Before the Public Utilities Commission of the State of California

Order Instituting Rulemaking on the Commission's Proposed Policies Governing Restructuring California's Electric Services Industry and Reforming Regulation. 	
Rulemaking 94-04-031
(Filed April 20, 1994)

Order Instituting Investigation on the Commission's Proposed Policies Governing Restructuring California's Electric Services Industry and Reforming Regulation.	
Investigation 94-04-032
(Filed April 20, 1994)

COMMENTS OF THE OFFICE OF RATEPAYER ADVOCATES REGARDING REVIEW OF QF CONTRACT RESTRUCTURINGS 
AND MODIFICATIONS IN RESPONSE TO THE ASSIGNED COMMISSIONER AND ALJ RULING OF FEBRUARY 6, 1998

The Office of Ratepayer Advocates (ORA) hereby submits these comments in response to the Assigned Commissioner and Administrative Law Judge's Ruling Regarding Review of QF Contract Restructurings and Modifications, dated February 6,1998. The Ruling sets forth five issues to be addressed in these comments.  ORA will address each issue in turn.
1.	Please Comment On Whether The Commission Should Adopt The QFRRL Process Set Forth In Attachment A.
ORA joins with the utilities and IEP in supporting the QFRRL process and generally concurs with the response to this question in the joint filing of PG&E, Edison, and SDG&E.  
For the record, ORA notes its interpretation of provisions of the QFRRL process that received significant attention by the parties.  First, a conscious decision was made in paragraph two to make it discretionary for ORA to review agreements between QFs and utilities.  This flexibility recognizes the fact that ORA has limited resources and may not always have the resources available to review a particular restructuring proposal.  Except for restructurings that are primarily resolutions of disputes, ORA intends to endeavor to review as many proposals as possible. An ORA review is not guaranteed under the QFRRL process but is at ORA’s discretion.
Further, Section three of the QFRRL Proposal which lists documents to be produced was intended to act as a guideline to the utility to provide the minimum information necessary to review a contract restructuring. Section 3 is not intended to in any way limit ORA’s access to information. ORA may have follow up questions and applicants shall provide without unreasonable delay the information requested by ORA, if possible.
2.	What Should Be The Commission's Standard Of Reasonableness For Approving A QF Contract Restructuring Or Modification?
QF contract restructurings should provide commensurate ratepayer benefit under a broad range of reasonable economic and operational assumptions. This standard is consistent with prior Commission policy, including the Commission’s Guidelines for Contract Modifications contained in Decision (D.) 88-10-032. Any other standard could compromise ratepayers' ability to share in the benefits of contract restructuring.  A standard of simply ratepayer benefit does not provide enough protection for ratepayers from restructurings which disproportionately benefit QFs. Even such standards as "significant" or "robust" ratepayer benefit could be inadequate to protect ratepayers from unfair restructurings. 
For example, consider the case of a proposed restructuring involving a 200 MW project.  The utility and QFs have negotiated a buyout payment of $150 million and the ratepayer benefit analysis shows an expected savings of $8 million, with a sensitivity range from $1 million to $15 million. Consider further that the QF’s projected Net Operating Income (NOI) is $75 million. Therefore, the QF's benefit associated with the contract termination is $75 million. In this case, ratepayer benefits may be “robust” and “significant” but not commensurate with the cost of the termination, the size of the project or the benefit accruing to the QF.
Further, as the competitive market unfolds, QFs may have opportunities to obtain higher prices through “green” marketers. If a QF has a market opportunity at a price comparable to the contract price, clearly the QF should not receive its full projected NOI under its contract as a buyout payment. To do so would unfairly enrich the QF at the expense of ratepayers. Contract restructuring negotiations must consider all relevant and known factors affecting the risk and benefit to ratepayers and the QF to result in a reasonable outcome.
Further, since QF costs are borne by ratepayers, the reasonableness of utility restructuring decisions should be based upon ratepayer impact, without regard to considerations which solely impact utility shareholders, not ratepayers. 
3.	Should Negotiations Between QFs And Utilities With Respect To QF Contract Restructuring Or Modification Be Voluntary?  Should Utility Decisions On Contract Restructuring Or Modifications Be Subject To Reasonableness Review?
Since the Commission has no direct oversight over QFs, ORA is interpreting this question to be whether utilities can be ordered to negotiate with QFs.  Forcing utilities to negotiate with QFs would severely impair the utilities’ ability to effectively negotiate, by preventing them from walking away from unreasonable QF offers or fruitless negotiations. Thus, the Commission should conclude that negotiations between utilities and QFs are a voluntary exercise of utility discretion. Utilities should not be ordered to negotiate or to amend a QF contract. 
However, the exercise of utility discretion regarding whether to negotiate or amend a contract is subject to reasonableness review. The mere fact that the utility has voluntary  discretion to negotiate should not be a defense against claims of imprudence. Since ratepayers bear the cost of QF contracts and consistent with long standing Commission policy, utilities are required to act reasonably and to demonstrate the reasonableness of their actions through clear and convincing evidence. Therefore, all restructuring decisions must be subject to reasonableness review. 
This policy is fully consistent with prior Commission decisions, in which the Commission has stated that a finding of reasonableness is based upon whether the decision represents 
“..the exercise of reasonable judgment in light of facts known or which should have been known at the time the decision was made.”  (D. 87-06-021, p. 19.)  
Further, the Commission has stated that it is the utility's burden to demonstrate that its actions are reasonable through clear and convincing evidence and not the burden of any other party to prove otherwise (D. 87-07-026, pp. 19-20; D. 88-03-036, p. 5; also see D. 88-10-032).  
To eliminate the requirement that utilities act reasonably in their dealings with QFs in the area of contract restructuring, or to find that reasonableness review is only appropriate where the utility has modified a contract, would be akin to writing a blank check for QF costs and would create a disincentive to negotiate contract restructurings.
4.	How Should The Shareholder Incentive Mechanism Adopted In The Commission's Preferred Policy Decision Be Implemented?  Please Discuss, Inter Alia, How The Incentive Mechanism Should Be Calculated, Tracked, And Recorded.
The incentive mechanism, as implemented by D.96-12-077, should be eliminated or modified. Shareholder incentive payments may complicate restructuring decisions by creating an incentive for the utilities to exaggerate ratepayer benefits similar to the way that cost-of-service regulation incents utilities to make unwise investments.  Ideally, the shareholder incentive program should be eliminated.  The rate freeze adopted in AB 1890 adequately promotes utility restructuring efforts by rewarding cost-saving modifications with an increase in headroom for recovering stranded costs.  If the incentive is maintained, the reward (positive or negative) should be earned by shareholders as savings (or costs) from restructured contracts are realized by ratepayers, calculated relative to actual replacement costs.
Utilities have adequate incentives to engage in cost-saving QF restructuring during the rate freeze period. At a minimum, the Commission should eliminate the incentive reward for deals which produce benefits during the rate freeze period -- the utility is already rewarded for such deals. In fact, the utility, not ratepayers, may reap all the benefits from a deal which only saves money during the rate freeze period.
The Commission authorized a ten percent incentive to encourage the utilities to pursue beneficial contract restructuring in D. 95‑12‑063.  However, the incentive is skewed.  The incentive, in effect, is for the utility to forecast benefits for a given buyout, rather than to actually deliver those benefits.  Determining the ratepayer benefits to be received from a buyout is complicated and requires the exercise of judgment and speculation about future power costs.  The utility is in a far better position to evaluate the continuing viability and cash flow of its QF projects, and therefore is in a position to skew  or overstate the benefits of buyouts.  
Further, benefits are highly sensitive to forecasts of replacement costs.  Insofar as the utility serves to gain by exaggerating benefits (to obtain a larger reward), the forecast of replacement costs may become litigious and subject to manipulation by the utilities.  
All parties benefit if the utility shareholders' interests are aligned with its ratepayers'.  This produces the most effective incentive, as well as minimizing the need for regulatory review.  However, an incentive based upon projected savings will not align those interests completely. For example, it is impossible to determine "actual" savings from a buyout, because no one will never know how the project would have performed in the absence of the buyout. However, replacement costs can be tracked over time.  ORA strongly recommends that if maintained, the shareholder incentive be calculated monthly, relative to actual replacement cost, to eliminate this concern.
Utility ratepayers should receive an incentive reward to the extent that actual benefits are received by ratepayers relative to future replacement cost.  If utility incentive dollars are not linked to actual ratepayer savings, replacement cost forecasting will become litigious. Without an incentive reward based on projected savings, ORA can utilize a range of reasonable replacement costs to verify savings. Tying the incentive to a forecast of replacement costs will perpetuate the errors of foresight which have resulted in ratepayers paying billions in excess costs for QF power.  In the absence of a connection between the incentive and actual replacement costs, buyouts may further increase ratepayer costs, with utilities and QFs the beneficiaries.
Basing the reward on a forecast shifts replacement cost forecasting risk solely to ratepayers, insulating the utility from forecasting errors.  It may result in shareholders earning a reward for buyouts which actually increase ratepayer costs. 
How the Shareholder Incentive Should be Calculated
The incentive reward should be calculated based on the difference between the nominal revenue forecast for each QFCTC adjustment period, adopted by the Commission when the application of the incentive to a modification is approved, less any capacity repayments forecasted to be received, less payments actually made to the project during the period, less the cost to replace any terminated or dispatched energy or capacity.  Replacement cost should be the greater of any available QF contract price or the power exchange price.
The utilities should enter a monthly debit or credit to the QF Contract Restructuring Shareholder Incentive (QFCRSI) Subaccount representing 10% of the benefit or cost to ratepayers during the preceding month. In each annual Revenue Adjustment Proceeding (RAP), the QFCRSI will be subject to reasonableness review and potential audit. To recover the incentive reward, the balance in the QFCRSI Subaccount should be debited or credited to the QFCTC account such that a positive reward increases QFCTC and a corresponding debit or credit should be booked to a (below the line) shareholder asset account.
ORA has requested that the Commission modify its decision implementing the shareholder incentive reward (Petition for Modification of D. 96-12-077, dated February 14, 1997) to ensure that QF incentive rewards to utility shareholders are calculated using actual benefits to ratepayers, rather than on a "forecast basis" as the decision currently provides. A reward based on actual savings best reflects the value to ratepayers of utility decisionmaking.  A reward based on forecast savings engenders forecast gaming and error. 
In its Petition for Modification, ORA recommends that the Commission eliminate language in D.96‑12‑077 which states that "PG&E's draft Preliminary Statement language for this subaccount is complete and consistent with the intent of D.95‑12‑063.  In their compliance filings, Edison and SDG&E should use PG&E's language."  (page 25.)
The Commission should add language to the decision ordering the utilities to submit Preliminary Statement language to implement the Qualifying Facility Contract Restructuring Shareholder Incentive (QFCRSI) Subaccount consistent with the calculation of the incentive based upon actual savings relative to replacement cost in each month.  
5.	Set Forth Any Other Critical Issues You Believe Necessary For The Commission To Address Now In Order To Facilitate QF Contract Restructuring Or Modification, And Commission Review Thereof.
	There are no other critical issues that ORA believes are necessary for the Commission to address now in order to facilitate QF contract restructuring. However, after resolving the issues raised in the ACR, the Commission should consider Enron’s Motion for an Order to Show Cause. 
	Finally, ORA recommends that, for those restructurings which come before the Commission for preapproval, the Commission act quickly to approve those proposals which are supported by ORA and unopposed by other parties, to preserve the benefits of contract restructuring for ratepayers.

	Respectfully submitted
/s/	JOSEPH DEULLOA
—————————————
	JOSEPH DEULLOA
Staff Counsel

Attorney for the Office of Ratepayer Advocates

California Public Utilities Commission
505 Van Ness Ave.
San Francisco, CA 94102
Phone: (415) 703-1998
March 25, 1998				Fax: (415) 703-4592