PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA  
  
ENERGY DIVISION 					         RESOLUTION  E‑3666
								         MAY 4, 2000  

  
R E S O L U T I O N  
 
Resolution E‑3666.  Southern California Edison Company requests authorization for recovery of costs associated with its participation in the California Power Exchange Corporation forward market for ancillary services.  Approved with modifications.

By Advice Letter 1443-E, filed on March 21, 2000.

SUMMARY  
  
By Advice Letter 1443-E, Southern California Edison Company (SCE) requests authorization for recovery of costs associated with its participation in the California Power Exchange Corporation (PX) forward market for ancillary services.  SCE proposes quarterly trading limits for its participation, and requests that the term of its participation be through the end of its rate freeze. This Resolution approves the advice letter with modifications.

BACKGROUND  

The Federal Energy Regulatory Commission (FERC), by its Order of May 26, 1999 (87 FERC ¶ 61,203) approved a proposal by the California Trading Services Division (CTS) of the PX to establish a Block-Forward Market (BFM) for sales and purchases of energy for delivery through the PX.

On December 31, 1999, the PX, on behalf of CTS, filed a proposal at the FERC to expand its energy BFM with enhancements to the services available (California Power Exchange Corporation, Docket No. ER00-951-000).  The FERC conditionally approved the PX’s proposal (California Power Exchange Corporation, 90 FERC ¶ 61,173 (2000)) on February 24, 2000.

In Resolution E-3658, issued March 16, 2000, the California Public Utilities Commission (Commission) authorized Pacific Gas and Electric Company (PG&E) and SCE to participate in, and to recover costs of participation in, the expanded BFM until the end of each utility’s respective rate freeze. 

On February 17, 2000, the PX, on behalf of CTS, filed tariff amendments and rate schedule revisions with the FERC which would, among other things, allow CTS participants to trade ancillary services on a forward basis (California Power Exchange Corporation, Docket Nos. ER00-1641-000 and ER00-1642-000).  The PX has requested that these tariff amendments and rate schedule revisions become effective by May 1, 2000.  The PX proposed two categories of service enhancements relating to the availability of ancillary services.  The first category is bilateral scheduling and delivery of ancillary services.  The second category is a monthly forward market for physical ancillary services.

With FERC’s approval of the proposed tariff amendments allowing CTS participants to trade ancillary services on a forward basis, forward trades involving the sale of ancillary services will be scheduled for delivery in the PX Day-Ahead Market.  Currently, the California Independent System Operator (ISO) provides the only market for ancillary services.  The ISO operates only day-ahead and hour-ahead ancillary services markets and not the type of forward markets that the PX is proposing to offer.  The new forward markets proposed by the PX will supplement the existing spot market for ancillary services currently administered by the ISO. 

The ISO currently recognizes the following types of ancillary services:  Regulation Up and Regulation Down  (collectively referred to as Regulation, but priced and sold separately), Spinning Reserve, Non-Spinning Reserve, and Replacement Reserve.  Under its “Ancillary Services Requirements Protocol” (“ASRP”), the ISO assigns to scheduling coordinators responsibility for procuring certain levels of each ancillary service, in amounts determined pursuant to the ASRP.  Each service identified above can substitute for all subsequently-listed services.  How this works is easily illustrated with the following examples:

Example 1: An ancillary services buyer can purchase Regulation (Up and Down) instead of Spinning Reserve or Non-Spinning Reserve or Replacement Reserve to satisfy an ISO requirement for any of these services.  This is so because any unit that meets the ISO’s criteria for providing Regulation (See ASRP 4.2.1) also meets (and in fact exceeds) the ISO’s criteria for providing the latter services  (See, e.g., ASRP 5.3 et seq.).

Example 2: A buyer could likewise purchase Non-Spinning Reserve to satisfy an ISO requirement that the buyer have available Replacement Reserve.  

The substitutability of services is, however, a “one-way street.”  Thus, for instance, in the last example Non-Spinning Reserve would substitute for Replacement Reserve, but Replacement Reserve would not substitute for Non-Spinning Reserve.

In this Resolution, we use the term “superior” and “inferior” service to describe the relationship between the various services.  In example 1, Regulation is a “superior” service to Spinning Reserve, Non-Spinning Reserve, and Replacement Reserve, because Regulation can substitute for any of these services.  In addition, Regulation presumably costs more for a generator to provide, since it requires having a unit available to respond in real time to changing load.  The latter three services are “inferior” to Regulation.  In example 2, Non-Spinning Reserve is a “superior” service to Replacement Reserve.  Non-Spinning Reserve is substitutable for Replacement Reserve, and also presumably involves greater cost for the generator due to the quicker response time associated with Non-Spinning Reserve versus Replacement Reserve.  As a general rule, “superior” services should cost more than “inferior” service.  This has not always been true in the ISO’s ancillary services market, as we discuss further herein.

By Advice Letter 1443-E, filed on March 21, 2000, SCE requests authorization for, and recovery of costs associated with, participation in the PX forward market for ancillary services.  SCE limits its request to the five following ancillary services: 1) spinning reserve, 2) non-spinning reserve, 3) replacement reserve, 4) regulation up reserve, and 5) regulation down reserve.   In its request, SCE proposes quarterly trading limits for its participation, and requests that the term of its participation be through the end of its rate freeze.  SCE’s advice letter references only participation in the monthly forward market for physical ancillary services.  SCE makes no request to engage in bilateral scheduling and delivery of ancillary services.

The ISO filed a letter of support for SCE’s Advice Letter 1443-E on April 4, 2000.  The ISO’s Department of Market Analysis believes that a BFM for ancillary services provides a valuable hedging option to California’s day-ahead and hour-ahead ancillary service markets, and that allowing participation by the Investor Owned Utilities (IOUs) will create a more robust and efficient California wholesale energy market.  

A joint letter of support for SCE’s Advice Letter 1443-E was filed by the Office of Ratepayer Advocates (ORA) and The Utility Reform Network (TURN) on April 10, 2000.  ORA and TURN believe that it will provide an option that will allow SCE further flexibility to hedge against potential price spikes in ancillary services.   In addition, they state their general support of the development of forward markets for ancillary services at the PX.  They believe that adding new products to the PX BFM and allowing PX customers to procure ancillary services within the PX will expand market participation, enhance market liquidity, and enhance market efficiencies.

The PX also filed a letter of support for SCE’s Advice Letter 1443-E on April 10, 2000.  The PX believes that participation in the CTS ancillary services market will provide SCE with an important opportunity to protect against potential price volatility and contribute to greater efficiency in the California energy market.  The PX requests that the Commission approve this advice letter as expeditiously as possible in order to allow SCE’s customers to benefit from this new tool during the critical summer months.

On April 25, 2000, the FERC authorized the PX to begin trading of ancillary services products 
on May 1, 2000.  California Power Exchange Corporation, 91 FERC ¶ 61, 079.

NOTICE  
 
Advice Letter 1443-E was served on other utilities and government agencies, and to all interested parties who requested such notification, in accordance with the requirements of General Order 96-A. 

PROTESTS

The Energy Division received a timely protest to Advice Letter 1443-E from the California Department of General Services (DGS), however, it was subsequently withdrawn. 

DISCUSSION  

As SCE correctly points out in Advice Letter 1443-E, the Commission has been supportive of the PX’s efforts to develop an ancillary services forward market.  The question is whether IOUs should be allowed to participate.  SCE claims that its participation in the forward market for ancillary services will enable it to mitigate the cost of spot market purchases from the ISO during periods when the spot market is susceptible to extreme price volatility and thus improves efficiency, increases supply, and benefits consumers.  

In Resolution E-3658, we authorized SCE and PG&E to participate in, and to recover costs of participation in, the PX expanded energy BFM until the end of each utility’s respective rate freeze.   In doing so, we made various statements recognizing the potential value of forward contracting to ratepayers.  We believe the same ratepayer benefits apply to forward contracting in the ancillary services market. We agree with SCE that its participation in a forward market for ancillary services would provide the opportunity to lock-in manageable prices and allow SCE enhanced flexibility to hedge against volatility in the ancillary services market on behalf of its bundled service customers.  

SCE limits its request for cost recovery to the five following ancillary services: 1) spinning reserve, 2) non-spinning reserve, 3) replacement reserve, 4) regulation up reserve, and 5) regulation down reserve.  SCE does not seek authorization regarding other products that may be offered by CTS at this time.  We note further that SCE does not seek authorization to engage in bilateral scheduling and delivery of ancillary services. We accept SCE’s limitations, and affirm that if SCE wishes to participate in other markets offered by the PX, it must file for Commission authorization in a separate advice letter filing. 

SCE also requests that quarterly limits (in megawatts (MWs) per hour) be established for its participation in the forward markets as follows:
				Jan-Mar	Apr-Jun	Jul-Sep		Oct-Dec
		(1^st Qtr)	(2^nd Qtr)	(3^rd Qtr)	(4^th Qtr)
	
Regulation Down		325		300		250		225
Regulation Up			500		475		400		325
Spinning Reserve		375		350		425		450
Non-Spinning Reserve	175		300		350		400
Replacement Reserve		175		175		200		175

SCE’s proposed limits are reflective of its historical ancillary service obligations.  Although we generally support the use of explicit position limits, we do not believe that individual limits should be established for each of the ancillary services.  Instead, we adopt a total, aggregated, number for each quarter.  The approved position limits are 1550 MWs, 1600 MWs, 1625 MWs, and 1575 MWs maximum in any hour for the 1^st, 2^nd, 3^rd, and 4^th quarters, respectively.  

The reason we favor aggregated position limits is due to the ISO’s experience with its ancillary services markets, and the historical problem of “perverse” pricing.  "Perverse" pricing exists when the market clearing price for a "superior" service (e.g., regulation up reserve) is lower than for an "inferior" service (e.g., non-spinning reserve).  The ISO Market Surveillance Committee (MSC) has observed regular occurrences of perverse pricing in the ISO's ancillary services markets (See October 18, 1999 MSC Report on Redesign of California Real-Time Energy and Ancillary Services Markets).  In response to this observed perverse pricing, the ISO, in its role as a purchaser of ancillary services, has adopted what it calls the "rational buyer" program.  The ISO takes advantage of the fact that "superior" services are substitutable for "inferior" services.  At times of perverse prices, the ISO buys cheaper "superior" services to satisfy its requirement for more expensive "inferior" services.

Disaggregated limits, such as those proposed by SCE, would require forward purchases of "inferior" ancillary services once the purchaser has forward contracted for its limit of "superior" services.  Disaggregated limits could interfere with SCE using a "rational buyer" type program in response to perverse forward ancillary services prices.  Once SCE forward contracted for its position limit of a "superior" service, SCE would have to purchase "inferior" service(s) even if the forward price for the "superior" service is less expensive than the forward price for an "inferior" service.  

Accordingly, we adopt aggregate quarterly limits, as set forth above.  Aggregated limits will enable SCE to purchase ancillary services in a manner that mimics the ISO's "rational buyer" program, should perverse prices make an appearance in the PX's ancillary services markets.  In other words, SCE would purchase a “superior” service if it is less expensive than an “inferior” service.

In Resolution E-3637, the Commission recognized that costs may be incurred by SCE which will not be billed by the PX or ISO, and thus authorized the establishment of the Block-Forward Memorandum Account (BFMMA).  SCE states that if such costs are incurred by SCE as a result of its use of the new forward ancillary service products, these costs will also be tracked in the BFMMA for future Commission review.  To be able to do this, SCE should revise its BFMMA tariff sheets to reflect the addition of this new segment of the PX BFM.

COMMENTS

SCE has stipulated to waive the 30-day waiting period required by Public Utilities Code Section 311(g)(1) and the opportunity to file comments on the draft resolution.  Accordingly, this matter will be placed on the Commission’s agenda directly for prompt action.

FINDINGS  

1.	By Advice Letter 1443-E, SCE requests authorization for recovery of costs associated with its participation in the PX forward market for ancillary services, subject to quarterly trading limits, until the end of its rate freeze. 

2.	A forward market for ancillary services would provide the opportunity to lock in manageable prices and allow SCE enhanced flexibility to hedge against volatility in the ancillary services market on behalf of its bundled service customers. 

3. 	Cost recovery is limited to costs associated with monthly forward purchases of the five following ancillary services: 1) spinning reserve, 2) non-spinning reserve, 3) replacement reserve, 4) regulation up reserve, and 5) regulation down reserve.  If SCE wishes to participate in the auction for other forward products offered by the PX, it should file for Commission authorization in a separate advice letter filing.  SCE has not requested, and the Commission is not authorizing, SCE use of the PX CTS bilateral scheduling and delivery of ancillary services products.

4.	SCE’s participation in the ancillary service forward market should be limited to 1550 MWs, 1600 MWs, 1625 MWs, and 1575 MWs maximum in any hour for the 1^st, 2^nd, 3^rd, and 4^th quarters, respectively.

5.	SCE should revise its BFMMA tariff sheets to reflect the addition of the new ancillary service segment of the PX BFM.

THEREFORE, IT IS ORDERED that:  

1.	Southern California Edison Company’s Advice Letter 1443-E is approved as modified in Ordering Paragraphs 2 and 3.

2.	Southern California Edison Company’s participation in the ancillary service forward market shall be limited to 1550 MWs, 1600 MWs, 1625 MWs, and 1575 MWs maximum in any hour for the 1^st, 2^nd, 3^rd, and 4^th quarters, respectively. Southern California Edison Company is not hereby authorized to use the PX CTS products for bilateral scheduling and delivery of ancillary services.

3.	Southern California Edison Company shall revise its tariff sheets to reflect the addition of the new ancillary service segment of the Power Exchange Block-Forward Market and file a supplemental advice letter with such revised sheets with the Commission within ten (10) days.  The advice letter shall be effective today.

4.	This Resolution is effective today.

I hereby certify that the foregoing resolution was duly introduced, passed and adopted at a conference of the Public Utilities Commission of the State of California held on May 4, 2000; the following Commissioners voting favorably thereon:  

  

  								        	                                            
        	WESLEY M. FRANKLIN  
      Executive Director

LORETTA M. LYNCH
           President
HENRY M. DUQUE
JOSIAH L. NEEPER
RICHARD A. BILAS
CARL W. WOOD
      Commissioners