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
WATSON COGENERATION COMPANY
ON QF CONTRACT RESTRUCTURING ISSUES

Roger A. Berliner, Esq.
R. Thomas Beach,
   California Energy Policy Advisor
Brady & Berliner
2560 Ninth Street, Suite 316
Berkeley, CA  94710
Telephone:  (510) 549-6926
Facsimile:  (510) 649-9793

On behalf of
WATSON COGENERATION COMPANY

April 29, 1998

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
WATSON COGENERATION COMPANY
ON QF CONTRACT RESTRUCTURING ISSUES

In accordance with the direction of Assigned Commissioner Josiah Neeper, Watson Cogeneration Company (Watson) respectfully takes this opportunity to respond to the comments of several parties on issues concerning the restructuring of contracts between the electric utilities and qualifying facilities (QFs).   Initial comments on these issues were filed on March 25, 1998. 

Watson responds first to a proposed settlement that Watson understands will be filed today in joint reply comments from the three investor-owned electric utilities (IOUs), the California Cogeneration Council (CCC), the Independent Energy Producers Association (IEP), Enron Capital and Trade Resources, and other parties (hereafter, the “Proposed Settlement”).  These comments convey Watson’s preliminary concerns with the Proposed Settlement.  Watson certainly is willing to continue discussions with the settlement parties, in an effort to address these issues.  Watson also responds to the opening comments filed by the Southern California Gas Company (SoCalGas).

I.	WATSON’S PRELIMINARY COMMENTS ON THE PROPOSED SETTLEMENT
Watson’s concerns with the Proposed Settlement focus on Paragraph 2, which deals with the issue of the voluntary nature of QF contract restructurings.       

Watson believes that QF contract restructurings should be voluntary for both parties.  However, this presumes that the contract restructuring process is limited to revising QF / utility power purchase contracts, and that a utility does not seek to use the process to restrict the future ability of a QF to compete in the new electric market, once the QF’s capacity is no longer under contract to the utility.  The Commission has encouraged QF contract restructuring as a means to enhance competition in the new market, by increasing significantly the number of competitors in that market.  The competitive benefits from QF contract restructuring will be attenuated if the utilities are allowed to condition contract buyouts or buydowns on QFs agreeing not to engage, after contract termination, in transactions that otherwise would be allowed under California law.  In passing AB 1890, the California Legislature established explicit provisions, in Section 372, for the competitive options for cogeneration QFs that will exist in the new marketplace.  QF contract restructuring must not be used as a vehicle for the utilities to restrict those options.

In reviewing the Proposed Settlement, Watson hopes that the Commission will make clear to the utilities that the enhanced competition from bought-out or bought-down QF capacity is a significant, positive benefit of QF contract restructuring, a benefit that the utilities should not seek to limit.  The Commission’s order in this matter should make clear that the utilities should not use contract restructuring negotiations to restrict a QF’s future competitive opportunities.  In particular, the utilities must not use a QF’s failure to agree to such restrictions as the basis for rejecting a proposed restructuring deal.  Accordingly, the Commission should indicate its willingness to entertain reasonableness challenges, on a QF’s own motion, if a QF believes that the utility is blocking its restructuring deal in an effort to limit future competition from that QF.

Watson also believes that a utility should be free to reject a QF contract restructuring deal only after the utility has made a good faith effort to bargain with the QF.  The opening sentence of Section 2 of the Proposed Settlement states that “QF contract restructuring negotiations are voluntary for both utilities and QFs” (emphasis added).  This language suggests that a utility can refuse to restructure a QF’s contract without even having engaged in good faith negotiations with the QF.  This appears to Watson to be contrary to the Commission’s express encouragement to the IOUs to pursue contract restructurings, and to the Commission’s longstanding policy that utilities must negotiate in good faith with QFs.  The utilities should not be able to use the voluntary nature of restructurings as a means to avoid even talking with a QF.  In its order in this matter, the Commission should remind the IOUs of their longstanding obligation to negotiate in good faith with QFs.  The parties to the Proposed Settlement also could remedy this concern through the simple modification of replacing the word “negotiations” with “agreements.”
 	
II.	WATSON’S RESPONSE TO SOCALGAS

Southern California Gas Company (SoCalGas or the Gas Company) transports natural gas to many gas-fired QF projects in southern California, including Watson.  SoCalGas filed opening comments on Commissioner Neeper’s ACR.  To Watson’s knowledge, this is SoCalGas’ first formal participation on QF contract restructuring issues, despite numerous opportunities over the past fifteen months.  SoCalGas now claims that QF contract restructuring will have an adverse impact on natural gas ratepayers, because restructuring may result in lower gas throughput to QF projects that restructure their power purchase agreements with the electric IOUs.  The Gas Company also asserts that the courts do not provide adequate protection for the revenue impacts of these throughput losses, because SoCalGas has difficulty enforcing in court its gas transportation contracts with QFs.   SoCalGas requests that the Commission grant it, in effect, “a seat at the table” in QF contract restructuring negotiations, with access to all information on the potential benefits of restructuring deals.  The Gas Company wants the calculation of ratepayer benefits from QF contract restructurings to include compensation to gas ratepayers for lost transportation revenues.

As explained below, Watson strongly objects to SoCalGas’ eleventh hour attempt to insert itself into the QF contract restructuring process.  SoCalGas’ proposal would significantly complicate and delay QF contract restructuring transactions.  Furthermore, it is highly questionable whether gas ratepayers really would benefit from the Gas Company’s “seat at the table.”

A.	SoCalGas Is Seeking Primarily to Protect Shareholders, Not Ratepayers.
SoCalGas’ comments are founded on the premise that, if QF contract restructurings reduce SoCalGas’ throughput to gas-fired QFs, “gas ratepayers will be burdened with higher transportation rates to pay for the fixed costs of the existing gas transportation network.”  SoCalGas Comments, at 2 (emphasis added).  As a threshold issue, Watson questions the extent to which SoCalGas’ ratepayers actually are at risk for higher transportation rates as a result of QF contract restructurings.  In 1993 SoCalGas negotiated, and in 1994 the Commission approved, the so-called “Global Settlement.”  This settlement governs how SoCalGas’ transportation rates will be set in the five-year period ending July 31, 1999, and, in certain respects, in years after this date.  In particular, in the Global Settlement, the Gas Company’s shareholders assumed, for a five-year period, all downside risks that revenues from noncore transportation services would fall below the revenue requirements allocated to noncore customer classes.   In addition, SoCalGas’ shareholders assumed all risks of revenue shortfalls from discounted transportation contracts, even after the Global Settlement period.

As a result, SoCalGas’ ratepayers bear, at most, only limited risk for revenue shortfalls resulting from QF contract restructurings.  Until the Global Settlement expires, 100% of the risk for such shortfalls will be squarely on SoCalGas’ shareholders.  Watson presumes that the utility will continue to be at risk for noncore revenue shortfalls after the Global Settlement expires, with that risk allocated between ratepayers and shareholders based on the gas throughput forecast that the Commission adopts in the next SoCalGas BCAP case.  That case will set a throughput forecast, and resulting rates, to become effective when the Global Settlement expires on August 1, 1999.  The risk of lower throughout to QFs will fall on ratepayers only if that throughput forecast reflects reduced throughput to gas-fired QFs.  In Watson’s view, at this time it is impossible, and indeed inappropriate, for the Commission to speculate on the outcome of the next SoCalGas BCAP case.  What does seem clear is that much, if not all, of the burden of revenue losses from QF contract restructurings will fall on SoCalGas’ shareholders.  SoCalGas’ March 25 comments suggest that revenue losses from QF contract restructurings are solely an issue for ratepayers; SoCalGas does not even mention its shareholders’ much more certain and substantial interest in noncore revenue shortfalls.  Watson submits that, at this time, SoCalGas’ ratepayers have no clear interest in QF contract restructurings.  SoCalGas’ primary interest in intervening in this case is to protect its shareholders.

B.	The Commission Should Not Interfere in QF / Utility Power Purchase Contracts In Order to Bail Out SoCalGas.

 	SoCalGas’ comments complain that it has inadequate remedies in the courts to protect its ratepayers from the consequences of QF contract restructurings.  SoCalGas Comments, at 5 - 6.  The utility uses this assertion to justify its request that the Commission provide it with “a seat at the table” in QF contract restructuring negotiations.

Watson believes that SoCalGas’ alleged difficulties in recovering revenues from restructured QF projects may be a function of the utility’s poor contracting practices.  The Commission may want to open an investigation into those practices, if the CPUC believes that ratepayer interests are at stake.  However, as noted above, the ratepayers’ interest in SoCalGas’ contracts with QFs is zero today, and uncertain in the future.  As a result, Watson questions whether the Commission should intervene to protect the utility’s shareholders from the possible failings of those gas transportation contracts.

Of even greater concern to Watson, SoCalGas’ proposal amounts to a request that the Commission interfere in QFs’ power purchase contracts with electric utilities in order to create contractual rights for SoCalGas that the gas utility does not have today.  SoCalGas is neither a party to, nor a third-party beneficiary of, those power purchase contracts.  For the Commission to create such rights for SoCalGas would be a dramatic departure from the Commission’s longstanding reluctance to interpret or modify QF power purchase contracts on its own motion.  Heretofore, the Commission’s involvement in QF contract restructuring has been limited to a review of the prudence of the restructured contracts, from the ratepayers’ perspective, in order to determine if restructuring costs are reasonable and recoverable in rates.  The Commission will greatly discourage the restructuring process if it acts, as SoCalGas requests, to interfere in those contracts to create third-party rights where none exist today.        

C.	SoCalGas’ Proposal Would Greatly Complicate QF Contract Restructurings.
SoCalGas’ proposal would require QFs, in effect, to negotiate with both the Gas Company and their purchasing electric utility, at the same time.  A QF would have to negotiate with the Gas Company even if the QF intended to continue to perform under its existing contract with SoCalGas, or if the QF was simply taking tariffed service from SoCalGas, with no long-term contractual obligation to transport gas on SoCalGas’ system.  For example, Watson currently takes service under SoCalGas’ tariff for cogenerators.  If Watson negotiates a contract restructuring with Edison, SoCalGas appears to want a piece of that restructuring pie even if the only impact of the restructuring is a lower level of throughput from Watson on the SoCalGas system.  As noted above, SoCalGas cannot know whether this reduced throughput will result in higher rates for other ratepayers, without prejudging the outcome of future SoCalGas cost allocation proceedings.  Viewed from another perspective, SoCalGas’ proposal would place a wholly new obligation on QFs (such as Watson) that take tariffed service — an obligation to maintain their present throughput on the SoCalGas system if they restructure their power sales contract, or to compensate SoCalGas for speculative future impacts on gas ratepayers.

SoCalGas’ comments ask the Commission to allow it access to all documents, studies, etc. that a QF and its purchasing electric utility exchange during their restructuring negotiations.  SoCalGas Comments, at 4.  This information could include, for example, analyses of the QF’s electric production costs.  SoCalGas has no right to this commercially sensitive information if a QF takes tariffed service, with no long-term obligations to SoCalGas, or if a QF is current on its contractual obligations to the Gas Company.  Providing the Gas Company with such information would give the utility a major advantage in future rate or contract negotiations.  Watson anticipates that such negotiations will become more frequent and more contentious, due to increased competition that gas-fired electric generators in southern California will face from other sources of electricity.  

Finally, QFs face significant costs and risks in negotiating a contract restructuring with their purchasing electric utility.  Watson doubts that any QF would care to more than double those difficulties, by negotiating with two utilities at once, unless the QF contractually was forced to do so.  Frankly, to allow SoCalGas a seat at the table would introduce another daunting dimension to restructuring talks: SoCalGas’ relationship with the purchasing electric utility.  As the Commission knows well, relations between the jurisdictional gas and electric utilities are not always smooth (to put it mildly).   QFs do no want their contract restructurings delayed and complicated by gas and electric utilities arguing over the division of ratepayer benefits.

For all of these reasons, SoCalGas’ proposal will have a chilling effect on QF contract restructurings involving gas-fired projects.  If the Commission wishes to see significant progress on contract restructurings for such QFs, it should firmly reject SoCalGas’ proposal.  The Commission should make clear that the Gas Company is going to have to rely on the strength of its own contracts with QFs for the recovery of its revenues.

III.	CONCLUSION

As Watson has emphasized in the past, encouraging QF contract restructurings challenges the Commission to find a delicate balance of interests between ratepayers, QFs, and the utilities.  If the Commission favors any one of these interests too heavily, or injects unrelated parties and issues into restructuring negotiations (e.g. what the QF does with its power after restructuring, or SoCalGas’ separate contract with a QF), these negotiations will not bear fruit, and QF transition costs will not be reduced.  Watson appreciates the Commission’s attention to these reply comments.  Watson hopes that they will assist the Commission to find the crucial middle ground on these matters.

Very truly yours,

Roger A. Berliner, Esq.
R. Thomas Beach,
   California Energy Policy Advisor
Brady & Berliner
2560 Ninth Street, Suite 316
Berkeley, CA  94710
Telephone:  (510) 549-6926
Facsimile:  (510) 649-9793

On behalf of
WATSON COGENERATION COMPANY

April 29, 1998