BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA Order Instituting Rulemaking on ) the Commission's Proposed ) R.94-04-031 Policies Governing Restructuring ) California's Electric Services ) Industry and Reforming Regulation ) ____________________________ ) Order Instituting Investigation ) on the Commission's Proposed ) I.94-04-032 Policies Governing Restructuring ) California's Electric Services ) Industry and Reforming Regulation ) ____________________________ ) THIRD ROUND COMMENTS OF SOUTHERN CALIFORNIA GAS COMPANY (U 904 G) ON THE COMMISSION'S RULEMAKING ON PROPOSED POLICIES GOVERNING RESTRUCTURING OF CALIFORNIA'S ELECTRIC SERVICES INDUSTRY D. G. CLEMENT STEVEN D. PATRICK IVAN J. TETHER Attorneys SOUTHERN CALIFORNIA GAS COMPANY 633 West Fifth Street, Suite 5200 Los Angeles, California 90071-2071 DATED: July 26, 1994 (213) 895-5150 TABLE OF CONTENTS Page Overview 3 3 3 3 3 3 3 BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA Order Instituting Rulemaking on ) the Commission's Proposed ) R.94-04-031 Policies Governing Restructuring ) California's Electric Services ) Industry and Reforming Regulation ) ____________________________ ) Order Instituting Investigation ) on the Commission's Proposed ) I.94-04-032 Policies Governing Restructuring ) California's Electric Services ) Industry and Reforming Regulation ) ____________________________ ) THIRD ROUND COMMENTS OF SOUTHERN CALIFORNIA GAS COMPANY (U 904 G) ON THE COMMISSION'S PROCEEDING ON ELECTRIC SERVICES INDUSTRY: COMPETITIVE WHOLESALE MARKETS AND MARKET INSTITUTIONS IN A RESTRUCTURED ELECTRIC INDUSTRY Pursuant to Ordering Paragraph 1 of the above-captioned proceeding dated April 20, 1994 and Ordering Paragraph 2 of the Assigned Commissioner's Ruling dated July 8, 1994 and the Rules of Practice and Procedure of the California Public Utilities Commission ("Commission"), Respondent, Southern California Gas Company ("SoCalGas") hereby files these comments. 4 Overview Many parties have responded at length to the Commissions proposed restructuring of the electric services industry. The Gas Company has followed the issues, proposals and arguments of various parties and experts with great interest. We remain convinced that the proposed restructuring is worth pursuing, and we hope our comments will be helpful to the Commission as it sorts out issues and options. Our comments below make the following major points: The Commission's vision of restructuring includes, where feasible, the introduction of competition in the electric service industry. The Gas Company believes that a fully competitive market must include a direct access option. The restructuring of the natural gas industry demonstrates the feasibility of transforming a highly regulated industry structure characterized by long-term contracts to one in which flexibility, market competition, and customer choice are preeminent. The Commission's role in wholesale electric generation is limited, and a competitive wholesale market is already developing. Thus, Commission involvement in the wholesale market should be "light handed," focusing on facilitating non-discriminatory access and pro-competitive policies. Although greater competition in the electric wholesale market is consistent with the Commission's vision and 5 restructuring objectives, we believe the vision should continue to include direct access. Preserving competitive retail options ensures that gains in efficiency are translated into customer benefits. Consistent with encouraging competition for the benefit of consumers, we urge the Commission to preserve the opportunity of all energy utilities to compete and to win. Utilities ought not to be precluded from competitive markets outright, nor should they be saddled with obligations to serve that no longer fit the new "regulatory compact" or competitive conditions. Finally, we encourage the Commission to stay committed to a consistent, long-term approach that addresses related issues systematically. Notwithstanding the focus of this particular panel hearing, we believe that both competitive restructuring and performance-based regulation need to be implemented to achieve the Commission's objectives. Significance of Direct Access to Restructuring Comments in this round of hearings focus on a key aspect of the proposal: What is the appropriate structure of the electric generation industry in California, and what ought the Commission do to bring that structure about? This question sets aside, albeit only temporarily, many other critical and difficult matters. But the industry structure 6 question is itself enormously complex, with major implications for the cost and quality of electric service in the state well into the future. At this juncture, the focus of the structure debate is the following question: Is direct access necessary to achieve the goals stated by the Commission, or would less sweeping alternatives suffice? Indeed, would direct access create problems and lead to chaos, policy frustration, and bankruptcy of electric utilities? In lieu of moving quickly to direct access, where end-users would contract directly with any supplier, some respondents have argued in favor of concentrating first on restructuring the wholesale segment of the market. Direct access would come later, if at all. Without debating here each of the claims that can be made for or against direct access, we would urge the Commission to pursue direct access as a key element in its restructuring vision, and to develop policy that provides as much customer choice as possible. While the benefits of competition in the wholesale generation market may overshadow immediate gains from retail direct access, we believe that maximizing customer choice will, in the long run, make for better service and lower costs. In part, we base this view on the experience of the natural gas industry deregulation, to which we now turn. 7 The Transition of the Natural Gas Industry Since the late 1970s, natural gas markets have experienced a transition that parallels the restructuring envisioned by the Commission for electric services. That experience can be a source of helpful insight as we look to the likely outcome of electric restructuring. As the 1970s drew to a close, the United States natural gas industry could be roughly characterized as follows: At the wellhead, federal price controls created a crazy quilt, with huge disparities in price for what was essentially a single commodity. Interstate pipelines purchased gas under long-term fixed-price contracts that typically included substantial take-or-pay or full-requirements terms. In turn, pipelines sold at the city-gate to local distribution companies (LDCs) under contracts that were similarly long-term and which tied the LDCs to significant minimum purchase requirements. From an economic perspective, long-term contracts have economic effects similar to those of vertical integration. That is to say, an interstate pipeline that holds long-term contracts with producers is in many respects equivalent to an integrated pipeline company that owns producing properties. Adding long-term contracts with local distribution companies creates a structure that, in many ways, is similar to a vertically integrated producer-pipeline-distributor. Thus, 8 the gas industry structure in place prior to 1980 was, in effect, vertically integrated. (The extent of vertical integration in the gas business was therefore not terribly different from what we observe today in electricity markets.) In a relatively short time, this entire structure was dramatically refomed. Congress set in motion a process that eventually would decontrol all wellhead prices. FERC policies dictated a separation of commodity sales and transportation, allowing end-users to purchase gas directly FEJ edit.and arrange transportation. In California, large users were allowedor virtually requiredto arrange for their own supplies. Moreover, FERC emphasized a "let the market decide" policy with respect to construction of new interstate pipeline capacity. As a consequence of deregulation, new opportunities for marketers emerged. In the short run, some exploited market imbalances resulting from long-term contracts that were out of step with reshuffled markets and lower gas prices. Others sought to facilitate the complex purchase and transportation arrangements that were necessary in the new environment and to offer price and risk packages beyond those proffered by producers, pipelines, or local utilities. The result was (1) an efficient wellhead ("wholesale") gas market and (2) lower prices to end-uses. The quasi-vertically integrated structure was swept away in favor of a multitude of unbundled, openly competitive markets. 9 In many respects, the Commission's electric restructuring proposal, including direct access, parallels the restructuring of the gas industry. In contrast, a proposal to stop short of direct access would correspond to a gas industry in which utilities continued to perform all procurement for end-users other than resellers. While one could imagine some intermediary that would centrally administer all gas sales into a pool and all gas purchases out of the pool (at uniform prices), such a centralized institutional arrangement would not create the same strong incentives that now exist to find cheaper gas, cut costs, and innovate how gas is sold. Thus, the experience of the gas industry suggests that direct access in electricity markets would ensure vigorous competition, lower prices, and wider customer choice. The Commission ought to retain direct access as part of the restructuring package. The Role of the Commission in Promoting Appropriate Market Institutions The Commission has both the authority and power to shape market institutions in certain respects. Companies subject to its jurisdiction must comply with Commission regulations regarding what products may be sold and the prices of those products, who may or may not sell to the company, how the utility may structure contracts with other parties, and so 10 forth. Regulation may prevent or condition entry of new firms that would offer certain services. Of course, the Commission has considerable latitude in the exercise of its authority. It may, if it chooses, let many major issues of market structure and market institutions get sorted out via ordinary competitive processes. At the same time, Commission discretion is limited by statute, federal pre-emption, and market realities. Our recommendation for restructuring of the electric services industry is to promote what Alfred Kahn has called "light-handed" regulation. Under a light-handed regulatory approach, the Commission would intervene in shaping market institutions only where there is a clear and compelling need to do sowhere market competition would be unworkable. Such an approach is well aligned with the perspective voiced in the draft restructuring proposal favoring competition over regulation where competition is workable. A policy of light-handed regulation and "let the market decide" entails affirming ordinary commercial contracts, minimizing policy changes that render existing contracts uneconomic, and eliminating unnecessary review or other impediments to utility contracting. Given the enormous power over such matters held by the Commission, exercising restraint and allowing the market to operate requires a long-term commitment to the new "light-handed" regimen. The development of a spot market for electric power will 11 promote a more efficient market in electric generation, but the role for the Commission here is indirect. The Commission should actively work with the FERC to develop wholesale transmission open access and pricing that create a more competitive wholesale power market. It should facilitate the creation of Regional Transmission Groups (RTGs) and work with them to implement FERC (wholesale) and Commission (direct access) transmission access and pricing policies. Nondiscriminatory access and transparent transmission pricing are necessary for the creation of spot and secondary markets for electric power. After appropriate preconditions for competition are established, there will be no need for regulatory intervention in the power generation market. The Commission's Order recognizes the development and success of industry-led institutions like the Western Systems Coordinating Council (WSCC) and Western Systems Power Pool (WSPP) in facilitating power transmission, system coordination, and power-related financial transactions in the west. We note the WSPP already provides its members a market price for electricity. Moreover, the WSPP is considered by many to be more efficient than the spot market in the United Kingdom. Marketers such as Enron and Louis Dreyfus are already active members; expansion of the WSPP can further enhance the efficiency of this market. Thus, this market is likely to be highly competitive and efficient, so there would 12 be no public policy basis for Commission intervention. To the extent that market conditions are favorable to competition, Commission intervention could hurt rather than help customers. A broad policy embracing competition would be more constructive than trying to manage competition. Wholesale and Retail Wheeling The Commission has been urged to defer the introduction of direct access (retail wheeling) at least until such time as wholesale wheeling has been fully implemented and its impact evaluated. Some have questioned whether there would be any net efficiency gains from direct customer access once wholesale access is fully developed. Southern California Edison, for example, favors a new mechanism, POOLCO, in which a new cooperative intermediary would create a central market for power purchases. POOLCOs operator, unaffiliated with any producer or transmission interest, would establish a single spot market price and dispatch strictly on a least-cost basis. POOLCO builds on FERC efforts to create a more competitive wholesale market. This market is characterized by nondiscriminatory open transmission access and transparent pricing. A POOLCO-like mechanism would potentially appeal to non-utility electric generators worried that electric utilities would favor their own generating facilities. In addition, we recognize its potential to 13 improve efficiency in the wholesale generation market. Ideally, POOLCO might achieve substantial efficiencies in the wholesale market. All who wish to sell into the market do so at identical prices, insuring a least-cost mix of sources. Investment in new generation facilities would presumably reflect profit opportunities given the expected path of spot prices. There would be no advantage or disadvantage conferred on utilities, which would presumably sell into the pool or into other markets based on price. In this scenario, at any given point in time, every generator receives the same price and terms, and every end-user pays the same (tariffed) rate. Why complicate the situation by allowing, but not requiring, each end-user to search out better deals? The answer lies in the different incentives of individual end-users and the incentives of POOLCO. POOLCO acts, by assumption, in the interest of the average, typical end-user. It will search the market and take risks that match the preferences of the average customer. It will shun arrangements that satisfy a few users but are too risky or otherwise inappropriate to the typical user. Direct access implies that end-users can compete among themselves in searching out deals. Those who expect to fare poorly in such competition might prefer limiting electric restructuring to the wholesale market and blunting retail competition. But, as in other markets, blunting competition means that fewer options are explored. On the other hand, if 14 direct access and POOLCO co-existed, POOLCO would serve the interests of utility customers while direct access customers would be able to seek alternative suppliers and terms. Direct access provides market discipline to ensure the benefits of POOLCO are passed through to retail customers. Utility Opportunities to Compete Among the central issues that arise regarding the Commission's role in promoting appropriate market structure is the position of regulated utilities in emerging competitive markets. Would-be competitors understandably prefer that the Commission exclude the utility from as many markets as possible, just as utilities want access to as many markets as possible. The primary concern guiding the Commission should be the long-term interests of consumers. Those interests are typically served by allowing all comers to enter the market and letting consumers choose. Only where a seller engages in anti-competitive practicesfor which there is likely to be a remedy under existing state or federal lawis Commission intervention likely to benefit consumers. Likewise, allowing a utility to compete in a market but only on terms that are more restrictive than those available to other competitors may protect competitors but does not promote competition. As we argued in Round I comments, the current FERC hearings 15 on Transmission Access and Pricing for the Wholesale Power Market (RM93-19-000) should go a long way towards unbundling transmission and generation costs at the wholesale level. Such unbundling will deny companies that provide vertically integrated electric services the potential to exclude or to discriminate against third-party transmission users. Also, after unbundling, a vertically integrated utility will lack the ability to subsidize its higher priced generation by charging itself lower transmission rates. Making transmission rates transparent to all users and unbundling control area services make generation costs more visible, thereby promoting healthy competition. The move towards performance-based regulation (PBR) makes such competition still more certain. Conclusion: The Importance of a Comprehensive Approach to Restructuring As we remarked in our Round I comments, we encourage the Commission to adhere to its strategy to approach electric restructuring comprehensively rather than piecemeal. We believe both fundamental elements of the Commission's approachincreased use of competition where feasible, and a shift to performance based ratemaking where competitive markets are precluded by natural monopolywill contribute substantially to restructuring objectives. Increased 16 competition ought not be limited to the wholesale market. Comprehensive restructuring, as opposed to fainthearted, piecemeal approaches, is warranted. WHEREFORE, these Comments are respectfully submitted to the Commission and served on all Parties by SoCalGas pursuant to Commissioner Orders. Respectfully submitted, SOUTHERN CALIFORNIA GAS COMPANY By: __________________________________ Ivan J. Tether D. G. CLEMENT STEVEN D. PATRICK IVAN J. TETHER Attorneys SOUTHERN CALIFORNIA GAS COMPANY 633 West Fifth Street, Suite 5200 Los Angeles, California 90071-2071 DATED: July 26, 1994 (213) 895-5150 17 CERTIFICATE OF SERVICE I hereby certify that I have this day served the foregoing document on all parties as shown on the attached service lists pursuant to the Commission's Rules of Practice and Procedure. I declare under penalty of perjury that the foregoing is true and correct. Dated at Los Angeles, California, this 26th day of July, 1994. __________________________ Michelle McConnell