ANDREW L. NIVEN

Attorney for
PACIFIC GAS & ELECTRIC COMPANY

Law Department
Pacific Gas and Electric Company
77 Beale Street
San Francisco, California 94120

Telephone: (415) 973-6640

Facsimile: (415) 973-6272

This Appendix represents the proposal and opinion of Pacific Gas and Electric Company, and is not intended to represent the consensus or approval of the Ratesetting Working Group.

DESCRIPTION OF OPTION

In this Option, Track 1 items are Generation, Transmission (including ancillary services), Distribution, Competition Transition Charges (CTCs) and Public Goods (the Five Consensus Items). All parties to the Ratesetting Working Group (RWG) agree that the Five Consensus Items must be unbundled by January 1, 1998 to meet the goal of establishing a competitive market for generation. This need is paramount. The desires of some parties to accelerate the further unbundling of rate components should be subordinated to the necessity of first unbundling the Five Consensus Items. Therefore, Option 2 (like Option 1) classifies all further unbundling beyond the Five Consensus Items as Track 2 - that is, "those issues that are desirable but not necessary for direct access implementation."/

Option 2 would also begin now to address the possible unbundling of Track 2 items. In parallel with the Track 1 process, and to the extent that resources are available in addition to those that are devoted to Track 1, the RWG would begin immediately to identify potential distribution services that are candidates for unbundling after January 1, 1998. This Track 2 process would include establishing criteria for selecting the unbundling candidates, specifying the needed cost studies, and identifying potential avoided cost credits or other pricing mechanisms for each candidate. Among the factors to be considered by the RWG would be the utility's obligation to serve, the degree of competition, the extent of market penetration, and other factors relevant to the services in question. Finally, the RWG would recommend what Commission decisions are needed for Track 2 unbundling to proceed, including any threshold determinations that Track 2 unbundling of a specific service is or is not in the public interest. With this separate process in place, direct access can begin on January 1, 1998 with the unbundled Five Consensus Items while the RWG continues its work on Track 2 items.

THE EXTENT OF UNBUNDLING IN OPTION 2

Track 1

Under Option 2, only the Five Consensus Items of Generation, Transmission (including ancillary services), Distribution, Competitive Transition Charge (CTC), and Public Goods would be unbundled as Track 1. By assuring that all needed resources are focused first and foremost on unbundling of the services essential to enable direct access by January 1, 1998, this approach provides the greatest likelihood of meeting the Commission's objectives. Unbundling these five items, designing rates for each, and obtaining Commission approval by June 30, 1997 in accordance with the proposed schedule described below will require significant ongoing effort on the part of the Commission, the utilities and other stakeholders. Further, successful resolution of this level of unbundling is only one of many complex tasks that must be completed to accomplish the Commission's January 1, 1998 goal./

Track 2

This approach does not designate any items as Track 2, since to do so in advance of the necessary analysis would be premature. However, Option 2 does set in motion the process of reviewing Track 2 items for ultimate determination by the Commission.

CPUC POLICY DECISIONS

Certain threshold policy questions must be addressed to determine whether any further level of unbundling, specifically in the distribution service arena, is either appropriate or, more fundamentally, in the public interest. If the Commission decides to move beyond unbundling of the Five Consensus Items as part of Track 1, then the following policy issues (which are also listed in the Consensus Report) should be framed, debated and resolved in a public forum first.

• The extent of distribution service unbundling necessary to provide the Commission's desired level of customer choice for all customers.
• The potential tradeoffs between the extent of distribution unbundling and the timing of the implementation of direct access.
• The potential tradeoffs between the incremental costs of additional unbundling and the value to customers.
• The potential tradeoffs between the degree of accuracy of the cost estimates used for the unbundling of distribution services and the timing of the implementation of direct access.
• The relationship of costing methods used for unbundling distribution services to the Commission's concerns about avoiding cost shifting.
• The relationship between the extent and timing of distribution unbundling and consumer protection and education.
• The need to establish general principles and standards that will minimize regulatory oversight and litigation.
• The need for and extent of the Utility Distribution Companies' (UDC) ongoing obligation to act as an exclusive default provider for those not selecting alternative suppliers or for those returning from service with alternate suppliers.
• The need to balance the opportunities and responsibilities of the market providers.

Additionally, the Commission should determine: (1) whether unbundling of distribution services would create new stranded cost categories, and if so, what is the appropriate mechanism for recovery of these costs; (2) what mechanism would be instituted for addressing any cost shifting resulting from distribution unbundling as low cost-to-serve customers are sought out by aggregators, leaving the remaining higher cost customers with the default provider; (3) the extent to which providers of unbundled distribution services would be regulated; and (4) the ability of the UDC to offer these services on a competitive basis.

In order to pursue Option 2, the Commission must first clarify that only unbundling of the Five Consensus Items is required by January 1, 1998. The utilities will then file applications for this level of unbundling on November 15, 1996, as directed by Commissioner Duque's June 21, 1996 ACR. Meanwhile, the RWG will begin to identify additional distribution services that are candidates for unbundling and begin the tasks necessary for unbundling these services after January 1, 1998. Under this option, the Commission would establish a formal procedural schedule for considering unbundling of distribution services beginning after January 1, 1998, with requirements for RWG status reports in 1997 to ensure continued progress.

IMPLEMENTATION AND TIMING ISSUES FOR OPTION 2

Information Requirements

Separating bundled revenue requirements into the Five Consensus Items requires that several data-intensive steps be completed for the three electric utilities and approved by the appropriate regulatory body:

• Detailed definition of the boundaries separating the Five Consensus Items, particularly regarding the transmission versus distribution demarcation being addressed by the CPUC and FERC;
• Mapping the currently bundled authorized electric revenue requirement into the Five Consensus Items, a task never before performed by CPUC rate case decisions or by the utilities' accounting systems;
• Refunctionalization of certain assets from one cost category to another;
• Direct assignment and allocation of common costs such as administrative and general expenses;
• Allocating revenue requirement and designing rates to reflect the costs associated with the Five Consensus Items without shifting costs among customer classes or among rate schedules within a customer class; and
• Changing the format and content of customers' bills to clearly convey needed information about unbundled rates.

Further unbundling of distribution services in Track 2 would first require the resolution of the major policy questions listed in Section III above. In addition, unbundling of distribution services would require a Commission approved methodology for developing avoided cost credits for services to be provided by others.

Procedural And Analytical Steps

Functional unbundling must begin by assigning total costs to the generation, transmission, distribution and public goods categories. Final separation between distribution and transmission, however, must await FERC's determination of the definition of transmission. Generation and CTC will be separated based on the costs of power from the Power Exchange. Shared costs must be allocated to all functions.

Following the issuance of this report, the RWG, through its Analysis sub-team, would begin examining and applying the different methods for developing avoided costs for selected distribution services, under a range of different market penetration scenarios, and different presumed UDC roles and responsibilities as a default provider for the service. This would help the parties understand the rough magnitude of the possible avoided cost credit for these services, as well as the complexities associated with the development, administration and application of this credit. This process would help inform the Commission regarding the possible scale and scope of financial transactions that would be generated by this unbundling, and would provide useful background information supporting the issuance of an OII necessary to determine whether this additional unbundling would serve the public interest and lead to lower costs.

Proposed Schedule

Under Option 2, the Commission, as well as the parties, would devote all necessary time and resources to resolving the complex issues and completing the complicated tasks necessary to meet the January 1, 1998 deadline for direct access. In parallel with the Track 1 process, and to the extent that resources are available, the RWG would begin immediately to identify potential distribution services that are candidates for unbundling after January 1, 1998. Option 2 anticipates that unbundling applications for Track 1 items will be filed by the utilities on November 15, 1996, with Commission approval of a methodology for unbundling of Track 1 items by June 30, 1997, followed by a six-month implementation phase. Track 2 issues would be formally addressed by the Commission after January 1, 1998.

IMPLICATIONS OF OPTION 2

Extent Of Expected Customer Participation

This option is based on the Commission's stated purpose of establishing a competitive generation market and customer choice of generation provider. On January 1, 1998, several options are expected to be available to all customers. These include: (1) bundled purchases from the Power Exchange through the UDC; (2) Contract For Differences (CFDs) around the Exchange price; (3) virtual direct access; and (4) direct access. Under these options, marketers will have the opportunity to serve all customers without further unbundling of distribution services. Whether a customer chooses one option over another will depend on the extent to which the customer believes he or she will benefit. The success of the Commission's restructuring efforts, however, should not be judged solely on the number of customers electing direct access, but on the extent and timing of the availability of all these options.

Cost­Shifting

With regard to unbundling distribution services as part of Track 2, this option would ensure no cost shifting provided that any credits offered on selected unbundled services would be based on avoided costs reflective of the customer class and other relevant attributes (e.g., location, size, etc.).

Utility Incentive Structure

Under Option 2, utilities retain the same incentive to provide reliable distribution services to all customers whether they acquire their generation services through bilateral contracts or stay with the UDC. This option does not result in any change in utilities' incentive structure.

Why Option 2?

Option 2 will best balance the need to implement Direct Access by January 1, 1998, with the desire to address the possible unbundling of distribution services.

By focusing all needed resources on the unbundling of the Five Consensus Items, Option 2 provides the greatest likelihood of achieving the Commission's January 1, 1998 deadline for direct access. The five items currently identified as Track 1 items are essential to enable direct access by January 1, 1998. Unbundling these five items, designing rates for each, and obtaining Commission approval by June 30, 1997, will require significant ongoing effort on the part of the Commission, the utilities and other parties. Further, successful resolution of this level of unbundling is only one of many complex tasks that must be completed to accomplish the Commission's January 1, 1998 goal. The design, establishment and operation of the Power Exchange, ISO, and UDC, as well as the appropriate communication links among these entities and the new market retailers, and any necessary legislation or regulation of such must also be completed and in place by January 1, 1998.

Finally, Option 2 initiates the process of examining the possible unbundling of distribution services leading to the Commission's careful consideration of whether Track 2 unbundling is in the public interest.­I. DESCRIPTION OF OPTION 1II. THE EXTENT OF UNBUNDLING IN OPTION 2 1A. Track 1 1B. Track 2 1III. CPUC POLICY DECISIONS 1IV. IMPLEMENTATION AND TIMING ISSUES FOR OPTION 2 1A. Information Requirements 1B. Procedural And Analytical Steps 1C. Proposed Schedule 1V. IMPLICATIONS OF OPTION 2 1A. Extent Of Expected Customer Participation 1B. CostShifting 1C. Utility Incentive Structure 1D. Why Option 2? 1