4. Pricing Approach - The Renewable Auction Mechanism

4.1. Background

The Existing FIT for projects up to 1.5 MW uses a fixed price set by the Commission, equal to the MPR, and stated in a published tariff. For the RPS annual solicitations, sellers submit bid prices to a utility and these prices are subject to negotiations, which can take up to a few years, before the contract is finalized. The initial inquiry into expanding the Existing FIT in the June 2008 Amended Scoping Memo and Ruling did not separately scope pricing as an issue. In August 2009, ED proposed that the price for the new program be established by use of a market-based competitive auction mechanism - the RAM. The RAM employs an auction, wherein sellers which meet certain minimum criteria are eligible to submit non-negotiable price bids. The buyer then selects winning sellers based on the lowest priced bids first, and signs non-negotiable standard contracts with the winning sellers, incorporating the prices bid by that seller. The cost of RAM, as proposed by ED, would be contained with an authorized revenue requirement for the program.

The Staff Proposal suggests that using an auction to set contract prices may induce developers of system-side renewable DG to bid the lowest prices they would be willing to accept to develop renewable energy projects. This mechanism would also allow the state to pay developers a price that is sufficient to bring projects online but that does not provide surplus profits at ratepayers' expense.

4.2. Parties' Positions

In response to ED's proposal, parties argue in favor of two primary pricing methodologies: (1) fixed and published rates; or (2) contract prices established via a market.

Several parties advocate for an administratively determined fixed-rate FIT.¹⁸ In support, they assert a fixed rate set in advance in a published, publicly available tariff makes the price transparent and easily known to all stakeholders. In their view, the advantages of this approach include providing price certainty for project evaluation and cost recovery, reducing transaction costs, moderating program administrative costs, and protecting ratepayers against excessive prices.

Other parties recommend a fixed rate FIT for projects up to a certain size (e.g., 3 MW in Senate Bill [SB] 32¹⁹), and the RAM for larger projects.²⁰ Among the reasons in support, advocating parties say this approach provides transactional efficiencies for the smallest projects, employs the latest guidance from the legislature, and secures the benefits of competitive markets for relatively larger projects.

Many parties support setting the price for the new procurement mechanism through ED's proposed auction approach - the RAM.²¹ In their view, this approach, where bidders receive the price they bid, captures changing market prices in a timely way, is easy to implement, and can provide competitive market prices for ratepayers, IOUs, and sellers. TURN, for example, supports RAM over an administratively set fixed-rate program since RAM "provides greater developer certainty to promote DG projects while minimizing the potential for significant windfall profits at ratepayer expense."²² Solar Alliance argues that RAM's competitive process drives down electricity costs, which can offer ratepayers rapid price adjustments.²³ Further, Recurrent prefers RAM over a fixed rate because it avoids the ratepayer backlash of setting the rate too high, as occurred in Spain and Italy.²⁴

4.3. Discussion

4.3.1. Policy and Practical Considerations

The RPS statute and program were conceived, initially designed, and remain focused on the renewable market segment being competitive. We use this preference in our consideration of the appropriate RAM pricing mechanism. In addition, as discussed in Section 3, we see the need to adopt a new procurement tool that simplifies the procurement process for the system-side renewable DG market. To accomplish this objective, and to design an efficient and effective program, the pricing mechanism should satisfy staff and parties' policy and administrative priorities. These goals include, but are not limited to: 1) lowering transaction costs for the buyer, seller, and regulator, 2) executing contract prices that are financeable for the developer but also not an overpayment from a ratepayer perspective, 3) the ability to respond quickly to market changes, and 4) promoting the development of a long-term sustainable market.

No party suggests that prices for this program be negotiated in the same manner as the annual RPS solicitations. We agree. We have already determined that the transaction costs of submitting bids that are subject to further negotiations is not appropriate for the smaller system-side DG market.

Both Energy Division's RAM proposal and party comments supporting a fixed-rate FIT argue that their respective approaches will reduce transaction costs. RAM opponents assert that the cost of bid preparation can be significant, while it is zero under a fixed price FIT. However, no credible estimates are presented on the cost of either approach, and we are not convinced that the costs differ significantly.²⁵ Even with a fixed price program, a rational project developer must have some level of understanding about the economics of the project, including a price or range of prices that is likely to make the project economic. The RAM adopted here does not permit negotiation over price, terms, or conditions. Under these circumstances, there is minimal cost to put a bid on paper, and no transaction cost related to price negotiation. Thus, we are not persuaded by a qualitative argument that the cost of RAM bid preparation is burdensome as compared to preparing a project for a fixed price program.

We also consider the regulatory cost of determining the appropriate fixed price to put in a published tariff. There are costs for data collection and analysis. IOUs, parties, and staff will incur costs to participate in Commission proceedings, the outcome of which may be appealed. The time and cost of an administrative process to set a fixed price is not zero, and could be the same as or more than the sum of all bid preparation costs. Accordingly, we find that the price as bid and standard contracting aspects of RAM would reduce transaction costs for the seller, utility, and regulator.

Next, we evaluate whether the fixed price approach and/or the market-based RAM proposal result in contract prices that are reasonable - i.e. financeable to the developer and competitive for the ratepayer. Advocates of a fixed-price approach contend that a published fixed price FIT is necessary for relatively small projects because it provides certainty for project evaluation and cost recovery, which will increase investor certainty and facilitate simpler financing. RAM provides a similar result. This is the case because a rational bidder will bid no less than its best cost estimate. Whatever it elects to bid (i.e., its cost or higher), this information gives the bidder adequate certainty to do an economic evaluation of its project.²⁶ If the bid is later selected, the rate is set and known over the life of the project, and is reflected in a long-term contract with a creditworthy off taker. This process gives reasonable certainty to projects for the purposes of both initial evaluation and subsequent cash-flow for cost recovery.

In addition, unlike an administratively established fixed price, however, RAM also balances the ability for a small project to secure financing and attain a reasonable price, with the assurance that the ratepayer is not overpaying. Parties are concerned that a fixed price could result in ratepayer backlash if the price is set too high, as occurred in Spain and Italy.²⁷ We agree that there is potential for a fixed price to be set too high or too low, and either option could create financial and regulatory uncertainty. If the price is too high, it would be unreasonable for ratepayers. If it is too low, no projects would be built.

Recurrent attests to the reasonableness of a RAM mechanism for projects in the 1 to 20 MW range. Recurrent reports that it is an independent power producer successfully developing projects via auctions in this size range. Recurrent welcomes the healthy competition that an auction can stimulate and which, according to Recurrent, brings value to IOUs, ratepayers, and society. In response to parties who express concern that small sellers are unduly burdened by market mechanisms, Recurrent states:

As one of those "small sellers" that concern these parties, Recurrent Energy categorically disagrees that competing in a RAM is unduly burdensome, unreasonably costly, or somehow unfair. ... We are much more concerned by the specter of administrative price-setting gone bad, than by the need to compete through an auction process to meet our buyers' need.²⁸

Recurrent opposes a fixed price based FIT, saying that:

... [S]etting too high an energy rate (by accident or design) at the expense of utilities, ratepayers and society can result in hostility to solar development that undermines the longer-term stability of our markets.²⁹

We endorse healthy competition and seek to avoid regulatory approaches that result in hostility from ratepayers or undermine long-term market stability. We also look for an approach that can quickly respond to changes in cost (both increases and decreases). Administrative determination of contract prices is less likely to be as responsive to cost changes than is a seller determining the price it wishes to seek in an auction based on its understanding of the underlying project costs, and changes in those costs.

By allowing developers to bid in their price and also eliminating further price negotiations, the RAM appropriately balances the goals of maintaining a competitive market and reducing transaction costs for small renewable projects. We note that experience to date in the California Solar Initiative, as well as SCE's Solar Photovoltaic Program and the Renewables Standard Contract (RSC) program suggests that the market for smaller scale projects appears robust with a significant number of competing sellers. However, as discussed later, we adopt necessary safeguards to protect stakeholders from adverse outcomes in case the market is not sufficiently competitive to reach optimal results. Those safeguards include a cap on total program capacity that can be submitted for simplified contract review, IOU discretion to procure less than the authorized cap in instances of market manipulation or uncompetitive pricing, and ongoing monitoring and reporting. Additionally, the Commission retains discretion to reject contracts submitted for its consideration pursuant to this program if they are not found to be in ratepayers' interests.

4.3.2. Jurisdictional Considerations

When commenting on contractual terms and conditions, a number of parties opined that the Commission has no jurisdiction to establish a fixed rate FIT. By ruling dated May 28, 2009, parties were directed to file briefs on this legal issue. In summary, there is significant dispute among the parties regarding the Commission's jurisdiction to set a fixed price FIT. There is, however, no dispute that the Commission has jurisdiction to set prices at avoided cost for IOU purchases from qualifying facilities (QFs) pursuant to § 210 of the Public Utility Regulatory Policies Act (PURPA.).³⁰ Further, there is no dispute that the Commission has jurisdiction to rely on a market-based mechanism to set prices. Thus, to avoid this legal dispute and implement a new procurement mechanism as quickly and efficiently as possible, the Commission may either comply with PURPA and establish an avoided cost price, or it may adopt a market-based approach. If it pursues the first option, the Commission could develop a fixed price tariff applicable to QFs at avoided cost, and implement the recommendations of the attorney general and others to update avoided costs for new market conditions and additional factors.

PG&E and several parties assert that RAM avoids the jurisdiction question. PG&E states:

The proposed auction process would resolve the issue parties briefed previously in this proceeding; namely, whether the Commission has authority to establish prices for wholesale energy sales in interstate commerce ... The RAM, by employing a competitive solicitation, should yield market-based prices and avoid the issue of Commission jurisdiction to set prices in the wholesale generation market.³¹

SCE says the Commission's authority is to set FIT prices either (a) at avoided costs for QFs or (b) to "use a market-based pricing structure."³² SCE describes RAM as providing "a competitive, market-based mechanism which appropriately looks to the market for pricing."³³

IEP points out that we have for several years required IOUs to undertake competitive solicitations to procure conventional and renewable resources. The results do not conflict with the Federal Energy Regulatory Commission's (FERC) jurisdiction, according to IEP, precisely because the solicitations produce market-based prices.³⁴ IEP concludes:

...no conflict with FERC's jurisdiction is created if the Commission requires or encourages the utilities to pursue competitive solicitations for specific products. In this approach, the Commission acts within its jurisdiction by requiring or encouraging a competitive approach to the products that might be the focus of a feed-in tariff and by accepting the market-based prices that result from that competitive procurement. The resulting prices are just and reasonable and are authorized by FERC through its market-based rate authority.³⁵

We agree with these parties. Under RAM we do not set the price, but rely on a market-mechanism that is compatible with FERC's rate-setting in wholesale markets. RAM avoids or eliminates the jurisdictional issue, and we adopt it, in part, for precisely this reason.

The reasonableness of this approach, however, relies on a critical assumption: the market is and remains sufficiently competitive to produce just and reasonable rates, result in efficient and optimal outcomes, and protect both buyers, sellers, and ratepayers. We address competitive aspects of the market when we discuss Commission oversight of the RAM program and appropriate ratepayer protection mechanisms.

¹⁸ These parties include FIT Coalition, Santa Monica, SFUI, CALSEIA, GPI, IEP, CEERT, Solar Alliance and Sierra Club.

¹⁹ Stats. 2009, ch. 328

²⁰ This is a primary recommendation for some, and an alternate recommendation for others, including DRA, GreenVolts, Axio and CARE.

²¹ These parties include PG&E, SCE, SDG&E, Recurrent, Reid, TURN, Solar Alliance and Vote Solar.

²² Pricing Comments at 1.

²³ Pricing Comments at 11.

²⁴ Pricing Comments at 2.

²⁵ Recurrent convincingly says: "The developer resources required to bid for these projects through an auction process are a small percentage of the projects' total expense and certainly should not present an insurmountable obstacle for responsible developers, whether small or large, who are willing to make the investment and take the development risks that these projects entail." (Pricing Reply Comments at 2.)

²⁶ Our adopted program does not permit price negotiation.

²⁷ TURN, Recurrent Energy, Vote Solar, and the Solar Alliance (Pricing Comments).

²⁸ Recurrent Pricing Comments at 5-6.

²⁹ Recurrent Pricing Comments at 11.

³⁰ 16 U.S.C. § 824a-3 (2006); see generally 16 U.S.C. § 2601 et seq. (2006). This authority was most recently affirmed in Order on Petitions for Declaratory Order, 132 FERC ¶ 61,047 (July 15, 2010).