The Gas Accord was reached after development of a full record on ITCS and backbone credit amortization issues. We should review that record in order to test the reasonableness of the settlement.
In A.94-06-044, PG&E asked to amortize in rates $60.1 million of recorded and forecast costs in its ITCS account, for the period from August 1, 1993, through December 31, 1994. Amortization would have begun September 1, 1994, and the account would continue to record ITCS costs until the expiration of PG&E’s contract with PGT in 2006. PG&E originally sought ex parte approval of a noncore amortization rate of $0.14/Dth, and no core rate. Four parties--CIG and CMA together, DRA, El Paso, and Palo Alto--protested the application. CIG/CMA and El Paso argued that PG&E’s marketing efforts in support of Line 401 have increased ITCS charges. Palo Alto sought a reduced ITCS rate because it serves core customers. In D.94-11-024, the Commission authorized a noncore ITCS rate of $0.07/Dth, subject to refund. On February 9, 1995, ALJ Robert Barnett issued a ruling which identified disputed issues and ordered hearings to evaluate the legitimacy of costs in the ITCS account. In D.95-04-007, the Commission approved an agreement between PG&E and Palo Alto that reduces the ITCS rate for Palo Alto and the City of Coalinga. On January 29, 1996, before the scheduled hearings began, the ITCS application was consolidated with this proceeding. In Resolution G-3142, approved August 2, 1996, the Commission authorized a $0.06/Dth reduction of the noncore ITCS rate, with PG&E shareholders at risk for associated revenue shortfalls. The resolution preceded PG&E’s filing of the Gas Accord, but the rate reduction is an element of a Gas Accord side deal between PG&E and CIG/CMA.
The Commission has always intended that ITCS amortization by PG&E should be subject to reasonableness review. In D.91-11-025, the Commission rejected a settlement that proposed the ITCS mechanism, but adopted capacity brokering rules based on the settlement. [ D.91 - 11 - 025, 41 CPUC2d 668, discussion at 696, Ordering Paragraph 3 at 707, Rule F at 728 (1991).] The settlement called for amortization after Commission findings that costs were reasonably incurred. In D.94-11-024, the interim ITCS rate was made subject to refund "should the stranded ITCS costs prove to have been caused by improper acts of PG&E." [ D.94 - 11 - 024, Ordering Paragraph 3, 57 CPUC2d 309, 313 (1994).]
In seeking to justify costs in the ITCS account, PG&E begins by arguing that ITCS obligations, which are principally El Paso demand charges for unused pipeline capacity, are sunk costs in economic terms. Therefore, they do not harm ratepayers. PG&E submits that it should be allowed full ITCS recovery because it has followed all applicable rules and guidelines in its capacity marketing activities. By setting Line 401 prices which compete with brokered interstate capacity, PG&E claims that it is taking a competitive stance in the marketplace, and that competition in general has brought billions of dollars in benefits to California consumers. The Commission has recognized that new pipeline capacity is essential to fostering gas-on-gas and pipeline-on-pipeline competition. PG&E opposes the theories of TURN and El Paso that Line 401 marketing activities have devalued brokered El Paso capacity. PG&E believes that its actions should be judged against what a reasonable manager of sufficient education, training, experience, and skills would do in similar circumstances. [ D.90 - 09 - 088, 37 CPUC2d 488, 499 (1990).] According to PG&E, its capacity brokering actions meet that standard because PG&E: (1) promoted the brokering of excess capacity in competitive markets, (2) created separate marketing teams for Line 401 and brokered capacity, (3) avoided unnecessary discounting, (4) used minimum bids responsibly, (5) negotiated prices below minimum bids in order to meet market prices, and (6) sought to maximize capacity brokering revenues. In marketing competing Line 401 capacity, PG&E claims that it has again followed Commission rules and guidelines, and has not driven Southwest competitors from the market.
In its prepared testimony, DRA recommended no disallowance of ITCS costs, but asked that the ITCS account be terminated when PG&E’s contracts with El Paso expire at the end of 1997. In briefs, DRA revised its position, alleging that PG&E’s conflict of interest has increased shareholder earnings at ratepayer expense. Therefore, DRA recommended disallowance of 50% of past ITCS costs and elimination of core responsibility for future costs. DRA later signed the Gas Accord, under which PG&E would bear all core ITCS costs and 50% of noncore ITCS costs.
TURN argues that core customers should be made indifferent to operation of Line 401 by adjustment of $40.1 million in 1993 and 1994 costs, separated into $13.2 million of ITCS costs and $26.9 million of unrealized capacity brokering revenues that should have been credited to PG&E’s core fixed cost account. These amounts, which include core portions of Transwestern pipeline costs, should be disallowed or reassigned to the noncore. The core indifference policy should also be applied prospectively. TURN believes that ITCS costs and lost revenues are the direct result of PG&E’s Line 401 marketing practices, which are driven by PG&E’s conflict between shareholder and ratepayer interests.
El Paso asserts that ITCS and core capacity costs associated with Line 401 pricing practices should be allocated to the Line 401 revenue requirement. According to El Paso, PG&E’s Line 401 practices, core and UEG procurement practices, and use of Transwestern capacity have caused stranded costs of approximately $101 million through May 1995. PG&E’s conflicts of interest have led PG&E to favor Canadian over Southwest supplies.
New Mexico also believes that PG&E’s actions have hindered the operation of a competitive market for gas in Northern California. According to New Mexico, PG&E’s minimum bids, service terms, and marketing efforts have consistently favored Line 401 over brokered Southwest capacity. New Mexico supports El Paso’s determination of stranded costs, and recommends that PG&E shareholders be held responsible for all ITCS costs.
We reject PG&E’s arguments that capacity brokering has no effect on ratepayers. As discussed earlier in this decision, ITCS costs are fixed, but loss of capacity brokering revenues has affected the set of all PG&E customers except the shippers that choose Line 401 capacity over brokered Southwest capacity. Such lost revenues are direct harm to captive original system ratepayers caused by PG&E’s marketing practices.
We accept use of the "reasonable manager" standard in the present circumstance, but other prudence standards apply as well: (1) the utility has the burden to show with clear and convincing evidence that its operations have been reasonable and prudent; (2) the Commission has a legitimate concern with the processes employed to reach management decisions, not only with outcomes; (3) reasonableness depends on the information that managers knew or should have known; (4) utility actions should reflect the exercise of good judgment and should be expected to reach the desired result at the lowest reasonable cost consistent with good utility practices; (5) reasonable and prudent acts do not require perfect foresight or optimum outcomes, but may fall within a spectrum of possible acts consistent with utility needs, ratepayer interests, and regulatory requirements; and (6) Commission guidelines are only advisory in nature, and do not relieve the utility of its burden to show that its actions were reasonable in light of existing circumstances. Many past Commission decisions support these principles.
We find that by exercising market power in setting Line 401 prices that compete against brokered Southwest capacity, PG&E has imprudently placed shareholder interests above original system ratepayer interests. PG&E has failed the "best efforts" standard ordered by the Commission for marketing of unused interstate capacity. [ D.91 - 11 - 025, Appendix B, Rules for Natural Gas Transportation and Capacity Brokering, Rule III.G.3, 41 CPUC2d 668, 724 (1991).] The individual PG&E managers in charge of Line 401 sales and capacity brokering sales may have acted reasonably, but PG&E senior managers in control of both activities have relied on market power to the detriment of ratepayers, have failed to recognize the importance of PG&E’s conflict of interest, and have failed to resolve the conflict of interest in a reasonable manner, either by establishing a fair balance of shareholder and ratepayer priorities or by promptly bringing the conflict of interest to the Commission’s attention.
When it sold Line 401 capacity, PG&E held sufficient market power to undercut Southwest prices and drive capacity brokering sales down to nearly zero. Instead, PG&E priced Line 401 to meet Southwest prices, and noncore marketers took approximately equal fractions of the available competing supplies. This rough balance shows that PG&E had market power, not that PG&E was merely a player in a competitive market. Line 401 prices met Southwest prices, not the opposite. PG&E’s attention to shareholder interests is further revealed by its focus on Line 401 marketing promotions and by continued reliance on minimum bids for brokered capacity. The evidence does not rigorously prove any dependence of brokered capacity prices on minimum bids, but minimum bids otherwise serve very little purpose.
We make no attempt to weigh customer harm caused by PG&E’s conflict of interest against overall competitive benefits caused by the pipeline expansion. We appreciate that increased interstate pipeline capacity and access to Canadian supplies have brought down California gas prices, but we cannot attribute specific benefits to Line 401. Those benefits could have been achieved without PG&E’s ongoing conflict of interest.
After review of all the facts and arguments before us, we judge that the Gas Accord fairly resolves ITCS issues. PG&E will absorb 50% of noncore ITCS costs, less brokering credits, and 100% of core ITCS costs, less credits. These amounts are higher than the relief recommended in the ALJ’s proposed decision. The record does not show whether interim rate revenues to date have recovered noncore ITCS obligations.
Turning to the backbone credit balancing account, we see a similar situation. PG&E sought rate recovery of the full amount in the account, arguing that its backbone credit transactions followed Commission rules and were reasonable. Prior to the Gas Accord, DRA and TURN recommended that PG&E be denied recovery of any backbone credit costs. They also recommended termination of new entries to the account, which we have accomplished in D.96-09-095. El Paso opposes PG&E recovery of backbone credits awarded to its UEG department, and supports rehearing of Resolution G-3122, in order to reduce the applicability of backbone credits. El Paso opposes PG&E recovery of backbone credits previously awarded to ineligible customers.
In D.96-09-095, we found that backbone credit benefits flowed to PG&E shareholders and holders of upstream pipeline capacity rather than end users, that the backbone credit partially subsidized Line 401, and that Southern California exchange agreements were contrary to the purpose of the credit. [ D.96 - 09 - 095, Findings of Fact 6, 8, and 11, at mimeo. pp. 12 - 13 (1996).] We now find that in its pursuit of shareholder benefits through backbone credit transactions, PG&E again imprudently placed shareholder interests above original system ratepayer interests. PG&E senior managers exercised market power to the detriment of ratepayers, failed to recognize the importance of PG&E’s conflict of interest, and failed to resolve the conflict of interest in a reasonable manner.
PG&E shareholder responsibility for 100% of backbone credit costs under the Gas Accord is a reasonable resolution of this dispute. As was true for ITCS costs, the settled amount exceeds the relief recommended in the ALJ’s proposed decision. It is reasonable that foregone backbone credit amortization exceed foregone ITCS amortization because PG&E actively pursued shareholder revenues, as opposed to meeting Southwest prices when selling Line 401 capacity.
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