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 ) ___________________________________ ) REPLY COMMENTS OF THE CALIFORNIA DEPARTMENT OF GENERAL SERVICES ON COMPETITIVE MARKETS AND MARKET INSTITUTIONS IN A RESTRUCTURED ELECTRIC INDUSTRY (ROUND THREE) Douglas M. Grandy California Department of General Services 717 "K" Street, Suite 409 Sacramento, CA 95814 (916) 323-8777 Dian M. Grueneich Grueneich Resource Advocates 582 Market St., Suite 407 San Francisco, CA 94104 (415) 834-2300 Attorneys for the State of California Department of General Services August 18, 1994 INTRODUCTION The State of California Department of General Services ("DGS" or "State") offers these reply comments on Competitive Wholesale Markets and Market Institutions in the Restructured Electric Industry (Round III Issues). DGS submits these comments on behalf of state agencies as electricity consumers. In fiscal year 1992-1993, the State spent nearly $175 million dollars on electric service. DGS supports the opening comments filed by the Division of Ratepayer Advocates ("DRA"), the California Large Energy Consumers Association ("CLECA"), Pacific Gas and Electric Company ("PG&E"), and the Independent Energy Producers Association ("IEP") regarding: (1) the current wholesale market models, (2) the role of such models in a transition to direct access, (3) preferred market models in a restructured industry, and (4) steps the Commission should pursue on these issues. In particular, we support the following views: 1. Wholesale competition has not produced major benefits for ratepayers, because current wholesale market models insulate utilities from competition as far as their existing power generation assets are concerned. 2. Conflicts of interest are inherent in the vertically-integrated utility. Regardless of whether the Commission pursues an improved wholesale market model only or direct access, a threshold step is separation of utility generation and transmission/distribution assets (i.e., competitive and non-competitive activities). 3. The proposal of Southern California Edison ("SCE") and San Diego Gas & Electric Company ("SDG&E") for a "POOLCO" does not resolve the conflict of interest inherent in the vertically-integrated utility. 4. The Commission should adopt DRA's suggestion of issuing a strong policy statement regarding anticompetitive activities by utilities, in order to protect consumers. 5. Once a competitive market is in place, the participants can determine whether additional mechanisms, such as a spot market pool, are needed, but the transition to competition should not be delayed to develop new mechanisms. 1 Our comments below address positions and comments of several of the key parties, as presented in both the Opening Comments and at the August 4, 1994 hearing. DRA Comments DRA's Opening Comments (p. 3) make a threshold observation with which DGS concurs completely: . . .Utility profits primarily accrue from the actions of regulators rather than the satisfaction of customers. It should therefore come as no surprise that utility management appears to be more driven by influencing regulator action than by meeting customer needs. On the specific issues for this round of comments, DRA's Opening Comments present compelling arguments that wholesale competition is not fully mature and that many segments of the wholesale market continue to be dominated by monopolistic utilities. Current wholesale market models insulate utilities from competition as far as their existing power generation assets are concerned. As a result, ratepayers pay needlessly high rates and California's environment continues to suffer from outdated fossil-fired plants. Thus, there is a fundamental problem with relying solely upon the existing wholesale market (or making minor changes to it) to secure significant change. DGS agrees. A second major point of DRA's Opening Comments (p. 9) that DGS supports is that the utilities' ability to dominate the market will continue to be substantial as long as the utilities are vertically integrated and have control over transmission systems. DGS joins with DRA and most other major parties in calling for separation of utility generation and transmission assets as the single most important threshold step to take in the restructuring.1 A third important aspect of DRA's Opening Comments that DGS supports is the need for the Commission to take affirmative steps to deter anticompetitive utility behavior. As DRA points out, even under universal direct access, certain utility functions (such as control area service) will continue to remain monopolies and be sheltered from competition. Utilities will attempt to impose high charges to ratepayers for such 1The problem in the wholesale market is not that the operational mechanisms do not exist. The problem is that -- as most parties concede -- the wholesale market allows new, less expensive generation to compete only at the margin. This results from the fact that utilities have major disincentives to purchase less expensive, non-utility owned generation so long as they have major investments in their own generation and their financial futures are tied to the continued operation of such generation. The paramount step to correcting the deficiencies in the wholesale market is removal of the utilities from the generation business. Or, alternatively, as CLECA recommends, removal of the utilities from the transmission business. 2 services, in order to cover losses and risks in their competitive operations. The Commission must vigilantly supervise utility activities which are not subject to competition. Moreover, as DRA recommends (p. 10), the Commission should announce at the outset of the restructuring process that all anticompetitive behavior will be punished and identify the steps the Commission will pursue to deter anticompetitive behavior. DRA also aptly describes the deficiencies in the SCE/SDG&E "POOLCO" proposal. As DRA's Opening Comments (p. 12) state: There is general agreement that some kind of centralized coordination will be required as the number of transactions increases exponentially. However, while a pool is probably inevitable at some future juncture, DRA does not believe it is a necessary prerequisite to initiating direct competition. Those who limit their discussion to the development of a competitive wholesale market perhaps with a comprehensive policy structure are being distracted from the main discussion of consumer choice. DRA does a great service in this case by listing the twelve (12) separate functions that a pool can perform, ranging from system operation to economic functions. DGS concurs with DRA that in order to evaluate the question of whether a pool is necessary from the outset, the Commission must address each of the separate functions of a pool and the availability of players and mechanisms to perform those functions both with a pool and its absence. We further concur with DRA that some of the pool's functions -- such as setting a price for short-term markets -- are currently being provided by the Western States Power Pool ("WSPP"). Finally, we agree wholeheartedly with DRA (p. 17) that the Commission should not mandate creation of a new power pool, but should instead encourage the existing infrastructure to expand to meet the needs of the changing market. The Commission should focus its role on policy guidance and consumer protection. PG&E's Comments The State agrees with the majority of PG&E's July 26, 1994 Opening Comments. In particular, we applaud PG&E for its "customer oriented perspective": [PG&E] also believe[s] that, as this competitive electric generation business matures, consumers should obtain the full benefits of the lower prices it will produce. PG&E Opening Comments, p. 3. We further agree with PG&E that a retail power pool is probably essential, to ensure efficient dispatch and coordination. However, as PG&E correctly points out, direct access can begin in advance of the 3 creation of such a pool. SCE/SDG&E (and their consultants, Hunt and Hogan) are incorrect in asserting that direct access must be delayed for years to create a new, highly complex and bureaucratic pool system. CLECA's Comments Like other parties, CLECA in its Opening Comments (p. 3) states that wholesale sales/purchases represent a small fraction of the total sales/purchases of generation (kWh) by PG&E, SCE, and SDG&E: . . .Such [wholesale] sales pose no threat to the economic viability of the utilities' own generating plants, which presently can be operated without regard to the pressures of external markets, and the excessive operating costs of such plants can routinely be passed on to end use customers. (footnote omitted) DGS concurs with the essential points of CLECA's comments (p. 4) -- that direct access and spinning- off (or auctioning off) of utility generation assets are necessary to confront these excess costs now. Wholesale transactions, with the utility acting as an agent for all end-users, do have theoretical resource benefits. However, in practice, wholesale transactions for the California utilities have not maximized resource benefits and, simultaneously, have failed to allow customers to create their own purchasing and risk management approaches. DGS concurs with CLECA's statement (p. 6) on the preferred endpoint of this restructuring for California: a vertically de-integrated system featuring a competitive generation market with no party having undue market power, a fully integrated and regulated transmission system, and disaggregated, regulated distribution systems that are closer to the end-use customer. DGS further concurs with CLECA's position -- echoing that of DRA and all other non-utility participants in this case -- that the future competitive market must be structured to avoid undue market power. For this to occur, ownership (rather than merely decisionmaking, as SCE/SDG&E propose) of generation and transmission must be separated. DGS agrees with CLECA (p. 7) that separate operation but continued ownership (as proposed by Edison) is not sufficient. IEP's Comments DGS supports IEP's Opening Comments (p. 3) that wholesale competition by itself is insufficient to achieve the Commission's objectives and that, for the California utilities, retail competition and customer choice are the self-correcting mechanisms needed to keep wholesale markets truly competitive. 4 We further agree with IEP (p. 4) that it is a mistake to consider "POOLCO" as an alternative to generation divesture. POOLCO is meant to ensure efficient dispatch decisions. As IEP points out (p. 4), POOLCO by itself does not resolve the conflict of interest inherent in the vertically-integrated utility and will neither procure wholesale competition nor ease the burden of regulatory oversight by this Commission. POOLCO allows the generating utility to maintain the two separate sources of current utility revenue: revenue from the sale of energy and capacity, and revenues for overhead, infrastructure, and unamortized depreciation of generation and transmission assets, or "rate base." As a result, the utility "competes" for power sales based only on the marginal cost of production, whereas independent competitors must look to power sales revenues to cover all of their costs, including costs of production, overhead, etc. IEP (pp. 11-12) clearly delineates differing roles of a pool versus divestiture: . . .Both divestiture and power pools undoubtedly make sense on their own merits, and the one is not exclusive of the other. Divestiture goes to the creation of a competitive market - as it solves ratemaking issues (stranded costs) necessary of resolution, eliminates conflict of interest concerns and facilitates less intrusive regulatory oversight. Pools, on the other hand, address the functioning of the competitive market once it exists. (emphasis in original) (footnote omitted) As IEP (p. 12) notes, a central issue regarding SCE/SDG&E's proposed administratively-created pool is the feasibility of the Commission being able to create such a pool, given the strong overlay of Federal jurisdictional issues. DGS concurs with IEP (pp. 12-13) that the participants in a competitive California market -- once it is in place -- can best determine the structure and rules characteristic of a pool or other institutions that are needed or will emerge.2 Finally, DGS supports IEP's (p. 13) position -- and that of most other non-utility parties -- that the Commission needs to move quickly to the threshold policy conclusion that utilities should divest themselves of generation assets. As IEP aptly summarizes: . . .Divestiture ensures true competition through the elimination of interlocking positions and conflicts of economic interest, it is the only way to successfully ease the need for aggressive regulatory oversight, and it offers a mechanism to determine stranded costs. SCE/SDG&E Comments 2One caveat is that care must be taken to ensure the structure of mechanisms does not inadvertently preclude use of renewable intermittent resources such as wind and solar. 5 Our responses above have identified our central concern with the SCE/SDG&E POOLCO proposal: it fails to deal with divestiture of utility generation and transmission assets and thus ignores the conflict of interest issues central to current operating systems. We offer the following brief comments on other aspects of the POOLCO proposal. First, we find compelling the statements made at the August 4 hearing by Howard Harris that even under the England/Wales pool, over eighty (80) percent of the transactions are undertaken outside the pool, through bilateral contracts. And, according to Mr. Harris, the England/Wales pool does not provide price transparency. These two facts call into question the benefits of establishing a similar pool for California, at least in advance of direct access. SCE's Opening Comments (p. 2) claim that its POOLCO concept is needed in order to provide continued reliability and efficient real time operation of the electric power system. However, we concur with PG&E and others that there is every reason to believe that the existing system structures, such as WSPP and the Western Systems Coordinating Council ("WSCC"), can continue to be modified to ensure reliable operation and economic dispatch. SCE's fundamental concern appears to be that there will be "free riders" on the restructured system who will not pay their fair share for the costs of using the system. Id. Edison concedes this issue has not been of concern to date but claims that is because "utilities subject to cost of service regulation have not had a significant economic incentive to evade bearing their fair share of the costs associated with reliability." Id. Thus, Edison appears to imply that, absent a POOLCO, utilities will not have an incentive to pay system costs. These comments go to the heart of our concern about utility conflict of interest. Utility generation and non-generation (or alternatively, competitive and monopoly activities) must be separated from the outset, to avoid giving the utilities an incentive to impose charges on their monopoly services (e.g, those offered under a POOLCO) to cover competitive losses.3 3We are similarly concerned with SDG&E's observation that "any unallocated residual costs (e.g., Poolco overheads)" would be recovered through general adder charges on all energy flowing through the system. SDG&E Opening Comments, p. 22. 6 Other Parties Comments At the August 4 hearing, Philip O'Conner offered the so-called "Tehachapis compromise." Under Mr. O'Conner's approach, customers in Northern California would be served under PG&E's proposal (bilateral contracts), whereas customers in Southern California would be served under SCE/SDG&E's proposal (POOLCO). We urge the Commission to reject this recommendation for two reasons. First, as Mr. O'Conner conceded, the major basis for his proposal was that it would allow the utilities to do what they wanted. The focus of the Commission's criteria for changes in this restructuring proceeding must be on whether new structures benefit consumers, not whether they appease utilities. Second, we concur with PG&E's reaction at the August 4 hearing that it is probably physically impossible (or at least highly inefficient) to operate the interconnected transmission grid under two very different models. CONCLUSION DGS appreciates this opportunity to offer these comments and will continue to participate actively in the Commission's restructuring of the electric industry. August 18, 1994 Respectfully submitted, GRUENEICH RESOURCE ADVOCATES _________________________________ By: Dian M. Grueneich 7