3. Local RAR (Staff Report I.)⁵

3.1 Sustaining the Policy Objectives for Local RAR

As noted above, the Commission has stated its intention to add a local procurement obligation to the overall RAR program to ensure that sufficient local generation capacity is contracted for and available to the CAISO to meet local reliability needs. The Commission adopted this policy after it determined that LSE-based procurement of the capacity needed in transmission-constrained areas would be more effective in promoting RAR goals than continued reliance on CAISO procurement of such capacity through its RMR process:

Concerns about local reliability and CAISO's reliance on RMR contracts led to consideration of localized RAR for all LSEs in Phase 1 [of R.04-04-003]. D.04-10-035 determined that adding a local component to the RAR program would be consistent with the Commission's prior decisions in which it has been held that LSEs are responsible for procuring the resources needed to meet their customers' needs. Discussing the costs of local RAR (higher procurement costs, higher forecasting and planning costs for LSEs, program complexity, and possible market power) as well as the benefits (contracts with longer terms than RMR contracts would assure revenue streams to generators, LSEs would be better able to identify cheaper and environmentally friendly alternatives to RMR contracts, and possible incentives for transmission upgrades) the commission determined that the likely benefits of local RAR outweigh the likely costs. (D.05-10-042, p. 77.)

Our primary task in this decision, then, is to refine and implement the Commission's policy for Local RAR. Questions remain about various aspects of the Local RAR program, including the best way to identify and define load pockets and to quantify the capacity needed within those areas to meet appropriate reliability standards. We intend to resolve these remaining questions in future proceedings. Nevertheless, nothing in the Phase 1 record persuades us that we should turn back from our objective to establish annual local procurement obligations beginning with the 2007 compliance year. The Commission decided nearly two years ago that Local RAR is the most effective way to assure reliability in transmission-constrained load pockets, and we are concerned that further delay in its implementation for another year could thwart long-term achievement of the program goals. As IEP observes in its reply comments regarding the LCR study, "[t]his is one situation where the adage, `The perfect is the enemy of the good,' applies." (IEP Reply Comments, May 3, 2006, p. 1.) We find that it is reasonable to implement Local RAR for 2007 using the record before us, and, for 2008 and beyond, to address the remaining questions about Local RAR in Phase 2 of this proceeding.

In earlier RAR proceedings and in Phase 1 of this proceeding, parties have observed that the ability of LSEs to readily purchase, sell, or trade quantities of capacity that meets RAR program requirements would be beneficial for reducing market power concerns and concerns about the impact of load migration on LSEs. We intend to issue a decision in the near future to clarify several aspects of the RAR program and promote the development of a capacity product that would meet this need.

3.2 LCR (Staff Report I.A.)

3.2.1 The LCR Study Process (Staff Report I. A. 1.)

Local load pockets are defined by physical transmission constraints. If the transfer capability into a load pocket is less than the load demand within the area, then, depending on reliability criteria, additional generation capacity within the load pocket will be needed to satisfy the load demand. This amount of generation capacity is the LCR or Local Capacity Requirement. In simplest terms, the LCR study is the process of identifying the specific areas within the CAISO Controlled Grid that have local reliability problems due to transmission constraints and, for each area so defined, determining the generation capacity, in megawatts (MW), that would be required to mitigate these local reliability problems.

The LCR study is the foundation for our establishment of local procurement obligations, the costs of which are borne by the LSEs and their retail customers. Therefore, this Commission must be reasonably assured that the LCRs it uses to establish those procurement obligations are reasonable. This requires consideration of the LCR study process as well as the study outcomes.

At the outset of this proceeding, parties suggested that an independent third party rather than the CAISO should be selected to perform the LCR study for 2007. However, this suggestion could not reasonably have been pursued with any expectation of our adopting Local RAR in time for 2007. At this time, the CAISO-which, as the grid operator, has direct knowledge of system conditions and operations-appears to be particularly well positioned (if not uniquely so) to determine where load pockets exist and what their associated LCRs are. We note also that by the time this proceeding was underway, the CAISO had already completed an LCR study for 2006. It was clearly in a position to conduct the LCR study for 2007 within the expedited schedule for Phase 1. No party identified the means by which a third party could have been selected and funded to complete an LCR study for 2007 within the applicable time constraints.

In a ruling issued on February 10, 2006, the ALJ directed the CAISO, LSE respondents, and other interested parties to meet and confer to work towards agreement on study scenarios reflecting an array of input assumptions that the CAISO would use in the 2007 study. The ruling indicated that this approach could be expected to produce study results that would enable the Commission to make policy determinations in this proceeding about the appropriate level of reliability and the LCRs associated with that reliability choice. This process allowed the parties to register concerns about study input assumptions and methodology, although it did not yield total agreement on how the study should proceed.

As described earlier, the CAISO convened a workshop shortly after the issuance of the 2007 LCR study report, and it issued a corrected report shortly after that workshop. Several parties have voiced concerns about the expedited review period that was necessary to enable implementation of Local RAR for 2007. However, a decision is needed now so that the LSEs' procurement obligations can be identified on a timely basis, enabling them to engage in procurement to meet the identified obligations. We find that the parties had an adequate opportunity to participate in the CAISO's post-study workshop, to submit comments and replies on the study, and to make their substantive concerns about the study known to the Commission. As explained below, moreover, we will provide an additional opportunity for such participation.

PG&E suggests that the 2007 LCR study process be kept open to require the CAISO to provide further information regarding the study methodology and inputs, and to provide parties additional opportunity to suggest corrections and transmission solutions that would lessen the LCRs determined by the CAISO without lessening reliability. We find this suggestion has merit in light of (1) the expedited review time that parties had before their comments on the LCR study were due, (2) the numerous comments indicating that questions remain about the study's application of industry reliability criteria, (3) the significant increases in LCRs from the 2006 study, and (4) the possibility that additional operational solutions may be available to reduce the need for generation procurement. While a cutoff date is needed as the CAISO suggests, it appears that there is a window of time in the coming weeks for the CAISO to determine whether any opportunity exists to make corrections or adjustments to avoid local area generation procurement that, upon further review, may not be needed. We therefore ask that the Energy Division, after consulting with the CAISO, convene an additional workshop on the 2007 LCR study, the study issues suggested by PG&E, and the allocation of any LCR reductions to LSEs. Because time is limited, the workshop should occur within 25 days of the service of this order and on not less than 10 days' notice to the service list for this proceeding.⁶

While we adopt the CAISO's April 28, 2006 corrected LCR study as the basis for establishing Local RAR for 2007, we authorize the Energy Division to notify LSEs of revised, reduced local procurement obligations for 2007 that reflect any LCR reductions from the 2007 LCR study that are determined by the CAISO to be warranted, based on our adopted reliability option. We direct the Energy Division to divide any such corrected LCRs among LSEs according to the principles adopted in Section 3.3.2 and to issue any such revised local procurement obligations at least 60 days prior to the due date for final Local RAR compliance filings for 2007. The Energy Division does not have authority to increase the LCRs and associated procurement obligations adopted by this decision, or to decrease the reliability level we adopt below.

In conclusion, we find that it was reasonable to rely on the CAISO to perform the 2007 LCR study and that the study process provided adequate opportunity for parties to participate. Further, subject to the additional review discussed above, we find that it is reasonable to use the study results as the basis for implementing Local RAR for the 2007 compliance period.

3.2.2 LCR Issues (Staff Report I. A. 2 and I. A. 3.)

3.2.2.1 Reliability Options for 2007

The meet and confer process described above resulted in a common understanding that the CAISO's LCR study would determine a range of LCRs based on different service reliability levels. In addition, the CAISO agreed to incorporate transmission projects that were determined to be operational on or before June 1, 2007 as well as feasible operational solutions brought forth by Participating Transmission Owners (PTOs). Such operational solutions would result in an intermediate reliability option. The CAISO's LCR study report, which acknowledges the role of this Commission in adopting a reliability option, thus presented the Commission with three LCR options. These options reflect different service reliability levels that are driven by transmission grid operating standards that the CAISO must meet. The options are summarized as follows:

Option 1 - Meet Performance Criteria Category B
For each defined local area, this option represents the LCRs, and resource deficiencies that must be addressed, in order to achieve a service reliability level based on "Performance Criteria-Category B" as set forth in the Planning Standards established by the North American Electric Reliability Council (NERC).⁷ Category B describes the system performance that is expected following the loss of a single transmission element, such as a transmission circuit, a generator, or a transformer, a condition referred to as "N-1." This option has a lower level of capacity required and will therefore have an expected lower level of reliability because less capacity is available to the CAISO.

Option 2 - Meet Performance Criteria Category C and Incorporate Suitable Operational Solutions
This option represents LCRs and deficiencies associated with "Performance Criteria-Category C" with operational solutions. According to the CAISO's LCR study report, Category C describes the system performance that is expected following the loss of two or more system elements expected to happen simultaneously, a condition is referred to as "N-2." By reflecting transmission operational solutions, this option allows for a lower generation requirement. However, long-duration outages would potentially subject load to extended outages.

Option 3 - Meet Performance Criteria Category C through Pure Procurement
This option provides the highest service reliability level. This option represents LCRs and deficiencies associated with "Performance Criteria-Category C" but without operational solutions. It relies instead on installed generation capacity rather than transmission operational solutions to address identified capacity deficiencies.

The following table, copied from the CAISO's LCR study report, summarizes the key LCR study results.⁸ It shows the identified transmission-constrained areas and relevant resource and load data for Options 1 and 2. For 2007, the CAISO determined that Option 3 is relevant for only one of the nine identified local areas--the North Coast/North Bay area. The Option 3 LCR for that area is determined by adding 80 MW to the corresponding Option 2 data. The CAISO explains that this 80 MW difference reflects a recently confirmed new operating procedure. We understand that many other operating procedures are embedded within the transmission system configuration, and it would not be a simple undertaking to identify Option 3 reliability LCRs based on the assumed removal of these procedures. We are confident that such LCRs would be significantly higher than the corresponding Option 2 LCRs.

DRA and TURN recommend that Option 1 be adopted for 2007. The CAISO recommends Option 2, and Constellation and PG&E provisionally support the CAISO's recommendation while IEP supports it without reservation. AReM believes that additional information is needed before an option can be selected, especially information regarding the probability of outage events, and EPUC agrees that additional information is needed.

Selecting one of these three reliability options invokes the Commission's policy of balancing reliability objectives against the cost of achieving a particular reliability level. We would prefer to have better quantitative information at our disposal regarding the probabilities of operational events as well as information regarding the ratepayer and societal costs of service interruptions. Moreover, we expect that progress can and should be made towards producing such information for future LCR studies. However, AReM's recommendation for further study implies that we should suspend implementation of Local RAR indefinitely. We find this approach to be unnecessary, and therefore unreasonable given our stated intention to implement RAR for 2007. The record is adequate to support a decision at this time.

We note that no party recommends Option 3, which is the highest level of reliability identified by the CAISO and which, for 2007, applies to only one of the nine transmission-constrained areas identified by the CAISO. We find little justification for its adoption, so the choice before us between Option 1 (Category B) and Option 2 (Category C). The case for Option 2 is made by the CAISO in its description of the possible consequences of operating under Category B criteria:

Option 1 is a service reliability level that reflects generation capacity that must be available to comply with reliability standards for NERC Category B given that load cannot be removed to meet this performance standard under Applicable Reliability Criteria. However, this capacity amount implicitly relies on load interruption as the only means of meeting any Applicable Reliability Criteria that is beyond the loss of a single transmission element (N-1). These situations will likely require substantial load interruptions in order to maintain system continuity and alleviate equipment overloads including load interruptions prior to the actual occurrence of the second contingency. [Footnote Omitted]. (LCR Study, p. 12, emphasis in original.)

The case for applying Option 1 in 2007 is made by TURN and DRA. TURN makes its recommendation with the expectation that there will be substantial backstop procurement by the CAISO in 2007. However, in deference to the Commission's role in determining the appropriate service reliability level for retail customers, the CAISO makes clear that it does not intend to pursue backstop procurement to achieve Category C reliability if the Commission establishes LSE procurement obligations based on Category B. Also, while DRA supports Option 1, it appears to also support reliance on N-1-1 criteria, which, as the CAISO points out, are associated with Category C. We are mindful that the recommendations for Option 1 are advanced on behalf of customers who may be willing to accept a lower level of service reliability in return for reduced procurement costs. Nevertheless, we are not persuaded that these advocates fully and unequivocally support what the CAISO explains could be the consequences of their recommendation.

The most persuasive information before us is the CAISO's conclusion that a decision to adopt Category B criteria for purposes of local procurement obligations would likely result in substantial load interruptions when N-1 conditions occur. No party has presented information that would lead us to conclude that the risk of such interruptions is acceptable if that risk can be avoided or mitigated. The CAISO has determined that for 2007, the totals of the LCRs for the nine identified local areas are 22,649 MW and 23,857 MW under Options 1 and 2, respectively, a difference of about 5%. Given the reduced risk of interruptions expected under Option 2, we consider the required procurement of an additional 5% of needed capacity to be reasonable. We make this reliability determination for 2007 only. While we expect to apply Option 2 in future years in the absence of compelling information demonstrating that the risks of a lesser reliability level can reasonably be assumed, we nevertheless leave for further consideration in this proceeding the appropriate reliability level for Local RAR for 2008 and beyond.

We conclude that Option 2 represents the appropriate reliability level for establishing LSEs' local procurement obligations for 2007, with one proviso: we direct the Energy Division to calculate reduced LCRs for those areas for which the CAISO has identified a deficiency in qualifying capacity resources. These areas are identified as Sierra, Stockton, Greater Fresno, and Kern in the CAISO's LCR study report, although it is conceivable that supplemental review process described above could affect this list of deficient areas. We take this approach to deficiencies because we do not find it reasonable to require LSEs to procure capacity that, according to the LCR study, does not currently exist in an area. PG&E's contention (in its April 28 comments, p. 7) that "[w]hen adopting an LCR study the Commission should never accept a requirement greater than available resources (i.e., a determination that a local area is deficient), since that determination is, properly, part of the grid planning process," is apropos. Similarly, as AReM contends, LCRs should be "reasonable and attainable" to the extent that they are translated into local procurement obligations.

We wish to emphasize that we authorize this "blanket waiver" treatment of deficiencies for 2007 only in view of the limited time remaining in 2006 for LSEs to acquire the capacity needed to meet their 2007 obligations and the fact that we do not yet have experience with the administration of LSE-specific waiver requests. Since one of the long-term objectives of RAR, including Local RAR, is to provide appropriate incentives for investment in generation resources where they are needed, we do not intend to continually approve a practice that could undermine this fundamental program objective. Finally, while we recognize that this blanket waiver for deficiencies could reduce expected reliability in the affected local areas to less than that associated with Category C, we see no practical alternative for 2007.

3.2.2.2 Load Forecast

The CAISO's study used a 1-in-10 year summer peak load forecast. Aglet recommends that a less stringent 1-in-5 year forecast be used. According to Aglet's calculations, this could result in reduced ratepayer costs of about $41.45 million in 2007.

For all but one of the nine local areas identified by the CAISO, the LCR study shows that the difference between the applicable 1-in-5 and 1-in-10 load forecasts is less than 3%; the difference in the Greater Fresno area is less than 5%. The total difference for the nine areas is 2.4%. As a rule of thumb, using the less stringent 1-in-5 forecast would result in a corresponding one-for-one reduction in the LCR for an area. However, the CAISO notes, the exact reduction could be different due to load growth characteristics specific to each local area. Also, if the local area constraints are non-linear, or if the effectiveness factors between generation and load within the same area are significantly different relative to the worst thermal constraint, then the difference in LCR results would not mirror the difference in load forecast.

For purposes of establishing Local RAR for 2007 only, we accept the CAISO's judgment to use 1-in-10 load forecasts to calculate LCRs. At this time, we are not persuaded that the potential cost reduction of using a less stringent load forecast justifies the reduced reliability that may result from doing so. However, we are not satisfied that this issue has been fully vetted. Accordingly, parties may revisit this issue in Phase 2 for 2008 and beyond.

3.2.2.3 Commission-Jurisdictional LCRs

The CAISO's LCR study presented LCRs for the CAISO Control area, which also includes non-Commission jurisdictional LSEs. AReM believes that LCRs for Commission-jurisdictional LSEs should be separated out of the total LCRs on the basis of their proportional shares. AReM understands that the CAISO may not be able to perform the necessary calculations by local service area although it can do so by PTO service area. AReM is concerned that the PTO service area approach may create biases, and urges that the CAISO be required to calculate, in the most accurate way possible, LCRs that are specific to jurisdictional LSEs. SCE concurs with this recommendation.

We fully concur that the LCRs calculated by the CAISO should be allocated to jurisdictional LSEs on the most accurate basis possible. The CAISO should work with the Energy Division to perform this crucial calculation either on a local area basis, if possible, or otherwise on a PTO service area basis. The Energy Division will use this jurisdictional allocation in establishing Local RAR allocations to individual LSEs (see Section 3.3.2 below).

CMUA suggests that we use an LCR study that is applicable solely to jurisdictional LSEs, and that CMUA members continue to work with the CAISO on the technical analysis underlying the 2007 LCR study. Since we are concerned with the LCRs that are applicable to LSEs under our jurisdiction, we are not necessarily opposed to this suggestion. Moreover, we appreciate and welcome the CMUA's willingness to pursue improvements to the LCR study process, as it appears that the CMUA brings expertise that could lead to a more robust study process in the future. However, to the extent this proposal would require the CAISO to complete another LCR study before we adopt Local RAR for 2007, we reject it.

3.2.2.4 Generator Listing

The Staff Report noted the expectation that the LCR study would provide a list of generators that meet reliability needs in each local area, and it asked the CAISO to identify in the generator list the size (MW) and the owners of the units identified as qualifying capacity in local areas. Although the LCR study report did not include such a listing, the CAISO stated in its May 3, 2006 reply comments that it intended to publish a list of resources by local area and sub-area, including the unit qualifying capacity, before June 2006.

A complete listing of the qualifying resources, including the ownership and capacity information, is clearly crucial information for the LSEs who will be obligated to purchase qualifying capacity. Once published, this list is designated for use in LSE compliance filings throughout 2007.

3.2.2.5 Transmission Improvements

The Staff Report described the expectation that the CAISO's proposed LCRs for each local load pocket would include consideration of non-generation resources, including operational responses to contingencies identified in the 2007 LCR study (such as short-term equipment upgrades, reevaluation of line ratings, and demand response), as well as load shedding options. We concur that the solutions to the problem of transmission constraints should not be limited to generation alone. We address here how certain solutions ought to be addressed.

The LCR study identified a potentially higher rating for South of Lugo that, if not confirmed by SCE, could increase the LA Basin Area LCR. TURN expressed concern that this operational solution might not be reflected in the local procurement obligation to be met by LSEs in 2007. TURN asks that the Local RAR implementation process provide SCE an opportunity to formally confirm this upgrade. In its April 28 comments, SCE stated that it has confirmed that the path limit will be increased from 5,600 MW to 6,100 MW by June 1, 2007. This upgrade should be reflected in the LCR for the LA Basin Area.

IEP suggests there should be a transparent process for interested parties to learn about proposed operational solutions and verify that such solutions are superior to the option of adding generation. Constellation is similarly concerned about a lack of clarity regarding the CAISO's proposed use of operational solutions. As we noted earlier (see Footnote 3, supra), we recognize the importance of weighing the cost-effectiveness of generation and transmission solutions so that the most cost-effective solution can be pursued. We therefore generally concur with IEP's belief that transparency regarding the availability and feasibility of transmission-related solutions is appropriate, to the extent permitted by law, and subject to the CAISO's need for security and reasonable confidentiality protocols. Accordingly, we ask that the CAISO give careful consideration to IEP's request that the CAISO prepare a report detailing by local area the operational measures the CAISO expects to rely on to meet or reduce each area's LCR for 2007, and that similar reports be prepared for future LCR studies. We understand that the CAISO and PTOs work together to identify and confirm new operating procedures, and we think it would be beneficial if stakeholders are able to track that process.

While we generally agree that there is a need for transparency regarding operational solutions, we also recognize that, as the CAISO asserts, determining the feasibility of operating solutions is within the province of the CAISO and its PTOs.⁹ We strongly encourage the CAISO and the PTOs to continue their efforts to identify and implement cost-effective transmission-related solutions.

3.2.2.6 Hetch Hetchy Imports

CCSF is concerned that the CAISO's determination of transmission-constrained areas failed to consider San Francisco's firm transmission rights through an interconnection agreement with PG&E to deliver approximately 200 MW into the load pocket. CCSF thus believes that its Hetch Hetchy hydroelectric generation facilities and related transmission were inappropriately excluded, leading to an overstated LCR for the Greater Bay Area. The CAISO responds that the study takes into account energy imported into the load pockets, and that it identifies the capacity requirement that allows the energy to be imported while maintaining grid reliability.

We accept the CAISO's explanation of its treatment of the Hetch Hetchy resource in the context of our overall acceptance of the 2007 LCR Study assumptions and methodology for the 2007 Local RAR only. This is without prejudice to our determination of this issue with respect to LCR study methods and assumptions for 2008 and beyond.

3.2.3 LCR Study Process for 2008 and Beyond
(Staff Report I. A. 4.)

For 2008 and beyond, we expect that we will continue to rely on the CAISO to perform annual LCR studies or study updates to identify load pockets and associated LCRs. We do not prescribe whether annual LCR determinations should be the product of a new study each year or the product of an annual update to a multi-year LCR study. Regardless of how the annual LCR determination is characterized, we seek reasonable assurance that the local procurement obligations that we establish are based on up-to-date information about the transmission grid and its operational characteristics. Therefore, an annual determination of LCRs through a process that allows meaningful party participation is appropriate. In this section, we express our preferences and intentions for how future LCR determinations should occur.

PG&E notes the need for consistency in study methodology and approach to promote the willingness of LSEs to enter into long-term contracts. We concur, but at the same time we do not want the objective of consistency to prevent needed study improvements from being considered. Instead, we seek the appropriate balance between the sometimes competing objectives of consistency and accuracy. We expect that the CAISO and interested parties will do likewise.

One of the LCR study questions that need to be resolved for 2008 and beyond is the degree to which the identified transmission-constrained local areas should remain fixed. We think it is clear that the areas should be fixed for at least one year to coincide with the annual Local RAR cycle, but whether the local areas designations should be fixed for several years at a time is less clear. On the one hand, a fixed definition of local areas may promote long-term transactions; on the other hand, the transmission system is continually evolving, and transmission constraints are not necessarily fixed over time. We do not intend to promulgate procurement obligations that are based upon stale information, as that could lead to wasteful over-procurement or dangerous under-procurement. Future LCR determinations should reflect, as nearly in time as possible, the then-current state of the transmission system. We go no further at this time. We accept the Staff Report's recommendation that the duration of constrained local area determinations be taken up when we consider the 2008 LCR study.

Several parties, including the CAISO, have discussed the benefits of using a probabilistic rather than a deterministic approach to determining local capacity requirements. We support efforts to add components of such an analysis to the LCR study, as it should lead to more economically efficient decisions regarding the capacity that is needed at any particular location. At the same time, we understand that a probabilistic study approach may be very data-intensive, and that it may require more than one year to develop. We ask the CAISO and interested parties to take all reasonable steps to implement this approach as soon as practicable.

A number of parties have discussed the potential benefits of basing the Local RAR program on monthly rather than annual determinations of local capacity needs of the CAISO. While this approach merits further consideration in LCR studies for 2008 and beyond, we adopt the annual approach for 2007.

Constellation observes that a fixed and known schedule for the LCR update process should help the successful development of transparent, liquid, and stable markets that will provide the necessary incentives for infrastructure investment and minimize volatility. PG&E points to the importance of coordinating the work of the CAISO and that of the transmission and planning staffs of the PTOs. These and other comments underscore the need for a more developed plan for the LCR study process. Also, the experience of the parties in Phase 1 of this proceeding underscores the importance of allowing sufficient time for stakeholder participation in the process and review of the study outcomes.

The Staff Report presented a proposed schedule for 2008 Local RAR that was designed to facilitate coordination of the LCR and Grid Planning processes, provide adequate time for market participants to meet their local procurement obligations, and provide sufficient time for review of the LSEs' compliance filings. Aglet supports this proposed schedule with minor modifications. Aglet suggests that the CAISO study be issued February 5, 2007 and that the CAISO host a meeting concerning the study one week later. Aglet also suggests that parties' comments on the 2008 study be due March 5, 2007. AReM concurs with the schedule as well, although it proposes that the due date for LSE compliance filings be extended on a day-for-day basis if for some reason the June 2007 date for notifying LSEs of their 2008 local procurement obligations is not met. AReM also notes that the one month interval for LSEs to procure "residual" capacity may be optimistic. Finally, AReM notes the need to coordinate Local RAR procurement and the CAISO's RMR process. IEP suggests that the date for notifying LSEs of their LCR allocations be moved forward from June 2007 to be concurrent with the Commission's adoption of local procurement obligations in May 2007.

Aglet's proposals for a CAISO meeting and dates certain for the LCR study's release and for comment strike us as reasonable, although we make adjustments to the specific dates suggested by Aglet. AReM's proposal for a day-for-day extension of time also strikes us as reasonable, and we direct the Energy Division to calculate and provide notice of any such extension. AReM's concern regarding coordination of the Local RAR procurement process and the CAISO's RMR process is addressed in Section 3.3.7.1 of this decision as to the 2007 Local RAR. IEP's suggestion to consolidate dates appears to be based on the assumption that adoption of the 2008 procurement obligations and allocations to individual LSEs can occur concurrently. While there may be benefits to this approach, it may not be possible to accommodate it due to the compressed time frame of our adopted schedule.

We approve in principle the proposed schedule and the suggested modifications to it, but after reviewing the comments on the ALJ's proposed decision, particularly those of the CAISO, we are persuaded that additional adjustments are needed for proper coordination of the Local RAR and grid planning processes. We also recognize the need for some flexibility as the Local RAR program commences. For example, it may become necessary to revise the schedule to coordinate with the procedural events in Phase 2 of this rulemaking. In addition, it will be necessary to coordinate this process with the CEC's review and adjustment of preliminary LSE load forecasts, and the scheduling impacts of this need to be considered. Also, the detailed RMR coordination schedule for 2007 that is discussed in Section 3.3.7.1 may also affect this schedule. Accordingly, we leave to the Assigned Commissioner or the ALJ, in consultation with the CAISO and the CEC, discretion to adjust the schedule as necessary or appropriate. We ask the CAISO to bring forward any further timing suggestions that may be necessary to synchronize the LCR and planning processes, and we ask the CEC to provide its scheduling suggestions as well. The approved schedule, which includes adjustments for non-business days, is set forth below:

LCR/Local RAR Schedule for 2008

January 5, 2007	PTOs submit base cases and load forecasts to the CAISO
March 9, 2007	CAISO releases 2008 LCR study
March 20, 2007	CAISO hosts meeting on LCR study
April 6, 2007	Parties comment on 2008 LCR study
May-June 2007	Commission reviews CAISO's 2008 LCR study and adopts Local RAR for 2008
June 2007	Commission allocates 2008 Local RAR to all LSEs
October 1, 2007	LSEs file Local RAR showing and "Year-Ahead" System RAR
November 1, 2007	CAISO analyzes demonstrations for "residual" needs due to effectiveness factors and reports back to LSEs
December 3, 2007	LSEs demonstrate any additional procurement of "residual" through revised Local RAR, year ahead System RAR, and even December 2007 monthly System RAR, after which time the CAISO may engage in backstop procurement to resolve Local RAR deficiencies. (Date could be adjusted to coincide with monthly showing date.)

3.2.4 Zonal Capacity Requirements (Staff Report I. A. 5.)

During the Phase 1 workshop process, the CAISO reported that it had identified a need for "zonal" LSE procurement obligations. Consistent with the Assigned Commissioner's Scoping Memo, we will explore whether and how to establish zonal capacity procurement obligations later in this proceeding.

3.3 Local RAR Program Design Issues (Staff
Report I. B.)

3.3.1 Adoption of Local RAR Annually (Staff
Report I. B. 1.)

For 2008 and beyond, we anticipate the Local RAR program design will remain relatively fixed based on this decision and the refinements we expect to make in our Phase 2 decision in this rulemaking. On the other hand, as discussed earlier, LCRs will be determined each year to reflect the evolving transmission system and generation fleet. The Staff Report invited comment on whether annual formal proceedings should be instituted to consider and adopt the annual LCR determinations. The report posited that, at least initially, the approval of LCRs each year could not be delegated to the staff.

The LCR process for 2008 will be carried out under the umbrella of this proceeding. For the 2009 and subsequent LCR determinations, it appears that the annual determination of LCRs can possibly be made a through a ministerial process that is delegated to the staff, just as administration of the allocation process discussed in the following section is delegated to staff. We ask that the Energy Division and the CEC, as well as the CAISO and other parties, present for our consideration in Phase 2 their recommendations on whether and how such a process can be implemented.

3.3.2 Allocation to CPUC-Jurisdictional LSEs
(Staff Report I. B. 2.)

As we determined in Section 3.2.2.3, the first step for determining the procurement obligations for individual LSEs is to determine the portion of the total LCR in each area that is to be allocated to Commission-jurisdictional LSEs as a whole. Once such jurisdictional LCRs have been determined, and are adjusted for resource deficiencies as discussed in Section 3.2.2.1, they can then be translated into procurement obligations for the individual LSEs that are subject to our Local RAR program.

The Staff Report suggested that assigning Local RAR obligations by proportion of load served in existing IOU distribution service areas would provide administrative simplicity. By comparison, the report noted, there would be significant obstacles to implementing the alternative of identifying which load is located in each particular local load pocket. Under the staff's proposed approach, an LSE would have a local procurement obligation in each IOU distribution service territory in which it serves load. Each LSE's Local RAR would be a percentage of the total Local RAR adopted by the Commission based on the CEC-approved maximum monthly peak load forecast for each LSE in the applicable IOU distribution service area. The forecasted peak load would be based on the same basic load forecasting process used to determine System RAR. Staff's allocation method appears reasonable and non-controversial, and we hereby adopt it. Expressed as a formula, the local procurement obligation for an LSE will be calculated as follows:

[LSE IOU service area RAR/Total IOU service area RAR] *
Total Jurisdictional Local RAR in IOU service territory = LSE Local RAR

AReM's Local RAR proposal recommended that LSEs should not be obligated to procure less than 1 MW for a particular local area. The Staff Report did not concur with this proposed exemption. We share staff's reluctance to exempt any LSE from local procurement obligations. On the other hand, the comments of several parties persuasively make the point that transactions of less than 1 MW are not commercially reasonable, at least at this time. Accordingly, we will adopt this proposed exemption for Local RAR. We also approve the proposed rounding convention of AReM and other parties for both System and Local RAR. Fractional MW of 0.5 and greater should be rounded up to the next highest MW and fractional MW of .49 and lower should be rounded down to the prior MW; provided, however, that this rounding convention does not supersede the Local RAR exemption of RARs of less than 1 MW.

In its April 28 comments (at p. 7), AReM suggests that we consider subtracting IOU generation from LCRs to avoid the need for crediting, bilateral transactions, or transfer payments. According to AReM, this "off the top" method for allocating procurement obligations would resolve its concern that IOUs might hold back their units and instead seek CAISO backstop procurement payments. We find insufficient justification for AReM's off-the-top approach, and therefore reject it. We are not persuaded that the problem of IOUs withholding capacity exists and, if it does, that subtracting generation from LCRs would be the most effective solution.

We authorize and direct the Energy Division to perform the calculations necessary to establish local procurement obligations for individual LSEs employing the policies and procedures adopted herein.

3.3.3 Load Forecasting and Assignment Notification of
Local RAR (Staff Report I. B. 3.)

The Staff Report anticipated that the Energy Division and the California Energy Commission (CEC) staff would coordinate to calculate each LSE's local procurement obligation and notify the LSE by letter of its obligation. This notification would be made concurrently with the notice to LSEs of their System RAR year-ahead forecasts.

AReM raised a concern in its March 13 comments that this schedule may not be compatible with the schedule for this Phase 1 decision. The Staff Report concluded that this concern would not be an issue if we determine that LSE local procurement obligations are based on LSE load shares in IOU distribution service areas, which we have done. Several parties suggested that we approve a day-for-day extension of time for compliance filings should the June 30 notification date not be met.

The general approach described by the Staff Report is not contested, and we hereby approve it. We have already determined that a day-for-day extension of time is reasonable in connection with compliance filings for 2008 and beyond, and we make the same determination in principle here for the 2007 compliance filings. We recognize that LSEs need adequate time to meet their known procurement obligations, and we intend to preserve as nearly as possible the 90-day interval between official notification of the obligation and the compliance filing date. We note however, that we are adopting a revised implementation schedule to accommodate and facilitate coordination of Local RAR with the RMR process, as discussed below in Section 3.3.7.1. Also, we have established a supplemental LCR review process which could affect this schedule to the extent that the supplemental review results in reduced LCRs for 2007. Accordingly, as with the 2008 Local RAR schedule, we leave to the discretion of the Assigned Commissioner, the ALJ, and the Energy Division to make appropriate revisions to the schedule for 2007.

3.3.4 Aggregation of Local Areas (Staff Report I. B. 4.)

Several parties are concerned about market power issues that can arise when procurement obligations are established for small local areas. These parties have advocated aggregating the seven local transmission-constrained areas identified in the CAISO's 2006 LCR Report that are within PG&E's distribution service territory. The aggregation concept has two components: (1) determining each LSE's allocation of Local RAR based on its share of load in all of the local areas within the IOU distribution service area and (2) determining which qualifying capacity (generation) counts towards the Local RAR showing, if all the areas have been aggregated. Two major aggregation proposals have emerged, one by the IOUs in their joint Local RAR proposal (as modified in PG&E's April 5, 2006 clarification to the IOUs' proposal) and one by the Energy Division in the Staff Report. TURN has offered a variation of the Energy Division approach as a compromise proposal.

The IOU proposal would split PG&E's service territory into two categories, one consisting of local areas where 95% of local generators are needed and one where less than 95% of local generators are needed. The Energy Division proposal would aggregate all the local areas within the IOU's distribution service area to create a single local procurement obligation for the entire service area of that IOU. Thus, the seven local areas within PG&E's distribution service area would be aggregated as the "PG&E Local Areas." TURN's compromise proposal would limit the percentage of the PG&E Local Areas procurement obligation that could be fulfilled through procurement of capacity in the Greater Bay Area to 50%, while the remaining 50% of capacity needed to meet the Local RAR could be procured in any of the six remaining local areas in PG&E's service territory.

Because such aggregation of local areas could possibly lead to over-procurement in some areas and under-procurement (with CAISO backstop procurement required) in others, we would prefer to avoid any aggregation. However, the Phase 1 workshops and comments have shown persuasively that (1) significant market power concerns persist and (2) aggregation can mitigate these concerns. We also note that aggregation may help to reduce transaction costs. We therefore conclude that an aggregation approach is necessary for 2007. For 2008 and beyond, we intend that aggregation would be employed only if it is shown that other market power mitigation measures such as a tradable capacity product remain unavailable or are inadequate to address market power.

Several commenting parties agree that, compared to the IOU proposal, the Energy Division aggregation proposal would be more effective in mitigating the exercise of market power and would be administratively less complex. On the other hand, there is also general acknowledgment that the Energy Division proposal could lead to greater backstop procurement by the CAISO. After reviewing the comments on the ALJ's draft decision, in which, among other things, TURN withdrew its support for the proposal and the CAISO and PG&E reiterated their support for more than one local area in PG&E's territory, we are persuaded that a variation of the aggregation proposals before us should be adopted for 2007 as the best approach for market power mitigation while minimizing CAISO backstop procurement. We determine that the Greater Bay Area should not be aggregated with any other area, and that the remaining six local areas within the PG&E territory (Humboldt, North Coast/North Bay, Sierra, Stockton, Greater Fresno, and Kern) should be aggregated as one for purposes of Local RAR for 2007.

With this modification, we conclude that the TURN proposal to limit Greater Bay Area procurement to 50%, while intriguing because it may have the potential to significantly mitigate the over-/under- procurement concern associated with aggregation, should not be adopted. Among other things, we note that the LCR Study appears to reveal that there may be insufficient un-contracted for resources in the six local areas in PG&E's territory to implement TURN's approach for 2007.

As a result, for local RAR compliance purposes, LSEs will have 1, 2, 3, or 4 local procurement obligations depending on where they serve load - LA Basin Area, San Diego Area, Greater Bay Area, and Other PG&E Local Areas.

Constellation proposes having a procedure whereby any use of CAISO backstop procurement to meet 5% or more of an LSE's overall local procurement obligation would lead to Commission evaluation of the aggregation mechanism. Given our underlying preference to avoid any aggregation approach in the first place, we agree that this program component should be subject to ongoing review and monitoring by stakeholders. We are not prepared, however, to adopt a formal 5% trigger for such evaluation. We will instead rely on our Energy Division, the CAISO, and interested parties to advise us if backstop procurement grows to excessive levels. Parties can do so, for example, through a petition for modification.

3.3.5 Compliance Demonstrations for Local RAR (Staff
Report I. B. 5.)

3.3.5.1 Annual Showings

The Staff Report proposed that LSEs be required to make an annual compliance filing demonstrating that they have met 100% of the applicable local procurement obligation for each month of the next calendar year (January through December). This Local RAR compliance filing would be made concurrently with the LSEs' "year-ahead" compliance filing for System RAR, which, pursuant to D.04-10-035, is due September 30 each year.¹⁰ Resources that count towards meeting Local RAR would also count towards meeting System RAR. The Staff Report notes that these proposals reflect agreements reached in RAR workshops in the predecessor RAR proceeding, R.04-04-003.

The Staff Report identified several reasons for this "100%/twelve months" approach for Local RAR. First, it is possible that even if all LSEs procure their full allocation of Local RAR, they will not necessarily have procured all of the resources necessary to meet the reliability needs of a particular local load pocket. This outcome is possible because such a deficiency can only be determined after the CAISO has had the opportunity to analyze the effectiveness factors of all of the units actually procured to meet the Local RAR in a local load pocket. To the extent that additional units are needed to meet effectiveness factor concerns, the CAISO needs to identify the units, and LSEs should have the first opportunity to engage in this procurement, rather than automatically rely on CAISO backstop procurement mechanisms. Consequently, Local RAR demonstrations should be made in sufficient time to permit the CAISO to engage in such analysis and identify residual procurement needs. Second, the CAISO needs to be able to prepare for any necessary backstop procurement after the LSEs have made all of their procurement demonstrations, including those that may meet residual needs. The CAISO must have sufficient time to review any additional procurement demonstrations and determine if backstop or "supplemental procurement" is required. If so, the CAISO must have sufficient time to engage in a process to secure the resources it needs to maintain local area reliability. Third, a year-long procurement obligation should provide assurance of revenue adequacy to those units that are most needed to ensure the reliability of the CAISO grid, and encourage the type of longer term, LSE-based procurement that the CPUC supports.

A majority of parties supports these staff recommendations, which is consistent with the agreements reached on these issues in workshops in the predecessor RAR proceeding. Aglet, however, proposes that year-ahead Local RAR showings mirror System RAR showings by demonstrating 90% of the obligation for the five summer months (May-September). Aglet believes this would allow some spot market purchases of capacity needed in local areas. Pilot Power takes a similar position both for program simplicity and because of its position that non-IOU LSEs should not be required to purchase 12 months of local capacity on behalf of customers they do not have under contract. Sempra Global believes that a January-December Local RAR adds complexity to the RAR program because the System RAR year-ahead obligation covers the summer months from May to September.¹¹ According to Sempra Global, the complexity of this mismatch of year-ahead compliance cycles would be burdensome for LSEs as well as the Commission, the CEC, and the CAISO. Sempra Global thus proposes that the Local RAR program be established on a June through May cycle for consistency with System RAR, which would result in the Local RAR program commencing five months later than under the Staff Report's proposal.

The parties opposing the staff recommendation do not adequately address the reasons discussed in the Staff Report for a 100%/12-month requirement. Although Local RAR is designed to serve the same basic objectives as System RAR, and simplicity is an important program design objective, there are sound reasons for tailoring the specific RAR program components to comport with their underlying circumstances. As noted in the Staff Report, the local program component entails an iterative process in which the CAISO evaluates nominated local resources and identifies deficiencies requiring either supplemental LSE or backstop CAISO procurement. Also, as TURN points out in its April 28 reply comments, the proposals for a five-month obligation ignore the fact that the CAISO's local reliability needs are not limited to the five summer months. We therefore will not adopt the alternative proposals for a 90% and/or a five-month obligation. We also reject Sempra Global's proposal to defer implementation of Local RAR by five months. Parties have been on notice for nearly two years that we intend to adopt Local RAR, and we have already had to defer instituting Local RAR so that the concept could be fully vetted with the input of interested parties. An additional five-month deferral in the start of the program is unwarranted and, we believe, unwise in light of the need to achieve underlying program goals.

We recognize Pilot Power's concern that 12-month resource commitments may not fit well with the business models of those LSEs that have relatively small customer bases and customers that are not under contract, and therefore, may have volatile load profiles. However, we are seeking through both System and Local RAR to provide the appropriate incentives for needed infrastructure investment, among other things. It does not appear that short-term resource commitments of less than a year will be sufficient to provide such incentives. Requiring LSEs to procure the resources needed to serve their own customers at the time a showing of such procurement is made is the best tool we have available at this time. In Section 3.3.6, we address the issue of load migration and a means of mitigating its impact on LSEs' procurement obligations.

In summary, LSEs are required to show they have fulfilled 100% of their local obligation for a 12-month period. In addition, to avoid unnecessary over-procurement, we clarify here that LSEs must show in their compliance filings all units they have procured that are eligible to satisfy local requirements, even if such units exceed the LSEs' obligation.

3.3.5.2 Monthly Showings

AReM notes that the Staff Report does not include a proposal for requiring LSEs to make month-ahead compliance filings for Local RAR. Without specifically making such a proposal, AReM notes that the local procurement obligation could be accommodated with the monthly reporting obligation now required for System RAR. However, AReM contends that if a monthly compliance filing obligation is established for Local RAR, LSEs must be allowed to make adjustments for load migration. SCE urges clarification that there will only be annual compliance demonstrations for Local RAR.

We will not adopt a monthly compliance obligation for Local RAR. This is an area where, we believe, program simplicity is warranted. Section 3.3.6 addresses our policies that pertain to AReM's concerns regarding load migration.

3.3.5.3 Compliance Filing Process

The Energy Division proposes in the Staff Report that Local RAR compliance demonstrations be made by advice letter filings using a Commission-provided template and in accordance with a Local RAR Filing Guide, patterned after and possibly consolidated with the System RAR filing guide as updated and/or amended.¹² The Local RAR template would include the LSE's local procurement obligation by service territory, the LSE's contracted-for units of qualified capacity within local areas, the name of the local area where the units are located, the MW of qualified capacity, the contract ID numbers, etc. The template would have adjustments for Demand Response programs and as well as for RMR units. We affirm this approach for implementation of the Local RAR program, and authorize the Energy Division to make appropriate revisions to the templates and filing guide with respect to both system and local requirements as necessary for orderly program implementation and in accordance with this order.

3.3.6 Post-Compliance Sales of Capacity
(Staff Report I. B. 5. and I. B. 6.)

As many stakeholders have repeatedly observed in this and previous RAR proceedings, and as we agree, a promising solution to the LSEs' concerns about load migration would be the ability of LSEs to buy and sell portions of resource commitments as load changes, provided such trades take place in a manner that preserves the availability of the underlying resource to the CAISO. It is for this reason, among others, that we intend to issue a decision facilitating the trade of capacity products in the near future, and to explore capacity markets in greater detail in a subsequent phase of this proceeding.

With one-time annual showings for Local RAR, no adjustment for incremental load migration during the year, and no monthly filings with true-ups for load migration, AReM maintains that LSEs must have flexibility to manage their local capacity resources as they see fit. In particular, AReM contends that an ESP that has fully met its local procurement obligation, as evidenced in an appropriate compliance filing, should not be subject to any further, after-the-fact evaluation. If the ESP then loses a large customer and wishes to off-load some or all of its local RAR capacity, AReM maintains it should be allowed to do so.

SCE opposes granting such flexibility to LSEs, arguing that LSEs should not be able to sell capacity during periods in which the capacity is reflected in the LSE's Local RAR demonstration. Alternatively, if such sales are allowed, SCE maintains that the selling LSE must be required to demonstrate that the capacity was sold to another LSE that has an obligation to make the sold capacity available to the CAISO for the same periods in which it was used in the selling LSE's Local RAR compliance showing. Otherwise, SCE notes, the annual Local RAR demonstration process could be rendered meaningless if LSEs can sell their Local RAR capacity and not make it available to the CAISO. PG&E, essentially agrees with SCE's position, arguing that the LSE must uphold its obligation for the full extent and period identified in the compliance filing demonstration and not sell, trade, default, or otherwise undermine the intended availability of the resource.

We see no reason to prohibit the sale or trade of qualifying Local RAR capacity provided that the capacity remains fully available to the CAISO under the same terms and conditions, for the same periods, and in the same local area for which the capacity was nominated in fulfillment of the local obligation when the selling LSE made its compliance showing. Eventually, assurance of such continued availability may be realized through appropriate trading mechanisms. For now, we agree with SCE that assuring this full availability to the CAISO requires a positive demonstration by the selling LSE, as part of its monthly compliance filing for System RAR, that the capacity was sold but remains fully available to the CAISO.

3.3.7 Counting Resources for Local RAR
(Staff Report I. B. 6.)

We are adopting a program in which each LSE will demonstrate that it has met its local procurement obligation by showing, in annual compliance filings, its contracted-for capacity from qualifying generating units in the relevant local area or areas. Different units may be used to meet the Local RAR in different months, so long as compliance is demonstrated for every month. In large part, the counting rules for determining which types of resources qualify towards fulfilling the local procurement obligation follow those for System RAR. In Section 3.3.7, we address issues that arose in the workshops regarding the appropriate treatment of certain resource categories.

3.3.7.1 RMR Resources

Through its Local Area Reliability Service (LARS) process, the CAISO identifies generators that must be available in or for a particular local area due to transmission constraints. To assure operational reliability, the CAISO enters into RMR contracts with those generators. RMR costs are paid by all load through CAISO uplift charges that are applicable throughout the service area of the PTO.

As their name implies, RMR units are those generation resources that the CAISO needs the most to ensure local reliability. PG&E explains that RMR units acquire their designation because their very necessity gives rise to an opportunity for their owners to exercise market power. PG&E also points out that these units are often expensive, even at cost-based RMR rates. The Commission has expressed a policy preference to minimize the use of RMR contracts. (D.04-07-028, p. 13.) On the other hand, the Commission has also agreed that RMR should remain in place for 2007.¹³

Consistent with the Commission's long-term policy objective to minimize the use of RMR, the Staff Report suggested that RMR units would not count towards Local RAR. The Staff Report noted that the CAISO's RMR process would not finalize RMR contracts for 2007 until on or about the planned October 2, 2006 Local RAR filing deadline. This timing issue, the report concluded, would preclude RMR Condition 1 and Condition 2 units from being eligible to count towards either Local RAR or System RAR demonstrations for 2007.

The comments in response to the Staff Report reveal that this proposal struck a collective industry nerve. Almost all commenting parties contend that RMR units should count for Local RAR, at least for 2007. Even the CAISO, which, "as a general principle wants to see the replacement of RMR sooner rather than later," would not object if the Commission were to credit RMR Condition 1 and Condition 2 resources against Local RAR as an interim step for 2007. (CAISO comments on Staff Report, April 21, 2006, p. 6.)

We continue to believe that reliance on LSE-based procurement fostered through Local RAR, rather than the RMR process, is the better long-term policy for addressing the reliability of transmission-constrained local areas. However, notwithstanding our policy preference to minimize the use of RMR contracts, it is apparent that both Condition 1 and Condition 2 RMR contracts should count for Local RAR for 2007. Not only is this consistent with the settlement of the IEP Complaint, pursuant to which RMR likely will remain a significant factor for 2007, it also gives recognition to the fact that the shift from predominant reliance on RMR to predominant reliance on LSE procurement will require a transition period with intricate coordination issues. It is clear from the comments that failure to allow RMR units to count for Local RAR for 2007 could lead to unnecessary and costly over-procurement to meet the reliability needs of local areas.

Fortunately, the timing issues that were described by the staff can be resolved. D.04-10-035 established September 30 as the date for annual RAR compliance filings by LSEs, and it would not be unreasonable to assume that that date should remain fixed for both System year-ahead and Local RAR filings. But that decision also indicated that an important part of the Local RAR process is to coordinate "the timing of LSE procurement efforts to acquire needed resources must be closely coordinated with the expiration of CAISO RMR contracts." (D.04-10-035, p. 33.) It is the coordination of Commission and CAISO processes that should govern, not a particular filing date. If September 30 compliance filings are incompatible with such coordination, we are prepared to change our RAR program as necessary. We will therefore (1) allow Condition 2 RMR units to count for Local as well as System RAR for 2007, (2) allow Condition 1 RMR units to count for Local but not System RAR for 2007, and (3) make several necessary adjustments to the RAR filing process as described in detail below.

In arriving at an improved coordination schedule, we first note that if the compliance showings occur simultaneously with the CAISO's RMR designations, two problems occur. First, there is little or no chance for LSE procurement to take the place of RMR. Second, there is no chance for the CAISO's RMR procurement to be credited against the LSE's Local RA obligation. Given that RMR procurement in 2006 was roughly 10,000 MW - it is in all customers' best interest to find a way to ensure appropriate local RA credit is given for RMR units. The CAISO's reply comments included a suggestion to move up the filing deadline for System "year-ahead" RAR and Local RAR compliance filings by one week. We adopt a modified version of the CAISO's proposed schedule, and we describe in greater detail the steps required to coordinate the timing of RMR and LSE procurement. This revised schedule allows for RMR credits to be assigned to LSEs as a reduction of their local procurement obligation.

We require that all LSEs file Preliminary Local RAR compliance showings on September 22, 2006.¹⁴ This preliminary Local RAR demonstration can be as much as the LSEs' full Local RAR demonstration,¹⁵ but, at a minimum, it must accurately show whether the LSE has, by September 22, 2006, entered into any contract with a unit that is among the list of units proposed for 2007 RMR Contracts.¹⁶ These demonstrations will not be used to determine compliance with local procurement obligations but they are required to be accurate. An LSE that has no 2007 RMR-proposed units under an RAR contract prior to September 22, 2006, would make a simple filing to that effect, as this information may help reduce CAISO RMR procurement. The LSEs are strongly encouraged to be as comprehensive as possible in their Preliminary Local RAR demonstrations because an LSE that makes more than the minimum showing may help to reduce RMR procurement.

To the extent that an LSE's Preliminary Local RAR showing contains any RMR units, the showing needs to indicate whether the LSE bought the RMR units outright or bought only the Local RAR counting benefits via a "wraparound" contract to the RMR contract. To qualify as meeting Local RAR, a wraparound contract must fully displace the RMR contract fixed costs. The wraparound contract also must allow the generator to set the Annual Fixed Recovery Cost (AFRC) or Fixed Option Payment Factor (FOPF) of Annual Fixed Revenue Requirements (AFRR) to zero, such that the contracting LSE is paying 100% of the fixed costs and no other transmission customers are paying for that part of the RMR contract obligation.

In requiring a Preliminary Local RAR demonstration on September 22, 2006, we will be allowing the CAISO a week to review the filings prior to its issuing RMR contract renewal notices. If a unit is bought outright, there should be no CAISO RMR contract renewal at all. If a unit is bought by wraparound contract, then the CAISO may still execute an RMR contract renewal but the Local RAR capacity credit of the RMR contract would not be distributed to all LSEs as Local RAR credit; instead the Local RAR counting benefit would accrue only to LSE that is paying for the wraparound contract. If an LSE has a wraparound contract that does not set AFRC or FOPF of AFRR to zero (i.e., it does not fully displace fixed cost recovery), the Local RAR credit would be allocated as if it were an RMR unit without any wraparound contract. However, in that case the LSE that pays for the wraparound contract may receive System RAR credit for the unit.

We expect that when the CAISO sends renewal notices to its RMR contracts for 2007, it will only send them to those units that are on the CAISO Board-approved RMR list and that are not fully represented in the Preliminary Local RAR filings as having a separate RA capacity contract. We expect that this Preliminary Local RAR showing process will allow the CAISO to sign up for RMR those CAISO Board approved potential RMR units that have not been fully procured through our LSE RA procurement process.

After finalizing the RMR contracts for 2007 by October 1, 2006, the CAISO will know which RMR units are available and the total MW of RMR capacity. The CAISO, in coordination with the Energy Division, will then separate the total RMR contract amount (in MWs) by Commission-jurisdictional and non- jurisdictional, RMR-paying entities, and also by the Local Areas. Working with the Energy Division, and using the preliminary Local RAR filings, the CAISO will determine the amount of Commission-jurisdictional RMR that can be allocated as "Local RAR" credit to all the RMR-paying LSEs. As already noted, some RMR contracts may not be available to be shared as "Local RAR" credit to all RMR-paying LSEs if they are procured for a specific LSE through a wraparound contract. The Energy Division will notify each LSE of the amount of RMR capacity that can be allocated to it as "RMR credit" in order to offset Local RAR. The allocation will be in proportion to their responsibility to pay for RMR contract fixed costs, which we expect to be a proportional load share basis. We expect the Energy Division to make this notification as expeditiously as possible, and not later than October 6, 2006.

In the case of traditional RMR, where all LSEs are paying for the RMR fixed costs through transmission rates in the form of (a) AFRC or (b) FOPF of AFRR, then all such LSEs receive a proportional credit of RMR as a credit allocation from the Commission.¹⁷ In the case of an RMR unit with a "RMR Cost-Displacing Wraparound" contract with one LSE, then that LSE receives the "Local RA counting credit." Stated another way, if any LSE has a resource adequacy capacity contract that sets the (a) AFRC or (b) FOPF of AFRR of a RMR unit to zero, such that the contracting LSE is paying the fixed costs and such that no other LSE pays any part of the fixed cost obligation, then the LSE would receive 100% of the Local RAR counting benefit arising from that unit.

As discussed further below, we expect that prior to making any backstop procurement decisions for local deficiencies in 2007, the CAISO will review the Local RAR demonstrations, the RMR resources as finalized, and the effectiveness of any Local or System RAR resources that are filed in the "year ahead" demonstrations.

On October 31, 2006, all LSEs will make Local and System RAR compliance filings for 2007. These are the final, annual RAR showings for 2007 and they supplant the filings that were required on September 30. The compliance filings will include a demonstration that 100% of the local procurement obligation is satisfied for 12 months of 2007 and that 90% of the system RAR obligation for the five summer months of May through September is satisfied. As noted earlier, the filings must include any unit held by the LSE that satisfies local requirements, even if such unit exceeds that LSE's local obligation. Failure of an LSE to demonstrate it has met its Local and System RAR obligations in these filings would subject the LSE to Commission-imposed penalties.

For their Local RAR showings, LSEs will use the Local RA obligations allocated to them on July 25, 2006, in accordance with the schedule we approve below, and subtract the RMR credits provided to them by October 6, 2006. The remaining amounts represent their local procurement obligations, i.e., the Local RAR capacity that the LSE must have under contract for 2007.

For System RAR, LSEs may use the System RAR obligation allocated to them on July 25, 2006, subtract the provisional "RMR Condition 2 credit" allocations received around the same time. If a unit that was included in the "RMR Condition 2 credit" was not designated RMR by the CAISO for 2007, then the LSE may only use the updated Provisional "RMR Condition 2 credit" that is received anytime on or before October 6, 2006. Although the Commission and the CAISO will not know by October 31, 2006, that that the unit will select Condition 2 for 2007, we decide here to assume that it will do so for the purposes of the System "year ahead" showings. We explain further below how the LSEs must "make up" the Condition 2 units in their monthly system RA showings if a unit switches from Condition 2 to Condition 1 mid-year.

We have described a detailed procedure to accommodate the transition from an environment that relies mostly on CAISO procurement through the RMR process to one that relies mostly, if not entirely, on LSE procurement to meet local reliability needs. We recognize that this procedure may be seen as a diversion from the objective of program simplicity. However, we find it is necessary to coordinate the RMR and Local RAR processes in a manner that should avoid costly over-procurement of resources during the transition. The following schedule summarizes the procedure:

Schedule for Coordinating RAR and RMR Processes for 2007

(Does not include monthly compliance filings for System RAR)

June 29, 2006	Commission adopts Local RAR Decision.
July 21, 2006	Energy Division and CEC host staff workshop to discuss final CPUC-share of 2007 LCR, divided by local areas & aggregated in accordance with decision.
July 25, 2006	Energy Division notifies LSEs of their Local RAR for 2007 and their Provisional RMR Condition 2 system RA credit.
August 2006	CAISO's RMR study process complete.
September 6-7, 2006	CAISO Board meets to consider RMR contract designations.
September 22, 2006	LSEs file Preliminary Local RAR showings.
September 29, 2006	CAISO finalizes (by October 1, 2006) its RMR contract renewal process by sending renewal notices.
October 6, 2006	Energy Division notifies LSEs of their 2007 RMR credit for Local RAR.
October 31, 2006	LSEs make System "year ahead" and Local RAR showings for 2007.
November 8, 2006	CAISO notifies all LSEs of any collective deficiencies to allow for additional LSE procurement.
December 1, 2006	Last date for LSE to file amended Local RAR or System "year ahead" RAR showing to reduce CAISO backstop for collective deficiency.
After December 1, 2006	CAISO engages in any backstop required to cure collective local deficiencies and notifies the Energy Division so that it can notify LSEs of their System RAR credit to their monthly showings.

3.3.7.2 Dispatchable Demand Response Resources

The Staff Report proposed that dispatchable demand-response resources should count towards meeting Local RAR, provided that such resources are located within the defined local areas. The report noted, however, that implementing this proposal for 2007 would require that the CEC develop supplemental information about these resources. It therefore invited parties to comment on the feasibility of developing such information in a timely manner for 2007. Alternatively, if the information could not be obtained in time, this counting protocol would be implemented for 2008.

The comments reflect broad support for allowing dispatchable demand response to count for meeting local procurement obligations starting in 2007. SCE, however, states that it does not currently map the locations of its demand response program participants, and their associated curtailable load, to local areas. SCE recommends that this issue be deferred to the 2008 Local RAR filing cycle.

As AReM notes, SCE's service area has one load pocket whereas the service area of PG&E has seven load pockets. Yet, PG&E supports counting dispatchable demand response and has raised no issues regarding the development of data to support doing so. Thus, even though the IOUs do not currently map demand response resources to local areas, it is not clear why they could not do so for the future.

We hereby determine that qualifying, dispatchable demand response resources should be allowed to count for Local RAR showings to the extent feasible. We ask that the CEC pursue the collection and development of the data that are required to achieve this. We recognize that it may not be possible to implement this counting protocol until 2008.

3.3.7.3 Distributed Generation

The Staff Report recommended that new distributed generation (DG) resources should count towards meeting Local RAR. D.05-10-042 addressed DG by adjusting the RAR forecast using a simple DG impact assessment methodology, and the Staff Report proposed similar treatment for Local RAR. Those parties who commented on this proposal support it. Constellation questions the qualification that only new DG resources would qualify, and recommends instead that all DG resources qualify in the same manner. We concur with Constellation's concern in part. However, DG impacts are already subtracted from load forecasts, and Constellation's proposed change could result in double-counting DG impacts. We adopt the Staff Report recommendation with the understanding that the staff's proposed qualifier for "new" DG resources refers to DG resources identified after the relevant load forecasts have been determined.

3.3.7.4 Effectiveness Factors

A significant amount of workshop time was devoted to the question of whether a resource that is located outside of a designated local area should count as qualifying capacity within that area to the extent that it is effective in meeting the LCR for that area. The CAISO has indicated that it could develop resource listings that show, for specific units, a range of effectiveness factors based on how effective those units would be in addressing various contingencies. As TURN states in its March 13, 2006 comments (at p. 5), it would be a "customer-friendly" policy to allow "generating units that are not located within the boundaries of a local area to contribute toward meeting that local area's LCR if the CAISO's modeling shows that such units meet some minimum `effectiveness factor.'"

The Staff Report concluded that for 2007, notwithstanding the potential benefits of allowing units to count for local area obligations to the extent of their effectiveness, out-of-area resources should not count for purposes of meeting LSE's procurement obligations for that area. Staff came to this conclusion based on the fact that each generator has multiple effectiveness factors depending on the reliability of the system, the transmission contingency that needs to be addressed, and which other units are available to the CAISO. Staff also noted that fixing local area boundaries, and, therefore the generation units within the boundaries that can satisfy the Local RAR, would greatly simplify the administration of the Local RAR program. If out-of-area units were allowed to qualify based on their effectiveness factors, the Energy Division would have to deal with questions of which effectiveness factor to apply, and what system configuration to assume. The Staff Report noted that even with this counting protocol for 2007, effectiveness factors would be of use. Specifically, staff points out that the CAISO would be able to take into consideration all RAR resources, both inside and outside the local areas, when determining whether to engage in backstop procurement for 2007. This should allow the CAISO to optimize backstop procurement.

A number of commenting parties support the Staff Report's recommendations regarding effectiveness factors. This includes the recommendation that a list of qualifying resources within each local area be established and that only those resources count for Local RAR, as well as the report's observation that the CAISO should evaluate effectiveness factors in connection with backstop procurement. While DRA agrees with the Staff Report as to 2007 Local RAR, it also believes that efforts to incorporate effectiveness factors into Local RAR should be undertaken for future years. CMTA/CLECA likewise agrees with the report's recommendation for 2007, while also agreeing that this topic may appropriately be revisited in the future. Constellation recommends that the use of backstop procurement be monitored, and that if the CAISO engages in more than a minimal amount of backstop procurement, this issue should be revisited.

TURN contends that if a resource that lies outside the boundary of a local area is as effective as another resource within the area for meeting the area' local reliability needs, then such a resource should be countable for Local RAR. TURN refers to the example of Moss Landing, which is located outside of the Greater Bay Area but may be effective in meeting that areas needs. TURN believes this requires further study.

PG&E maintains that the CAISO should make effectiveness information available to LSEs for as many of the contingencies as possible, so that LSEs have a greater opportunity to meet the actual reliability needs.

We adopt staff's recommendation to disregard effectiveness factors for the 2007 Local RAR program, as attempting to incorporate them into resource qualifications would lead to undue program complexity. On the other hand, several comments underscore the need for further consideration of the extent to which out-of-area resources ought to count towards meeting procurement obligations. We will therefore be willing to consider this topic in further proceedings for 2008 and beyond. We note that the problems of non-static effectiveness factors and administrative complexity would have to be overcome. We generally concur with PG&E's position that LSEs should have as much information about the effectiveness of resources as possible, and urge the CAISO to work with our Energy Division and stakeholders to provide such information.

3.3.8 Evaluation of Compliance Demonstrations and
Actions Taken Due to Non-Compliance with Local
RAR (Staff Report I. B. 7.)

3.3.8.1 CAISO Evaluation and Actions

The Staff Report described a process whereby the CAISO would review Local RAR compliance filings as well as (1) showings by non-jurisdictional entities and (2) RMR contracts to determine whether the amount of RAR capacity under contract in each local area meets or exceeds the Commission-adopted Local RAR level. If the adopted level is satisfied in the aggregate, the CAISO would not engage in backstop procurement even if one or more individual LSEs was deficient in its showing. Staff notes that "being satisfied in the aggregate" is limited to procurement of the MWs identified in the LCR study and does not address the technical requirement for maintaining voltage and frequency; provided, however, that the CAISO may need to engage in additional backstop procurement if an assessment of unit effectiveness for the total capacity procured by LSEs discloses that additional procurement is required. Staff notes that such an assessment would consider out-of-area units to the extent they are effective in addressing the area's needs. Staff proposes that LSEs be given first opportunity to engage in additional procurement rather than have no choice but to rely on CAISO backstop procurement.

Staff proposes that when the CAISO engages in backstop procurement, the costs would be allocated as follows:

-- If the deficiency is the result of an individual LSE's failure to make a compliant Local RAR showing, then the CAISO's costs for local resources procured on behalf of deficient LSEs (both CPUC-jurisdictional and non-jurisdictional) would be billed directly to the Scheduling Coordinators responsible for those LSEs.

-- If the deficiency is the result of collective error, i.e. under-procurement occurred in a particular local area even though all LSEs were compliant with their own Local RAR, then the costs for local resources procured on behalf of all LSEs would be allocated to all Scheduling Coordinators responsible for the LSEs in the PTO service territory on a load share basis.

Staff proposes that all LSEs would be notified of the CAISO's backstop procurement actions, and any backstop procurement would be made available to LSEs on a load share basis as a credit towards their monthly System RAR showings.

CAISO notes that the staff proposal for CAISO review and possible backstop procurement raises issues regarding the roles of the Commission and the CAISO that warrant further discussion between the agencies. CMUA is concerned that the scenario outlined by the staff could be read as a proposal whereby non-jurisdictional entities such as publicly-owned electric utilities (POUs) would make compliance showings pursuant to our Local RAR program, and POUS would incur CAISO backstop procurement costs for not complying with our Local RAR program.

We understand the concerns that were raised by the CAISO and by CMUA. We reiterate that we are establishing locally based procurement obligations that are applicable to the IOUs, ESPs, and CCAs under our jurisdiction, not POUs. We also recognize the distinction between the CAISO's responsibility for grid reliability and our role regarding service reliability that is applicable to Commission-jurisdictional LSEs and their retail customers. We welcome and encourage, and are encouraged by, the ongoing dialogue between the CAISO and this Commission, and note further that such dialogue is essential to meet the mandate of Pub. Util. Code § 380(a) that we shall establish resource adequacy requirements in consultation with the CAISO.

Constellation appears to be concerned that some LSEs might have a disincentive to procure from high-effectiveness, high cost units if the CAISO engages in backstop procurement as a result of effectiveness concerns. We cannot discount this possibility, but we do not find it to be grounds for adopting an alternative approach at this time. We agree with Constellation that it will be important for staff and parties to monitor the extent of backstop procurement to ensure that any unintended consequences are detected and can be addressed. Constellation also notes that aggregation of local areas may lead to backstop procurement by the CAISO, and urges that the resulting costs should be allocated on a load share basis just as backstop procurement for effectiveness is. We concur.

SCE seeks clarification that the process of determining whether a local area deficiency was the result of collective error will not mean after-the-fact reasonableness review of any LSE's Local RAR procurement. SCE goes on to state the position that once an LSE has been deemed to have met its Local RAR, there should be no mechanism for changing that LSE's procurement target and areas where it needs to procure. SCE's position comports with our understanding. The Local RAR obligation is a one-time per year compliance filing obligation (as discussed earlier, divided into preliminary and final showings for 2007 to accommodate the RMR process). If an LSE has met its Local RAR as evidenced in its compliance filing, any subsequent procurement obligation for the applicable compliance year would result from backstop procurement by the CASIO, not supplemental Local RAR obligations. LSEs would have an opportunity, but not an obligation, to engage in supplemental procurement in lieu of having to rely on CAISO backstop procurement.

PG&E agrees that LSEs should have an opportunity to procure to meet effectiveness needs prior to backstop procurement, and contends that RAR credit for backstop procurement should accrue to those LSEs that pay for it. We concur with this principle.

We believe that the Staff Report generally presents an appropriate mechanism for carrying out the Local RAR program. The essential elements of CAISO review and response, which we hereby approve, can be restated and summarized as follows.

-- Using the information available to it, including Local RAR compliance filings with the Commission, RMR contracts, POU procurement, and effectiveness factors of units nominated to fill the local needs, the CAISO will determine whether a local area has the needed local resources or is deficient such that additional capacity must be procured.

-- If the CAISO determines that a local area is deficient due to failure of a Commission-jurisdictional LSE to meet its Local RAR, the CAISO will engage in backstop procurement, the cost of which will be assigned to the deficient LSE's Scheduling Coordinator pursuant to CAISO tariffs. If the CAISO determines that a local area is adequately resourced, but notes that a Commission-jurisdictional LSE did not meet its local RAR, the CAISO would take no action with respect to that LSE.

-- If the CAISO determines that a local area is deficient due to "collective error" (for example, a deficiency results from the interplay of effectiveness factors) and not the failure of a Commission-jurisdictional LSE to meet its Local RAR, the CAISO will work with the Commission to provide the LSEs with an opportunity to procure the deficiency before the CAISO engages in backstop procurement. The cost of this backstop procurement would be assigned to the LSEs' Scheduling Coordinators pursuant to CAISO tariffs, provided, however, that any LSE that took advantage of the opportunity to procure local capacity in lieu of relying on CAISO backstop procurement would be credited for such voluntary procurement.

-- The portion of any backstop procurement by the CAISO that is attributable to Commission-jurisdictional LSEs would be made available to those LSEs on a PTO load share basis as a credit towards their monthly System RAR showings.

We understand and intend that the foregoing procedures are consistent with the respective roles of the Commission and the CAISO, and that they do not represent the imposition of any requirements of this Commission on non-jurisdictional entities. They also appear to be consistent with the CAISO's understanding of its role with respect to Local RAR. As the CAISO states:

[O]nce the Commission elects the Local RAR based on an appropriate service reliability level, as stated previously, the CAISO will assess the adequacy of LSE procurement, both from CPUC and non-CPUC jurisdictional entities and engage in procurement only as a backstop measure to the desired level of service reliability. [Footnote reference omitted.] (Comments of CAISO, April 21, 2006, p. 10.)

3.3.8.2 Commission Evaluation and Actions

Commission review of Local RAR filings will include a determination of whether each LSE has met its procurement obligation and is otherwise in compliance with RAR program requirements. As with the System RAR program, staff expects the compliance review will be delegated to the staff.

The Staff Report put forth two options to ensure compliance in the situation where an LSE has not met its obligation but the local area is adequately resourced because at least one other LSE is "long" on qualifying local capacity. The deficient LSE would either pay a transfer payment to the long LSE(s) in accordance with a transfer mechanism (discussed below) or it would be subject to a Commission-imposed penalty. In the situation where the local area is deficient, the Staff Report proposed that an LSE that has not met its obligation would be subject to (1) CAISO backstop costs directly allocated to its Scheduling Coordinator, as discussed above and (2) Commission penalties if no Commission waiver has been granted.

We approve the Staff Report's proposals for administration of the Local RAR program, including delegation of ministerial review responsibilities to the Energy Division. As with System RAR, the Energy Division is tasked with notifying LSEs that their compliance filing was received and approved. If the Energy Division determines that an LSE is non-compliant and resolution of the LSE's compliance status is not resolved between the Energy Division and the LSE, the Energy Division would refer the issue to the Commission through the recommended institution of a formal proceeding. We address various issues pertaining to penalties and waivers later in this decision.

3.3.9 The IOUs' Transfer Payment Proposal
(Staff Report I. B. 8.)

The IOUs' proposal for Local RAR included a recommendation for a transfer mechanism and payment process for the situation where an LSE does not meet its local procurement obligation with respect to a local area, yet the area is adequately resourced because one or more LSEs has procured local generation in excess of the Commission-adopted Local RAR. The Commission staff would identify such "long" and "short" LSEs and allocate or "transfer" credit for the local capacity from the long to the short LSEs. The long LSE would retain control over the resource since only the "local attribute" would be transferred to the short LSEs. The IOUs suggest a $24 per kilowatt-year (kW-year) "transfer payment" for such transfers from short to long LSEs. The total amount of the transfer payments owed by short LSEs would be allocated to the long LSEs in proportion to the size of the surplus demonstrated by each long LSE. Even though the proposal would allow transfers from any long LSE to short LSEs, the workshop participants and commenting parties generally acknowledged that IOUs are likely to be long, and ESPs are more likely to be short. The IOUs propose the transfer payment mechanism as an interim measure for 2007.

Proponents of the transfer payment mechanism argue that it would provide an incentive for LSEs to procure their own local resources, thus encouraging bilateral contracting with entities that have local capacity to sell. They also argue that in the absence of the mechanism, long LSEs may be tempted to hold their long positions rather than engage in bilateral contracting.

A number of parties stand in opposition to the transfer payment mechanism. The Staff Report questioned why a long LSE would prefer to hold excess local capacity, and suggested that IOUs with Commission-approved procurement plans should carefully consider the "least-cost/best-fit" procurement principle before deciding to hold on to local capacity that is not needed to meet its own local procurement obligation, yet could be of value to a short LSE. The Staff Report also noted a staff concern that the transfer mechanism would create administrative burdens, and that the costs may exceed the benefits. Staff would be required to review compliance filings to determine whether transfer payments are required, determine from and to whom payments are made, track payments, and follow up if transactions are not completed. Moreover, staff notes, it is possible that some of these functions may not be delegated to the staff.

We conclude that the proposed transfer mechanism should not be adopted as it would be administratively complex and burdensome for our staff to administer. We recognize the offer by PG&E to propose further detail on how the program might be carried out, but we are not persuaded that any such proposal could be developed and considered in the time remaining before Local RAR is implemented.

Moreover, we are not persuaded that the proposal is either necessary or justified by policy considerations. For example, it is not at all clear that the mechanism would provide any better incentive for long and short LSEs to engage in bilateral contracting prior to making Local RAR compliance filings than would the prospect of a combination of backstop procurement costs and Commission-imposed penalties. In fact, it strikes us that it is just as likely that the mechanism would act to discourage such trading, since parties could passively await administrative allocations rather than engage in commercial transactions to meet their obligations. In conclusion, we are concerned that the transfer payment mechanism and the variation proposed by TURN may not promote the objective of development and use of a tradable capacity product that would promote efficient achievement of RAR program goals.

AReM suggests that IOUs should be required to sell off any long capacity to other LSEs at reasonable prices. This requirement, AReM maintains, would prevent IOUS from using an administrative allocation to sell their excess local capacity. TURN has suggested the mandatory sales of the local attribute of resources. We will not adopt such proposed requirements. There may be reasons for a long LSE to hold on to capacity even though it does not need the capacity to meet its own local procurement obligations. However, while we do not mandate such sales, we join the staff in calling upon IOUs to carefully consider whether holding on to capacity that is not needed for Local RAR is in line with the "least-cost/best-fit" procurement principle. IOUs may wish to hold Requests for Offers (RFOs) for System RAR capacity concurrently with RFOs for their excess RAR capacity that satisfies local requirements so that they can better determine the "least cost/best fit" mix of RAR resources.

3.3.10 Enforcement and Penalties for Failure to Meet
Obligations (Staff Report I. B. 9.)

The Staff Report recommends that the Local RAR program include a penalty regime to promote compliance on the part of LSEs. Staff reasons that without the prospect of paying penalties in addition to paying backstop procurement costs, LSEs could freely rely on CAISO contracting to meet their local procurement obligations. Under the staff proposal, penalties would apply when an LSE fails to make a required compliance filing that shows that the LSE has met its local procurement obligation unless a waiver has been granted. (We discuss waivers later in this decision.)

We concur with the reasoning put forward by the Staff Report, and hereby adopt the principle that a penalty regime is necessary for Local RAR. It is clear that penalties over and above backstop procurement costs are necessary to deter non-compliance with the Local RAR program. If LSEs were free to rely on CAISO backstop procurement and simply pay the CAISO for that procurement (through the Scheduling Coordinator), and nothing more, the Local RAR program could be rendered ineffectual to the extent that LSEs elect such a course of action. This is fully consistent with our earlier determination that a penalty regime is needed for System RAR:

[A] regulatory program that imposes significant procurement obligations upon LSEs cannot be expected to succeed unless those LSEs have reason to believe there are consequences for noncompliance that outweigh the costs of compliance. (D.05-10-042, p. 93.)

Since a major purpose of the program is to move away from significant reliance on CAISO backstop procurement, we do not intend to pursue any action, or tolerate inaction, that condones or promotes continued reliance on backstop procurement when capacity can be purchased by LSEs.

Some parties have taken the position that penalties for failure to demonstrate fulfillment of the local procurement obligation should be used to defray the cost of backstop procurement by the CAISO. As the Staff Report correctly explains, however, the statutes pursuant to which the Commission may impose penalties upon LSEs provide that the proceeds from such penalties accrue to the State's General Fund. Additionally, the CAISO's tariff provisions for billing deficient LSEs on whose behalf it must engage in backstop procurement are independent from the Commission's enforcement process. Moreover, as noted above, we have determined that penalties over and above backstop procurement costs that an LSE pays for being deficient are necessary to achieve program goals. If we allowed penalties to be used to defray backstop procurement costs, we could undermine this effect.

Having determined that penalties are needed to assure that the Local RAR program goals are met, we turn to the elements of a penalty regime. D.05-10-042 adopted the broad policy that for System RAR, a penalty equal to 300% of the cost for new capacity (150% for 2006 only) is an appropriate sanction for an LSE's failure to acquire the capacity needed to meet its System RAR obligation. Several commenting parties have observed that penalties of that magnitude are unnecessary for purposes of the Local RAR program; some parties consider that level of penalty to be excessive.¹⁸ We are inclined to agree. It is our judgment that a penalty equal to 100% of the cost of new capacity is an appropriate penalty for failure of an LSE to meet its local procurement obligation.¹⁹

TURN has presented in its April 21 comments a persuasive analysis that allows us to provide greater definition to the establishment of penalty levels. As discussed below in connection with waivers, we are adopting TURN's proposal to establish a price of $40 per kw-year as a trigger for granting Local RAR waivers. That trigger price was derived by TURN from a settlement of the IEP Complaint (see Footnote 10). We find it to be a reasonable and appropriate measure of the cost of new capacity for purposes of the RAR penalty regime. We make this determination for both Local and System RAR penalties for consistency between the two RAR program components.

It is possible that an LSE is deficient with respect to both System and Local RAR, in which case penalties could accrue for both program elements. We clarify here that the penalties are not to be added; instead, the larger System RAR penalty would apply. In other words, if an LSE's deficiency would lead to a 300% penalty for System RAR and a 100% penalty for Local RAR, then the penalty would be 300%, not 400%.

Some parties have observed that additional clarification of the RAR compliance and penalty process is needed. The Staff Report stated agreement that more definition of the process is needed, and it discussed the possibility of developing a new Commission general order that would provide such definition. We agree such a general order is needed, and commend this proposal to Phase 2 of this proceeding. As staff point out, it will be important to establish rules so that LSEs and interested parties understand not only the penalties for being deficient, but also the consequences for other compliance failures on the part of LSEs, such as failure to make timely filings and submitting false information.

We note that time is of the essence with respect to LSE compliance filings. If an LSE fails to make a timely filing demonstrating it has fulfilled its local procurement obligation, the CAISO may determine that it needs to proceed on the assumption that the LSE is deficient and therefore engage in backstop procurement to cover the deficiency, even if the LSE has in fact acquired the capacity needed to cover its obligation. Such backstop procurement could be unnecessarily costly. Accordingly, the penalty for failure to make a timely compliance filing should, after a grace period not to exceed 10 calendar days, be equal the penalty for a deficiency.

3.3.11 Market Power (Staff Report I. B. 10.)

A constant theme throughout the workshops in both this proceeding and in the predecessor RAR proceeding has been the substantial concern that generators within local, transmission-constrained areas will have market power. Much of the generation available within such an area will be necessary to maintain reliability and serve load. Market power mitigation in the wholesale market is the jurisdictional responsibility of the Federal Energy Regulatory Commission. However, since market power is an inherent factor affecting the Local RAR program, we need to be assured that the program does not exacerbate market power concerns even as we seek to encourage appropriate and reasonable revenue adequacy to encourage needed investment in generation and transmission solutions.

AReM has suggested that we excuse LSE from any local procurement obligations unless several conditions are found to have been met. These include determinations that (1) sellers in the local area have no market power, (2) generation is available for purchase, (3) creditworthy counter-parties are available, and (4) generation rather than transmission upgrades is the cost-effective option.

We agree with AReM's concerns in part. For example, it would not be reasonable to require LSEs to procure generation in an area if generation is demonstrably not available to be purchased. Also, as noted earlier, we prefer that transmission solutions that are cost-effective be pursued and implemented. However, to the extent that AReM would have us make findings that each of its four pre-conditions is met for each local area before the Local RAR program is implemented, AReM's position is without merit. The answer to each of the concerns is to implement the program in a manner that sets reasonably achievable requirements for LSEs and excuses LSE from meeting demonstrably unreasonable requirements. We are satisfied that the program we adopt today does so.

With respect to market power specifically, it is important to recognize that this is an inherent factor to be dealt with through mitigation rather than inaction in the form of suspending Local RAR before it even starts. Mitigation is accomplished in several ways through our adopted program. First, we are not proposing to eliminate reliance upon CAISO backstop procurement altogether. We are instead attempting to foster LSE procurement in a way that reduces procurement by the CAISO as much as possible. As the Staff Report observes, our continued, though presumably minimal, reliance on backstop procurement will have the effect of capping how much income generators may expect to receive if they do not execute RAR contracts. The waiver trigger that we adopt in the following section is the means by which this market power mitigation is accomplished. Another mitigation measure that we adopt today is the aggregation of local areas within the PG&E service territory. We have also determined that LCRs determined by the CAISO should be adjusted to account for corresponding resource deficiencies identified by the CAISO, which should reduce the ability to exercise market power as well as address AReM's principle that procurement obligations should be attainable.

The Staff Report points out that the CAISO's Market Redesign and Tariff Update process will also yield market power mitigation. The report notes this would provide mitigation not only with respect to the exercise of market power in the CAISO markets, but it should also have a mitigating effect in the RAR bilateral contracting markets.

3.3.12 Waivers (Staff Report I. B. 11.)

Several parties requested that we allow waivers from the local procurement obligation under certain conditions. The staff report noted that without such a waiver option, LSEs that are unable to bilaterally contract for local capacity needed to meet their assigned obligation would be subject to both backstop procurement costs and potential penalties. Under a waiver process, the Staff Report suggests, an LSE would be able to request relief from the procurement obligation with a demonstration that it has made every commercially reasonable effort to contract for Local RAR resources. As proposed by the IOUs, a waiver request would have to demonstrate that the LSE actively sought products and either received bids with prices in excess of their proposed administratively determined local attribute price or received no bids.

The Staff Report invited comment on the questions of establishing a process for requesting waivers and reviewing and acting upon those requests, including (1) whether up-front standards could be adopted such that the process could be administered through staff action and (2) whether waiver requests would be made and acted upon prior to the Local RAR compliance filing or at or after the time of the compliance filing.

We find that a waiver process is necessary as a market power mitigation measure, and should therefore be adopted as a component of the Local RAR program. After reviewing the extensive workshop comments, we find that TURN has presented a fair, balanced, and credible approach that we will therefore adopt. As noted earlier, TURN has calculated a capacity cost of $40 per kw-year using data from the settlement of the IEP complaint.²⁰ We intend that this price would function as a trigger that could lead to the granting of a waiver, not as a price cap on what LSEs might be willing to pay. We recognize that there may be situations where an LSE might want to pay more. The trigger price is not the sole factor the Commission will consider in determining whether a waiver request is granted, since a contract's terms and conditions could possibly make a contract whose price is below the trigger price unreasonable for the LSE, or make a contract whose price is above the trigger price reasonable despite the higher price.²¹ We note also that we are not adopting a monthly price trigger; specifically, we are not adopting a trigger price of one-twelfth of the yearly price trigger ($3.33 per kW-month), as we would not expect RAR prices to be uniform throughout the year. Finally, we emphasize that the waiver applies to Commission-imposed penalties only. A deficient LSE would be responsible for any applicable backstop procurement costs even if it received a waiver from penalties.

The following process for waivers will be followed. An LSE requesting a waiver must make such request at the time it files its Local RAR compliance showing. The waiver request must include both of the following:

(1) a demonstration that the LSE reasonably and in good faith solicited bids for its RAR capacity needs along with accompanying information about the terms and conditions of the Request for Offer or other form of solicitation,

and

(2) a demonstration that despite having actively pursued all commercially reasonable efforts to acquire the resources needed to meet the LSE's local procurement obligation, it either

(a) received no bids,

or

(b) received no bids for an unbundled RA capacity contract of under $40 per kW-year or for a bundled capacity and energy product of under $73 per kW-year,

or

(c) received bids below these thresholds but such bids included what the LSE believes are unreasonable terms and/or conditions, in which case the waiver request must demonstrate why such terms and/or conditions are unreasonable.

An LSE's waiver request that meets these requirements is a necessary but not a sufficient condition for the grant of such waiver. The Commission will also consider other information brought to its attention regarding the reasonableness of the waiver request.

We find that administration of the ministerial aspects of this process may be delegated to our staff. For example, whether an LSE received any bids is an objective standard. On the other hand, whether proposed terms and conditions of a contract are reasonable is a question of judgment that must be reserved to the Commission. For such waiver requests, Energy Division should prepare a resolution for our consideration with its recommendations on whether the request should be approved or denied. We recognize that a waiver process that requires formal Commission action can be cumbersome and leave parties in a state of uncertainty. We stand ready to explore in the next phase of this proceeding whether additional objective criteria for waiver requests and other refinements to the waiver process can be developed and implemented.

Since formal enforcement actions begin with staff recommendations to the Commission, staff will be in a position to consider a waiver request along with any other pertinent information in making recommendations to the Commission on whether to institute formal enforcement proceedings with respect to a deficient LSE. The Energy Division will advise the LSE whether the Commission has accepted the waiver or will pursue the matter further. We ask that the Energy Division report to the Executive Director on the number of waiver requests and the number of such requests that are granted, and that a copy of such report be furnished to the Commissioners and the ALJ.

⁵ Where applicable, section headings herein include cross-references to the corresponding sections of the Staff Report.

⁶ We note that the Energy Division has scheduled a workshop for July 21, 2006 in anticipation of this requirement. Because of the CAISO's need for a cutoff date prior to July 21 for submission of operational solutions by PTO's, we ask that such solutions be submitted to the CAISO as soon as possible, and not later than July 10, 2006.

⁷ Pub. Util. Code § 345 provides that "[t]he Independent System Operator shall ensure efficient use and reliable operation of the transmission grid consistent with achievement of planning and operating reserve criteria no less stringent than those established by the Western Electricity Coordinating Council and the North American Electric Reliability Council."

⁸ See Attachment A, p. 2 of "Corrected 2007 Locational Capacity Technical Analysis and Errata of the California Independent System Operator Corporation," dated April 28, 2006 and filed May 1, 2006.

⁹ While system operators play a key role in assessing the effects of existing and planned facilities on loop flows and system reliability, the responsibility for determining what level of reliability and economic enhancements are appropriate for the state lies primarily on the Commission's shoulders. Remedying Undue Discrimination Through Open Access Transmission Service and Standard Electricity Market Design, FERC Docket No. RM01-12-000, "White Paper - Wholesale Power Market Platform," (April 28, 2003) at Appendix A, p. 16.

¹⁰ For the 2007 compliance year, the compliance filings would be made on October 2, 2006, the first business day following September 30. However, as discussed below, we are modifying the compliance filing schedule to accommodate coordination of the RAR and RMR processes.

¹¹ Sempra Global's discussion of this issue refers to a four-month, June through September compliance cycle for System RAR. However, D.04-01-050 established that the year-ahead procurement obligation for System RAR is for May through September. We note that for 2006 only, the procurement obligation is for June through September because D.04-10-035 adopted June 1, 2006 as the date for full implementation of the 15%-17% planning reserve requirement.

¹² The filing guide, instructions, and templates issued by the Energy Division were attached to the Staff Report as Appendixes A-G.

¹³ On August 25, 2005, IEP filed a complaint with FERC, seeking to replace the Must-Offer Obligation with an alternative tariffed payment structure. The Commission participated in that proceeding, Independent Energy Producers Assoc. v. California Independent System Operator Corp., FERC Docket No. 05-146 (IEP Complaint). Among other things, the Commission agreed to a proposed settlement provision of the IEP Complaint that called for RMR remaining in place through 2007.

¹⁴ The CAISO suggested "one week" but we find that it is useful to put an actual date to the suggestion. All RAR showings are submitted to the Commission and concurrently copied to the CEC and the CAISO.

¹⁵ A full RAR demonstration would be a showing for any unit on the CAISO's list of local units.

¹⁶ This would be the list of RMR units as approved by the CAISO's Board of Directors in early September 2006.

¹⁷ This allocation should be performed using the same methods used for allocation of LCRs as determined in Section 3.3.2.

¹⁸ Some parties have made the observation that a penalty of 300% of the cost of new capacity is more than is needed in connection with System RAR.

¹⁹ As DRA observes, Pub. Util. Code §§ 2107 and 2111 authorize the Commission to impose fines in the range of $500 to $20,000 per offense. Each violation is a separate offense, as is each day of a continuing violation. (Pub. Util. Code § 2108.) We believe the penalty regime established in D.05-10-042 and in this decision fully comports with this statutory authorization.

²⁰ TURN derived the $40 per kW-year figure by subtracting from the $73 per kW-year capacity price adopted in the settlement a conservative estimate of Peak Energy Rent of $33 per kW-year. In adopting this price as a threshold for the waiver program, we emphasize that it represents an unbundled, resource adequacy-only product that does not include energy. If an LSE seeks a waiver on the basis that it could not obtain capacity to meet its local procurement obligation through a bundled capacity and energy contract, a trigger price of $73 per kW-year would be applicable.

²¹ We do not think it likely that a counterparty's creditworthiness would be a term or condition that would lead to the granting of a waiver with respect to resource adequacy capacity products. As WPTF notes, creditworthiness issues are associated with bundled capacity and energy products but not with capacity only products.