IV. QFs

Currently, there are about 600 QFs under contract to PG&E, SCE, and SDG&E. These QFs supply power used to serve about one-fourth of the combined retail load for the three utilities. QFs have been reliably providing power for over 20 years, under standard offer and fixed-priced contracts, and under some non-standard offer contracts, approved by this Commission. As we discussed in our Interim Opinion, QF power does provide many benefits to California:

"As a general proposition, we find that QF power provides significant benefits to the state, in the form of more efficient industrial processes, as well as electric power. QFs have continued to provide power to the state during difficult circumstances during the past several years. A consequence of not making provisions for continuing QF contracts would be more QF power going off-line, creating additional net short that the utilities would need to procure during the interim period." (D.02-08-071, p. 31.)

We continue to strongly support the foregoing proposition, and in this Decision, we shall continue in 2004 the policies relating to QFs that we adopted for 2003 in our Interim Decision, D.02-08-071. In today's decision, we only address procurement planning activities for the short term. Accordingly, we shall not engage in a detailed discussion of the parties' positions on all of the QF-related issues that were addressed in: (a) the hearings that took place in the later part of 2003, (b) the subsequent briefing, and (c) the Proposed and Alternate Decisions issued on November 18 and December 4. Rather, we shall focus only on those QF-related issues that must be decided now in order to assure the continuing availability of QF power during 2004.

A. Parties' Positions

9. Utility Recommendations

PG&E, SCE, and SDG&E have proposed to not automatically renew expired QF contracts, but differ in their willingness to do so. SDG&E is the most willing of the three and does assume that its QF power deliveries will remain relatively constant throughout the forecast period, and that expired QF contracts will be renewed under certain conditions. However, all three utilities agree that the Commission should reexamine SRAC pricing to ensure that utility avoided cost more accurately reflects the cost of their replacement power alternatives. SDG&E is amenable to renewing expired QF contracts through the use of Standard Offer 1 (SO1) contracts that would be renewed annually based on need. SDG&E is opposed to the use of QF-only auctions.

PG&E occupies the middle-ground on QF issues with its proposal to offer one-year SO1 contracts with modifications pertaining to: (1) the provision of 1,000 discretionary curtailment hours, both financial and physical curtailment, (Tr.5744, lines 2-9), although the detailed protocols on specific curtailment frequency, duration, and notice provisions were not specifically set forth; (2) providing for an option to terminate a contract once the seller enters into a winning RPS bid; (3) revisiting SRAC methodologies; and (4) the opportunity for QFs to participate in any upcoming power solicitations.

SCE stands alone at the other end of the spectrum with its solicitation-only proposal. SCE contends that its Public Utility Regulatory Policies Act (PURPA) obligations will be fully satisfied simply by affording QFs the opportunity to participate in upcoming solicitations for renewable and/or non-renewable contracts. SCE asserts that California and other states have considerable discretion in implementing PURPA's mandatory purchase requirement, and that the demise of the California Power Exchange (PX) has not altered the basic proposition that PURPA may be properly implemented by providing QFs with the opportunity to participate in a competitive procurement process. SCE further notes that revival of mandated SO1 contracts would impose must-take obligations on the IOUs in all hours, including many hours when the true costs avoided by the QF purchases approach zero and may even be negative.

10. CCC Recommendations

CCC recommends that QFs should be (1) allowed to preferably enter into 10-year SO1 contracts, or alternatively, short-term annual SO1 contracts; (2) bid to provide long-term procurement products to the IOUs (such as firm capacity products), while (3) retaining their right to sell energy at SRAC prices to the IOUs in other hours.

CCC contends that QFs can supply additional power in 2004 and beyond:

"Cogeneration projects that could supply additional power to the IOUs in 2004 are, for the most part, already built and have operated successfully for many years. Most are located in the state's load centers, improve the reliability of the state's electric grid, and avoid the need for the California Independent System Operator (ISO) to contract for reliability must-run (RMR) generation." (CCC Direct Testimony, p. 3, line 3.)

CCC also encourages the Commission to reject PG&E's proposal to incorporate 1,000 hours of annual curtailment into SO1 contracts. CCC contends that PG&E has not shown that the utility's avoided costs are negative in this many hours, nor has the utility provided details on how it would administer such curtailments. CCC states that this issue would be best considered during a comprehensive review of SRAC pricing issues.

11. CAC/EPUC's Position

On QF issues, CAC/EPUC generally took the same position as CCC. However, CAC/EPUC emphasized the importance of state law, as set forth in PU Code § 372, in encouraging the Commission to support the continued development, installation, and interconnection of clean and efficient self-generation and cogeneration resources, and to improve system reliability for consumers by retaining existing generation and encouraging new generation to connect to the electric grid.

12. ORA's Position

Although ORA does not appear to oppose PG&E's power solicitation and SO1 contract proposals, ORA does state that these seem to be "inconsistent with the Commission's intent for a limited revival of SO1 contracts" (ORA Direct, p.80). Regarding PG&E's 1,000-hour discretionary curtailment proposal, ORA's direct testimony at page 79 did not reflect a full understanding of PG&E's proposal, as evidenced during hearings (Tr.5883, through 5886). Under cross- examination by CCC, ORA did express concern over the possibility that "PG&E's exercise of the [1,000 hour] curtailment right [might have] the effect of shutting down [some] QF operations" (Tr.5886, ln.17-20). ORA is not opposed to PG&E's proposal to revamp SRAC pricing methodologies, but ORA notes that no specific details were provided.

ORA's position on SCE's position that, "its PURPA obligations will be fully satisfied by affording QFs the opportunity to participate in upcoming solicitations for renewable and/or non-renewable contracts," is ambiguous:

"If, as SCE represents, additional SO1 contracts will not be a good fit to SCE's primary need, then so be it. SCE should not force itself to enter into this type of contract beyond those already required in existing Commission orders. SCE has indicated several planned new contracts during the plan period through 2012. But SCE should describe in more explicit terms the solicitation opportunities it plans to make available to QFs and all other bidders in both renewables and non-renewables." (ORA, Direct Testimony, p. 82.)

As a policy matter, ORA states that SCE should be more explicit in identifying specific opportunities for QFs to bid in future SCE solicitations.

13. Discussion

(a) Existing QFs With Expired, or Soon-to-be Expired, Utility Contracts

For purposes of this Decision, we only need to specifically address the issue of existing QFs with contracts that have expired during 2003 or will expire during 2004. This is because we shall be discussing the larger issues associated with longer-term procurement of QF power in our upcoming policy decision.

On the issue of whether to renew existing QFs with expired, or soon-to-be expired, utility contracts, the three utility proposals, already discussed in some detail, do differ from one another.

Of the three proposals, SCE argues in the extreme that renewal of existing QF contracts is not necessary and that QFs can instead compete in any upcoming power solicitation proposals that maybe offered in the future. Under SCE's paradigm, determinations of need might be made from time-to-time as the utility issues RFOs for power under certain quantity, quality, and duration parameters; in addition, instead of plainly stating its need in the form of an exact quantity, the utility might be expected to simply specify acceptable bidding units of, for example, anywhere from one megawatt to 25 MW, or more in order to avoid revealing its exact net short position.

The IOUs have proposed to comply, in whole or in part, with their PURPA purchase obligations by allowing QFs, including existing QFs with expiring contracts, the opportunity to participate in power solicitations. A competitive all-resource bidding process is an optimal means for an IOU to determine what resources can best meet its need for additional capacity. Ideally, QF participation in such solicitations is the best way for the IOUs to match their need for new capacity with the range of potentially available resources, including QFs. However, we do not believe that such participation should be mandatory for existing QFs seeking to renew their contracts.

In light of the continuing need for most of the power that QFs currently provide, and the short-term focus of this Decision, we do not accept the IOUs' proposal at this time, and we direct the IOUs to renegotiate expiring or expired contracts with existing QFs to cover calendar year 2004 on the terms discussed in further detail below.

We understand that most of the existing QF contracts will not expire before the end of 2005. Over the next two years, we expect to complete a thorough review of pricing policies relating to QFs. However, we need to make provision for those QF contracts that have either recently expired or will expire during the next year. Specifically, we should continue to provide interim treatment, as we did in D.02-08-071, for QF contracts expiring in the near term for which the QF and the utility do not reach agreement on the terms of a new long-term QF contract. Accordingly, the utilities shall continue to purchase power until December 31, 2004 from any QF pursuant to an SO1 contract under the following conditions:

· The QF must have been in operation and under contract to provide power with an IOU at any point between January 1, 1998 and the effective date of this decision; and

· The QF contract must be set to expire before January 1, 2005, or have already expired.

The pricing terms for any such contract should be consistent with existing Commission SRAC policy established in D.01-03-067, as modified by D.02-02-028; provided, however, to the extent that the Commission adopts a revised SRAC policy, the pricing terms of the contract shall be modified to reflect said revised SRAC policy as of the effective date of the Commission decision adopting a revised SRAC policy.

(1) New QFs During the Interim Period

Although we are directing the IOUs to extend expiring or expired contracts with existing QFs for another year, we are not allowing for any new QF contracts with new QF facilities during this short interim period in which we shall be evaluating how the QFs will fit into the IOUs' procurement planning processes on a long term basis. This should not prejudice any prospective new QF, as the electric restructuring related suspension we adopted in D.96-10-036 continues, until we complete work on the long term procurement issues that are the subject of this very complex proceeding.

Thus, as to new QFs, we direct the utilities not to enter into any new contracts until we have issued a decision on the long-term procurement issues on which hearings have already been conducted, and which remain under consideration in this proceeding.

(2) Revision of SRAC Prices

All three utilities contend that revision of the current SRAC methodologies for determining QF energy and capacity payments is needed. For many years now, SRAC has been approximated through time-differentiated energy prices (set once a month) and time-differentiated capacity prices (set annually). However, there is evidence on the record in this proceeding that indicates that the current SRAC energy pricing methodology has yielded prices in excess of spot market prices for significant periods of time.

The Commission has established SRAC methodologies used to calculate avoided cost energy and capacity payments for QF power. Per the requirements of Pub. Util. Code § 390, SRAC energy prices are tied to natural gas spot border prices, which have not necessarily reflected the more diverse utility portfolio that should be reflected in a utility's avoided cost. The result of the current SRAC pricing system has been that utilities have paid too much for QF power in certain time periods relative to market prices, in some cases, even just on the basis of energy prices not withstanding capacity payments. More specifically, based on current SRAC time of use factors, utilities have paid too much for QF power at certain times of day.

Because of this pricing problem, the Commission has also authorized utilities to purchase financial derivative products to hedge the QF price risk created, in part, by the approved SRAC methodology, which has been greatly affected by the volatility in the natural gas market over the past several years. In fact, the utilities have expended considerable sums of money hedging QF price risk resulting from this spot market-based (and in part Legislatively-mandated) avoided cost pricing formula. The amount of this hedging activity also indicates that the current avoided cost pricing formula has not reflected utility avoided cost either as accurately as we had hoped or as precisely as we would like to see in the future.

Accordingly, in our view, there is a pressing need to revisit the SRAC pricing system, which will accurately and fairly set utility avoided cost prices both under current and expected future market conditions and with an eye toward diverse utility resource portfolios.

In fact, Section 390 is now something of an artifact of the AB 1890 electric restructuring landscape, for the reason that Section 390 can never be fully implemented in accordance with the provisions set forth in Section 390(c) due to the demise of the PX.

As the foregoing discussion demonstrates, the SRAC energy pricing formula is now out-of-date. The capacity pricing component of the SRAC formula is also problematic, because the QFs receive capacity payments in addition to energy payments. With SRAC energy prices that can now be above market prices, the additional capacity payments that QFs receive could compound any inequity to the utilities and their ratepayers of the current SRAC pricing formula.

The Commission should carefully consider how to modify the SRAC methodology and whether to seek legislative changes to Section 390. We have a two-year window until most existing QF contracts begin to expire, and we should craft a remedy in the new OIR that better matches QF contracts with the actual needs and economic alternatives of the IOUs. Because it is so important that the current methodologies to establish SRAC be modified, we are directing the Commission staff to immediately begin work on a draft Order Instituting Rulemaking (OIR) that will examine and propose appropriate modifications to the SRAC methodology.

(3) PG&E's Proposed 1,000 Hours Curtailment Proposal

PG&E has proposed to offer SO1 contracts to QFs whose contracts have expired, provided the contract is mutually agreeable with possible annual renewal. As part of that contract proposal, PG&E included an updated curtailment provision, which would allow the utility, at its discretion, to physically and financially curtail such QF contracts up to 1,000 hours annually. PG&E contends that its proposal should be adopted for several reasons: (1) baseload power is not needed until after 2008, (2) allocated DWR contracts result in more energy than PG&E can use in many hours during the year, and (3) the 1,000 curtailment hours provision was previously approved by the Commission in connection with the Interim Standard Offer No. 4 Curtailment Option B. PG&E further contends that its 1,000-hour curtailment proposal is very reasonable and is perhaps overly generous, given that PG&E does not need additional generation during the next several years. (PG&E Post-Hearing Brief, September 15, 2003, pp. 85-87).

We are unpersuaded by PG&E's arguments on this issue. PG&E's 1,000-hour curtailment proposal is not the result of any detailed avoided cost calculations based upon an approved avoided cost methodology or concept. However, the planned hearings on modifications to SRAC should address PG&E's concerns, and will provide a more reasoned basis for the type of SRAC payment adjustments that PG&E's proposed contract provision seeks to effectuate.