7. Hedging
DRA and Pacific Environment raise issues relating to the utilities' hedging costs and practices. DRA specifically questions what it considers to be the relatively high costs of hedging incurred by the utilities. While DRA acknowledges the need for hedging, it argues that the cost of utility hedging has been too high relative to the value received. (DRA Opening Brief at 9-10.)
DRA, SCE and PG&E fundamentally agree on a change to the method of calculating the Customer Risk Tolerance (CRT), which is used as a metric to guide the utilities in determining their appropriate level of hedging against potential electric rate increases. Currently, the CRT is set at one cent per kilowatt-hour (kWh). DRA, SCE and PG&E propose shifting from this flat rate to indexing the CRT to a percentage of the individual utility's system average rate. (See, e.g., DRA Opening Brief at 10-11; SCE Reply Brief at 16-17; PG&E Reply Brief at 28-29.) SDG&E opposes this change. (SDG&E Opening Brief at 17.)
Under the current flat rate CRT, the utilities' hedging levels (as a percentage of system average rates) will vary as rates change. For example, if rates rise, the utilities effectively end up hedging a smaller proportion of electric rates, and vice versa. By shifting to a percentage of the system average rate, the hedging level adjusts in correspondence to rate changes.
Using a percentage of the system average rate is a more logical and consistent approach. We adopt this proposal, and change the CRT from one cent per kWh to a percentage of the utility's system average rate. The calculation of the CRT would be updated every two years in each LTPP filing. If for some reason the LTPP filing is delayed or not made, the utilities are directed to update their CRT two years from the filing of the previous LTPP via a Tier 1 Advice Letter.7
There is less agreement as to the appropriate level at which to set the CRT, and there appears to be some confusion regarding how the CRT is used. Before we determine the appropriate level for the CRT, we need to clarify what the CRT actually means.
DRA and SDG&E assert that the utilities' hedging is supposed to "keep consumer prices from rising more than twenty-five percent above the CRT value." (DRA Opening Brief at 10; SDG&E Reply Brief at 9.) Under this understanding, if the CRT was set at 10% of the system average rate, a utility would engage in hedging to protect against consumer prices rising more than 12.5%. But DRA and SDG&E also seem to use the actual CRT, not the CRT plus 25%, as the hedging target. For example, SDG&E calculates its current CRT to be 6.2% of its system average rate, and describes its hedging as "guarding against the risk of a temporary 6.2% increase in the customer's electric bill..." (SDG&E Opening Brief at 18.)
This confusion likely results from the language in D.07-12-052, which referred to a threshold metric of 125% of CRT. (D.07-12-052 at 174-178.) This 125% of CRT figure represented the rate level at which a PRG meeting would be required and remedial action would be considered, such as additional hedges. (Id.) In other words, even if the utility's forecasted value at risk would appear likely to result in rates increasing beyond the 1 cent per kWh CRT, no action was required until there was a forecast that rates were likely to increase by 1.25 cents per kWh. This gap has caused confusion, and may also have resulted in a de facto CRT that is 25% higher than the stated CRT. Accordingly, we are eliminating the difference between the CRT level and the PRG notification trigger level. If the CRT is expected to be hit or exceeded within the next quarter, the PRG is to be notified and additional remedial action is to be considered, consistent with the process described in D.07-12-052.
DRA proposes that the CRT be set at the equivalent of 10% of each utility's system average rate. (DRA Opening Brief at 11.) SCE proposes a level of 7.04%. (SCE Opening Brief at 13.) SDG&E recommends keeping its current level of 6.2%. (SDG&E Opening Brief at 18.) PG&E does not recommend a specific level, and does not expressly oppose any of the proposed CRT levels. (PG&E Reply Brief at 29.)
As DRA and the utilities note, hedging is a useful tool that protects ratepayers from "intolerable price spikes." (DRA Opening Brief at 9.) One question we need to look at here is what constitutes an "intolerable price spike" - what level of price increase would be intolerable? This question is necessarily subjective, and the record is not highly developed, with the parties largely suggesting numbers without much supporting analysis. DRA applies a brief common-sense analysis to show that hedging against a 6.5% increase on an average monthly bill of $95.97, taking into consideration the $3.00-plus cost of the hedging, means that the customer is being protected against the risk of anything more than an approximately $3.00 bill increase. (Ex. 400 at 26-27.)
DRA correctly notes that an effective $3.00 increase on a $96.00 bill is not a shocking or intolerable change. Based on a data response DRA received from PG&E, DRA recommends a CRT set at an indexed level of 10%. (Exhibit 400, Attachment 5.) Even without taking hedging costs into consideration, this would protect against an increase of more than $9.60 on the average $95.97 bill, as opposed to something near $6.23. When the costs of hedging are taken into consideration, this becomes even clearer, as the cost of hedging against a 10% rate increase should be lower than the cost of hedging against a 6.5% increase.
We agree with DRA that our currently authorized hedging appears to have resulted in ratepayers purchasing hedging to protect against relatively minor rate increases. In short, ratepayers have been paying for too much hedging. Raising the CRT to 10% of each utility's system average rate should reduce both the amount and cost of hedging. While this potentially increases the risk to ratepayers of rate increases, that risk remains relatively limited. In addition, with the elimination of the previous 25% gap between CRT and remedial action, the utility and PRG will be more closely monitoring hedging activities at the critical times when markets become more volatile.
To clarify, SCE notes correctly that:
The CRT is used in conjunction with the TEVaR metric to measure the market sensitive bundled procurement cost at a given confidence level. The Commission adopted a 95% TEVaR in D.07-12-052. TEVaR is calculated and compared to the CRT each month and reported to the Commission and the Procurement Review Group. The...adoption of a CRT rate equal to 10% of the IOU's system average rate...is only a component of the required CRT analysis.
The CRT is derived as follows:
1. A base load forecast scenario in kWh for the applicable rolling forward 12-month period is prepared.
2. The total 12-month load forecast is multiplied by the current CRT rate, which is expressed in cents/kWh. This represents the CRT that is compared to the monthly TEVaR calculation.
The CRT rate metric, which used to be 1 cent/kWh, will now be 10% of each IOU's system average rate at the time of submittal of the conformed bundled procurement plan. (SCE Opening Comments at 11-12.)
PG&E is also correct in its similar clarification:
[T]he CRT value is derived by multiplying the 10% system average rate value by the forecasted sales for the rolling 12-month period. This resulting CRT value is then compared to the VaRto- Expiration ("VtE") value at a 95% confidence interval. Thus, the risk metric calculation is CRT - VtE (95%)...(PG&E Opening Comments at 8.)
DRA also proposes that the Commission should retain a third party, supervised by the Energy Division, to evaluate how the Commission oversees hedging. In particular, DRA recommends that the Commission order an independent third party review of utility To-Expiration Value at Risk (TeVaR) models and practices. (DRA Opening Brief at 12-14.) Pacific Environment similarly recommends the Commission contract with an Independent Evaluator to evaluate hedging and risk management practices. (Pacific Environment Opening Brief at 29-30.) Finally, DRA proposes that the Commission should "conduct a stakeholder process to define the circumstances under which exceptions to limits outside of the approved IOU hedging plans will be authorized, and how these requests will be reviewed." (Id. at 14.)
The utilities question the need for and value of these additional processes at this time. (See, e.g., PG&E Reply Brief at 29-30.) We agree. While these may be reasonable activities for the Commission to undertake, it is not clear that there is a need for them now, particularly with the changes we are making in the use of the CRT. We may, however, consider undertaking a more comprehensive review of utility hedging practices in the future, as our practices under the LTPP stabilize.
7 If for some reason there is no LTPP filing that is usable for this purpose, then the two years will run from the date of Commission approval of the previous CRT.
