I. Introduction Jefferson Electric Inc. ( Jefferson Electric )1 will address in these reply comments three issues or concerns that various parties have raised in their opening comments on direct access and at the Commission's September 16 full-panel hearing. First, we will show that direct access eligibility should not commence with only a few very large consumers, but instead can and should be extended at the same pace to all customer classes. Second, we will demonstrate that direct access eligibility is needed for all consumers to ensure that all consumers benefit from competition and that the benefits of competition are maximized. Third, we will discuss how demand-side management ( DSM ) can flourish as a vital resource option under direct access. II. Making Competition Work for All Consumers The Commission has rightly made benefit to consumers the focus of its electric industry restructuring efforts. Many parties are concerned, however, that some consumers, especially residential ratepayers, may not get substantial benefits from restructuring. Smaller consumers lack the bargaining power of large consumers. Moreover, the current schedule for direct access eligibility places residential ratepayers behind all other customer classes. Jefferson Electric shares these concerns and, in response, offers below a concrete proposal to address them. 1 Jefferson Electric is a wholly-owned subsidiary of Jefferson Gas Systems, Inc., a company developing and marketing competitive energy- related services and programs to a broad array of energy users in California and throughout the United States. With the opening of California's electric services industry to competition, Jefferson Electric will engage in the direct sale of electric products and services to consumers of all sizes. 321188.DOC 1 A. Residential Ratepayers Should Be Eligible for Direct Access Simultaneously With All Other Customer Classes John Gamboa, of the Greenlining Coalition and the Latino Issues Forum, has stated that for residential ratepayers to have a realistic opportunity to purchase lower-priced generation, they should be the first customer class to gain direct access eligibility, not the last.2 Jefferson Electric believes that putting the residential ratepayer first is reasonable. Residential ratepayers constitute a huge customer class in both numbers and in energy consumption. They consistently pay among the highest electric rates, well in excess of utility system average and, in Jefferson Electric's opinion, much more than residential consumers would pay in a fully competitive electric marketplace. They have a claim to be the first to receive eligibility because they have the greatest need for rate relief. On the other hand, as proposed in the Blue Book, any residential ratepayer that prefers to receive full electric service from that ratepayer's current utility could continue to do so. The large number of residential consumers is not a serious obstacle to implementing direct access for this customer class. All parties recognize that single households will lack the time and know-how to contract directly with generation resources. Instead, residential and many commercial consumers are likely to contract with aggregators, who might be private merchants like Jefferson Electric, or buying cooperatives, or some form of governmental entity. The aggregator will then match the aggregated load with a set of generation resources selected for optimal efficiency in serving that load and its demands. 2 Mr. Gamboa's statement appears in a recent video entitled De- Regulating the Electric Utilities. 321188.DOC 2 The utility transmitting power to aggregated customers will deal directly with the aggregator, who will be responsible for metering and billing individual accounts under contract with that aggregator. From the transmitting utility's standpoint, serving the aggregator will not be any more difficult than serving a single large industrial customer that chooses direct access. Thus, utility accounting systems will not be overwhelmed by numerous individual residential direct-access customers. B. The Same Portion of All Customer Classes Should Be Eligible for Direct Access Starting January 1, 1996 The Blue Book sets January 1, 1996, as the start of direct access. Jefferson Electric supports that target and sees nothing about any particular customer class that should cause the Commission to slow the schedule. Indeed, as Jefferson Electric has noted in previous filings, the cost of delay is enormous. Jefferson Electric believes that the cost of delay to the residential ratepayer class alone exceeds $1 billion per year. Eligibility for direct access should also be extended to all nonresidential customer classes, starting January 1, 1996. These other classes, which can be divided into the commercial, industrial, and agricultural sectors, account for over two-thirds of California's electricity consumption. No substantial customer class should be denied the opportunity to participate in the direct access program from the beginning. The simplest and fairest way to ensure interclass equity is to commence direct access eligibility at the same time and on the same basis for all customer classes. In addition to equitable considerations, economic efficiency also requires that all customer classes become eligible for direct access at the same time. A key to lowering the cost of electric service 321188.DOC 3 will be to closely match loads and resources. An aggregator may be able to create an attractive load shape from a group of customers whose loads are complementary. Opportunities for such aggregation are increased if all customer classes are eligible to participate. Conversely, no one customer class will fully realize its potential savings under direct access if direct access eligibility is limited to that class alone. The utilities have stated, however, that they cannot presently accommodate direct access eligibility for the total consumption of all their customers at once, as many parties (including Jefferson Electric) previously had proposed. Therefore, a compromise, which should provide direct access opportunities for all residential and nonresidential customers while capping initial eligibility at a level that utilities can accommodate, is needed. Jefferson Electric has such a compromise proposal. Specifically, up to 20% of each of the residential, agricultural, commercial, and industrial classes would be eligible, on a first come- first served basis, for direct access service commencing January 1, 1996. The initial ceiling would increase an additional 20% each subsequent January 1, until all customers would be fully eligible for 321188.DOC 4 direct access as of January 1, 2000. Figure 1 shows this progression of direct access eligibility under this compromise proposal. Figure 1 Timetable for Direct Access Eligibility % of Class Market Share* Eligible for Direct Access** Customer Class (% of Statewide Consumption) 1996 1997 1998 1999 2000 Residential 33% 20 40 60 80 100 Agricultural 4% 20 40 60 80 100 Commercial*** 36% 20 40 60 80 100 Industrial*** 27% 20 40 60 80 100 % of total IOU load eligible for direct access if only non- residential consumers participate: 13 26 40 54 67 * Based on utility sales data by sector in 1992. Source: California Energy Commission, Opening Comments on Direct Access and Customer Choice, at Appendix A, pp. 3, 17, Tables 2, 8. ** Eligibility is expressed in terms of percent of total consumption by the respective class in the most recent calendar year for which data are available. *** The split between commercial and industrial sectors is size of connected load, per FERC Form 1. The crux of the compromise is that all consumers, large and small, simultaneously gain opportunities for direct access. Consumers would not be required to choose direct access, nor would they forego the opportunity to choose direct access later if they did not elect direct access service in a given year. At the same time, the schedule helps the Commission and utilities to manage the transition to increasing levels of direct access service. Many parties expect that transaction costs, the separate payment of transmission and distribution costs, and the sheer novelty of the direct access program will discourage residential and other small consumers from participation in direct access, at least in the early 321188.DOC 5 years. If that expectation is correct, then Jefferson Electric's proposal, as a practical matter, is only a modest acceleration of the Blue Book schedule. If Jefferson Electric and others can successfully aggregate small consumers, then denying direct access eligibility to those consumers amounts to taking money out of their pockets. C. The Process of Unbundling and of Separation of Functions in Preparation for Direct Access Should Begin as Soon as Possible There is much work to be done, however, well in advance of the actual start of direct access service. First, utilities must fully unbundle their services, functionalize their rates, and file appropriate transmission tariffs. Without this information, consumers cannot evaluate or compare competitors' prices and services, and competition is effectively stifled. The Commission should commence this work as soon as possible. Second, a key to restructuring is the separation of competitive from natural monopoly functions. The merchant function is an example of a competitive function, which must be kept entirely separate and distinct from the utility providing service over bottleneck facilities. One of the primary ways that merchants provide added value is by collecting and analyzing customer information to help the customer choose the package of electric services that best suits that customer's particular needs. Accordingly, the customer should have access to any information on that customer held by the utility. When a customer chooses direct access, control over metering and billing should pass to whatever entity fulfills the merchant function. The merchant, in return, should be obliged to buy the existing meter, at depreciated book value, from the utility. The merchant may then use or replace that meter, 321188.DOC 6 depending on the kinds and level of information that the customer can utilize. As noted in Section II.A above, the merchant, not the utility, bears the obligation to collect all consumption information necessary for a proper accounting and adjustment (if necessary) of any imbalance between the loads of a merchant's customers and deliveries from that merchant's supply sources. The merchant would make such information available as needed for audit purposes. III. Direct Access Ensures Meaningful Opportunities for Residential and Commercial Consumers A few parties suggest that only large consumers can benefit from direct access to the generation market. For example, the City of Los Angeles Department of Water and Power ( LADWP ) asserts that the cheaper energy will be taken by the large industrial and commercial users at the expense of others. (LADWP, Fourth Round Comments at page 2.) Equity is a proper and vital concern of this Commission. However, fairness for all consumers is one of the strongest arguments in favor of direct access, not against it. The disparity of benefits between consumer classes that LADWP fears is here today. Under the current monopoly utility service, residential and many agricultural and commercial consumers pay rates that are roughly twice as high as those of large industrial consumers. While costs of service and economies of scale may dictate rates for many consumers that are higher than industrial rates, several factors have contributed to widening the disparity. First, even under the current system, large industrial consumers have supply alternatives, such as self-generation, while other consumers do not. As a consequence, the utilities have had to lower industrial rates to retain those customers. 321188.DOC 7 Second, the utilities currently have almost no incentive to reduce the size of their overall revenue requirements, so the ability of one customer class to minimize its responsibility to defray those requirements inevitably means the responsibility of other customer classes will increase. Thus, the current relatively high level of residential and many agricultural and commercial rates is a product, in significant part, of those customers' captive status under the current regulatory structure. Only competition through direct access to alternative providers of electric supply services will free consumers from the zero-sum game of traditional ratemaking in which the residential and commercial consumers consistently lose. Liberated from captivity to the utility monopoly, the residential consumer for the first time will have access to the lower-priced energy and enhanced service options that many large consumers de facto already enjoy. Moreover, as explained in Jefferson Electric's Opening Comments on Customer Choice Through Direct Access, the residential consumer's attractive load profile and demand flexibility will enable such consumers, when aggregated, to wield substantial leverage in the marketplace. For all of these reasons, the Commission should give residential consumers the same access to the electric supply marketplace as other customer classes. The potential consumer benefits of that marketplace are real and substantial; equity dictates that residential consumers have the opportunity to pursue them. IV. DSM Under Direct Access Several parties fear that DSM will not successfully compete against other electric resource options in a direct access regime. For 321188.DOC 8 example, the Natural Resources Defense Council ( NRDC ) has suggested that direct access could result in a perverse incentive to consume rather than conserve electricity. This incentive would be created by the electricity pricing structure that NRDC anticipates will develop under direct access, although other parties do not expect such a pricing structure. Specifically, NRDC says: This type of commodity market will almost certainly elicit much increased use of take-or-pay contracts and/or contracts with much higher fixed-to-variable- cost ratios than is typical of current ratemaking practice. The result would be sharp reductions in rewards for reducing consumption not because electric services were significantly cheaper, but because the price structure had changes and more of the bill were not independent of kilowatt-hour usage. (NRDC, Comments on Customer Choice Through Direct Access at page 7.) Jefferson Electric believes both the kind of electricity pricing and the impact on DSM that NRDC hypothesizes are a likely consequence if the Commission limits electric industry restructuring to the creation of a wholesale pool along the lines suggested by Professor Hogan. Retail competition, in contrast, is likely to foster strong price signals to consumers and to lead to the development of new and expanded opportunities for DSM. As an initial observation, Jefferson Electric notes that experience with developing competition in the natural gas industry suggests it is regulation, rather than competition, that is responsible for the pricing structure NRDC criticizes. Before deregulation of wellhead prices, distribution companies and pipelines entered into take- or-pay contracts that resulted in above-market prices and heavy transition costs. With deregulation and the unbundling of commodity from 321188.DOC 9 transportation service, it is the regulated transportation service that is characterized by high fixed-to-variable rate components. The mandatory wholesale pool proposed by Professor Hogan would create a pricing structure similar to what has evolved in gas transportation. Under the Hogan proposal, end-users would see a variable cost consisting of a half-hour spot price. All other components of the utility's revenue requirement would be recovered through fixed charges. As a result, DSM would reduce the end-user's bill by a much smaller amount than under the current rate structure, and many DSM measures would appear not to be cost-effective. This flawed and misleading price signal is one of many reasons for the Commission to reject the Hogan proposal. Enhanced competition, and the pricing and service benefits that go with it, requires more than rejecting the wholesale-only version that Professor Hogan and some utilities espouse. The Commission must also ensure that no party has market power after restructuring, such that the party could dictate the structure of pricing and other terms and conditions of electric service. Among other things, it is critical for the Commission to require (1) a complete separation of the distribution from the merchant function, (2) the unbundling of utility services, and (3) nondiscriminatory access to transmission service. If the Commission imposes and monitors compliance with these requirements, then the competitive marketplace will determine terms and conditions of service, including the structure of electric prices, based on the needs, circumstances, and risk preferences of a large number of buyers and sellers negotiating freely. There is no reason to expect that sellers 321188.DOC 10 could dictate take-or-pay or high-fixed-charge contracts in such a marketplace. There are more fundamental reasons, however, to expect DSM to flourish under direct access. As Jefferson Electric observed in its Opening Comments on Direct Access Through Customer Choice, consumers are looking for total energy solutions, not just lower electricity prices. Such solutions include choices about fuels, appliances and equipment, conservation measures, load management, information systems, and many other things besides generation sources. Jefferson Electric and other merchants will have to satisfy their customers if they are to stay in business. The ability to reshape a consumer's load profile will become a competitive advantage. Merchants add value by providing customized electric service, not just kilowatt-hours. To summarize, in providing electric service and in keeping their costs competitive, merchants will need to give their customers a whole range of information, including appropriate price signals. Specifically, customers should know when the merchant's variable costs are high so that they can take steps to reduce or shift their consumption. Jefferson Electric fully expects that customers receiving direct access service will get far better price signals than they do currently from the utility monopoly. These signals will help identify DSM opportunities and will enable integrated resource planning to take place at the consumer level instead of at the utility-system level where, inevitably, one size fits all. V. Conclusion Direct access for all consumers will lead to lower electric prices, new and improved electric services, and a diverse resource mix. 321188.DOC 11 These improvements should not and do not have to come for one customer class at the expense of all others. In contrast, the traditional electric utility monopolist historically has treated smaller consumers and DSM with indifference or worse. Customer choice through direct access, if implemented fairly and with appropriate precautions against exercise of market power, will enable smaller consumers and DSM to make their true value felt in the marketplace. Respectfully submitted, Jerry R. Bloom MORRISON & FOERSTER By Jerry R. Bloom Attorneys for Jefferson Electric Inc. 321188.DOC 12 BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA Order Instituting Rulemaking on the Commission's ) Proposed Policies Governing Restructuring ) R.94-04-031 California's Electric Services Industry and ) Reforming Regulation ) ) Order Instituting Investigation on the ) Commission's Proposed Policies Governing ) I.94-04-032 Restructuring California's Electric Services ) Industry and Reforming Regulation ) REPLY COMMENTS OF JEFFERSON ELECTRIC INC. ON CUSTOMER CHOICE THROUGH DIRECT ACCESS Jerry R. Bloom MORRISON & FOERSTER 345 California Street San Francisco, California 94104-2675 (415) 677-7533 Attorneys for Jefferson Electric Inc. September 30, 1994 EXECUTIVE SUMMARY The benefits of electric industry competition will be maximized and will reach all consumers so long as all consumers are eligible for direct access. Provided that all customer classes are eligible in equal proportions, a reasonable way to phase in the direct access program would be to establish an initial ceiling on participation in the program, and raise the ceiling over time until up to 100% of all customer classes could participate. This phase-in approach is more equitable, and allows for greater opportunities for cost savings, than if direct access eligibility were extended in the next few years only to a narrow group of large industrial end-users. Implementing direct access quickly, fairly, and with appropriate precautions against exercise of market power is the surest way for the Commission to protect smaller consumers and secure the role of demand-side management in electric resource planning. It is in the direct-access marketplace that smaller consumers and demand-side management can at last make their true value felt. 321188.DOC i TABLE OF CONTENTS Page Executive Summary . . . . . . . . . . . . . . . . . . . . . . i I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 1 II. Making Competition Work for All Consumers . . . . . . . . . . 1 A. Residential Ratepayers Should Be Eligible for Direct Access Simultaneously With All Other Customer Classes . . . . . . 2 B. The Same Portion of All Customer Classes Should Be Eligible for Direct Access Starting January 1, 1996 . . . . . . . . 3 C. The Process of Unbundling and of Separation of Functions in Preparation for Direct Access Should Begin as Soon as Possible . . . . . . . . . . . . . . . . . . . . . . . . . 6 III. Direct Access Ensures Meaningful Opportunities for Residential and Commercial Consumers . . . . . . . . . . . 7 IV. DSM Under Direct Access . . . . . . . . . . . . . . . . . . . 8 V. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . 11 321188.DOC ii