An Incentive Framework For Utility Procurement of Energy Resources

Modeled After Cap-and-Trade Principles of the Sky Trust

1. Introduction and Summary

The purpose of this concept paper is to propose an incentive framework for investor-owned utility (IOU) procurement of energy resources that would: 1) explicitly account for the tradeoffs in costs (including externalities) related to resource options, both supply- and demand-side, 2) reflect the need to reduce California's dependence on fossil fuels for a variety of environmental, security and price volatility reasons, 3) provide a transparent yardstick for least-cost energy procurement and 4) create a funding source for energy efficiency programs that would drive utilities to conserve at the upstream level.

The term "procurement" is used in this paper to refer to one of the major responsibilities of the IOUs-to serve as electric and natural gas portfolio managers for their service territories, a task that involves assembling a mix of demand- and supply-side resources and contracts. The proposed framework would apply to the procurement practices of the large IOUs under the CPUC's jurisdiction, i.e., Pacific Gas and Electric Company, San Diego Gas & Electric Company, Southern California Edison Company and Southern California Gas Company. It encompasses the full range of energy procurement activities undertaken by these IOUs: electric power and natural gas procurement via bilateral contracts with individual suppliers or from wholesale energy markets, procurement from resources located in-state or out-of-state, and procurement from facilities owned and operated by IOUs or by other entities.

This concept paper utilizes the cap-and-trade principles of the Sky Trust proposal described in Peter Barnes' book "Who Owns the Sky?" The Sky Trust draws from experience with the Alaska Permanent Fund, which was established to manage the oil revenues on state-owned lands in the 1970s and distributes an annual dividend to each Alaskan. The Sky Trust concept has also served as the model for the Consumer Fiduciary Corporation proposed under the Climate Stewardship Act (S.139) and the non-governmental trustee for permit auctions proposed under the Clean Power Act of 2002 (S.556).

Briefly, under the proposed framework the CPUC would establish short- and long-term procurement goals for energy efficiency and renewable resources in its rulemaking proceedings, in coordination with other State agencies. For example, the CPUC might determine that the combination of cost-effective energy efficiency and "least-cost and best fit" renewables should result in zero-growth in carbon-based energy procurement over the next five years.¹ The CPUC would express this goal in the form of annual limits on carbon-based energy procurement over the same period. As discussed further below, the utilities would be required to hold (tradeable) allowances to procure carbon-based energy up to the CPUC-established limits. The CPUC, or a Trust set up by the CPUC for this purpose, would issue the allowances at a price that is market-based (e.g., established through auction), on an annual basis.

Allowance costs would be added to other costs of carbon-based energy and would be reflected in all utility procurement decisions. Allowance costs would also become an integral component of the avoided costs used in cost-effectiveness and "least cost-best fit" evaluations when considering energy efficiency and renewable energy proposals or projects. The issuance of allowances and associated costs of those allowances would also become an integral component of the CPUC's policies to promote energy efficiency programs on the gas-side, and to evaluate the cost-effectiveness of those programs relative to the costs of additional slack capacity, additional interstate pipeline reservation charges and emergency reserves of natural gas.

Ratepayers would pay for the allowance costs through rates (just as they do for all other reasonable and prudent costs of energy procurement), but the funds generated through these ratepayer collections would be set aside specifically to fund energy efficiency programs. In this way, the higher costs that ratepayers pay for the utility's procurement of carbon-based energy are "recycled" to fund energy efficiency programs. This funding would substitute for a large part (if not all) of the ratepayer funding for energy efficiency that is currently collected through procurement rates and the public goods surcharge. That is, the cost of allowances would not be additive to the amount of funding for energy efficiency currently in rates. In fact, the total amount of ratepayer collections would not change at all.

The utility's overall performance in energy procurement would be evaluated based on achieving the targets established for specific types of preferred resources (e.g., energy efficiency and renewable resources) as well as on performance targets established for long-term portfolio costs-including the cost of allowances. The proposed framework creates a strong incentive for utilities to aggressively pursue cost-effective energy efficiency and least-cost/best-fit renewable resources by: (1) limiting the amount of carbon-based energy the IOUs (collectively) would be allowed to include in their resource portfolios, and (2) establishing a market value via tradeable allowances for those limits against which to measure all non carbon-based alternatives. Monetary incentives/penalties could be structured based on these same parameters, coupled with periodic independent audits. In this way, the CPUC would create the financial motivation that IOUs lack under cost-of-service regulation to factor the full cost of resource options (including allowances) into all procurement decisions.

Sections 2-5 present a brief overview of the Sky Trust, discuss the objectives for utility energy procurement, elaborate on the proposed incentive framework in greater detail, and consider the issue of procurement performance and utility financial incentives in that context. Several issues and questions are raised throughout this paper for further consideration. The paper is followed by a "question and answer" attachment designed to further clarify the proposed framework.