APPENDIX 3


OPTION 3

PROPOSED BY

SAN DIEGO GAS & ELECTRIC COMPANY (U 902-E)



DAVID CROYLE

Pricing Principal
SAN DIEGO GAS & ELECTRIC COMPANY

8326 Century Park Court
San Diego, California 92123

Telephone: (619) 654-1124

Facsimile: (619) 654-1794



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


APPENDIX 3

OPTION 3: SELECTIVE UNBUNDLING OF COMPETITIVE SERVICES

Proposed by San Diego Gas & Electric Company

DESCRIPTION OF OPTION

Unbundling the cost of providing competitive distribution services, and transferring responsibility for service delivery from the UDC monopoly to the competitive retailer, is crucial to the success of electric restructuring. Merely unbundling generation from transmission and distribution functions is inadequate. Customer choice goals must be satisfied before a viable, competitive marketplace can exist. Accordingly, Option 3 calls for unbundling of the most essential competitive distribution services as identified by the retail community -- Track 1 services -- by January 1, 1998. The so-called Track 2 services must be unbundled soon thereafter, in no event later than January 1, 1999.

Retailers have stated clearly that certain revenue cycle services, identified within the broad areas of metering, billing, customer and collection services, must be unbundled by the time direct access is available to all customers. Otherwise, many customers, particularly small customers, may not have the opportunity to participate. Proponents of Option 3 strongly believe that unbundling such costs can and must be done by January 1, 1998 in order for the Commission's customer choice goals to be met.

In order to eliminate any constraints on retailer access to customers, the remaining ("Track 2") competitive distribution services must be unbundled before retailers offer these new products and services. This calls for an aggressive unbundling schedule. Rapid Track 2 unbundling will depend upon the cooperation of UDCs and retailers who must work together to identify and prioritize the most essential competitive services.

Unbundling implementation requires a practical costing methodology which targets the most critical services and meets the aggressive unbundling schedule called for in Option 3. SDG&E proposes such an approach which focuses on the cost savings to the UDC when retailers provide the unbundled service. As described in SDG&E's July 15 filing, this practical costing method is based upon proven costing methods and sound managerial accounting principles.

Option 3 offers a balance of selective unbundling with a practical costing approach which achieves the CPUC's desire to unbundle competitive distribution services, ensures customer choice to all customers ( not just the largest few), enables retail firms to emerge, and moves toward a competitive market in which retailers can provide services which were once the exclusive franchise of integrated utilities.

Extent of Unbundling


	Track 1 (by January 1, 1998)


Distribution services which are essential to retailers must be identified
and prioritized in order for direct access to be available to all customers
on January 1, 1998.  Under Option 3, essential revenue cycle services are
unbundled by January 1, 1998.  All indications from discussions within the RWG
and with retailers suggest that revenue cycle services, such as metering,
billing, customer and collection services, are candidates for unbundling in
the near term because:

1.  these services can be provided competitively;

2.  these services do not impair UDC system reliability;

3.  these services are of great interest to retailers.



	Track 2 (by January 1, 1999)


As the retail market evolves, UDCs must continue to unbundle distribution
services rapidly and responsively as new services emerge and retailers assume
the responsibility as the primary service provider.  Service classification
and costing methods refined in Track 1 can be easily applied to emerging
services.  In order to maximize retailers' ability to provide customers
choices for these services, rapid unbundling in Track 2 should be mandated by
the CPUC.

Description of Option



Option 3 addresses monopoly and competitive services separately.  Monopoly
services remain bundled and are provided exclusively by the UDC.  Competitive
services, on the other hand, are opened to the market with the most essential
revenue cycle services unbundled in Track 1. 


The major features of Option 3 include the following:

	
Classify Services as Monopoly or Competitive Services
Criteria are established to distinguish between monopoly and competitive
services based on whether there are safety, security, reliability or system
integrity reasons to justify exclusive monopoly provision of these services.
If retailers can provide the service without any harm to the distribution
system, then  the Commission should move toward allowing the competitive
market to provide them on an aggressive time schedule.

	
Determine Whether Competitive Services Need a Default Provider


Criteria are established to distinguish between services that require a
default provider and those that do not.  This is an important consideration
because the cost savings to the UDC varies depending upon whether the UDC
retains service capabilities.  Revenue cycle services are consistent with the
range of services that demand a default provider.

	
Unbundle UDC Cost Savings if Retailers Provide Service


The rapid penetration of retailers into competitive distribution services
requires a practical service costing methodology which can produce reasonable
and timely estimates for Track 1 and, subsequently, for Track 2 services.
SDG&E offers such an approach based on proven managerial accounting
principles in which UDC cost savings are estimated for services that retailers
can provide.  There are two variants of this costing methodology:


1.  Marginal Attributable Costs.  If the UDC is obligated to serve as
default provider, then the UDC must retain the capability of providing the
service to those customers who choose the UDC bundled service, and others who
choose to return to the UDC's bundled service at a later date.  This method
identifies and values UDC service activities and resources which can be
avoided, but recognizes that certain costs will remain within the UDC to meet
default provider needs. 


2.  Average Attributable Costs.  If the UDC does not have an obligation to
serve as default provider, then it need not retain resources and capabilities
for that purpose.  In this case, all attributable costs can be avoided.  This
cost method identifies and values UDC service activities and resources
associated with providing the UDC service and assumes no service capability
remains.

	Periodic Updates of UDC Cost Savings


As costs change within the UDC and the pace of retail penetration accelerates,
it will be necessary to update these cost estimates from time-to-time to
provide the most current price signals to customers and retailers.

CPUC Policy Decisions


 Endorsement of  SDG&E's Costing Methodology
SDG&E's costing methods were presented on June 26 to the RWG and further
detailed in the July 15 unbundling filing.  SDG&E proposes a demonstration
of the method by the RWG Analysis Subgroup, using one or more services, to
show that the method can be applied easily and produces reasonable estimates.
The CPUC needs to endorse this methodology -- the only service costing method
proposed in the RWG -- because it is both practical and reasonable.  

	Requirement that All UDCs Use the Same Methodology

To ensure consistency and conformity of unbundled cost-saving estimates,
all UDCs should adopt the same approach to service cost unbundling.  The CPUC
must rule that all UDCs use this method to unbundle service costs to ensure
equity to all parties. 

	Support for Which Distribution Services to Unbundle

Option 3 identifies essential revenue cycle services for Track 1 unbundling.
The CPUC needs to endorse these priorities and mandate that all UDCs unbundle
cost savings associated with these services to support direct access by
January 1, 1998.

	Support for Streamlining Approval of Cost Estimates

Proponents of Option 3 agree that cost-saving estimates should be:
(a) "reasonable" not "precise,"/ 
(b) comparable among the UDCs, and (c) available sooner rather than later.
The costing methodology proposed and applied to revenue cycle services, streamlines
the process of reasonably estimating costs.  Tariff review procedures must be
streamlined as well to consider retailers needs.  Default prices or
reasonableness tests can be established to ensure compliance by the UDCs.
Proponents believe that once services are identified, costs savings must be
estimated and approved within 90 days.  Benchmarks can be established
for revenue cycle services to confirm that they are, in fact, reasonable.

Process and Timing


 Information Requirements
By selectively unbundling only the highest priority services by January 1,
1998, and choosing to unbundle UDC costs savings where these services are
provided by retailers, information requirements are kept to a minimum.
Utilities already gather information on the cost of metering, billing, a
customer and collection services.  This information is currently used to
establish performance measures, benchmark against peers, and reengineer these
services to achieve better performance.  In addition, some utilities have
investigated outsourcing and to do so requires knowledge of the cost of
providing these services in house.  Obtaining the required data for these
services will be straightforward.

  Cost Estimation Procedures
As described in the July 15 report, this approach classifies services and
unbundles their marginal or average attributable costs, depending on whether
the UDC is the default provider.  To provide essential information to
retailers, both marginal and average attributable costs should be estimated.

  Schedule for Track 1
SDG&E will propose a demonstration of the costing method by the RWG Analysis
Subgroup on September 5 and advocates that all UDCs apply this method to select
services in the November 15 filing.  Once the CPUC endorses Option 3, all major
UDCs will perform cost studies for the remaining revenue cycle services
identified in the November 15 filing, so that the remaining (mid-1997) service
unbundling can be adopted by the CPUC by January 1, 1998, to meet the direct
access implementation date.

  Schedule for Track 2
Track 2 calls for applying the same costing methods, used to estimate revenue
cycle service cost savings by January 1, 1998, to the remaining competitive
distribution services on an aggressive schedule.  With the goal to allow
retailers to  provide competitive distribution services to retailers as soon
as possible, Track 2 unbundling must be sufficiently rapid to keep pace with
the emergence of retailers and retail services.  Option 3 calls for a period
of one year following January 1, 1998, to substantially complete unbundling
of competitive customer services.

Implications of Choosing Option 3

The remainder of this Option 3 summary addresses each of the nine issues developed by the RWG and listed in the body of the report as critical in the CPUC's evaluation of the proposed options. Option 3 offers the right balance necessary to achieve the CPUC goal of real customer choice by January 1, 1998:


 Unbundling is Feasible by January 1, 1998
There are three key features of this option that ensure that direct access
implementation is accomplished by January 1, 1998:

  1. Select Services. Focusing on revenue cycle services limits unbundling to the highest priority services and ensures choice to all customers by January 1, 1998.
  2. Costing Method. Proven and practical costing methods proposed support unbundling UDC cost savings for services retailers provide, and ensure the completion of cost studies in time for direct access implementation on January 1, 1998.
  3. UDC Resources. Unbundling distribution services will not delay functional unbundling nor WEPEX development. Different skills, people, data requirements and methods are involved in each case.

 Customer Choice is Assured to All Customers
Ensuring customer choice to the smallest customers demands that UDC cost
savings for essential services identified under Option 3 be unbundled by
January 1, 1998.  Revenue cycle services represent a higher proportion of
the small customer's  bill and without unbundling, retailers will be unable
to market to these smaller customers.  Option 3 takes the CPUC goal of
"customer choice to all customers"  seriously, introducing the voice of
reason -- and reasonableness -- into the RWG debate. 

  Reasonable Cost Estimates are Needed in the New World
"Precision costing" is unattainable and needlessly delays the unbundling
process.  Retailers must have "reasonable" cost estimates.  Default prices,
guided by benchmark studies, can offer the requisite "reasonableness check" and
avoid unnecessary regulatory oversight and challenges by parties who think
the estimates are either too high or too low.  

  Cost Method Minimizes Cross Subsidies and Cherry Picking
Cross subsidy issues are addressed by a costing method that unbundles only
marginal or average attributable cost savings and thus, leaves the rates for
one group of customers unaffected by the decision of other customers to take
service from retailers.  Cherry picking is further discouraged by unbundling
services into similar subcategories within which cost savings variances are
small.  For example, since meter reading costs differ in urban and rural
locations or between residential and commercial customers, then cost savings
may be needed by customer class and location.  This avoids the cherry picking
which occurs when rates are based on broad averages and competitors choose
customers which cost less to serve 

  Customer Protection and Education is Assured
Since the focus of Option 3 is essential revenue cycle services, critical
implementation issues designed to protect and educate the customer will have
already been addressed in the Direct Access Working Group (DAWG).  Metering
and billing issues, for example, are being resolved within that group.  Key
implementation steps and market rules are being identified and developed
through DAWG efforts.  Issues addressed in DAWG, for example, include the
timeliness and accuracy of meter reads and bills as critical customer
protection issues.  By choosing to unbundle revenue cycle services,
unbundling can "piggyback" on DAWG activities to support the Track 1 timetable.

  Lengthy Regulatory Oversight Must Be Avoided
Traditional utility thinking and regulatory procedures are outmoded in a
competitive environment where timing is critical.  Therefore, practical
considerations need to replace the more traditional regulatory processes to
make sure retailers are "enabled" without "disabling" the UDCs in the
process.  The costing method proposed under Option 3 simplifies the cost
estimation process.  With the review process also streamlined, compliance
with the CPUC's goal of customer choice to all will be achieved. 

  The Role of UDC as Default Provider Will Change
Since the primary goal of Option 3 is to move toward a market where any
services that can be, will be offered by retailers, the UDCs must move from
exclusive provider to default provider and enabler of the competitive market
over time.  How quickly  retailers will step up to and assume responsibility
for competitive services, and how long UDCs will need to serve as default
providers for essential services are open questions.  However, Option 3 does
provide a mechanism to begin the process of changing the role of the UDC and
to keep pace with the development of a competitive distribution services
marketplace.

Summary and Conclusions


The Commission must adopt an aggressive unbundling schedule for both Track 1
and Track 2 services.  Unbundling of services  is essential to customer choice
and vendor viability.  In order to achieve a market where retailers offer a
wide range of competitive distribution services, customers must have the
right to choose their supplier.  The ability to choose must be available soon
in order to meet the Commission's objectives for rapidly achieving a
competitive electric services industry.  Option 3 accomplishes the
Commission's goals within the appropriate timeframe. 

I. DESCRIPTION OF OPTION 1A. Extent of Unbundling 1B. Description of Option 1C. CPUC Policy Decisions 1D. Process and Timing 1E. Implications of Choosing Option 3 1F. Summary and Conclusions 1