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 ) ____________________________ ) FOURTH 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 August 24, 1994 (213) 895-5150 TABLE OF CONTENTS PAGE FIELD(overview \* Mergeformat ) 2 FIELD(benefits) 3 FIELD(monopsony)? 4 FIELD(surcharges) 7 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 ) ____________________________ ) FOURTH ROUND COMMENTS OF SOUTHERN CALIFORNIA GAS COMPANY (U 904 G) ON THE COMMISSION'S PROCEEDING ON ELECTRIC SERVICES INDUSTRY: CUSTOMER CHOICE THROUGH DIRECT ACCESS Pursuant to Ordering Paragraph 1 of the above- captioned proceeding dated April 20, 1994 and Ordering Paragraph 2 of Administrative Law Judge Kim Malcolm's Ruling dated July 26, 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. Overview In this fourth round of comments, the Commission has solicited comments on direct access, a key element in the broad strategy enunciated in the Commission s April 20 Order. In three previous rounds of comments, Southern California Gas Company has supported the Commission s effort to develop a comprehensive restructuring of the electric service industry. We support the two main strategies underlying the Commission s vision: (1) greater reliance on market competition rather than regulatory process to discipline utilities, and (2) evolution from the existing cost-of-service model of rate regulation to performance- based rates. Neither strategy on its own is likely to attain the policy goals the Commission seeks. Because we have already indicated our agreement with the broad strategy outlined by the Commission, including the phased development of direct access to electric power generation by retail customers, our comments here are brief. We make the following major points: The Gas Company believes that a fully competitive electric generation market must include a direct access option. . Direct access will provide a competitive check on the operation of the wholesale market, assuring that prospective efficiency gains in the generation services market translate into benefits for end-users. Direct access will not benefit selected consumers at the expense of -4- others. Competition is not a zero-sum game in which the benefits of the few come at the expense of the many. Proposals to suppress competition to protect consumers should be viewed with skepticism. . The use of transmission demand surcharges levied on direct access customers to recoup costs associated with uneconomic generating plant could encounter serious difficulties. Benefits of Direct Access There seems to be general agreement among most commentators that electric rates in California have been inflated by expensive generation procurement. There is considerable disagreement, however, as to who or what is to blame. In any event, most see a more efficient generation services market as key to bringing California electric rates down. The crux of the debate regarding how best to structure procurement to achieve a more efficient outcome is focused now on whether direct access by customers to generation services is a needed element in restructuring. One could argue indeed, participants in this proceeding have argued that substantial efficiency gains in procurement and generation can be achieved with policies focused at the wholesale level alone. The continued development of a spot bulk power market, nondiscriminatory access to transmission service, formation and expansion of regional transmission groups, and so forth, are all likely to contribute to this -5- more efficient generation market. If the wholesale market is highly efficient, what additional benefits could retail direct access provide? First, let us assume that a highly efficient wholesale market can and will emerge. There must be a mechanism that ensures that benefits from efficiency in procuring generation services are transmitted down to end- users. Adoption of performance-based ratemaking would allow electric utilities to retain for their shareholders a substantial portion of reduced costs. By allowing direct access, the Commission creates additional assurances that customers share in efficiency gains achieved at the wholesale procurement level. Second, the premise of the question the assumed high degree of efficiency in the wholesale market is itself one of the central objectives of establishing competitive direct access. Participants in the wholesale market will rationally pursue their own self interests within the rules of the game. They will not pursue efficiency as diligently as they will pursue their own economic welfare. They will have interests that partly reflect, yet are distinct from, the interests of retail customers. Indeed, the very diversity of interests among retail customers virtually precludes their complete satisfaction with any standard offer from the wholesale market. If retail customers believe they (or a third-party marketer) may be able to procure cheaper or otherwise preferable generation services, there is a sound public policy basis for letting them try. Given the opportunity to compete against utility procurement, customers may be able to induce -6- suppliers to make deals they would not make with the utility. For example, a refiner might offer an exchange of fuel or other products for generation services with a cash side payment, and such a transaction might mitigate price risks for one or both parties. Unless direct access is an option, there is no opportunity to search out such deals. If these inducements succeed, the result will be to induce additional supplies and drive down the market-clearing price for all customers. Forces opposed to direct access have suggested that direct access is objectionable because it allows some buyers to gain price advantages not available to all. Competition, however, is not only, or mainly, about determining which customers will obtain cheaper supplies. Rather, competition opens up additional supplies and so pushes down prices for all customers including those who are not in a position to shop for themselves. The search for lower prices in competitive markets produces widespread benefits. Opponents have also argued that direct access is infeasible or impractical because of the physical impossibility of tracing electrical energy from specific generators to specific consumers. Notice, though, that very much the same argument can be made with respect to natural gas transactions: one cannot trace gas molecules from the well-head to the burner tip. Still, there is a healthy direct access market in gas. The inability to meaningfully trace units from buyer to seller is relevant to how contracts are written and enforced, but it does not make transactions infeasible. -7- The Commission has noted that the introduction of direct access should alter the utility's obligation to serve, and this is a crucial issue if the benefits of restructuring are to be fully realized. The Commission has proposed a one-year waiting period before a direct access customer could return to tariffed utility service, but even this may saddle the utility with too heavy a burden. If the utility must provide service at tarriffed rates even after direct access provides competitive alternatives to customers, an adverse selection process could leave the utility serving only high-cost loads, making the utility noncompetitive in the rest of the market. Also, the direct access framework must result in a clear delineation of responsibilities for physical reliability, load management and back-up services. The system operator and direct access parties should have flexibility in negotiating and contracting for the most efficient arrangements possible. As has occurred in the gas industry, these arrangements will necessarily evolve as all participants become more familiar with the system and more experienced with new institutions arising out of the restructuring process. Monopsony at the Wholesale Level? At heart, economic arguments against direct access implicitly assume that purchasing is either (1) a natural monopoly or (2) can and should be organized as a collusive monopsony by consumers, operating though a utility-like agent, against generation suppliers. Neither provides a sound reason for rejecting direct access. -8- The case for natural monopoly is obviously weak. It may be that a single purchaser of electric power would have lower overhead and other fixed expenses. If so, the natural monopoly will emerge even if direct access is permitted. The utility-as-agent for collusive-minded-power-consumers argument would ask the CPUC to restrict competition at the expense of power sellers. The basic argument is as follows: a pool of buyers may confront an array of service offers. If the buyers compete, all offer prices will get bid up to the market-clearing level. Or, absent price discrimination among suppliers, the (monopsony) buyer may exploit the upward-rising nature of the supply curve, withholding incremental purchases to avoid paying higher rents to lower-cost supplies or lower-cost suppliers. See figure 1. Figure 1: Monopsonistic versus Competitive Price and Quantity The monopsony buyer limits purchases to Qm at price Pm rather than Qc at price Pc (the competitive quantity). It does so to avoid bidding up price and transferring more economic rents from customers to suppliers (the rectangle Qm .[Pc-Pm]). Maintaining output at Qm rather than Qc requires buyers to forego the potential surplus (shaded triangular area) between Qm and Qc, which is why the solution is inherently collusive. Without some central purchasing agent, individual buyers compete to capture the larger surplus and bid up price to Pc in the process. A variant of this -9- argument has the monopsonist price discriminating between suppliers, presumably passing on the rents to end-users. Although either the natural monopoly or the monopsony argument could supply a theoretic rationale for preventing direct access, neither seems particularly descriptive of the real world. Additionally, even if the preconditions for non-competitive market organization are satisfied, one could question the wisdom of a public policy that entails the suppression of competition. Direct Access Surcharges The Commission proposes to assess a demand surcharge on direct access customers. The surcharge would help recover costs associated with stranded or uneconomic generating plant costs. The objective of imposing a surcharge is equity to force direct access customers to bear some of the burden of sunk costs incurred on behalf of these customers. If the burden is not borne by direct access customers, it will be borne by other utility customers, by utility shareholders, or by generators whose contracts will become commercially untenable. Assessing the surcharge on the demand portion of the transmission tariff seeks to minimize price distortions. Prices that depart from marginal cost would lead to inefficient use of transmission service. A fixed charge based on maximum (or historical) use is designed to not raise the -10- marginal price of transmission-related services. It ought to leave these prices at marginal costs and so promote efficient use of the transmission grid. While the goal of minimizing price distortions and inefficiencies is appropriate, we must remember the dynamics and uncertainties in the world. The choices of a customer are not simply whether to switch to direct access (accepting the surcharge as the cost of substituting lower cost generating services for those available to the utility) or to remain a utility customer. Customers may self-generate some part of their own energy needs, locate some or all of their plant or operations to lower-cost areas, or simply close down. Some may encourage municipalization of the local distribution system. Customers may use different technology or invest in more energy-efficient equipment. Others might be able to bypass the local distribution system. All these choices are made more attractive by fixed demand charges because the surcharge increases total energy bills. Because some customers have a range of options that are sensitive to the level and duration of demand surcharges, the Commission s equitable objectives are likely to be only partly realized. A direct access candidate with good alternatives or one who is only marginally profitable will not pay their fair share. Our point is (1) that a demand charge, even a temporary one, is no guarantee of collecting stranded costs, and (2) that prices impact a wide range of choices. There is also an interesting wrinkle arising from the juxtaposition of -11- federal authority in regulating transmission rates, state authority over generation and distribution, and legal constraints on monopoly tie-in sales. Direct access will allow customers to select a different source for power generation but assumes no change in transmission or distribution arrangements. FERC might not agree to vary transmission rates to allow utility recovery of uneconomic generating plant investment. A recent federal case (Cajun Electric Power Cooperative v. FERC, No. 92-1461 (D.C. Cir. July 12, 1994)) raises the question of whether such policy by FERC might even run afoul of antitrust prohibitions against tie-in sales and whether ...there is no such thing as stranded investment, only a failure to compete. (Id., slip op. at 12.) Much the same difficulty arises if the CPUC ties the use of monopoly distribution service to (involuntary) sponsorship of an abandoned generation procurement program. 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: -12- __________________________________ 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 August 24, 1994 (213) 895-5150 -13- 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 24th day of August, 1994. __________________________ Michelle McConnell