3. Summary of Authority Sought

3.1. Resolution E-4277

Commission Resolution E-4277 approved, without modification, SDG&E's Advice Letter 2088-E for a power purchase agreement (PPA) consisting of a bilateral contract between SDG&E and Rim Rock. ³ The public version of E-4277 lists pertinent details of the PPA in table format.

The public version of E-4277 does not disclose the contract price but finds that it is reasonable, stating:

The Rim Rock contract price is at or below the 15-year 2008 MPR [market price referent] for a facility beginning operation in 2011. [citation omitted] Additionally, Confidential Appendix B shows that the Rim Rock contract price compares favorably both to all bids in SDG&E's 2008 solicitation as well as to its short-listed bids. Confidential Appendix C includes a detailed discussion of the contractual pricing terms.⁴

E-4277 also finds that that the project is viable "relative to other projects that were bid into SDG&E's 2008 RPS [renewables portfolio standard] solicitation."⁵

Power generated by the Rim Rock project is intended to meet part of SDG&E's RPS procurement goal under the California RPS Program, codified at Public Utilities Code § 399.11 et seq.⁶ Given Rim Rock's Montana location, the PPA provides for the following purchase/sale/delivery mechanism, which the California Energy Commission (CEC) has verified as RPS eligible. SDG&E ratepayers will pay for the power produced when Rim Rock is online and generating but will sell the null power⁷ back to the project company, which in turn will resell the null power into the energy markets in Alberta, Canada. SDG&E will retain the green attributes in the form of Renewable Energy Credits (RECs). It is these RECs that will be delivered to California under the CEC's RPS deliverability guidelines.

3.2. The July 15, 2010 Application

In the application filed July 15, 2010, SDG&E requests several amendments to the PPA, as well as authority to make a tax equity investment in the project and to hedge null power sales for a term of up to ten years in order to ensure price stability (SDG&E's present hedging authority is limited to five years). The proposed PPA amendments include:

· An increase in the PPA's term to 20 years;

· Changes to the PPA to allow the project to be built in phases;

· Deferral of the PPA's commercial operation date to no later than December 31, 2012;⁸

· Modification of the PPA's green attributes price to authorize a cost-based price that would not exceed an agreed upon price cap, to be fixed after Commission approval of the application and just prior to the project's "Construction Financial Closing," as defined; and

· Authority to make a tax equity investment of up to $600 million in the project holding company that would develop the project.

As the application explains:

The federal government offers significant tax incentives to assist in the development of renewable resources. First, Production Tax Credits ("PTCs") are direct dollar-for-dollar reductions in an investor's tax liability. A wind project will generate a benchmark PTC of $15 for each megawatt hour of electricity produced; this benchmark is escalated annually for inflation and currently stands at $22 for 2010. Next, the Modified Accelerated Cost Recovery System ("MACRS") allows for faster recovery of the costs of a wind energy facility. Most of the facility can be depreciated within five years, rather than the normal 20-25 year book life of the equipment. PTCs and MACRS together provide investors with a very large percentage - nearly 45% - of the return on their investment. (Application at 3-4.)

While traditionally, tax equity investors have been large investment or commercial banks (which typically have large "appetites" for tax credits and low financing costs), in the current economic climate not only is credit tight, but many of these entities are experiencing reduced tax appetites. The result is that low cost financing continues to be scarcer than before, which has had a negative impact on renewable energy project development.

SDG&E filed its application against this backdrop. The application states:

While in years past the utility rate of return had been higher than rates charged by financial institutions, that relationship has now been reversed. SDG&E can offer renewable projects lower financing and these savings can be passed through directly to ratepayers. (Application at 5.)

The application goes on to describe the proposed financing arrangement:

The structure of this proposed transaction ... is common for renewable generation projects in contrast with conventional (non-renewable) generation. The key difference that allows for this sharing of the project ownership between the IPP [independent power producer] and the utility is the role of tax equity - tax equity is fundamental to an RPS project. The financing of renewables is generally 100% equity financing, whereas financing of conventional generation is a combination of debt and equity. The debt in a renewables project is replaced by funds from a tax equity investor who will monetize the PTCs and depreciation in the project as part of the return on and of their investment. In this case, SDG&E would simply be a tax equity investor, taking on the role typically played by a financial institution. (Application at 5-6.)

Fundamental to a tax equity investment structure is the concept of partnership "flip." Under the typical tax equity investor/developer partnership, the investor receives as much as 99% of the benefit stream (e.g., tax credits, depreciation, cash) for some pre-determined period; thereafter the benefit streams switches (or flips) in the favor of the developer, who retains the ownership stake in the project and receives the majority of all subsequent proceeds.

At the PHC, SDG&E and Rim Rock represented that absent the new tax equity authority and the other proposed amendments to the PPA, the Rim Rock wind project would be unlikely to proceed. Consistent with their protests, DRA and TURN raised a number of concerns about the application. TURN argued that the Commission should reject the application. In TURN's view the proposed tax equity investment offered few benefits but created new and hard-to-quantify risks for ratepayers. TURN also argued that if amended as SDG&E proposed, the PPA would violate the then-existent moratorium on Tradable RECs (also known as TRECs).⁹ DRA declined to make a definitive recommendation until after it completed discovery but identified several potentially troublesome issues associated with the proposed tax equity investment, including SDG&E's treatment of cost items, ratemaking proposals, the adequacy of ratepayer protections, and whether the tax equity investment would provide disproportionate benefits to SDG&E shareholders.

The scoping memo recognizes that this application, which is the first tax equity investment proposal by an investor-owned utility to come before the Commission, raises a number of unique factual and legal issues. The factual issues identified largely focus on the complicated and complex cost implications of the relief requested, including corresponding ratepayer/shareholder risks and benefits, and whether one or more reasonable alternatives exist. The legal issues identified focus on whether the application as proposed is consistent with law and Commission policy.

The four active parties -- SDG&E, Rim Rock, DRA and TURN -- all sponsored witnesses at hearing, with DRA and TURN both recommending that the Commission deny the application. DRA and TURN strongly opposed a number of major elements of the tax equity proposal. They argued that:

· the size of the proposed tax equity investment -- up to $600 million financed by SDG&E's ratepayers (equivalent to approximately 79.99% of the total project costs) - was simply too large;

· the tax equity proposal exposed ratepayers to limited upside, but substantial risk, and correspondingly provided SDG&E's shareholders substantial benefit, but relatively little or no risk; and

· the proposal contained a serious structural flaw, in that SDG&E sought to obtain final Commission approval to execute the amended PPA, even though the applicable green attribute price would not be determined until a later date and without any review of SDG&E's subsequent due diligence or the inputs used in the final Base Case Model to calculate the final green attributes price.

3.3. Joint Settlement

The active parties ask the Commission to approve their settlement (attached to today's decision as Appendix 1), which resolves all disputed issues among them, and to authorize amendment of the PPA as specified in the settlement. Accordingly, they now expressly agree that the PPA should be modified as proposed in the application to increase the PPA's term to 20 years, impose a quantified price cap on the green attributes associated with the PPA, permit the project to be built in phases, defer the PPA's commercial operation date to no later than December 31, 2012, and permit hedging for terms of up to ten years. To address the concerns registered by DRA and TURN, other settlement provisions depart markedly from the proposal in the application and constitute significant concessions by SDG&E and Rim Rock. Specifically, the active parties now mutually agree that:

· SDG&E's purchase commitment should be reduced from 309 megawatts (MW) to 189 MW, a reduction of over 35%. This decrease directly reduces SDG&E's total project costs and, as described in the next bullet, is one factor that reduces total ratepayer investment. (See Appendix 1, § 2(a).)

· The percentage of project costs to be funded through ratepayer investment should be decreased from 79.99% (as proposed in the application) to less than 65%. The reduction in project costs, together with the cap on ratepayer investment at less than 65%, results in total ratepayer investment of no more than $250 million, compared to the application's request that ratepayer's fund an amount up to $600 million. (See Appendix 1, § 2(f)(i).)

· SDG&E shareholders should make a tax equity investment equal to no less than 10% of the project costs. This provision, developed in response to criticisms from DRA and TURN that SDG&E shareholders should "have skin in the game" in order to better balance respective benefits and risks, means that SDG&E shareholders, like ratepayers, are subject to reduced returns or possible loss in the event the project fails to perform in accordance with projections. (See Appendix 1, § 2(f)(iii).)

· Relevant transaction documents have been restructured to make recovery of shareholder investment subordinate to recovery of ratepayer investment by providing that ratepayer investment will be repaid first. (See Appendix 1, § 2(g).) This provision also serves to further rebalance risks and benefits for SDG&E shareholders and ratepayers.

· SDG&E guarantees ratepayer neutrality (i.e., that costs to ratepayers of the rate-based investment compared to project benefits will not exceed a zero net present value). SDG&E must file periodic reports to ensure that its ratemaking is consistent with these (and other) settlement terms. (See Appendix 1, § 2(h).)

· SDG&E and Rim Rock should provide DRA, TURN, and the Director of the Commission's Energy Division with various reports containing updated information about the key inputs in the run of the Base Case Model leading up to Construction Financial Closing (e.g. the energy price forecast for the Alberta Electric System Operator markets and the projected capacity factor for the Rim Rock wind generators), and should provide DRA and TURN with an opportunity to review and question these key inputs. (See Appendix 1, § 3.)

· Should the parties be unable to resolve, informally, future disputes that may arise among them regarding implementation of the settlement, they should engage in alternate dispute resolution with the assistance of the Director of the Commission's Energy Division, pursuant to the terms of the settlement. (See Appendix 1, § 3(j).)

· SDG&E commits (with some exceptions) not to procure any incremental TRECs from projects that are neither directly connected nor dynamically scheduled to a California-based balancing area authority, such as the California Independent System Operator and others, if such procurement would mean that more than 25% of SDG&E's REC purchases though 2017 consisted of TRECs. (See Appendix 1, § 4.)

³ See Resolution E-4277, November 20, 2009, at 1 and Ordering Paragraph 1.

⁴ Resolution E-4277 at 10; see also Finding 12.

⁵ Resolution E-4277, Finding 13.

⁶ All subsequent references to a statute or statutes mean the Public Utilities Code unless further specified.

⁷ Null power is a term used to describe energy stripped of all of the environmental and renewable attributes - also called green attributes -- of renewable electricity.

⁸ Commercial operation must begin no later than December 21, 2012 for the project to be eligible for production tax credits (PTCs).

⁹ Decision (D.) 11-01-025 lifts this moratorium.