant through inflexible or flawed dispatch protocols are clearly possible under a pooling structure. The difference is that price distortions and inefficiencies under mandatory pooling are not necessarily self-correcting. The very nature of a mandatory pool institution suggests that government intervention would be required to eliminate inequities or inefficiencies that arise. The potential for self-dealing abuses also exist under a mandatory pool structure, contrary to the assertions of the California Energy Commission and SCE. Magma believes that even under a system in which transmission and dispatch are controlled by a separate entity, allowing the utilities to remain in the generation business does not remove the incentive to favor their own assets. The Department of General Services correctly identities this flaw in SCE's POOLCO proposal: Utilities under POOLCO can easily give preference to their own generation in dispatch.... The utilities are not prevented from giving their own resources preference when they acquire resources on a long-term basis (either to supply capacity or on a "contract for differences" basis). We are thus left with the need to protect customers from utility preference for their own plants, even with a power pool.5 5Department of General Services Reply Comments, June 21, 1994, pp. 2-3. 12 Furthermore, as noted earlier, mandated wholesale pooling raises the possibility that utilities would be able to influence pool pricing via their concentrated ownership of assets. In the U.K., there has been widespread concern over the vulnerability of Pool pricing to manipulation based on the market power of companies which own the bulk of generating capacity.6 In sum, utility divestiture of generating assets is required even if the Commission chooses to move first (or only) to wholesale market. Separation of the transmission and dispatch will not completely cure utility inclination to favor their generation assets. In a wholesale market scenario, Magma believes that placing the utilities in a "procurement only" role similar to the role of the U.K.'s regional electricity companies, which provide distribution only, is the best assurance that they will seek the most efficient portfolios for their customers. F. Mandating a power pool would result in a regulatory system as cumbersome and confining as past regulatory schemes. Development and implementation of the rules, conditions and necessary institutions associated with a mandated pooling approach imply significant regulatory oversight. While advocates of this approach assert that the pooling simplifies transactions through centralization and common rules for transmission and dispatch (and, presumably price bidding), Magma believes that 6"Pool Price Statement," Office of Electricity Regulation, July 1993, p. iii. 13 constructing a central system to facilitate the physical and cash electricity market for the entire array of market participants does not imply simplicity. The inherent complexity of the rules and protocols necessarily associated with developing and operating a central pool would require a process reminiscent of the most intense proceedings conducted under command and control regulation. Regulatory action is also implied to remedy imperfections which may arise in bidding, dispatch, or pricing protocols or to amend pool operations in response to changes in industry conditions. On these grounds alone, a mandated pool is not the "market oriented" remedy to the ills of California's electricity industry. V. Conclusions Magma urges the Commission to proceed systematically to increase competition in the power market keeping its key objectives in mind -- (1) lowering costs, (2) achieving fair, competitive markets in generation and transmission, and (3) reducing regulation. None of these objectives requires the Commission to mandate a pool or forecloses mechanisms to achieve important State policy objectives. Along with residential consumer and environmental interests, Magma believes that continuing development of renewable resources serves the need for a balanced portfolio of generation resources and is among the State policies that should be continued. The difficult challenge 14 is to balance short- and long-run consumer interests in an industry that absent major reforms will remain controlled by utilities with monopoly and monopsony powers. Respectfully submitted, EDSON + MODISETTE ___________________________ Karen K. Edson 15