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 medium sized 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.
resecon.doc#388/27/96
It is our experience that most customers have an opportunity cost of capital significantly below that charged by the utilities in the calculation of retail tariffs. This is based on our review of the diverse body of individuals, companies, non profit organizations and associations comprising the utility customer base. Based on their different tax rates, different sources of capital, and different levels of commitment available from each customer for energy purchases, it is not surprising that customer's opportunity costs for capital are equally diverse. However, we have found that merely employing the same commitments currently made by these diverse customers to their utility, that these diverse customers could realize considerable savings through a tariff prepayment program. The essence of our proposal to the CPUC is for customers, and their representatives, to be given the opportunity to prove this point through the creation of a limited scale pilot program.
The largest single cost in retail gas and electric rates are the utilities revenue requirement to recover their capital charges for interest, depreciation, rate of return and income taxes. It is this cost of capital which we believe is being kept unnecessarily high, due to the structure of utility regulation, and which can be dropped dramatically by refocusing the system on the customer. Therefore, our proposal is to establish a pilot program in California, eligible to a very limited but representative group of customers, for a 2 year program to verify customer interest, market response and the policy impacts of prepaying all or a portion of the customer's current retail tariff.
This is not an abstract request for something that
may or may not be of interest, or is of limited benefit to a small
class of customers. Instead, this is a request for a specific
program, which we believe can be implemented on a pilot scale
immediately and should illustrate a number of fundamental issues
which will be a source of important input for the CPUC's ongoing
investigations in other proceedings. There are a couple of important
contrasting factors about this proposal, when compared to most
other restructuring proposals:
First, it is the smaller customers who realize a
disproportionate benefit, compared to the larger, high volume
energy using customers, because it is they for whom the largest
investments in facilities have been made.
Second, since the program proposes to prepay the full embedded cost, as allocated to each customer through their current tariff there is no stranded costs while utility shareholders receive full value and elimination of their risk of investment recovery.
For this initial group, the largest benefit is not the savings that are possible, but the opportunity to begin to build and participate in a whole new class of truly bundled retail energy products and services. Through the implementation of this program, we would expect to see the rejuvenation of demand side management and conservation programs as well as entirely new ways of buying energy that are driven by the interests of the customers, not the perceptions of the regulators through the eyes of the utilities.
The objective of this program is to create a very limited scale pilot program designed to provide customers, either directly or through their aggregators, an opportunity to take a more direct role in their energy services. This proposal is simple:
This proposal goes to the heart of how customers are charged for, and remain liable for investments in utility facilities. It is not expected that anyone, or any group could anticipate all issues that will present themselves if this proposal achieves widespread implementation. However, by conducting a pilot program now, it is possible to begin to first verify the contention that a less expensive option is available, and it should be possible to begin to permit all customers to participate in those savings while protecting the integrity of the utilities and the investments of their shareholders. The approach taken within this proposal is based on the belief that there is more knowledge to be gained from a limited scale operating program than from long and extended legal proceedings based on abstract arguments and studies.
There are five objectives for including this proposal
within Track 1.
First, it offers a reduced cost means to carry the
competition transition charge (CTC). As aggressive as the Commission
may feel it was being when setting the return to equity charges
on transition assets within the electric restructuring decision,
we forecast that customers would realize even lower costs through
this proposal. From this foundation, it is our contention that
as a threshold matter, if customers face a lower cost of capital
than that passed on by the utilities, then it is incumbent on
the CPUC to provide customers with the opportunity to minimize
their costs of shouldering this transitional burden. It is also
our hope that this proposal would provide to the utilities an
alternative to leaving large amounts of capital tied up in potentially
under-performing investments, and instead be allowed to "cash
out", to the benefits of shareholders and customers.
Second, it is the interest of the parties submitting
this proposal to begin to have the market develop and offer a
host of new, fully bundled products to consumers of all classes.
With one half to two thirds of total retail costs being paid
for services for non-commodity services, truly rebundled products
at the retail level are hampered by the variability that comes
from changing customer cost allocations. Instead, to have the
ability to prepay the tariff charges takes a major portion of
the costs and permits them to be locked in, thereby enabling the
market to begin to offer a very large range of fully bundled products
and services in ways fundamentally different than possible under
the current system. As the CPUC evaluates the structure of the
new gas and electric industries, this fundamental change could
have a profound effect on the nature of services available to
customers and the CPUC should stimulate this fertile ground soon.
Third, if it is true that there are lower cost of
capital than that built into the utilities rates, the system is
providing an unnecessary incentive for uneconomic bypass. Without
this avenue, and in an increasingly unbundled environment, the
risk of bypass becomes more severe and pervasive. It would be
much better to provide an outlet for customers seeking lower costs
to look first at employing the utility assets, without the unnecessary
burden of a regulated return putting utility shareholders and
other ratepayers at risk.
Fourth, the CPUC is on record of seeking ways to
reduce customer costs, without stranding utility investments.
This program would be separate from all other unbundling proceedings
and evaluations underway at the current time, as it cuts across
all tariffs and covers both electricity and gas utilities.
It is not possible to design an entire program of this scope in isolation, or to cover all elements in a brief presentation such as this. However, this description is intended to provide a sense of how we would initially propose the pilot program be approached, by describing some of the key features.
For each utility, we would propose that the term of the pilot be approximately two years. This time frame should sustain a relatively stable regulatory environment, offer enough time to initiate a program by a wide range of market participants, and begin to allow the CPUC to get a flavor of the character of the program that could result. However, it would be critical that there be an explicit time schedule, along with an explicit definition of thresholds for further action, review or modification.
For the program proposed, we envision four options available from which the CPUC would choose. Given that it is the cost of equity which the CPUC regulates, we suggest that this be the target for customer prepayments. It is our goal to recognize the low debt costs available to the utilities and to reward them for that, without impinging on their ability to secure those low costs. However, three other options exist that would produce a different utility capitalization over time at high participation rates. One, would not be a practical option during the pilot. In all cases, we envision that upon termination of the pilot, that capital prepayers not enrolling in a long term program would be bought out of the program and the shifting of value from the Customer Trust Account, back to the utility rate base. One of the reasons that we are proposing that the initial pilot program be very limited in size is this need to make the resorbtion of customers into the standard utility framework an inconsequential transaction, in the event the pilot is discontinued.
Option # 1. The capital prepayer would pay only the pro-rata equity charges. To employ this option, there would be no change in utility debt, meaning that debt would not be paid down by either the utility or the customer, so as to maintain the prevailing debt equity ratio at the time of enrollment. It is expected that the alternative capital provider would make an explicit commitment to the utility for debt service payments during the term, using the prepaid equity as a "bond" for performance. In this regard, the utility would be able to charge a debt acquisition fee and would be entirely free to dispose of prepayment cash into other corporate diversification projects without risking a change to the overall corporate debt equity ratio.
Option # 2. This is identical to #1, above, where the capital prepayer would pay the equity portion of the tariffs, but here, they would have the right to pay down debt principal over time. Thus, enrolled customers would pay to the utility an equity prepayment, and then a periodic payment to pay down the utilities' prorata debt-principal. The utility would be allowed to charge an incremental "debt acquisition fee" for these customers electing this option. Again, a commitment to maintain this debt service would be expected as a condition of participating in this option. It is expected that this option would not be available for the Pilot Program.
Option #3. The capital prepayer would fully, and privately prepay prorata ratebase. In this case, the prepayment would be made and all capital charges would be removed from the customers rates, leaving only the variable charges to be billed out on a monthly basis.
Option #4. The entire tariff charge would be prepaid, inclusive of all capital, operating and fuel charges. The result of this would be that customer accounting and billing for customers would merely debit the customer trust account, with no periodic payments by the customer coming to the utility.
It is expected that this program offers an interesting check and balance to cost of capital proceedings. If the rate is too high, all customers will want to buy the facilities and none will want to sell them back to the utility at embedded costs. If the rate is too low, the reverse will be true. All customers would want the utility to keep the facilities, or will want the utility to buy back the facilities at the embedded cost.
Upon receipt of the prepayment investment from the customer, or their representative, the utility would create a Customer Trust Account on the liability side of their balance sheet. For the first three implementation options, above, this account would be the simple repository of a weighted average share of all utility assets such that the depreciation schedule in this account would be identical for the utility's ratebase. This account would offset the increase in prepayment cash in their asset side of the balance sheet producing a net zero transaction for the utility shareholders. As part of the enrollment materials, there would be an explicit section that would specify that for the period of the pilot that prepayment of utility assets would confer upon the customer no rights associated with management, operations or disposition of the assets. In the case of option number 4, above, this account would contain both the prepaid capital charges, and the present value of the variable tariff costs.
In order to enroll, customers or their agents would pay the full, pro-rata share of utility embedded investment, based on each tariff, plus variable costs in the case of option 4, above. We would propose that during the Pilot, a limit of 5% of the rate base that could be prepaid, offered on a first come, first served basis. We would further suggest consideration that no rate class could exceed 5% participation until all other rate classes achieved at least 3% participation without CPUC review of the cause. Significantly disproportionate participation should serve as a signal to the CPUC that there is a cost allocation problem in the rates which would need to be evaluated. Again, this should be a pilot program and many parameters need to be looked at simultaneously.
Enrollment would be open to either customers or customer agents and the parties prepaying would be designated as the parties enrolling customers. Given the simple fact that enrollment would have no effect on the terms of service under a tariff, but instead only changes the timing of the payments due to the utility, there is no customer abuse concern here. Instead, it would be incumbent on the capital provider to insure that it had an arrangement in place to recover their charges from the customer prior to enrollment, otherwise the capital provider may face an inability to recover their costs.
Within this structure, it should be the right of the customers or their agents to designate to the utility which accounts they wish to allocate their prepayment to, and therefore qualify for enrollment. This provision is a critical element to insure that capital providers are able to allocate their investment in a manner that achieves full utilization. Failure of certain customers, reductions in energy needs and other reasons require that the prepaid capital be utilized by other customers, in a manner similar to the utilities' ability to reallocate costs to remaining utility customers.
Thus, we propose that capital suppliers would be free to un-enroll nonpaying customers and designate other customers to take advantage of these program at a small accounting fee.
The utilities are constantly re-investing in their facilities, to upgrade, improve or replace capital. To the extent that this is done without specific customers becoming liable for those improvement costs, these expenditures become an increase in the ratebase. Therefore, to keep the integrity of this prepayment program, these costs should become an annual increment required of prepayment program participants. Thus, if in a particular year, the utility reinvestment program is equal to 3% of the outstanding ratebase, then part of the requirement of program participants would be to prepay their share of that 3%.
The utilities would track the accrual of customer capital cost avoidance, to permit a monthly report for each participating capital supplier to track the remaining portion of their prepayment. Given the seasonal nature of many customers, and the unpredictably variable use of many customers both the utility and the capital supplier need to have a clear target of what customer enrollment is allowed for a given investment, and how that customer enrollment is allocated over time.
Upon designation by the capital provider that a customer is enrolled, the utility would switch the customers billing designation to the prepayment option of their same tariff. Customers would be free to designate their capital provider as the party to whom they would pay their bills, resulting in the capital provider paying the utility on the customer's behalf. This system is already in place for core aggregation, and with the prepayments in the hands of the utility, there should be no concern for the credit protections for these indirect utility billings.
Upon termination of the pilot program, either the
customers and aggregators would rollover into the long term program
or the utility would buy back the investment, re-enrolling the
customers into the standard tariffs. Repurchases by the utility
at this time would be at full, undepreciated value, based on the
weighted average value of the Customer Trust Account. Further,
at any time during the pilot, capital prepayment parties could
withdraw from the program, by having the utility buyout the investment,
subject to a "restocking fee" of 1% discount.
In many respects, the changes sought by this proposal are small. We believe that the utility system has developed the correct tools to supply energy to customers, to finance the infrastructure to provide those services, and the industry is evolving towards a focus on economic efficiency that will serve it well into the future. Therefore, what we seek is focused on how the system allocates rights and responsibilities, specifically, bringing the customer commitment much closer to the source of the capital which finances the facilities for which the customers are obligated to pay. This can be done simply and safely, and proving that is the essence of both our pre-proposal work to create a full program with suppliers and customers, and this proposal to create the limited scale pilot program.
It is probably important to point out that we assume that the utility cost of capital, as set by the CPUC is reasonable, for the structure of acquisition and deployment assumed by the current system. The distinction we seek to make is that there is another way, using the same level of customer commitment, the same credit protections, the same ownership and operations management of the facilities which offers significant savings to all customers.
What has been most difficult in the early conceptualization of the program was how to achieve direct comparability between the terms under which the customers more directly take on the responsibility for system investment and costs, with those offered by the utilities. The difficulty in wading through the complex process of utility regulation, at the foundation level of how utility shareholder compensation and incentives lie has made it clear to us why it has taken so long for this simple idea to surface. The task becomes much clearer once three issues are recognized as paramount.
Taken together, these three factors provide a clear path through which design and implementation efforts must travel. These three requirements each impose their own restrictions on the program.
This is actually not a very complicated matter. In simple fundamental form, the cost of capital has two elements, the market price of capital at the time of the transaction, and the safety of the capital throughout the term, thereby providing comfort to the supplier that the capital and its earnings will be paid on schedule. Since the sponsors of this program will be subject to those same debt and equity markets as faced by the utilities, we contend that the cost reductions are the result of efficiencies in the proposed program.
The key difference being exploited by this program is the focus on increasing the comfort level of the capital providers that funds provided to this program will be safer than an equity investment made into the utilities. Therefore, our program qualifies for lower cost capital. This is accomplished by making the commitments between the suppliers of the money and the energy users more direct, in concert with the same "ratepayer joint and several liability" features that define the current set of utility shareholder protections. This is actually easy to do, since the customers already have an implicit exclusive relationship with their monopoly utility. For those customers preferring another party to supply the capital required for the prepayment, we merely seek to make that implicit, exclusive utility commitment an explicit commitment to the alternative capital supplier, paying on behalf of the utility's facilities. This is accomplished contractually, within the context of the tariff changes permitting the prepayment of the utility tariff. The result is simply a much more efficient capital supply program for utility facilities, offering significant savings to customers. Again, as the program evolves through its pilot stages, customers will need to evaluate for themselves whether, in many cases they prefer to employ their own capital resources directly to qualify for participation in the program.
This direct linking of the two ends of the system, under this proposal, is a significant difference, in that it is one of the most basic elements influencing the costs of the utility system. Currently, the customer commitment to pay a tariff and liability of the utility to pay the originator of the capital, is linked by the CPUC through the regulatory process. As shown on Chart #1, the current system can be visualized as a hierarchical system, with the CPUC standing between the customer and the utility, and the utility further standing between everyone and the capital markets. Thus, at the current time, the customers' commitments can be said to be two steps removed from the capital markets. First, the customers' commitments are enforced by the CPUC, who in turn manages the coverage of these commitments to meet utility investments, as determined by the CPUC to meet fairness and anti-bypass goals. Second, the utility, as a multi-purpose institution stands in between the customers/CPUC relationship and the capital markets. The implication is that investors in the utilities see investments in their utility being backed by only an indirect commitment of the customer and where taxes, corporate diversification and capital formation issues reduce shareholder dividends to something well below the payments made for facilities repayment and operations. This is on top of the inherent risk associated with stock market investments based almost entirely on forecasts and the credibility of corporate management. While the origins of the current means of financing utility facilities are clear, we do not believe that this is the proper model for a serviced based industry approaching the year 2000. Our proposal, represented by Chart #2, illustrates a more horizontal structure for capital supply, is able to realize a significant improvement in costs due to its inherent improvements in efficiency in meeting the credit and protection needs of capital markets. This means the program is able to allow participants to qualify for lower capital acquisition and deployment costs. We believe that this is due to three factors:
This last issue is potentially highly complex, but is a critical element in the determination of a climate in which capital providers are investing funds safely. Again, our focus is to employ only terms and conditions of the existing system, in an unbundled fashion.
The issue of how to protect utility shareholder protections against bad debts and slow payments is handled through a variety of mechanisms that are widely disbursed through out the system's architecture. Incorporating these into the pilot program, to insure true comparability of capital costs, is the real challenge of this proposal. How to do this must start with an inventory of the means by which the utility and its shareholders are empowered to offer apparently liberal credit terms to virtually every home and business in the State of California. Based on our evaluations, the utilities provide services to a broad range of customers, while protecting shareholder credit exposure through the following devices:
1. Customer dedication: As the monopoly
supplier, the utility gets exclusive right to supply energy services.
This has two main features: First, it limits the ability of
customers to leave the system implying an extraordinary flexibility
to charge what ever rates need to be charged to achieve capital
recovery. While we recognize this flexibility is not unlimited
(hence the bypass risk), it is unquestionably a broad and important
mechanism to insure the security of investments made by the utilities.
Second, since the system is not dedicated to individual customers,
investment in facilities do not need long term customer commitments
or bonding because customers who fail to pay, for whatever reason,
leave the other ratepayers with the responsibility to pay off
the facilities built for the failed customer. From an investment
perspective, these two items taken together allow us to say that
there is a "fungibility of customers". Specifically,
the utilities make rates, collect their charges and receive their
rate of return from classes of customers which are comprised
of an ever changing array of individuals, families, companies
and organizations. The implication of this is that the utilities
are allowed to recover their capital costs from all customers,
whom ever they happen to be at any point in time. Customers that
use more energy are balanced by customers using less. Customers
who leave the territory, go out of business sell their operations
etc. cause the burden of capital cost recovery to be picked up
by some mix of remaining customers and territorial load growth
in the dynamic California marketplace.
Basic to making this program work is the need to,
at least in some ways, match this inherent customer fungibility
of liability for capital charges. To do this for the pilot program,
we propose two specific surrogates in combination. These are
the transferability of prepayment rights and the ability to prepay
for less than 100 percent of a customer's total needs. Thus,
we envision a program where we can prepay for a baseline amount
of the customers' prorata capital charges, with additional amounts
being billed at the full tariff rate. Failure of the customer,
significant reductions in energy use by the customer, or for other
reasonable cause, would find the aggregator or customer transferring
all or a portion of the rights arising from the prepayment to
another customer. Thus, eligibility for participation in the
program would be at the designation of the capital provider, with
reasonable limitations.
2. Customer Service Staff and facilities:
Each utility has very large staff to monitor, administer and follow
up billings and collections. A very large percentage of the utility
staff time is devoted to explanations of billing issues and assisting
in payments for individuals and firms having difficulty paying
their bills. From a credit security perspective, this large staff
is able to dedicate considerable time, with these costs paid by
all customers. It would be imprudent, during the pilot program,
to fully duplicate the utility staff at the offices of alternative
capital providers in order that they can, monitor and push collections
at a level equal to the utilities. This is not to eliminate their
requirement to prudently pursue their own collections, but during
the pilot program where we wish to evaluate alternative credit
costs and we seek to maintain the maximum efficiencies in the
system we believe that the utilities that are already staffed
for all customers would continue in this capacity.
The mechanism to permit the alternative capital providers to achieve comparability during the pilot program would be by being able to send nonpaying customers back to the utility. As these began as utility customers, their return should pose no different situation to the utility than the utility would have faced had they retained that customer. In the case of the capital provider, however, they would be reallocating their customer enrollment designation to another party and return the customer to the utility for full collection of charges that would have been billed.
3. The Uncollectibles Account as an "insurance
policy" against bad debts: Within the FF&U is a
self funding, all-ratepayer participation, insurance policy against
bad debts. This is levied on all customers, except wholesale,
regardless of actual credit standing. This system effectively
guarantees that failures by the utility to collect will be made
up by other ratepayers. It is critical that this proposed capital
prepayment program not focus only on the blue-chip customers,
but be accessible to impoverished and emerging areas of California
as well. The mechanism proposed is the making this insurance
provision for bad debts a two way street, both covering the private
capital suppliers as well as requiring them to pay into the insurance
fund on a basis equal to other utility customers.
4. Late Fees: Generally, utility customers
pay no penalty for late payment, and it is the experience of one
of the program sponsors that alternative gas sales have been hampered
under the CPUC's gas program because some customers routinely
paid their utility bill late, a practice which the alternative
supplier would have levied an additional charge. If this utility
practice is to be retained, we would hope to get a balancing account
established to cover the potentially high costs associated with
systematic late pays. Again, the right to return customers to
the utilities would serve as a protection.
5. Enforcement: We propose that during the pilot period, only the utility, performing their fiduciary role of system management, be authorized to shut customers off for lack of payment. It is critical that there not be an opportunity for customers to "game" the credit programs of alternative service providers. An important part of this is that the alternative service providers participating in this program must be able to access customer information about payment status. Our proposal is that there be a mechanism, with proper notice and review, to insure that customers can be cut off by the utility for non-payment to their capital providers, and continued right of the capital providers to enroll new customers to take advantage of the prepayment stranded by the non-paying customer.
Of all the factors evaluated, this seemed to be the
easiest. This is accomplished by merely adding a payment term
to all existing tariffs to include the right to receive service
under that tariff by either paying under standard terms, or through
the prepayment of the costs of that tariff. How this would be
done would be a function of which of the four options selected
as the CPUC's chosen implementation option. Fundamentally, however,
all operating terms of the tariffs associated with reliability,
services included or excluded, eligibility and liability to CPUC
regulatory oversight would be unchanged.
There are a number of issues which will need to be resolved for a long term program which can be simplified during a pilot. Again, the goal of the pilot is merely to test the simple hypothesis of customers having a lower cost of capital than that passed through by the utilities. Keeping the program short means that we propose no changes in utility operations or cost recovery, except on capital charges. During the course of the pilot, there will be ample opportunity to discuss and evaluate the options available for these issues.
There are several options available to the implementation of the program, based on what the customers are prepaying. In all cases, the program assumes either sophisticated customers or aggregated customers. What this means is that in a properly functioning industry the utility should be expected to become less "A&G" intensive because the customers will be providing a major portion of their own needs internally as a knowledgeable customer, or much of the initial customer service will be by the alternative service provider. It is critical, based on this, in order to create a viable and long term program, to envision the program that would result from some major increment of participation, such as 25% of customer base participating, even to the point of imposing a customer service fee to cover utility continued service in this area (i.e. unbundle customer service costs as well as many aspects of the long term marginal costs of support functions to marketing and customer service). This would provide the opportunity for customers to look to themselves or their alternative service providers for the service. In all four options, for the pilot program, we would propose that the utility keeps the current A&G number to act as a surrogate for otherwise avoided costs associated with independent customer using their alternative services providers as a first level of assistance. Once the longer term program is established, this would be adjusted to create an explicit avoided cost, with a use fee for enrolled customers.
As part of this program the utilities would allocate to each and every tariff their embedded, undepreciated capital charges. We do not take any position on which method of allocation is to be used, but we are strongly voicing the importance that all tariffs be included so that upon completion of the exercise all customers have the right to participate, and the sum of all allocations equals the total embedded costs. We feel that this is the best check and balance against game playing and would ensure that certain customer classes are not the dumping ground for cost allocations.
As described in the following section "Enrollment Criteria", disproportionate enrollment can signal poor cost allocation, creating disproportionate incentives. This exercise will test the accounting staffs of the utilities and the CPUC, and will cause considerable consternation regarding allocation of cost causality. However, any accusations of "cream skimming" by these programs must first look at whether through current CPUC authorized cost allocation, there is a subsidizing and a subsidized class of customers. The fact that the market will find it disproportionately attractive to serve the subsidizing customers over the subsidized customers should not be surprising. Instead, by opening up the programs to competition, we set in motion the ability of the marketplace to come up with new ways of serving customers originally deemed to be assisted through subsidy.
It is important to recognize that all aspects of the tariffs remain unchanged except for the addition of a prepayment option. All other issues regarding the total base rate, the services that rate provides for, the commitments required of the customer all remain unchanged. Therefore, assuming that there is some reasonable comparability of credit protections to the capital providers, failure of the market to offer services to one or another class of customers should speak more loudly than any abstract arguments coming from modeling exercises. This should, in turn lead to a review of procedures to insure that all customers are able to participate in these programs. Regardless of how the allocations occur, once the allocation is made, accepted, and customers enroll in the prepayment program, they would then be billed by the utility for only the operations and maintenance portions of the bill.
An important aspect of the long term program will be the determination of a basis under which to compensate the utilities for their service functions provided to prepay customers. A critical element of this is a recognition of the nature and service requirements of prepaid customers in a restructured industry. Specifically, it should be expected that in a broadly competitive environment that customer service, capital acquisition costs, regulatory intervention and related costs should be borne by the primary service provider with the direct relationship with the customer. It is inherent in this program that the customers sponsoring this program will be working with their service provider for a broad range of services as their primary contact. In an environment which is truly competitive, with 25%+ of the customer base relying on these alternative service providers, the utilities should be able to reduce their A&G expenses significantly. This is consistent with the goal of, over time, making a broad range of utility activities and services avoidable. Critical to that is the ability of alternative providers to be able to provide the services and charge for them. Thus, as described above, a portion of A&G expenses should become avoidable, including marketing and customer services charges. However, in the long run, we anticipate that the utilities should realize a profit on the provision of services they provide. In this case, if they provide capital to the customer, they charge for that, per the current rules, or per the first two suggested options above. Additionally, provision of distribution and transmission services needs to become a profit center related to the efficient deployment of personnel, facilities, consumed supplies, raw energy inputs and capital. The goal is to encourage efficiency and pay the utilities for the direct services to customers that they provide. Inherent in this statement is that the essential service the utilities provide is not the supply of capital, which is the fundamental basis on which they are paid today, but instead a daily service function of moving energy between supply and need. We believe that there are a variety of structures available in which this can be done competitively, with customer protections, and in a manner not inconsistent with energy conservation programs.
We strongly urge the Commission that there not be any significant effort to define the long term answer to this question at this early stage. Instead, through the pilot, all parties will be able to observe a new service paradigm, and with that image in their minds, we contend that productive and concrete discussions can be held later. We feel strongly that it would be best not to allow the positions of the parties to become polarized in abstract discussions based on what the character and effects of this program may be guessed to be from this early vantage point.
Program development expenses are system expenses to develop a new way of doing business and not merely the costs to be put onto the experimental program. The key is to restructure the utility industry to accommodate a broad range of service providers interacting with the utility on a wholesale basis. The long term program needs to set out a basic level of market penetration from which to calculate the "avoided costs". This is in contrast to determining avoided costs for a program during its pilot stages, in which the utility is retaining its standby functions. This is important because there needs to be a clear understanding of cost attribution and which parties are the benefactors. It is our contention that the development costs of this program would be a research and development expense, with the participants paying their variable costs to the utility. We raise this issue here because we have seen in other venues a limited audience being asked to cover the costs to restructure the utility, for a system the utility would own and which is basic to the utility being able to support the new structure of an evolving industry.
If, as economists state, investors invest at the margin where perceived risk is used to adjust return to produce a fairly consistent risk adjusted ROI target, we consider it presumptive to assume that utility shareholders may be disadvantaged by this proposal. Based on the theory of risk adjusted ROI, investors should be signaling that expecting a nearly 12% ROI, after tax in a utility equity investment is roughly similar to a low risk bond which today is yielding 6 - 8%, before tax. It must be remembered that utility investors do not buy pipe and wires. They buy stock certificates, in a volatile stock market, based on the investor's belief/hope that utility management can achieve a sustained growth in profitability. To add the adversarial features endemic to utility regulation merely adds another level of risk to the equation, further adding to the required return to achieve parity with the low risk bond.
Finally, the result of the transaction creating the Customer Trust Account need not carry any limitations for the utility on capital re-deployment. Thus, the utilities would be free to locate and invest in any activity, anywhere in the world that did not negatively impact their fiduciary role for their system customers. Assuming capital re-deployment, the over-all debt-to-equity ratio of the company would not change.
This program comes from the evaluation of private market parties, seeking ways to improve the system and reduce costs, and as such we believe illustrates a secondary benefit to the CPUC and the State's ratepayers of broader market participation. That benefit is that of having private parties expending private resources to seek ways to improve the system. The most profound efficiency of the marketplace is the generation of new ideas, most fundamentally, new ways of doing business, not just maneuvering within a well established paradigm. Therefore, we are suggesting that the CPUC recognize that efficiency and explicitly state their support for this type of activity to occur in the future. This carries with it two parts:
Encouraging other parties to take the risk to craft public benefit programs into a sound business structure by insuring an equal standing to propose and support positions to the CPUC, including similar standards of regulatory cost recovery, if any.
Limiting the roles of the utilities (or utility affiliates who continue to be subject to, or benefit from current style regulation) to compete in the program until established standards of competition are achieved.
First, we would like to point out that to date there has been an unequal standing in front of the CPUC to bring forth new ideas for system improvements. We believe that the encouragement of the marketplace to develop new ideas is critical, which means that there needs to be an equality in standing of new ideas, especially for ones generated without ratepayer subsidies. This is directly linked to the second item under this section. Specifically, limiting the ability of the utilities to take over new ideas, until they are truly operating on an equal basis with other supply and service firms.
We are concerned that if the CPUC grants our request, the utilities themselves will immediately petition the CPUC to offer identical services while continuing to receive current style protections. This concern is the same if conducted through a utility affiliate that receives indirect regulatory benefits from its parent. We believe that this opening up of the market for regulated entities would be short sighted. We implore the CPUC to employ the same reasoning that led them to limit the utilities sales of gas to noncore customers, until a competitive market was established. Failure by the CPUC to define the terms of when a competitive market exists is beginning to lead to an unnecessary amount of regulatory bickering, however, the basic concept of creating a threshold is sound. It is critical that the market develop, that diversified services begin to evolve, and to do this with the utilities from their position offering competing services in competitive response to the market is a serious impediment to the investment in the development of the new products and services. In the long run, utilities should be involved but their terms of engagement need to be based on a restructured obligation to serve within their monopoly authority. This is essential to insure that one organization does not have within it both a fiduciary responsibility for the system and its customers well-being while it separately seeks to maximize profits by out competing alternative users and even customers of that system. Stated another way, if the utilities view some system users as customers and others as competitors, where success of a "competitor" will detract from utility profitability, the system will be asking utility management to exercise a type of discretion and control that is simply unreasonable. Incentives, if they are to be successful must match policy objectives.
What this means is that if the utilities are willing
to create affiliates whose costs and profitability are derived
exclusively from the presentation of products and services to
customers, and there is no class of customers held out as the
exclusive domain for that utility affiliate, then the affiliate
can be considered an equal competitor, and participation in this
program would be reasonable. Obviously many details are contained
in these simple sounding statements, but to date, we have no proposals
by any utility company that meets these criteria. I. SUMMARY AND INTRODUCTION TO THE TARIFF PREPAYMENTPROGRAM 1A. Introduction 1B. Program Overview 1C. The Purpose for Including the Pilot Program Within Track 1 1II. DESCRIPTION OF THE KEY ELEMENTS OF THE TARIFF PREPAYMENTPROGRAM 1A. Proposed Term of Pilot Program 1B. Implementation Options 1C. Creation of the Customer Trust Account 1D. Enrollment Criteria 1E. Utility Reinvestment 1F. Accounting and Billing 1G. Program Termination 1III. FUNDAMENTAL ISSUES GUIDING PROGRAM DESIGN 1A. Qualifications for Low Cost Capital 1B. Unbundling of Utility Credit Protections 1C. Insuring Identical Access To System Services 1IV. ISSUES FOR CPUC CONSIDERATION FOR BOTH THE PILOT AND LONGTERM PROGRAMS 1A. Utility Indirect Costs And Their Avoidance 1B. Allocation of Avoidable Capital Charges to Tariffs, Changes to Tariffs 1C. Utility Compensation 1D. Program Development Costs 1E. Risk Adjusted Capital Theory And The Implications To Utility Shareholders 1F. Targeting Initial Program Participation And The Role Of The Utilities 1
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Tariff payments Payments for energy services
including prepayments
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