PATRICK MCDONNELL
on behalf of
AGLAND ENERGY SERVICES, INC.
900 Larkspur Landing Circle, Suite 240
Larkspur, California 94939
Telephone: (415) 461-5820
Facsimile: (415) 461-6803
This Appendix represents the proposal and opinion of the parties referenced herein, and is not intended to represent the consensus or approval of the Ratesetting Working Group.
This is a joint presentation of Agland Energy Services, Inc., Illinova Energy Partners, School Project for Utility Rate Reduction, Regional Energy Management Coalition, and SharePlus.
As the Commission proceeds with its efforts to develop a set of rules under which it intends to implement the electric restructuring, it is important to occasionally step back and look for signs that the Commission's program is still headed towards the desired goals. We believe one sign the CPUC should find telling relates to the minimum customer size at which customer choice will be present in the restructuring program, as this program is currently proceeding. We believe that the Commission should be curious why there is not one firm, other than the utilities within their own territories, out of dozens of well financed and experienced firms setting themselves up to do business under the CPUC's restructured electric market,/ who is targeting residential and small commercial customers. These customers account for roughly 90% of the customer accounts, and nothing is being done by the marketplace to serve them. Industrial customers, also, should be asking whether the impediments that are limiting even the introduction of basic competitive service delivery to the vast majority of customers also is restricting the nature and scope of benefits they hope to receive. This is a great deal of work for the State of California to go to, if we are only going to realize a modest change.
It is often easy to dismiss suggestions for new approaches, if it begins to appear that the change being requested is more than a minor variation to the common wisdom. However, we have looked at the conflicts between the parties, the costs of the system and the limitations in the system being proposed, and believe that there is a simpler and cheaper option which appears better for everyone. We are challenging the parties to the electric proceeding to merely look critically at the assumptions underlying what they believe will stimulate the creation of a competitive marketplace, one in which the CPUC can rely on to take over much of the regulatory burden. Under the more limited unbundling proposals , we believe that one will find the foundations for creating a competitive marketplace are quite thin.
Since our proposal goes to some deeply held assumptions about the system, it has been necessary to explore and describe how nearly all aspects of the system, with which customers are familiar, would be essentially unchanged, and that the results would still be cheaper, and more dynamic. The result, however, is that the presentation of this approach requires a greater length than the other options, as the burden of proof is on us to demonstrate why the assumptions are in error before we can begin outlining some of the implementation details. In turn we felt that we need to present our proposal with enough depth to cover the key issues associated with their implementation to verify that implementation was realistic and achievable, consistent with the CPUC's goals.
We are explicitly being humble about what can be included within Track 1. One key difference between Option #5, and the other options to this RWG report is our focus on creating a standard by which to evaluate the presence of a competitive system, which we seek to be operating as an "end state" of the electric restructuring process. This goes beyond merely the unbundling of commodity procurement, beyond the unbundling of many of the distribution services, all the way to the basic features of unbundling utility profitability and the obligation to serve. As such, we are the first to admit that California needs to proceed slowly, carefully, but with determination starting now. We attempt to present why this additional level of unbundling is necessary, and go so far as to describe in some detail how we would suggest a pilot program be established to begin to set in motion the reworking of the utility retail profit incentive. Beyond that, we propose that the implementation of this extensive unbundling be based on the work of working groups, after a clear direction is provided by the CPUC. It is here that the Commission's trade off between timing, participation, cost reduction, accuracy and the precise distribution of benefits can best be evaluated.
Where this all leads, is that the CPUC must specify what it is that is being opened up for competition, upon which competitive business may build upon. We admonish observers to operate with an assumption which is often not stated, that utilities are staffed by smart people, who in the face of competition can meet a variety of competitive challenges and can produce an efficient service delivery system. We must not build a system based on an assumption of utility inefficiency, for to do so is to admit failure, and is a condemnation of the 90% of the state's electric customers who, under current rules would have no viable alternative but the utility for their commodity procurement and distribution service delivery. Without the deep unbundling proposed here, long term and significant utility inefficiency is the only assumption, we have been able to identify, upon which the CPUC could expect to see a business opportunity created that extended the reach of competition to the vast majority of the State's electric customers.
We believe that system must reach higher than that low point. We believe anyone looking critically at the system, including reviewing the experience of the natural gas restructuring,/ must conclude that this low point is where electric restructuring is headed. What is required to make competition a reality is to make customer choice the driver. The change needed is at the basic level of how utilities are paid, and what is their unique role. It is the thesis of this presentation that until the other firms are competing for the same services as the utilities, and that the utilities are pricing their products and services so that they both recover their costs and return a profit from customers' acceptance of those services, competition will be an unrealized ideal. Nothing in the CPUC's decisions to date sets the stage for this simple result. In contrast, we can read a great many references to the Commission stating that customer choice is to extend to all customers and all classes. We hope that through this presentation that the conflict in these two Commission positions can be clarified, and a route to resolving the conflict be identified.
The result need strand no assets, should offer great opportunity for the utilities, reduce regulation, deliver tremendous cost reductions and thereby customer savings, and offer to change how energy is bought and sold. We cannot do that by tweaking the surface issues of the system. We must get to the heart of the matter.
The central feature of this proposal comes out of a recognition that two assumptions are severely restricting the ability of the electric industry to restructure. These assumptions are:
Until we take these assumptions out and look at them critically, the system runs the risk of serious underachievement. It is the results of our evaluations that when looked at critically, these assumption do not hold up, and taken together it is clear why there is not one single marketing company positioning itself to serve the residential and small commercial customers who comprise over 90% of the state's electric customers. Even the breadth and nature of services being contemplated by the marketing community for the roughly 10%, because of these assumptions, are being restricted to very narrow definitions.
The goal of our proposal is the complete segregation between all of each utility's retail distribution services from its ongoing monopoly fiduciary functions. We propose this to be within a structure where a new class of marketing company is created in which the local utility retail affiliate is but one member. To do this means that all members of that class of marketers, within whom the obligation to serve rests as a class, fund their retail service offerings entirely from the profitability of the products and services they supply.
As simple as this sounds, it is a profound change. The current utility model has virtually all utility profitability funded from ratebase finance, as set in the revenue requirement, which is set in the cost of capital proceedings. PerformanceBased Ratemaking, and other incentives, as more typically employed in the California gas industry, seem to be designed to influence this capital sourced profitability by only a few percent in their most extreme application, and in our mind make the system more complicated and less competitive.
Within our model, we would have the incentives of the utility retail affiliate be the same as that of the other members of the Tier One marketing firms. One of the cleanest ways to accomplish this goal of common funding is to permit parties to prepay to the wires company all capital charges that would apply to a particular group of customers. All other methods of accomplishing the goal of realizing a common source of profitability among competing marketing companies (inclusive of the utility retail arm) are more messy. They require that we overlay regulated, PBR type devices on top of the existing system which is demonstrably too expensive. The prepayment, as the final step in unbundling distribution services creates a transaction size that enables customers as small as residential to become direct participants in the restructured marketplace. Without this, even a utility retail affiliate would find the residential class of customers to be unattractive to serve, unless we continue to see ratebase finance subsidizing retail activities.
As many of our suggestions may require some rather significant structural changes to the utility system of service delivery, regulation and accountability, we assume most of the changes would be Track 2 items. However, we believe that many of these may be eligible for test and experimentation within track 1. More important than discussing which elements go into Track 1 and Track 2, however, is our concern that the Commission set in motion the process by which these assumptions underlying the system be explicitly examined and the opportunities to test their validity be opened up. We are concerned that to attempt to bring this deeper level of review into the process later may become impossible.
The program, as we have crafted it is the result of our digging ever deeper into the system's operations until we could find the point where utility, customer and supplier interests converged. It was our opinion that this was the point from which the restructuring must emanate, and by starting there we feel each of the groups in the system are improved.
Therefore, we would hope that through these suggestions, we would clarify that many of the current conflicts in the system are merely due to a restructuring program that tries to change too many surface features without being cognizant of the foundations. Instead, we believe that if we start from the proper point, there is no conflict between having a competitive structure, meeting the social objectives of the system, and insuring that there is fair compensation to the shareholders of the very companies who have provided us with some of the very best energy service delivery systems in the world.
This does not mean all Track 1 restructuring tasks conspicuously reflect this point of origin, instead, it becomes for us the beginning point in defining how the system is to work in order that these various interests are met. For us, we believe that the single most important task for the CPUC to conduct is to define how the system operates in the year 2010. Then, we can look at what will be required to get there. It is very telling that everyone has a different interpretation regarding what the CPUC's vision of the electric industry should be in the year 2010, and the complete inability of the Ratesetting Working Group to agree on what the CPUC has said is only a small case in point.
One of the issues upon which considerable disagreement is raised is how to move into the restructured environment conservatively, as electric supply is intimately tied to the physical health and welfare of all residents in the state. We make a distinction, however, between choosing a bold destination and moving conservatively. We believe that what can be done within Track 1 is to begin to experiment with features of these unbundled assumptions. Specifically, we believe have outlined in this material a means whereby we could implement pilot approaches to test these assumptions. Without trivializing the need for the Commission to base its decisions on a record of evidence, we caution the Commission that some of the major changes suggested here are best implemented based on a combination of abstract analysis and real world testing. Fundamentally, it would be a mistake to attempt to conceptualize all changes needed for a single implementation within windowless hearing rooms and reply briefs. Instead, some portion of the development of a Commission record should be from the real world, and this drives our goal of beginning a limited test of these programs within Track 1. We believe that we can demonstrate, within a set of limited scale and term pilot program, the key features and benefits that could be offered. This would provide the Commission, the utilities, new market entrants and customers in all classes a much better foundation upon which to evaluate the discussions and arguments provided in the proceedings to evaluate expansion of these efforts.
Each of the assumptions we questioned have a long history within the utility industry, and there is a logical foundation upon which their origination rests. However, as we approach the 21st century, a structure put in place in the industry's infancy is ripe for review. In both cases, we find that with the explosion of computer technology, the ability to track data, and to put suppliers of products and services together with their consumers has created an entirely new set of conditions. Further, as utility protections for cost recovery of items outside of the utility's control expanded over time and now with the increasing sophistication of the financial markets, we find that new opportunities are available to package the old system, as it has evolved. Thus, it is with a 1996 frame of reference we are evaluating how to take basic structural features of a system built in the 1920s into the 21st century.
We believe that when looked at critically, parties will discover that the current system of relying on ratebase finance to provide utility profitability, is very expensive and will effectively prevent the ability of the marketplace to provide the benefits of competition to more than a couple of percent of the state's electric customers. It is important to take up both of these questions separately.
An issue raised for years by utilities in California, as elsewhere, is that the adversarial nature of CPUC regulation imposes large costs on the system. Made as a statement from only the utilities, it was taken as a self-interested comment. Based on the experience at Puget Sound Power and Light in a program refinancing a portion of their ratebase in 1995, combined with statements of financial markets personnel, we believe that we can finally put a number on one aspect of the costs of regulation to California. The specific cost we are concerned about comes from the requirement for significant equity in the finance of the pipes and wires, because of the concern of the financial markets that regulatory disallowance could imperil the financial integrity of a thinly capitalized company.
What Puget Sound showed is that with a minor piece of legislation which merely memorialized a current ratemaking procedure, it may be possible to virtually eliminate the equity requirement in the finance costs of ratebase./ Generalized to the broader body of ratebase in the California context, that would imply a full 50% reduction on finance costs for the California utilities may be practical, implying an annual savings of nearly 2 billion dollars per year./ The benefit the CPUC seems to get for that cost is the ability to disallow investment decisions. This is where the cost:benefit ratio seems to be entirely out of line, but until the Puget Sound experience was available, hard documentation was lacking.
If we view this retroactive disallowance right costing nearly 2 billion dollars per year, we note that the largest single application during the past decade of that right has been to disallow approximately 200 - 300 million dollars. This means that in 10 years, the largest individual disallowance has been in the range of 10-15% of the annual cost. Aggregated over a decade, however, we are looking at a possible excess costs approximating 20 billion dollars, while the "benefit" to ratepayers, in terms of disallowances, would be in the range of less than one billion dollars. This is a cost:benefit ratio approaching 20:1. The big costs in the electric industry are the carrying costs of the assets, not their initial cost. Thus, the conclusion is that the system would be much better off being very restrictive about what is recoverable. We could even offer a premium value for a firm to get an asset approved for ratebase recovery. That is if, once approved for ratebase recovery, it was not subject to subsequent review and possible disallowance, for then, carrying costs could be minimized.
The above numbers are backward looking, and the CPUC has determined that ratebase finance will not be the driver for generation assets, after the transition period. However, unless we begin now to change the central role of ratebase finance in utility profitability, and instead elevate the customer's obligation to pay, we will be memorializing the same cost:benefit ratio for all remaining ratebase assets for which customers are obligated to pay.
We are further finding that reliance on ratebase finance, as the only meaningful source of utility profitability, is a serious impediment to the development of a competitive marketplace for commodity and services, as these are zero margin activities of the utilities. This would change only slightly under currently proposed PerformanceBased Ratemaking (PBR) programs. This is because PBR programs are currently being proposed as minor additions or reductions to the fundamental base, ratebase finance returns. While we believe that the need for unbundling services to expand service capabilities to the marketplace is nearly self-evident, most parties are not clear on why retaining current structures of ratebase finance produces such a significant impediment to the creation of a competitive marketplace.
Starting with the basics, commodity gross profit margins are always tiny, because of what a commodity is (an undifferentiated product, traded within a liquid marketplace). The result is that if the CPUC is even partially successful in seeing the creation of a commodity marketplace for electrical energy, then the largest imaginable gross profit margins available from commodity sales to most residential and small commercial customers would not be enough to even pay for the monthly postage stamp to mail an invoice. Given that the goal of the CPUC is to create a market price through the power exchange, and that commodity sales are a utility non-profit (meaning zero margin) item, then one must assume gross inefficiencies in the operations of the power exchange. That is the only assumption that would permit there to be a profit margin created which not only covers invoicing costs but covered any of the other items required to contract with and serve small customers. Even to add a host of services to the unbundled transaction, as suggested by some of the other options offered by the Ratesetting Working Group should not be expected to open up a transaction opportunity for small customers. The reason, again, requires an assumption that the utility is so inefficient in the supply of those non-profit (zero margin) service offerings that the CPUC will have failed in its principle mission of cost reduction.
The CPUC should not be proceeding down a path in which it is necessary to assume gross inefficiencies in the commodity procurement and service supply activities of the utilities in order to create a climate in which competition can exist. Instead, the CPUC needs to assume that the utilities will become ever more efficient, if facing competitive pressures, and it is therefore up to the CPUC to insure that there is a true basis for competition. Any questions about the validity of this can be referred to observations of the CPUC's core aggregation gas program.
It must be an initial grounding point that the utilities are profitably providing service to small customers. They profitably serve small customers because of the complex web of credit protections and profitability created through ratebase finance. They currently get virtually no profit contributions from commodity procurement and service deployment, which are the only items being widely discussed for opening up to competition./ Once opened up to competition, commodity prices, again, are to be based on a Power Exchange price which is contemplated to be a raw commodity price, meaning the supplying utilities' profitability is to come from elsewhere. Thus, if the CPUC is serious about all customers being eligible to receive the benefits of parties competing for their business, then the CPUC must provide a foundation for firms to compete at this small usage, service intensive level. It must not be based on an assumption of continued utility inefficiency, nor should it be based on maintaining customer perceptions of free and/or nonprofit services. Instead, the utilities should be given the incentive to serve customer needs, as defined by the customer, meaning that cost recovery and profitability at the customer level must come from the acceptance of the customer for the utility offering, vis a vis the competitive alternatives.
Fundamentally, this cannot happen if the utilities retain full current non-generation profitability for these customers through ratebase finance margins, even if the rest of the utility bundle is broken out. Based on our example in the attachment, we perceive a 350 -400 kWh per month customer pays approximately $3.00 to 5.00 in pretax profit from ratebase finance, out of a $40/mo electric bill. To duplicate this level of profit potential in the marketplace from commodity only sales is to assume approximately 50% commodity profit margins. To add commodity margins to some level of service unbundling for retail functions would still require an ability of the marketplace to provide comparable commodity and services at an approximately 30% lower cost before they add their profit, just to match the utility price. If that were the case, we would then have the utility still receiving $3.00 - 5.00/month in pretax ratebase finance returns, which used to subsidize all other utility functions, and the marketplace has then duplicated the utility offerings at a 30% + cost reduction but the customer has saved no money.
If we want true competition, we need to reduce that threshold. Profitability needs to be product and service specific, so we do not end up with the perverse arrangement of benefiting the utilities by reducing their work but retaining their profits. More fundamentally, we need to make sure that we create a restructured industry where customers have firms vying to serve them, by coming up with innovative product offerings and cost reduction strategies. Whether the customers elect to change suppliers, this competitive pressure is the only known mechanism to induce the primary service provider to be customer responsive.
The single most important factor influencing the cost of capital is risk. With capital costs being the largest single cost in the utility tariffs, and nearly 100% of the pass though cost of the CTC, minimizing risk should be central in the CPUC's restructuring effort. This is especially since cost reduction plays such a central role in the statements of why the CPUC is pushing the restructuring effort. Clearly, as we get into the restructuring, providing utilities with a reasonable opportunity for profit is basic and this is where creating comparable terms of service among competing entities at the retail level becomes critical.
The means to accomplishing this, as an efficiency improvement, gets back to risk. The underlying security for the recovery of utility ratebase is the customer's obligation to pay, as officiated by the CPUC. What is at issue is how to finance the cost of the pipes and wires, and what the underlying security for those pipes and wires is to be.
We do not contend that the utilities are charging too much for their capital acquisition services, based on the method of ratebase finance the system assumes we have to use. Instead, we contend that the method the system assumes we have to use is excessively expensive. The reason is that, one half of the cost of the pipe and wires is raised by selling stock certificates. As anyone watching the headlines will attest, the value of stock certificates, are not only based on the underlying pipes and wires of the utility selling the certificates, but the value is largely based on the volatility of the stock market, the credibility of management, and all filtered through an inherently adversarial relationship with a local utilities commission. What is lost is the inherent customer obligation to pay, and the result is an increase in risk.
Puget Sound Power and Light's program, funded in the Summer of 1995 to prepay a portion of outstanding ratebase, employed legislative authority to limit Washington State's utilities commissions' right to modify the customer obligation to pay. Instead, the Washington State Utilities and Transportation Commission was required to continue to use the cost recovery procedures for the designated assets currently in place. What was interesting is that even though no new customer obligation was created, the program was deemed so strong by the underwriters that it received a bond rating which was higher than that of the State of Washington. We find that to get the full 50% cost reduction that legislative action would be required to similarly acknowledge the nature and retention of the existing commitment of customers to pay, even though the right of the utilities' to a fair return is at the very foundation of the regulatory structure./ We find, however, that we can produce significant savings by mere CPUC approval of a set of pilot terms, to assist our experimentation with, and transition to, a longer term program designed to have the greatest possible impact./
It should be understood that if the CPUC were not wanting to always have the right to retroactively go back and restructure the eligibility for recovery, it would be possible for even the utilities to significantly reduce their equity contribution to the cost of "pipes and wires", which at a pre-tax cost which is three times that of debt. This again, speaks to the importance of focusing the system on recovery eligibility to insure that the carrying costs are minimized.
We propose this as a first step to understanding the true expense Californians are paying for the CPUC's ability to change cost recovery terms, in order to compare with the benefits received. That is what this proposal offers, a market based mechanism for financing ratebase, with competition able to act as the key driver to evaluate reasonableness. Implemented one step at a time, drastic change is not required, but an important benefit can begin to be observed and used to change the model in parties minds when looking at the future of the industry.
There are many parts to this, making it very difficult to conduct a simple and quick discussion on it. The essence of the argument is that many programs require a single entity to collect the moneys and administer the programs. The competitive effect of this is deemed small, as it is not immediately considered to involve a large percentage of the marketplace. Both assumptions are well off the mark. Programs that fall within this category include such programs as residential baseline rates, energy conservation, customer pilot light and a host of other public purpose activities conducted under the aegis of the utility shell. Taken together, the number of customers touched by these programs in some potentially very basic way quickly gets us back to over 90 percent of the state's electric customers.
The true cost of these, in a business sense to the utilities, has largely been irrelevant as long as the utility costs have been passed through and profitability comes from an entirely different arena, ratebase finance. The competitive implication is simple. All customers who are subject to these programs are effectively ineligible for direct competition. The only competitive benefits contemplated for these customers are commodity pricing benefits from the Power Exchange, but nothing in the other options presented in this RWG report would facilitate these customers getting service improvements or cost reductions as only the utility could be the service provider. There are two issues here, the issue of in what entity does the administration of these public purpose programs rest, and in what entity rests the role of "default" provider.
We believe that the essence of these programs comes down to two things: first, the reliability of supply of these public purpose objectives. Second, is the recovery of costs through surcharges on other customers. We believe that neither of these require a single provider as strict standards of financial capacity and operations protocols employed by the utilities in the administration of these programs can be generalized. It takes very little creativity to anticipate that, given multiple providers vying for the business of these customers, some exciting and innovative approaches in the applications of these subsidies may be discovered. It is germane to reiterate here that many of the very parties that will be competing in California are affiliates of utilities in other states. Thus, it should be with open arms that California should try and pull in the breadth and depth of experience available from these many, experienced parties. In short, we believe that the complexity of changing the system of revenue collection and customer care is overstated:
Neither the revenue collection as a sales tax, nor the administration of standards require the hands-on level of regulatory oversight used for the current utilities where the concern is the abuse of monopoly control. In comparison, verification of the adherence to the standards can be very lightly applied while retaining very high standards of performance. This gets to the Commission's goal of having competition become the more important regulator.
The obligation to serve comes up in every discussion when unbundling is the topic, as the need for the utility to remain as the only default supplier means that they must retain the ability to service all customers in their entire territory with a fully bundled program on a moment's notice. In a restructured industry, that insurance program is actually less reliable than its alternative, prevents the creation of a competitive marketplace and is expensive. Most important, adhering to this argument means that the vast majority of customers are inaccessible to full competition, meaning that the cost burial and service inefficiency has a convenient home.
We distinguish between being the default supplier on 1/1/98 from assuming that the utility is to maintain a service staff, and excess capacity ad infinitum, just in case some or all of the customers want to come back to the utility fold. We have no problem with the notion that customers not wanting to be bothered by the evolution to competition have a default option that is seamless. To assume, however, that something about the utilities is so unique that they are the only ones competent to take care of customers with a bad experience in the marketplace is to admit defeat. To further say that the utility, therefore, must be able to immediately service the entire territory wide customer base with fully bundled service requires such a large overhead on the system as to insure that defeat. We specifically have three problems with this. First, we cannot come up with a single service that we believe deserves this status. Second, we are concerned that such a designation inherently produces a discrepancy in service costs, due to ratepayer subsidization of base service costs. This, in turn prevents competition and makes utility default service a self fulfilling prophecy. Third, we strongly advocate that the mere presence of the marketplace will create far more redundancy in every unbundled function than the utilities would be able to sell to the CPUC. The difference is that this redundancy would be paid only by the customers of the service firms.
Until the CPUC defines its trade-off between timing, participation, accuracy and other issues, decisions on how much of this can proceed within Track 1 needs to be deferred. We will offer our interpretation of what we should be accomplishing within Track 1, which we believe are two things. First, Track 1 is where we should be testing and evaluating those features expected to be important to the system in the scale-up of restructuring in Track 2. Second, Track 1 is the sequencing process by which the system is to evolve, one step at a time. For both of these reasons, we believe that the prepayment program should be part of Track 1, because:
Begun in Track 1, the system design and implementation tasks in Track 2 will benefit from the knowledge gained..
One distinction regarding Option #5, is that it can operate on a separate track from many of the features of distribution services unbundling. While this option can be described as an extension of Option #3, comprehensive distribution unbundling, and we fully endorse the importance of that for the eventual need to achieve terms of service parity between the utilities and their competitors, the concept of tariff prepayment pilot can operate fully independently of most of those distribution unbundling issues.
What we seek of the Commission is to lay the foundations for each of Option #5's two parts.
First, the Commission should set the stage to correct problems derived from the current system of ratebase finance by allowing:
the "transfer" of a customer's obligation
to pay their share of utility investment to a third party, along
with participation in the uncollectibles account and the right
to have customers terminated for non-payment.
the third party would pay to the utility the embedded
cost of the pro-rata allocation of ratebase, and employ the utility's
operation's protocols to participate in the program.
customers would enjoy the benefits of the third party's use of a different carrying cost of capital to derive savings and incentive to expand service.
Second, the Commission should set in motion that
part of the program designed to correct the problems derived from
having only one party be the repository of the obligation to serve.
This should start with the acknowledgment of the character of
the marketing firms who comprise the new competitive industry./
The Commission should:
Transfer the obligation to serve from the utility's
retail arm to the class of Tier 1 marketing firms
Allocate the obligations among the Tier 1 group along
similar lines to those used by the insurance industry's allocated
risk pool.
Employ standards of performance and corporate strength
to insure that customer interests are fully protected.
Initiate the cost and allocation studies required
to evaluate the preferred source of revenue to fund the public
purpose programs, such as "sales taxes", meter fees,
etc.. Part of this would be to set standards of service delivery
which the CPUC would use to contract with the Tier 1 suppliers.
Acceptance by a qualified customer to participate with a given
Tier 1 supplier would authorize that supplier to receive compensation
from the Commission for providing those services.
Option #5 calls for the maximum possible unbundling. We propose that the unbundling of the utility include not only its 5 functions and some distribution services, but extend to the protections, roles and source of profitability. The primary issue considered important in this Option #5 is the clear articulation by the CPUC of the "end state" of their restructuring effort. In this case, we believe that it needs to be process specific, and it needs to allow for a structure which captures the efficiencies available and provides competition in all crevices of the customer base to insure that there are no burial grounds for costs or inefficiencies. As stated before, we do not anticipate that anything but limited scale and limited term tests are possible for implementation by 1/1/98 for these activities beyond that in an unbundling of distribution services. We expect that the bulk of the implementation of these more sweeping proposals would be officially classified as Track 2 items. It is actually far more important to us that the CPUC be crystal clear about what it is attempting to achieve, the standards by which they will judge it and what will be done if the results fail to meet their standards, than to achieve a hasty implementation. This does not mean delay implementation. Instead, it means move quickly with what can be achieved, but clearly state the characteristics of the program when we can say California is finished with the formal restructuring, and a new paradigm is in place. Only then can the necessary investment proceed on getting the system to that desired state.
To clarify the features of the system we would want to be in place, once the system is restructured, we present the following as components of the new restructured industry design:
In an effort to create a truly competitive marketplace, it is important to have a set of guidelines regarding what is the role of the parties, and therefore, what is the basis for competition. What follows is our recommendation of how the retail marketplace will be constructed upon the conclusion of the restructuring process. It is a design which would be phased in over the restructuring period, and would set the stage for a truly competitive marketplace for energy services, consistent with public purpose objectives.
a. All retail activities associated with the direct
customer interface could be unbundled, and put into a new, competitive
marketing affiliate, and that the costs associated with those
functions would only apply to those customers served by that affiliate.
The list of those activities to be put into the new entity would
include all billing, most metering, all customer service, uncollectibles
and ratebase finance. The key issue is how to have the retail
affiliate financially incented only by providing good customer
service.
b. This affiliate would be only one member of a
group of marketing companies, we would call Tier One marketers.
All terms of information access, system control and operations
tasks provided by the "wires" company that retained
the monopoly franchise status would be based on a single protocol
that applied to all members of that group of marketing companies.
c. There would be no retained special customer
right or responsibility that would accrue to the utility affiliate,
instead, issues associated with obligation to serve, credit protections
and special needs customers would apply to the group as a whole,
not unlike the "allocated risk pool" model used in the
insurance industry. Issues related to universal access, customer
credit protection, responsibilities associated with turning off
customers and restraining this right if health and safety issues
are called into question come down to how are the costs for these
issues allocated. Therefore, these programs' costs need to be
quantified, and the cost reallocation process specified. All
Tier One marketers would be deemed to participate in these programs,
including their costs and right for cost recovery on equal terms
based on a revenue generation activity based on the sale tax
model.
d. With the opportunity to compete in all functions
and for all services comes with it a need to accept a set of comparable
responsibilities. The goal, , is that there will be no carving
out of any direct customer activity which only its affiliate is
empowered to provide. However, given the need to retain a set
of public purpose objectives in the supply of energy in 21st century
California, the multiple suppliers of these services requires
standards of strength, performance and protocols for operations
that would apply to all Tier One suppliers. It is expected that
policing the adherence to the standards should be minor, especially
compared with the level of regulatory oversight associated with
current utility functions.
e. For companies not desiring to, or unable to, meet the strength and operating requirements of a Tier One supplier, there would be restrictions on service to certain classes of customers or making certain kinds of service offerings. However, there would be no restrictions on which Tier One suppliers with whom these parties could contract to provide these more broad services. For example, marketers with specialized sources of power may contract with any of several different Tier One suppliers to take a branded, source of "green" power to market. This green power could be marketed directly, similar to how natural gas is marketed directly to customers today. The difference between this and the current gas industry model is that in the gas model there is only one Tier One supplier. That is the local gas utility. In this proposed electric model, commodity only suppliers could use any Tier One supplier.
e. In order to create competition initially, the costs charged by the utility beginning on 1/1/98 should reflect a cost avoidance which is larger than may actually be the case, because without an assumption of some presumed level of market penetration, there is no cost savings. Therefore, the utility needs a cost recovery mechanism for the fact that there may be a lag between true cost avoidance and the need to reflect that avoidance, if competition is to be created. Given the phase in approach to the unbundling, and the fact that the bulk of the marketplace may remain with the utility, this cost reallocation problem should be small. What this means is that the functions transferred to the retail affiliate are part of the currently approved revenue requirement and that the difference in costs between 12/31/97 and 1/1/98 will be negligible. While the loss in utility affiliate market share will be small on 1/1/98, the marketing community needs the opportunity to see some significant portion of the cost differential that will eventually result, to build its own service infrastructure and fund customer savings. There may need to be a phase in of some of the savings, as some set of facilities, personnel and program costs become replaced during the phase in period of the restructuring. A clear statement of how the savings would be calculated is actually more important than having the highest possible number on day one, if that meant getting timely political approval.
f. The abilities of the local utility to offer unbundled services to its customers would be based on a finding that the unbundling has, in fact, been accomplished. This would mean that the retail functions of the utilities were both functionally and financially separated. This should provide an incentive for them to discover the quickest means to accomplish the goal of a truly competitive environment, within their territory.
There are many lessons from the gas industry, regarding how to price, monitor and evaluate the separation of utility functions into competing units. We would hope that California can learn from these, and avoid some of the serious abuses that resulted.
In order that the utilities' terms of capital acquisition for ratebase are the same as customers and their aggregators, key utility credit protections would be unbundled. This component of unbundling fails to make it onto many lists, primarily because of its inconspicuous nature. However, if we intend to create a competitive marketplace, then the terms of customer eligibility must be the same. Similarly, if we are going to unbundle the obligation to serve, then issues regarding customer credit status must be equilibrated. Included within this category are the recasting of the uncollectibles account as a multi-participant insurance fund, creation of a structure in which failure to pay qualified aggregators can trigger electric account disconnection, and flexible enrollment to match the utilities cost reallocation abilities due to load variations. Failure to include these features in an unbundling means that broad groups of customers would be inaccessible to competition merely because of their relatively poor credit status. In other business sectors, this is called red lining, and to our knowledge has never been addressed in the natural gas arena. We believe it should be explicitly be addressed in the electric restructuring.
Acknowledge a customer's existing right to prepay their utility tariff, and enable customers or their aggregators to calculate what the customer's obligation to pay is based upon (each customer's pro-rata allocation of undepreciated ratebase and operating charges). As is currently the case, these prepayments (albeit currently small in number and amount) effectively decrease a utility's capital acquisition requirements.
Since the payment is merely a prepayment of a tariff, all aspects of utility facilities and operations, including ownership, control, dispatch and maintenance would remain with the utilities
As is currently the case with prepaid costs, these prepayments would be logged into a liability account on the utility balance sheet, offsetting the increase in cash as a asset item, which for this program would be called the Customer Trust Account. The intent is to prevent the triggering of a taxable event, and to segregate the prepayment amounts for current tracking and against which to capture the accrual of depreciation on an identical schedule with other utility ratebase.
Work with the legislature on a structure of capital cost certification that is stringent, such that once made, it can be considered final. It would still be up to the CPUC's discretion to reallocate these recoveries among customer groups, for Tier 1 suppler collection, until such time as another system consistent with customer utilization and cost recovery is identified.
The primary item we request for Track 1 is the clear
statement of the CPUC of a process wherein we may conduct the
evaluation and testing of these alternatives to monopoly roles
and payments. We believe that a limited term, limited scale
tariff prepayment pilot could be implemented by 1/1/98, we would
suggest some of the following categories be created, for experimental
implementation.
Create Tier 1 Supplier designation, define standards,
and begin to identify components of the obligation to serve which
can easily be transferred.
Unbundle credit protections to avoid "redlining"
by allowing the utility retail arms and the marketing companies
to employ the same terms of eligibility for customer enrollment.
Unbundle ability to prepay embedded cost, on pilot
basis to begin to open up the transactions available to residential
and small commercial customers.
Authorize the tracking mechanism of capital recovery, based on energy consumption as is inherently incorporated into current rates./
There will be a number of issues here related to scaling up the programs, both in terms of customer participation, services covered and streamlining the administration. However, we must acknowledge that another goal will be to modify the programs to correct cost allocation and cost stranding problems that may be identified through market action. While it will be the goal to minimize these effects, any opening up of the marketplace will reveal existing cost allocation problems, and this fact should be explicitly acknowledged now. Thus, this does not imply a new problem, labeled "cherry picking" by competitive firms, instead, competition becomes a tool to identify where subsidies currently exist and how they flow. It is a circumstance that is inevitable with opening up any previously monopoly function to competition, and can be seen at work in natural gas and other areas. It is only a problem if it is not recognized, and there is a single party, the regulated utility with an antiquated obligation to serve under average rates. Instead, we are attempting to point out with this presentation that it is up to the CPUC to modify the utility obligation to serve, and then to determine whether these subsidies need to be classified as meeting a public purpose and therefore that they would be added to the "responsibilities" of the Tier 1 suppliers. Thus, the Commission's goal to not to shift costs among customers because of the restructuring will have to confront the reality that the current rate structure has a tremendous array of customer cross subsidies, operating between and within rate classes. The result, if not addressed, will be significant variations in the rates of market penetration among and between customer classes, to the detriment of the system as a whole, unnecessarily. Therefore, with Track 2, we see three key items:
Program modifications, based on market penetration
and other program results.
Broader scale implementation, based on program success.
Utilization of system performance standards to gauge
the restructuring's success. Standards would include: successful
market penetration of all classes, availability of systemic cost
reductions, and parameters associated with market dynamics.
The CPUC needs to state that it is intending for all customers to actually receive the direct benefits of competition. From this simple starting point, the Commission should open up a formal process, within the restructuring, to evaluate the degree this goal needs to be within Track 1 and the degree that most small customer participation can be acceptably delayed well into Track 2. This gets directly to the nine points in the RWG's consensus paper on what the CPUC must do to provide guidance to the system and its participants.
It is this speed of implementation which we believe is most important for the Commission to answer, in the context of the customer participation goals and degree of accuracy of cost unbundling that will determine what portions of this Option #5 makes it into Track 1. The fundamental CPUC policy decision we seek is the clear, and unambiguous statement of where the system is to be heading. As simple as it may sound, if the CPUC states that it's policy is that all customers are to get to participate in the competitive environment, with a system founded on least cost principles, then we believe the CPUC has no choice but to create a formal procedure by which to begin to evaluate how to implement these Option #5 objectives.
We believe that the system can simply implement and administer a pilot approach to customer prepayments, and begin to implement the unbundling the obligation to serve, within Track 1. However, it must start with this unambiguous statement of CPUC intent, and the empowering of the working groups to recommend ways to meet the participation, timing and accuracy objectives.
To facilitate this process, we have attempted to
provide, in the form of attachments, descriptions of how a pilot
program would operate, to guide the Commission in the central
feature of our proposal, getting the cost basis of the utilities
retail arms in line with competing marketing companies.
Implementation of the key proposal is described in
the attachments. The timing, however, must lie with the Commission's
working groups. It is within these forums, reporting back on
what can reasonably be achieved within the implementation parameters
stated by the Commission that timing can be responsibly answered.
While there is a large series of details to be included within
an implementation, the key items, as we would currently identify
some of them as follows:
Unbundling of the Capital Charge:
1. Back out capital charges from current rates, define the formula required to prepay for a customer. This is based on existing allocations of utility "revenue requirements".
2. Create a tracking process for these charges currently built into volumetric, customer and demand charges, to enable the tracking of "recovery" achieved by groups of customers.
3. Create standards of participation, maximum and minimum, to use in assessing the program, to insure that cost shifting is identified, and measures are available to correct them.
4. Authorize the creation of the Customer Trust Account, as a liability side account on utility balance sheets, to track prepaid revenues over time.
5. Unbundle access to utility credit protections,
including the uncollectibles account and selected balancing procedures.
Unbundling the Obligation to Serve:
1. Transfer of the Obligation to serve from its sole residence in a single utility entity, and to a class of suppliers. As this is actually a broad range of different, discrete duties, each need to be identified, and the economic and operating studies conducted to evaluate the process by which to accomplish the unbundling.
2. Evaluate the current source of revenue for providing the public purpose objectives inherent within the Obligation to Serve, and recommend any changes.
3. Develop a CPUC monitored mechanism to collect
moneys for these programs, and then disburse them based on the
supply of the Public Purpose Services by Tier 1 suppliers to qualified
customers.
If it is a goal that all customers are to be truly accessible to the competitive market forces, whether they elect to switch from UDC service or not, then this extensive unbundling is mandatory. This bare bones requirement for competition is based on:
It is not enough to vaguely assume that with some amount of unbundling that sufficient incentive will be created to stimulate competition. Instead, is incumbent on the CPUC to state specifically how it assumes that it is opening up enough of the utility system to truly create a competitive opportunity. Failure to do this produces empty promises, incapable of being fulfilled, wastes considerable time and resources and is not productive.
It should take very little to recognize that for the marketplace to come in to compete for small customers requires an assumption that there be more than non-profit commodity and service activities of the utilities open to competition. We must not require an assumption that these services will successfully resist the CPUC's efforts to make them responsive to market forces, and become less expensive. That is a fatalistic assumption. It is important to first note, then look into why, and then finally correct the problems preventing even one major electric marketing company out of the dozens targeting California to look at serving the small customers. The CPUC must look carefully at this indicator. Either it means that the utilities are so efficient that the marketplace cannot match their performance, or it means that the terms of competition are not the same between the utilities and the potential competitors.
It must be understood that to merely contract for service with a customer a marketing firm must have staff and facilities in place to conduct or maintain:
These are not discretionary. Even the smallest customer contracted relationship will require all of these, just for a simple commodity sales transaction. As soon as we add a services component to the transaction bundle, then the list grows very quickly.
It is a threshold matter that for a business to have incentive to serve a customer class requires a perception that the profit potential from serving a customer group is in line with the transaction costs required to provide that service. Tied into this is the simple fact that competition for a customer will be much more meaningful if that competition is based on the same conditions.
Thus, as stated before, the CPUC must explicitly state where it expects the costs for these services to be recovered from, while assuming that the utilities and the industry are becoming increasingly efficient. Based on this simple assumption, it is not possible to retain ratebase finance as a primary source of utility profitability and expect that there will be any new firms willing to invest the millions of dollars required to properly compete in this market. Again, the complete absence of any firms looking to the smaller customers should speak loudly.
By paying the full, embedded cost, there should be no cost shifting introduced by this proposal. Instead, it is the means to discover existing cost shifting, and it is up to the CPUC to determine whether to correct these existing problems once they are pointed out.
PerformanceBased Ratemaking, otherwise known
as profit centers, should be the basis for utility compensation.
Only when utilities are risking their profits, based on the services
the customers elect will there be competition. In turn, this
needs to be the foundation of utility profitability, not the profitability
haircut. I. INTRODUCTION AND DESCRIPTION OF OPTION5 1A. Introduction 11. A Challenge 12. The Assumptions 13. Simplified Program Description: 14. Purpose of the Phased Implementation Schedule 1B. A Closer Look At The Underlying Assumptions, And A Search For An Alternative 11. The Assumption That Ratebase Finance Is Necessary And Competitively Neutral 1a) The Current System Of Ratebase Finance Is Too Expensive 1b) The Current System Of Ratebase Finance Is Anticompetitive 1c) Moving Forward, Getting To The Heart Of Capital Costs 12. The Assumption That There Can Be Only One Party Vested With The Obligation To Serve 1a) The Need For A Single Administrator Of Pubic Purpose Programs 1b) The Default Provider 1C. Implementation 1II. THE EXTENT OF UNBUNDLING 1A. Description Of The Extent Of Unbundling: The Proposed Features Of A CPUC Defined End State For The Electric Restructuring 11. Creation Of The Tier 1 Supply System 12. Unbundle Utility Credit Protections 13. Unbundle The Ability To Prepay Embedded Costs 1B. Segregation Of Track 1 From Track 2 11. Track 1 Items 12. Track 2 Items 1III. CPUC POLICY DECISIONS 1IV. IMPLEMENTATION AND TIMING ISSUES 1V. PROJECTED IMPLICATIONS OF OPTION #5 1A. Customer Participation 1B. Cost Shifting 1C. Utility Incentive Structure 1
ATTACHMENTS TO MORE FULLY
DESCRIBE THE PROPOSED PROGRAM:
1. EXAMPLE OF RESIDENTIAL
SERVICE
2. PROPOSAL TO CREATE A TARIFF PREPAYMENT OPTION
WITHIN CALIFORNIA UTILITY TARIFFS
The purpose of this presentation is to illustrate
the reason behind the marketing community's unanimous avoidance
of the residential and small commercial sector of the CPUC's electric
restructuring program. The reason, most simply stated is the
perception that the electric industry will follow the lead of
natural gas, limiting the arena of competition to only the commodity
transaction, or maybe opening up only limited distribution services.
These companies, many of them affiliates of utilities in other
states, are certainly familiar with residential service needs,
and the opportunities they present. What they are saying, through
their inaction, is that the only party being given a profit opportunity
which is commensurate with the transaction requirements at the
small customer level is the local utilities. Parties can argue
at length about opening up competition to all customer classes,
but if you cannot get anyone to invest in the infrastructure to
serve those customers, we are facing empty promises. An illustration
may be helpful in setting the stage for understanding the scope
and character of the problem.
If we hypothesize a residential customer with a monthly
electric bill of approximately $40/mo, comprised of approx. 350
kWh/mo. The utility economics for this customer can be best understood
within three categories, as approximately:
Gross commodity: at about $14, based on the present
cost of generation, including capital and variable charges (assuming
gross generation costs in the range of $.04/kWh).
Services: at about $15/mo., including such as marketing,
billing, customer assistance, A&G, etc., ( which we estimate
to be around $.04/kWh at the residential level)
Rate Base Finance: at about $11/mo., for non-generation,
capital related charges (including about $5/mo in pretax profit)
to cover approximately $200 of embedded, undepreciated investment
in wires and equipment required to serve a dispersed, small load)
Fundamentally, commodity markets are high volume,
tiny margin transactions. This is true in every commodity, because
by definition commodities are undifferentiated items traded within
highly liquid markets. It is our experience that when a commodity
margin begins to exceed 1 - 2 %, then it is no longer a commodity
transaction. Instead, there is some other service, or function
which is being performed. This is true whether we are talking
about wheat, oil, natural gas or the emerging market for electricity.
Therefore, to expect that companies can serve these customers,
based on the margins from only this narrow business activity of
commodity transactions, thereby obligating themselves to pay for
the costs of providing services to even mediumsized customers
is a failure to recognize the market realities.
As a result of the generation-only unbundling, and
assuming no change in the methods of CTC and rate base finance,
we should see very little change in the above economics until
the CTC is paid off. The CPUC has endeavored to insure that all
customers are able to enjoy market based commodity pricing from
the beginning of the phase-in of restructuring, calling it "virtual
direct access". That insures that the difference between
the marketing community's price and the utility's power exchange
price will be small, thereby benefiting customers who do not directly
participate in the restructuring. We do not fault that decision,
only the failure to recognize the competitive implications of
it. The implication of failure to provide extensive unbundling
can be best described in sequence.
Incentives from Unbundling Generation: Assuming typical
commodity-to-commodity competition begins on 1/1/98, we would
expect to see total profitability from a commodity sales transaction
(typically below of 2% of gross value) producing less than $0.20
per month, which would be nearly 40% short of the cost of the
stamp required for sending an invoice in first class mail. It
must be recognized that in order to compete successfully, not
only must the supplier expect to make a profit, but the customer
must either get a savings or realize a service improvement from
the new relationship, all out of this margin.
Incentives from Unbundling Services: Moving then
to the services side, even if the services component were unbundled,
it must be remembered that this component is purely a cost pass
through item for the utility meaning that this is virtually without
utility profit. Thus, to unbundle some services along with the
commodity is to request the marketing community to match the current
level of utility service, using newly deployed facilities and
personnel, in competition with the utility using existing personnel
and facilities on a non-profit basis. The marketing community
is confident that this can be done in the initial period. However,
all parties believe that with the increased competitive posture
of the utilities (assuming some services are actually unbundled,
which is still an openly debated issue), that this utility cost
target will come down significantly within only a few years, much
of which could occur during the phase in implementation period
through the year 2002. Thus, a significant investment in the
infrastructure required to compete with the local utilities in
their non-profit arena must be seen as a questionable proposition.
Incentives from Unbundling Rate Base Finance: The
answer, simply stated, is that if the CPUC is serious about creating
robust competition, then all aspects of the utility service program
must be unbundled, including the capital charges, where the profitability
lies. Only when all suppliers are competing on the same terms,
getting their costs and profits from the supply of services which
customers elect, can we say that we have a competitive marketplace.
To retain this profit item for the utilities, but unbundle the
areas which are non-profit would have the effect of offering to
keep the utility profit unchanged while reducing their work.
It would fail to recognize that this lack of profit margin on
these other areas is actually an indication of an internal cross
subsidization. We believe that the easiest means by which to
open up this part of the utility structure is allowing the marketplace
to pay off a customer's embedded, undepreciated rate base. Then,
with the utility affiliates allowed to do the same thing, all
parties could both provide for and charge for a broad range of
services, where their profit potential begins to match the transactions
cost for these customers.
Without the third dimension of unbundling, it is unrealistic to expect competition in all segments of the marketplace. This is not because the market is inefficient, not because these customers require a monopoly utility, not because the utilities are uniquely efficient, but because the profit opportunity is not commensurate with the tasks and risks required to serve this market.