5. Discussion

5.1. Debt Equivalence

Debt Equivalence (DE) is the term used by credit rating agencies for long-term fixed obligations, such as PPAs, that are included in their financial risk analyses for the IOUs. We have been considering the appropriate role for DE in the LTPP process since the 2004 LTPP proceeding.

D.04-12-048 found that the costs associated with rebalancing an IOU's portfolio to counter the effects of DE should be considered in an IOU's cost of capital (COC) proceeding, but not in the LTPP proceeding. D.04-12-048 also found that IOUs may impute a DE of 20% to the fixed cost component of PPA bids as an evaluation tool in comparing bids in a competitive solicitation. However, that decision also indicated that DE was a "subjective factor based on the credit agencies' perceived risk associated with PPAs, that the credit agencies' views are "not static and can change with respect to a particular PPA during the term of the PPA," and that "the imputed costs for existing PPAs will be reduced as the regulatory climate in California improves."7

In the 2006 LTPP proceeding, the IPP trade associations urged us to eliminate DE as a bid evaluation tool for the IOUs. In D.07-12-052, we reviewed and reanalyzed the use of DE in the evaluation of bids and found that while the cumulative impact of DE associated with the PPAs in an IOU's portfolio could potentially impact its credit rating, the IOU's COC proceeding is the appropriate forum to address this potential impact. Consequently, D.07-12-052 determined that the IOUs could no longer use the DE adder for the evaluation of individual bids in RFOs.

PG&E, SCE and SDG&E all filed PFMs asking us to revisit this finding, and in response we issued a ruling on May 20, 2008, asking parties to respond to several assumptions and questions related to the DE issue. The arguments set forth in the initial PFMs, the responses and replies to the PFMs, and the additional requested briefs and reply briefs have provided a wealth of additional information for our consideration on this topic. Following careful deliberation of the competing positions we revise our opinion in several areas, as described below.

5.1.1. The DE Adder as a Bid Evaluation Criterion

Because the DE associated with a PPA is a factor considered by rating agencies and is a factor the Commission evaluates when it determines an IOU's return on equity in the IOU's COC proceeding, we find it is appropriate in some cases for the IOUs to recognize the effects of DE in their bid evaluation processes.

Specifically, we find that it is appropriate to consider DE in cases in which the bids included in the solicitation are sufficiently similar that a comparison of relative DE-effects would not in turn suggest the need to consider other, potentially countervailing risk-related effects of selecting one bid over another. Consequently, we will allow the use of the 20% DE adder in head-to-head competition between PPAs where no UOG projects (including EPC or PSA bids) are being considered. We empower the utilities to develop in their bid evaluation protocols, in consultation with their IEs and PRGs, to ensure that in head-to-head competition, the use of the DE adder does not disadvantage bids for renewable and innovative low-carbon resources that may have higher capital costs than traditional gas-fired generation.

As pointed out by IEP, though, there are a number of both risk-creating and risk-mitigating effects associated with an IOU signing a PPA rather than building UOG, as indicated by the following lists compiled by a Standard and Poor's representative:

The complexity of the risk-related pros and cons associated with PPA versus UOG ownership suggested by these two lists (and the fact that, presumably, neither list is exhaustive) suggests that it would be inappropriate to single out and consider only one specific risk-related effect (i.e., the risk associated with the additional DE within a particular regulatory framework) of a PPA bid on the potential impact to an IOU's credit ratings when comparing PPA and UOG bids. Consequently, we will continue to prohibit the use of the DE adder in solicitations that include both PPA and UOG (including PSA or EPC) bids.

5.1.2. The DE Adder and Pub. Util. Code § 454.6

The IOUs also requested reconsideration of the DE adder issue in solicitations that include contracts for repowering in order to ensure that they could adhere to the requirements of Public Utilities (Pub. Util.) Code Section 454.6. Pub.Util. Code § 454.6 states that a contract for a repowering or replacement that meets the criteria established in Pub. Util. Code § 454.5(b) shall be recoverable in rates, "taking into account any...debt equivalence associated with the contract...." In the event that an IOU submits an application for a replacement or repowering project that requires Pub. Util. Code § 454.6 rate recovery treatment, the IOU should certainly include the DE associated with this contract in its COC proceeding filings such that the Commission can include this DE in its consideration regarding adjustments to the IOU's debt/equity ratio and/or return on equity. Nothing in D.07-12-052 or this decision should be construed to suggest otherwise. We find no merit, though, in the IOUs' position that Pub. Util. Code § 454.6 requires that DE costs also be taken into account in the IOUs' bid evaluation process for these repower projects. 

5.2. Head-to-Head Competition Between PPAs and UOG

In the 2006 LTPP proceeding, IEP and CMA raised some important and valid concerns regarding the challenges associated with IOU solicitations that include UOG and IPP bids, and in response to their arguments:

· D.07-12-052 placed a ban on direct utility bids in IOU RFOs; and

· R.08-02-007, the 2008 LTPP, will consider whether and how a level playing field can be achieved (or approached) for head-to-head competition between all types of UOG and PPA bids.

IEP and CMA are still concerned that allowing PPAs to compete against PSAs, and in some circumstances EPCs, will interfere with moving towards a truly competitive market, and their PFM asks us to make further modifications to D.07-12-052 related to UOG bids. As discussed below, we are not persuaded to make any modifications to D.07-12-052 on this topic.

As noted in D.07-12-052, we initially proposed in the proposed decision (PD) a complete ban on UOG bids. However, in their comments on the PD, DRA and TURN so cogently argued in favor of permitting head-to-head competition, that we changed the final decision and elected to continue to permit head-to-head competition between PPA and PSA (and under appropriate circumstance EPC) bids under the current hybrid market paradigm, while we await the development of a more complete record on this issue in the 2008 LTPP proceeding. Nothing in CMA or IEP's PFMs leads us to modify our conclusions on this interim compromise. We are still gathering data on various aspects of this process, and allowing one more round of RFOs with PSA and PPA bids will be useful and instructive in our assessment of head-to-head competition evaluation methodologies in the 2008 LTPP. We also note that in continuing to allow this limited head-to-head competition, we are not "limiting competition to construction," as IEP's PFM states, since PPAs are still in the RFO mix.

One point raised by the Petitioners in this context that requires additional clarification is D.07-12-052's inclusion of EPC bids "under appropriate circumstances." The purpose of allowing EPC bids is in no way intended to provide the IOUs with a broad loophole that allows for what are essentially direct utility build projects, as suggested by the Petitioners. The purpose of this inclusion is to acknowledge that certain extraordinary circumstances that are unpredictable in advance may necessitate utility ownership of generation at a particular site. The point we are making in including EPCs in the head-to-head competition discussion is that even under these circumstances, our preference is for an open solicitation by the IOU for the contract for this project, rather than the selection of a construction contractor by the IOU via an internal, less transparent process.

While extraordinary circumstances are by definition difficult to identify a priori, our intention is to set a high bar for an "appropriate circumstance" for an IOU to circumvent the potential for private ownership by soliciting EPC bids. Simply owning land on which generation could be built does not meet this test. Requesting EPC bids in general in an RFO as an alternative to PSAs and PPAs certainly does not satisfy this requirement either.

5.3. Exceptions to RFO Solicitations

The Commission has repeatedly stated its desire to develop a functional competitive energy market in California, and as explained in the Decision, we are in the process of implementing a number of programs and safety mechanisms in support of this end state. In the interim, we are operating in an evolving "hybrid market," and the issue of whether and under what circumstances an IOU can propose utility owned generation outside of a competitive solicitation represents one of the challenges posed by such a market. As we stated in the Decision, we continue to believe in a "competitive market first" approach. As such we believe that all long-term procurement should occur via competitive procurements, rather than through preemptive actions by the IOU, except in truly extraordinary circumstances.

However, as noted by several parties throughout this proceeding, unique circumstances could arise that dictate a need for UOG outside of a competitive RFO. D.07-12-052 divided the unique circumstances warranting some form of utility ownership into five categories and noted that the categories were not to be considered permanent but that they may change based on continued experience with procurement processes.9 We repeat the five unique circumstances here for purposes of addressing the PFM:

· Market Power Mitigation - the IOU must make a strong showing that as a result of some attribute of the desired resource, a private owner would have the ability to exert significant influence over the price of its development or of the price and quantity of its output (energy, capacity, or ancillary services);

· Preferred Resources - while we continue to rely on markets to deliver efficiently priced products for ratepayers, we see no reason to limit our options and intend to continue to deploy all resources available to us, including utility development and ownership, to meet California's vital environmental policy objectives;

· Expansion of Existing Facilities - we can envision certain unique circumstances in which ratepayers would benefit from development on or expansion of an existing IOU asset that would not lend itself to the PPA project structure, but the IOU would need to make a strong showing that such development were clearly preferable to a resource that could be obtained via a competitive solicitation that would not necessarily result in utility ownership;

· Unique Opportunity - an attractively priced resource resulting from a settlement or bankruptcy proceeding (we anticipate that these opportunities will diminish over time); and

CMA argues in its PFM that the exception for reliability could be considered redundant, since the Commission has the authority to order UOG for "emergency reliability" purposes. CMA is, in fact, correct. The Commission has the authority to execute a number of decisions in order to ensure reliability. CMA also argues that this exception could "undermine the effectiveness of the planning metrics used to develop RA requirements." We disagree with CMA's assertions. Allowing a certain exception to the RFO requirement is in no way intended to impact or alter the RA requirements - including load forecasting conventions, the planning reserve margin, or resource counting conventions. The RA requirements are not the subject of this proceeding and they remain squarely in a separate proceeding.10 This exception merely provides clarity surrounding how procurement to address reliability issues - as dictated by the RA requirements - may occur. We find that the exception for reliability is well founded and should remain in D.07-12-052. We continue to identify this exception for purposes of clarity, transparency and completeness.

We do, however, agree that D.07-12-052 should be modified to eliminate the "Expansion of Existing Facilities" exception. The arguments presented by CMA and IEP on the due process issue are compelling, and that alone is sufficient to support the modification. We also agree that the language used in the decision may create some uncertainty, and for this reason also modify the Decision. We note that in removing this exception based on due process concerns, we do so without prejudice, and we do not preclude the expansion of existing facilities for UOG projects approved via one of the remaining four exceptions to the competitive RFO requirement.

We continue to look unfavorably upon any procurement option selected outside of a competitive solicitation but we also realize that in certain instances this may be the optimal method for meeting the needs of California's ratepayers.

5.4. Code of Conduct

IEP presents strong arguments supporting the development of a code of conduct for ensuring that when a utility is competing head-to-head as a seller of a product with other sellers, and the utility is the buyer, that there are bans on preferential access to information within the divisions of the utility. We agree, and in fact, language in D.07-12-052 addressed that very point. What we are not prepared to do at this time, however, is to develop, in a public forum, a universal code of conduct for all three utilities to be used in all solicitations where there is head-to-head competition. D.07-12-052 only permits bids that result in utility ownership that are developed by independent parties - direct utility-build bids are prohibited - and given this limitation we conclude that the current system whereby each utility develops its own code of conduct, in consultation with its IE, PRG and the ED staff, adequately protects ratepayers and ensures the integrity of the solicitation process.

However, we recognize that the procedure, as established, does not provide potential RFO participants (i.e., the bidders) any certainty that a code of conduct exists. Therefore, we shall require that any RFO that seeks any form of utility ownership options must include this code of conduct in the RFO bid documents when they are issued.

Phase II of the 2008 LTPP, R.08-02-007 is scoped to evaluate "whether and how refinements can be made to the bid evaluation process to ensure fair competition between power purchase agreements and utility-owned generation bids and alternatives to the competitive market approach where competition cannot be used to reach equitable and efficient outcomes."11 Therefore, we are not going to adopt changes requested in the PFMs to modify D.07-12-052 but rather will focus the Commission's attention on the 2008 Rulemaking and make changes and modifications to the process, as warranted, in the next LTPP decision.

5.5. Solicitations and Existing Generation

Calpine's request to modify D.07-12-052 to require the IOUs to request bids from existing generation in all RFOs is denied. Existing generation is assumed by the utilities and the regulators to be available to IOUs when their net-short positions are calculated. Therefore, recontracting with these resources is not sufficient to meet new generation requirements.

The Decision allowed IOUs the ability to tailor RFOs to meet specific requirements (i.e., address system reliability needs and therefore limit the solicitation to new or repowered generation or RA requirements - system, zonal, or local). In support of this position, the Commission agreed with the IOUs that all parties benefit from this practice. The Commission believes that IPPs actually benefit from this practice in that they are properly discouraged from utilizing their resources to develop bids for products not needed by the IOU.

We continue to expect RFO product descriptions to be based on each utility's operational needs and not create false barriers to participation or otherwise limit the competitive process.

5.6. SDG&E's Need Authorization

In its PFM, SDG&E asks the Commission for procurement authority to meet its anticipated need in the time between the Commission's anticipated approval of Sunrise and the point in time when the new line is operational. In D.07-12-052, we bifurcated SDG&E's procurement authority into 530 MW [130 MW already approved peakers plus 400 MW of additional power] if Sunrise was not approved, and 130 MW [0 MW of additional power] if it was approved. SDG&E is concerned that even if Sunrise is approved, in the time period between approval and operation, SDG&E will face a shortage of local area capacity.

Whether or not to approve the SDG&E's application for a certificate of public convenience and necessity for the Sunrise Powerlink transmission project is the subject of Application 06-08-010 and we do not prejudge that matter here. The Commission's goal in conditioning the need authorization on the outcome of the Sunrise project was to minimize the amount of local area resources SDG&E procures in the event that the Sunrise project is approved and obviates the need for some or all of these resources at this time. However, history has taught us that there is a significant degree of uncertainty surrounding the approval and timing of transmission projects. Adding to this the recent challenges and delays a number of local generation resources have faced in SDG&E's territory, we share SDG&E's concerns regarding the potential for significant local area capacity shortfalls and do not find it prudent to attempt to "finesse" the timing of this procurement. 

Consequently, we authorize SDG&E to procure up to the 530 MWs of new local capacity authorized in D.07-12-052, with the stipulation that applications for this procurement should be supported by updates of the status and projected on-line date of the Sunrise Powerlink project. Subtracting the 133 MWs of resources already approved by the Commission, this results in an additional 400 MWs of authorization for local area resources through 2015.

All of the requirements associated with the types of resources and process requirements identified in D.07-12-052 remain in full force.

5.7. Independent Evaluator

In D.07-12-052, the Commission required the use of an IE for all RFOs seeking products greater than three months duration. The intent behind this directive was to ensure a transparent and fair bid selection process that was beneficial to ratepayers, especially in cases where affiliates or utilities are bidding into the solicitation. Our requirement that the utilities utilize IEs for short- and medium-term products, rather than just long-term (greater than five years), is to ensure that RFOs where affiliate or utility bids may be present are conducted in an impartial and transparent manner regardless of contract duration while also addressing the fact that an IOU may not know whether an affiliate would bid into the solicitation prior to bid evaluation and selection. However, the Commission recognizes that there are RFOs for many different types of products, including standard and non-standard products, and RFOs may happen in a matter of hours or days, making the selection and retention of an IE in some cases burdensome, costly, and ultimately unnecessary. While we appreciate WPTF's point that sufficient time has not lapsed to make such a call, we seek to adequately balance the realities of procurement and the cost of the IE program with the need for fairness and impartiality. Given that solicitations for products of three months or more in duration require consultation with the PRG, of which DRA and ED staff are members, we believe that robust systems are in place to ensure impartiality without unnecessarily impeding the procurement process.

With the goal of protecting the interests of ratepayers, the logical demarcation for retention of an IE [in addition to when an affiliate or a utility is a bidder in the solicitation] would depend upon the complexity of the product sought (e.g., standard products would be considered non-complex products and therefore may not require the use of an IE); however, the record does not establish a clear breaking point for complex versus non-complex products. Given that product complexity is often directly correlated with product duration, we find it prudent to adopt the Joint Parties' PFM allowing for the retention of an IE for products greater than two years duration.

We uphold the requirement that IOUs employ an IE whenever an affiliate or utility bidder is present, regardless of contract duration. To ensure that an IE is retained in such cases, we require that an IOU address the possibility of affiliate or utility bids by designating at the outset of an RFO whether such bidders are allowed to participate. If the IOU does not wish to make such a determination up front, the IOU could require that all parties that intend to participate in an RFO submit a notice of intent early in the RFO process such that an IE can be retained before bids are received. However, the IOU assumes a risk in adopting this approach. One of the requirements of the IE is to ensure that an RFO has not been designed in a manner that unfairly favors some bidders over others. Consequently, if an affiliate bids into an RFO for which no IE was contracted a priori, the IOU runs the risk of having its RFO nullified in the middle of the process if an IE makes a finding of this kind.

Further, we do not adopt SCE's suggestion that an IE only be retained for solicitations where an affiliate bidder is present, regardless of contract duration. While the initial intent of the IE was to ensure fairness of RFOs where an affiliate may be among the bidders, our experience has shown us that sources of bias, or perceived sources of bias, whether intentional or not, may become present during complex solicitations with or without affiliate participation. We maintain that the ultimate goal of the IE is to ensure a fair and competitive solicitation process, and retaining an IE for more complex solicitations is a prudent step toward achieving this objective.

The portion of SDG&E's June 9th, 2008 PFM requesting that short-term (from one month to one year) RA capacity transactions be exempt from the IE requirement is denied. While short-term RA capacity RFOs may involve a somewhat standard evaluation process, no such formal standard RA products are currently in place; thus the possibility for additional evaluation criteria beyond standard criteria could be necessary. Therefore, the Commission requires, as stated above, that an IE be retained for all RFOs where an affiliate or utility bidder participates into the solicitation. At such time as the California Independent System Operator designates standard RA products, this requirement could be revisited. As stated in D.04-12-048 and upheld in D.07-12-052, the IE process may be changed or updated in a later proceeding based upon experience and lessons learned under the current rules and regulations.

5.8. Conclusions

The Commission understands that the hybrid market, by its very nature, presents many challenges to establishing a fair and open solicitation process in which all participants compete on a level playing field. Until there is a different model for developing new resources, however, we will continue to function under the IOU/IPP hybrid-model and take all reasonable steps to ensure that the integrity of the solicitation process is not compromised and that ratepayers are protected. To that end, we find that only the following requested modifications to D.07-12-052 are granted;

1. We authorize the IOUs to recognize the effects of DE when comparing PPAs against PPAs in their bid evaluations but not when a UOG project is being considered;

2. We grant the request to delete the exception of allowing IOUs to chose UOG projects outside of a competitive solicitation based solely on the synergies associated with the expansion of existing facilities;

3. We clarify the circumstances under which EPC bids may be considered;

4. We authorize SDG&E to procure up to the 530 MW of new local capacity that was conditionally authorized in D.07-12-052, clarifying that applications for this procurement should be supported by updates of the status and projected on-line date of the Sunrise Powerlink project;

5. We modify the circumstances under which an IOU must retain the services of an IE to RFOs that seek products two years or greater in duration. However, we still require that an IE be utilized whenever an affiliate or utility bidder participates in the RFO, regardless of contract duration.

The other changes requested in the PFMs are denied.

5.9. Further Modifications to D.07-12-052

For clarification, we made the following changes to D.07-12-052, to incorporate the modifications we grant today and to correct typographical errors:

· Conclusion of Law 30 contains an extraneous word "for" after evaluating, we remove the word "for."

· Eliminating bias in the RFO process: we replace the word "impartiality" with "bias" on page 208 of the Decision.

· Page 140, we clarify that an IE must be utilized for all competitive RFOs that seek products of two years or more in duration. We specify that the contract duration clock begins: (1) at the time the contract resources begin delivery or the product is made available, if delivery or availability of the product occurs within one year of contract execution; or (2) at the time of contract execution if delivery or availability does not begin within one year of contract execution.

· Pages 207-208, we clarify that we are allowing four [not five] categories of unique circumstances, and we are deleting the following: "Expansion of Existing Facilities - we envision certain unique circumstances in which ratepayers would benefit from development on or expansion of an existing IOU asset that would not lend itself to the PPA project structure, but the IOU would need to make a strong showing that such development was clearly preferable to a resource that could be obtained via a competitive solicitation that would not necessarily result in utility ownership."

· Finding of Fact 62, we change "greater than three months in length" to "two years or more in duration." In addition, we add that the contract duration clock begins: (1) at the time the contract resources begin delivery or the product is made available, if delivery or availability of the product occurs within one year of contract execution; or (2) at the time of contract execution if delivery or availability does not begin within one year of contract execution.

· Finding of Fact 96, we delete "expansion of existing facilities."

· Ordering Paragraph 9, we change "greater than three months in length" to "two years or more in duration." We add that the contract duration clock begins: (1) at the time the contract resources begin delivery or the product is made available, if delivery or availability of the product occurs within one year of contract execution; or (2) at the time of contract execution if delivery or availability does not begin within one year of contract execution.

· Ordering Paragraph 31, we delete "expansion of existing facilities."

· Ordering Paragraph 13, we modify to read as follows: Such costs, if any, shall not exceed a total annual amount of $400,000, and the total shall be paid by PG&E, SCE and SDG&E on a pro rata basis (i.e., 33.3% to each IOU) unless the contractor(s) perform work related to only a specific utility.

7 D.04-12-048, pp. 129-133.

8 David Bodek, "Standard & Poor's Imputed Debt Calculations for Power Purchase Agreements," Society of Utility and Regulatory Financial Analysts, April 19, 2007, Slides 5 and 6. This slide presentation is available at < http://www.surfa.com/ppres.php> under "2007 Forum Presentations." (Cited in IEP's Opening Brief on Debt Equivalence Issues, June 20, 2008, p. 7.)

9 In addition, D.07-12-052 stated that the IOU must demonstrate, as part of its application that holding an RFO is infeasible.

10 R.05-12-013, or its successor; R.08-01-025, or its successor; R.08-04-012, or its successor.

11 OIR, February 14, 2008, p. 11.

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