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 ) (Filed April 20, 1994) Reforming Regulation. ) ________________________________________) ) Order Instituting Investigation on ) the Commission's Proposed Policies ) Governing Restructuring California's ) I.94-04-031 Electric Services Industry and ) (Filed April 20, 1994) Reforming Regulation. ) ________________________________________) COMMENTS OF THE SIERRA CLUB ON THE DEVELOPMENT OF COMPETITIVE ELECTRICITY MARKETS July 25, 1994 Dr. Richard Ferguson, Chair Committee on Energy and Global Warming SIERRA CLUB 6715 Rocky Canyon Road Creston, California 93432 (805) 239-8096 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 ) (Filed April 20, 1994) Reforming Regulation. ) ________________________________________) ) Order Instituting Investigation on ) the Commission's Proposed Policies ) Governing Restructuring California's ) I.94-04-031 Electric Services Industry and ) (Filed April 20, 1994) Reforming Regulation. ) ________________________________________) COMMENTS OF THE SIERRA CLUB ON THE DEVELOPMENT OF COMPETITIVE ELECTRICITY MARKETS SUMMARY -- Utility Minipools - The biggest competitive bang for the smallest restructuring buck. The major structural change required in California to meet the Commission's restructuring objectives is the phased divestiture of utility generation assets and their replacement by power purchased from independent generators in utility operated competitive "minipools" with pollution price indexing. The utilities would retain their existing distribution, transmission and system control functions. The Commission has three essential roles to play in the establishment of utility minipools: 1) to establish and enforce the rules governing the divestiture process including equitable distribution of transition costs; 2) to establish and enforce the rules under which the competitive minipools will operate so as to fulfill the state's policy objectives; and 3) to establish the unbundled tariff structure for pricing continuing utility services. The Sierra Club believes that the prompt divestiture of utility generation assets and the establishment of robust pool- type markets with pollution price indexing for the purchase of electrical energy by the utilities would rapidly satisfy all the Commission's objectives, including lower costs for all consumers, universal direct access, and environmental protection. In addition, jurisdictional disputes with other states and the federal government would be minimized, and the transition could begin almost immediately. These comments include a discussion of what the divestiture process might look like, rules under which the minipools might operate, and the benefits which would be expected to accrue from this restructuring. Comments of the Sierra Club - Market Development page 1 The Emerging Consensus for Wholesale Markets As the Commission has noted, many parties have commented on the desirability of establishing open access competitive wholesale markets for electrical generation in California.1 2 Several, however, legitimately fear that this process will take a long time and become mired in jurisdictional disputes between California, its neighbors and the federal government. To provide the benefits of competition to California consumers quickly, acquisition of generation services by California utilities must become more competitive without having to wait for interstate agreements to be worked out. Many also believe that these markets will not be truly competitive and provide the desired benefits unless the regulated utilities are excluded as sellers of generation services.3 Several have also pointed out the difficulty of accurately assessing transition costs unless the market is allowed to establish the value of utility generation assets. Establishing Utility Minipools The most straightforward strategy to restructure the California electric industry and avoid the above problems is for each of the California investor owned utilities (IOUs) to be divested of their generation assets over a suitable transition 1 See first round comments of the Sierra Club and many others. 2 Comments of William W. Hogan, CPUC hearing in Los Angeles, June 15, 1994. 3 See, for example, the first round comments of the AES Corporation. Comments of the Sierra Club - Market Development page 2 period. Replacement power would be purchased from independent generators by each IOU at auction in short term contracts with pollution price indexing.4 That is, each IOU would form its own "minipool" for the competitive purchase of wholesale electricity. Utility distribution, transmission and system management functions would remain unchanged. Energy acquired by each IOU from its own generation facilities would be reduced to zero over transition period. Disposition of these facilities would be left to utility discretion with suitable CPUC oversight to ensure adequate recovery of asset value. During the transition, the price awarded for generation from the remaining utility generation facilities would be capped at the present average rate or less. Each IOU would purchase electricity to replace generation from utility facilities and expiring QF contracts through an auction of short term time-of-day contracts with pollution indexing and portfolio management targets. Independent generators would be subject to anti-trust oversight to ensure a robust market. Contracts for differences would provide direct access benefits and long-term hedging opportunities. The utilities would provide continuing services, including DSM, through unbundled, tariffed pricing structures. Tariffs would be performance based, where performance is compared to appropriate price reduction targets determined by the Commission. As the transition progressed, the California IOU generation 4 See the second round "Comments of the Sierra Club on Balancing Policy Objectives in a Competitive Environment" for a discussion of the pollution indexing mechanism. Comments of the Sierra Club - Market Development page 3 system would increasingly come to resemble three open access power pools operated by the utilities for their service territories. These utility minipools would be integrated with each other and with regional pools as they develop. Sharing Transition Costs As divestiture proceeds, transition costs5 will be evaluated by the market, not by theoretical calculations. Some equitable fraction of these costs should be borne by utility shareholders, and the remainder will be passed through to consumers via the Commission's proposed "competition transition charge" mechanism. The utilities should retain flexibility and discretion regarding the disposition of their generation assets, consistent with targeted reductions in utility generation. Rates for power from remaining utility facilities should be limited to the present average rate or less in order to prevent short term increases in costs to consumers due to utility divestiture decisions. The prospect of competitive markets has helped destabilize utility share prices, since the book values of some utility assets are thought to be considerably different from their true values in a competitive environment. The surest way to stabilize share prices is through the sale of these assets at market prices to unregulated generators, equitable recovery of transition costs, and protection of the regulated core utility business of 5 These costs represent the difference between the value of generation assets written down to market value minus the values written up, based on the prices received by the utility as it divests itself of these assets. Comments of the Sierra Club - Market Development page 4 distribution, transmission and system control. The Commission's role in the divestiture process would include: a) determining the schedule for reducing allowed generation by remaining utility facilities; b) ensuring that utilities receive fair market value for divested assets; c) ensuring that accounting for stranded investments and windfall profits is accurate; d) designing cost recovery mechanisms which equitably distribute transition costs between consumers and shareholders. Operation of the Utility Minipools It is essential that the minipools conduct auctions with robust bidding, free from gaming strategies which can disrupt pool function and lead to market failure. To ensure proper market function, no single seller can be allowed to accumulate too large a market share. Indeed, this is one major reason for excluding utilities from participating as sellers in the market. Attention to anti-trust concerns must be acute. Disputes over transmission access and transmission pricing by the utilities are expected to decline, since the utilities would no longer have an interest in protecting their share of the generation market. Never the less, the tariff structure adopted for transmission services will provide advantages to some generators and disadvantage others. If bid prices are to reflect marginal costs, the costs of transmission must be transparent. Comments of the Sierra Club - Market Development page 5 Pollution Price Indexing Of especial concern to the Sierra Club is the fact that all electricity is not created equally. Electricity from dirty, polluting fossil facilities is an inferior product compared to clean energy from renewable resources. The market must contain a mechanism for discriminating between the two and ensuring that prices paid to power generated by polluting facilities is appropriately lower than prices for clean power. Pollution price indexing is therefore essential to the proper functioning of the minipools. In order to reduce prices paid for electricity from polluting resources, the market must be given adequate information in the form of a pollution index for each block of power offered for sale. Generators bidding into the market shall submit both a price and a pollution index value. The bid prices determine dispatch order, and the pollution index is used to compute differences between market clearing prices and prices paid to successful bidders. Pollution price indexing provides a first order correction to market clearing prices which is essential if competitive markets are to meet the state's environmental goals. Second order corrections can be made through "green" contracts for differences from minipool prices to further fine tune the state's generation portfolio. However, the market itself must contain effective financial disincentives to pollution emission. Pollution price indexing is an essential mechanism which must be an integral part of the emerging markets. The Commission's role in the operation of the minipools is Comments of the Sierra Club - Market Development page 6 the establishment and enforcement of the rules governing these markets, including: a) anti-trust oversight to limit the market share of any generator to prevent gaming of market prices; b) determination of a suitable pollution index which, to a first approximation at least, results in a portfolio of generation resources which meets the state's policy objectives; c) development and enforcement of other rules which are found to be necessary for the proper functioning of the markets and ensure that the price of electricity purchased by the utilities is the true least-cost price, including appropriate social costs. Summary of Expected Benefits from Minipool Development The following is a list of the expected benefits which California can expect from the development of utility minipools. Perhaps the most attractive feature is the fact that California can embark upon this development almost immediately. California's electricity industry is in many ways unique, and the establishment of minipools is especially suited to solve California's problems. We believe that this impressive benefit package satisfies the all of the Commission's objectives in this proceeding. 1) Immediate cost reductions would become available from the rapid exposure of uneconomic utility generation assets to competition and achievement of performance targets for remaining utility functions. Comments of the Sierra Club - Market Development page 7 2) Direct access would become an immediate reality through contracts for differences from pool prices with minimal regulatory oversight required. 3) Stranded investments and windfall profits would evaluated by the market as utility assets were divested, not by theoretical calculations. Transition costs would be recovered through the Commission's proposed competition transition charge mechanism. 4) Pollution price indexing would ensure that clean California resources are not competitively disadvantaged by polluting resources, without requiring development of federal mandates. 5) Regulatory reform would occur through the replacement of regulatory control of the generation sector by transparent rules governing the functioning of the minipools. Unbundling of service costs and performance based rates of revenue recovery for utility distribution, transmission and system control functions would further simplify and clarify regulatory involvement. Regulatory problems will persist so long as regulated utilities compete with unregulated competitors for generation market share. 6) Jurisdictional disputes would be minimized, since the proposed changes appear to be within the CPUC's existing legislative mandates. The transition process could begin immediately. Comments of the Sierra Club - Market Development page 8 7) Reciprocity agreements with other states could be pursued, but progress in California would not be delayed by the need to resolve interstate issues. 8) Integration into regional systems could continue at the present rapid pace whether or not California's model is adopted by utilities in other states. 9) Policy objectives would be relatively unaffected by divestiture. Pollution pricing, green contracts for differences, pool purchasing set-asides would provide strategies for meeting California's portfolio management targets. Sustained orderly development of renewable resources could continue. Cost-shifting between customer classes need not occur. Cost-effective DSM investments would continue. 10) Decoupling would occur automatically upon divestiture. During the transition, the need for decoupling would be minimized by the price and quantity caps on allowable utility generation sales. 11) Utility obligations to serve would not be complicated by bilateral contracts between direct access customers and competing generators. 12) Utility stability would be maximized by the redefinition of the regulated utilities' role as providers of distribution, transmission and system control services. Uncertainty created by the prospect of increasing competition in generation markets and exposure of uneconomic generation assets would be avoided. 13) Independent power producers would have open access to California markets and would continue to develop access to Comments of the Sierra Club - Market Development page 9 regional markets. 14) Market stability of minipools involving many competing sellers should be high, and the volatility problems experienced by the British pool might be avoided. The market shares of generators selling into the minipools would be limited by anti- trust considerations, and the resulting robust mix of smaller competitors should improve market function and stabilize prices. 15) Municipal utilities could continue to enter into contracts with the IOUs, perhaps to purchase power from the minipools on a regular basis. 16) Self-generation would no longer be a threat to other customers and might even be encouraged. 17) Bypass would also disappear as a threat. Transactions to sell excess self-generated power would be facilitated by the minipool markets. 18) Retail wheeling would remain a mythical concept. Bilateral contracts for differences from pool prices would be encouraged to provide "direct access". 19) Cross-subsidies between the utilities' generation operations and T & D operations would no longer be possible. 20) Transmission access would less become contentious since utilities would no longer have generation market shares to protect. 21) Smooth transition - Resulting changes in prices, costs, portfolios, jobs, etc., would be phased in gradually as the transition progressed with minimal disruption of established practices. Comments of the Sierra Club - Market Development page 10 Respectfully submitted, July 25, 1994 _____________________________ Dr. Richard Ferguson, Chair Committee on Energy and Global Warming SIERRA CLUB 6715 Rocky Canyon Road Creston, California 93432 (805) 239-8096 Comments of the Sierra Club - Market Development page 11 PROOF OF SERVICE BY MAIL I, Richard Ferguson, am over the age of 18 years and employed in the County of San Luis Obispo. My business address is 6715 Rocky Canyon Road, Creston, California 93432. On July 25, 1994, I served the within document COMMENTS OF THE SIERRA CLUB ON THE DEVELOPMENT OF COMPETITIVE ELECTRICITY MARKETS in R.94-04-031/I.94-04-032 by placing a true copy of each enclosed in a sealed envelope, with postage thereon fully prepaid, upon and properly addressed to those on the service list in this proceeding which have requested service, with two copies (one on paper and one on computer diskette) also served on the Division of Strategic Planning at Creston, California. Executed on July 25, 1994 at Creston, California. _____________________________________ Richard Ferguson