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ALJ/CAB/sid Mailed 7/21/2006

Decision 06-07-029 July 20, 2006

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Order Instituting Rulemaking to Integrate Procurement Policies and Consider Long-Term Procurement Plans.

Rulemaking 06-02-013

(Filed February 16, 2006)

OPINION ON NEW GENERATION AND LONG-TERM CONTRACT PROPOSALS AND COST ALLOCATION

Title Page

OPINION ON NEW GENERATION AND LONG-TERM CONTRACT PROPOSALS AND COST ALLOCATION 2

Executive Summary 2

I. Introduction 5

II. Background 8

III. Summary of Proposals and Comments 14

IV. Adoption of Modified Proposal 23

V. Motions 50

VI. Comments on Draft Decision 51

VII. Assignment of Proceeding 54

Findings of Fact 54

Conclusions of Law 59

ORDER 61

APPENDIX A - Excerpt from Presentation of Kevin Kennedy

APPENDIX B - Excerpt from Presentation by Dave Ashuckian

APPENDIX C - Post Workshop Comments

OPINION ON NEW GENERATION AND LONG-TERM CONTRACT PROPOSALS AND COST ALLOCATION

Executive Summary

The electricity market crisis of 2000-2001 cut short the restructuring process envisioned by Assembly Bill (AB) 1890, and numerous developments since then have left California with a hybrid market structure subject to significant legislative mandates. Direct Access (DA) was frozen by the Legislature, several non-bypassable charges have been imposed on migrating customers, and the bankruptcies and litigation that followed the crisis have resulted in acquisition of new power plants by the investor-owned utilities (IOU). These developments have left some questioning what is the future of the California electricity market.

With this decision today, the Commission seeks to signal that it is committed to the fundamental principles that have guided electricity market restructuring in California and elsewhere: competition and customer choice. In particular, we intend to pursue policies to develop and maintain a viable and workably competitive wholesale generation sector in order to assure least cost procurement for bundled utility customers. At an appropriate juncture, in another proceeding, we intend to explore how we may increase customer choice, by reinstituting DA or via other suitable means. In the interim, we will strike a balance between requiring that electric service providers (ESP) are "responsible citizens" while ensuring that our actions do not undermine the ESP's business model.

However, determining the appropriate market model and developing the necessary institutional infrastructure takes time and a more extensive record than we have developed thus far in this proceeding. Phase II of this proceeding, in tandem with Phase II of the Resource Adequacy (RA) proceeding, Rulemaking (R.) 05-12-013 will tackle the longer term market structure questions.

Our foremost responsibility is to assure continued reliable service at reasonable cost. At this point in time, we are faced with the urgent need to bring new capacity on line as soon as 2009, at least for Southern California. We therefore devoted Phase I of this proceeding to working with the known need and we found that in order to maintain adequate capacity and reserves throughout the state, 3,700 megawatts (MW) of new generation must come on line beginning in 2009. The required new resources are in addition to the investments the IOU's are expected to make in energy efficiency and renewable generation and are consistent with the State's Loading Order policy, the goals established in Energy Action Plans I and II, the Commission's greenhouse gas policy, and Commission decisions implementing these policies.

Given the significant savings resulting from making use of pre-existing transmission and gas interconnections at brownfield sites, we strongly encourage market participants to take advantage of opportunities to repower older facilities. For the purposes of upcoming requests for offers (RFO), new generation should be understood to encompass both greenfield facilities and repowers of existing units, where feasible and appropriate.

The more challenging question we faced was how to assure timely construction of the necessary capacity without compromising our longer term goals of achieving competition and customer choice. The only complete solution presented to the Commission was the Joint Parties' proposal (JP). The JP would make the IOUs the entities responsible for acquiring new generation capacity, on a temporary basis, for bundled and unbundled customers alike. While other parties offered critiques of the JP, their alternative solution can be summarized simply as "stay the course": continue with ongoing market reforms and somehow or other the new capacity will get built.

Given the urgent need for new capacity and the lengthy lead-times required both for new construction and to develop and implement new market institutions, we conclude that staying the course is too risky. Developers have indicated that they require long-term contracts to undertake new projects, and both ESPs and IOUs are unwilling to sign long-term contracts in the current regulatory and market framework. ESPs' customers are on short-term contracts and ESPs are currently unable to recruit new customers with the suspension of DA. IOUs are concerned that without assurances that the associated costs of long-term contracts can be passed on to customers that have already left bundled service, or that adequate capacity would be available to serve DA customers that opt to return to bundled service, long-term contracts are too risky.

This presents a recipe for stalemate and, ultimately, scarcity. We therefore conclude that immediate and affirmative Commission action is required to assure construction of adequate new capacity during the time in which we are transitioning to more robust and durable market institutions.

Accordingly, we will adopt a modified version of the JPs' proposal on a limited and transitional basis. This new cost-allocation mechanism will not apply to commitments made after new institutions are decided upon, developed and in place. We will not approve this cost allocation for any additional utility-owned generation, since that generation is essentially dedicated to bundled customers. We adopt recommendations from the Indicated Parties in order to limit the procurement role of the IOUs. The proposal's salient feature is that it divides the management of the energy and capacity components of the newly acquired generation, so that the IOUs are not responsible for the energy management of the new capacity by default. Instead, the energy component of new generation contracts would be managed by the entity that values the energy the most, as revealed through an auction or other bidding process. This practice is consistent with both ESPs and IOUs managing their energy purchases separately. Implementation details for this proposal will be worked out in Phase II of this proceeding.

We are supportive of the proposal that load serving entities (LSEs) that can demonstrate that they are fully resource adequate over a sufficiently long time horizon should be allowed to opt-out of the cost-allocation system. In Phase II of R.05-12-013, we will consider proposals for how an opt-out system can be designed and implemented, concurrent with our consideration of multi-year resource adequacy and capacity markets.

Phase II of this proceeding will provide guidance for how the IOUs are to conduct their forthcoming procurement processes.

Our intent is that the long-term market rules and institutions to be developed in Phase II of the RA proceeding will supersede these temporary arrangements. That proceeding will examine creating multi-year RA requirements for all LSEs as well as capacity markets and other arrangements for assuring that sufficient generation is built when and where it is needed. Potentially, cost recovery for plants built pursuant to these temporary arrangements ordered in this decision may be completed under the new structure, with a seamless transition, depending on the details of the new structure.

I. Introduction

As we announced in the Order Instituting Rulemaking (OIR) initiating this rulemaking, "The first order of business for this proceeding will be to examine the need for additional policies that support new generation and long-term contracts for California, including consideration of transitional and/or permanent mechanisms (e.g., cost allocation and benefit sharing, or some other alternative) which can ensure construction of and investment in new generation in a timely fashion."

Simultaneously with this focus on new generation, the Commission also indicated its interest in capacity markets and exploring the concept and mechanisms of capacity markets in Phase II of the companion procurement R.05-12-013.

The State's energy policies - as noted in the Commission's and the California Energy Commission's (CEC) Energy Action Plan II (EAP II)1 and the CEC's Integrated Energy Policy Report (IEPR) - uniformly point to the need for the State to invest in new generation in both northern and southern California.

Therefore, we are adopting a cost-allocation mechanism, on a limited and transitional basis, that allows the advantages and costs of new generation to be shared by all benefiting customers in an IOU's service territory. We designate the IOUs to procure this new generation. The LSEs in the IOU's service territory will be allocated rights to the capacity that can be applied toward each LSE's RA requirements. The LSEs' customers receiving the benefit of this additional capacity pay only for the net cost of this capacity, determined as a net of the total cost of the contract minus the energy revenues associated with dispatch of the contract.

In light of the adoption of this new cost allocation mechanism, we order Pacific Gas and Electric Company (PG&E) and Southern California Edison Company (SCE) to proceed expeditiously to procure new generation, as previously authorized in Decision (D.) 04-12-048. We also order PG&E, SCE, and San Diego Gas & Electric Company (SDG&E) to include in their 2006 long-term procurement plans (LTPP), resource plans that demonstrate whether there is additional system need for new capacity in their service territories in the next four to five years.2 Based on this additional system need, we will also consider in Phase II of this rulemaking, whether the transitional policies we adopt herein should be extended to additional MWs of new generation. Finally, we note that the Commission is considering capacity markets and multi-year resource adequacy requirements (RAR) in Phase II of R.05-12-013.

1 In EAP II, a policy statement issued jointly by both the Commission and the CEC, established a set of priorities for the energy policy for the State. See http://www.cpuc.ca.gov/PUBLISHED/REPORT/50480.htm.

In EAP II, we state, "Significant capital investments are needed to augment existing facilities, replace aging infrastructure, and ensure that California's electrical supplies will meet current and future needs at reasonable prices and without over-reliance on a single fuel source." Even with the emphasis on energy efficiency, demand response, renewable resources, and distributed generation, investments in conventional power plants will be needed. The State will work to establish a regulatory climate that encourages investment in environmentally-sound conventional electricity.

Key Actions 3 and 4 implementing "Electricity Adequacy, Reliability and Infrastructure" state we will "encourage the development of cost-effective, highly-efficient, and environmentally-sound supply resources [after incorporating higher loading order resources] to provide reliability and consistency with the State's energy priorities," and "establish appropriate incentives for the development and operation of new generation to replace the least efficient and least environmentally sound of California's aging power plants."

2 Additional guidance on Phase II plan filings will be forthcoming via a scoping memo.

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