5. Reasonableness of PG&E's Special Electric Contracts

Background

In D.87-05-071, the Commission authorized PG&E to offer electricity under special contracts.² Under these contracts, certain customers that could have bypassed PG&E's system by installing equipment to generate their own electricity pay discounted electric rates in exchange for their agreement not to leave the system. The Commission authorized PG&E to offer contracts designed to retain customers via rates attractive enough to dissuade those customers from generating electricity themselves. At the same time, the Commission sought to assure that those customers receiving discounts continued to pay at least the marginal cost of the service the utility provided. The Commission found that "[s]pecial contracts can be useful in retaining potential bypassers on the system and in increasing sales to existing customers"³ and that "[s]pecial contracts can provide an overall benefit to ratepayers."⁴

In D.90-12-128, the Commission reviewed the first of PG&E's special electric contracts and required the revenues from the contracts to recover the marginal cost of energy, capacity (generation, transmission and distribution) and customer costs.⁵ Specifically, "the Commission concluded that, in order to receive expedited approval, a contract should include a floor price designed to assure that the utility recovers from the customers no less than the lowest price possible that does not disadvantage other ratepayers in either the short or long run."⁶ This floor price, when multiplied by the customer's specific usage data, yields the "floor revenues,"⁷ the minimum amount that must be recovered under the contract.

One other concept, the Contribution to Margin (CTM), is important in our evaluation of the special contracts. To calculate the CTM, the floor revenues are subtracted from contract revenues. This, in turn, sets the standard for reasonableness, for "[i]t would be unreasonable for a utility to enter into a contract that can reasonably be foreseen as not providing a preferable CTM."⁸

Under current regulations, if a contract generates a negative CTM, PG&E's shareholders must fund the difference between the contract's revenues and the floor revenues. As the Commission has stated: "Any amounts in the memorandum account . . . that reflect the difference between adopted marginal costs and the contract rates should be disallowed."⁹ Similarly, "[t]he absence of protection in the . . . contract's floor provision to cover generation, transmission, and distribution capacity costs is unreasonable.  PG&E should not be allowed recovery for any future shortfall resulting from the inadequate floor revenue provision." ¹⁰ Following a review of these contracts in the RAP proceeding, shareholders fund any negative CTM through a credit entry to line 8 of the TRA, Shareholder Participation Credits. This procedure has the effect of holding shareholders responsible for revenue shortfalls generated by the special contracts.

During the period under our review, PG&E administered seven special electric contracts. These contracts are between PG&E and the following entities: Mills Hospital, Peninsula Hospital, Sequoia Hospital, Semitropic Water Storage District, Avenal State Prison, Genentech, Inc. and Exxon.¹¹ The Commission first reviewed the contracts with Mills Hospital, Peninsula Hospital, and Sequoia Hospital in PG&E's 1988 Energy Cost Adjustment Clause (ECAC) Proceeding, which resulted in D.90-12-128 (D.90-12-128; 1990 Cal. PUC Lexis 1416). The Commission first reviewed PG&E's contracts with Semitropic Water Storage District, Avenal and Exxon in the 1995 ECAC proceeding, which resulted in Decision 97-07-052.¹² The Commission initially reviewed and approved PG&E's contract with Genentech in D.94-09-071, which found that "[b]ased upon all the facts and circumstances known to the Commission at the time of this decision, PG&E's decision to enter into the Amended Proposed Agreement [with Genentech] is prudent."¹³

PG&E: A Commission-set Methodology for Contract Assessment Shows that a $33,166 Shareholder Credit is Warranted

PG&E asserts that it reasonably administered its special electric rate design window contracts and appropriately calculated the shareholder credit entries to the TRA. PG&E states that it complied with standing Commission decisions governing and establishing the marginal costs used to calculate floor revenues and the CTM of special electric and rate design window contracts.

PG&E states that D.90-12-128 and D.97-03-017 adopted a methodology for calculating the marginal cost of electricity that should be used to calculate the floor revenues and the CTM of special electric and rate design window contracts. PG&E further claims that it has followed the Commission-adopted methodology and used the Commission-adopted marginal energy, capacity (generation, transmission, and distribution) and customer costs in effect during 1999 and 2000 to calculate floor revenues and CTM for each of its special electric and rate design window contracts during that time frame.

PG&E states that it has demonstrated that "with the exception of Sequoia Hospital in 1999 and Peninsula Hospital in 1999 and 2000, all of PG&E's special electric and rate design window contracts generate positive CTM."¹⁴ PG&E notes that its analysis finds that during 1999, "contract revenues from Sequoia were $10,666 below the floor revenues required for that contract and contract revenues from Peninsula were $11,986 below the floor revenues required for that contract."¹⁵ Similarly, in 2000, the revenues from the Peninsula contract were $10,513 below the floor revenues.¹⁶ As a result, PG&E has requested authorization to record a shareholder credit of $33,166 to line 8 of the TRA.¹⁷ This accounting action has the result of disallowing $33,166 from the amount that PG&E may collect from ratepayers.

Finally, PG&E contends that any other approach to calculating floor revenues and determining the CTM is not legal. In particular, PG&E argues that D.90-12-128 requires PG&E to use the adopted marginal costs in effect to calculate the floor and determine the CTM of its special electric contracts. PG&E further states that the applicable marginal costs in effect in 1999 and 2000 are those the Commission adopted in Phase 2 of PG&E's 1996 General Rate Case, D.97-03-017. PG&E concludes that the use of another proxy to recalculate the 1999 and 2000 CTM would violate D.90-12-128 and D.97-03-017.

ORA: A Shareholder Credit of $40 Million is Warranted

ORA argues that the "record clearly demonstrates that PG&E has failed to compute the contribution to margin associated with its special electric contracts in accordance with long-standing Commission guidelines, and must therefore be directed to recalculate costs of service for Special Contract customers to reflect generation costs incurred on Schedule PX."¹⁸ ORA states that its testimony showed that "there is a negative CTM associated with PG&E's Special Contracts" and that the "resulting revenue shortfall is embedded in the TRA."¹⁹ ORA argues that "PG&E's CTM methodology is flawed, since PG&E failed to consider vastly changing market conditions after the 1998 electric deregulation, the electricity and gas crises in the second part of 2000, and PG&E's methodology did not acknowledge the effect of Schedule PX on its procurement costs."²⁰

ORA further argues that "all customers, whether or not they are buying electricity pursuant to Special Contracts, must pay the full cost of the service they are receiving."²¹ ORA notes that its "CTM estimate generated an amount of about $40 million in revenue shortfall during 1999 and 2000 to serve those customers on Special Contracts."²² ORA concludes its brief by arguing that "PG&E's faulty calculation does not reflect the actual costs to serve those customers, and therefore inappropriately and contrary to Commission policy PG&E's calculation transfers responsibility for any revenue shortfall from shareholders to ratepayers."²³

Discussion: PG&E Follows Commission-set Methodology

The key precedents for establishing the reasonableness of Special Contracts are D.90-12-128 (1990 Cal. PUC Lexis 1415; 39 CPUC 2d 183) and D.97-03-017 (1997 Cal. PUC Lexis 138; 71 CPUC 2d 212). Together, they incontrovertibly detail how the Commission expects PG&E to calculate floor revenues, CTM and the reasonableness of any special contract. The line of reasoning is straightforward. In D.90-12-128, Conclusion of Law 5 states: "The adopted marginal cost in effect at the time should be used to determine reasonable floor revenues."²⁴ Then, in D.97-03-017, a General Rate Case decision for PG&E, the Commission ordered that:

"1. The marginal costs for electric service by Pacific Gas and Electric Company (PG&E) as set forth in Appendix B to this order are adopted only for the limited purposes of: (1) payments to qualifying facilities (through capacity allocation factors and the capacity value); (2) evaluation of demand-side management cost-effectiveness, and (3) price floors for discounted special contracts."²⁵

No subsequent Commission decision has changed marginal costs. Further, no party requested either in its protest to PG&E's application or at the PHC that the Commission use this proceeding to alter the methodology for calculating marginal costs and/or price floors.

The November 2, 2001 Scoping Memo in this proceeding does not identify alteration of the methodology for calculating marginal costs as within the scope of this proceeding. Moreover, the scope set in the November 2, 2001 Ruling is consistent with a long history of Commission rulings in RAP proceedings. Prior to the first annual RAP, a Coordinating Commissioner's Ruling of May 14, 1998 identified the functions of the annual RAP proceeding:

"Function: Consolidate revenue requirement adjustments; authorize recovery of preceding calendar year's revenue requirements; adjust authorized revenue requirements for current calendar year; verify and adjust as appropriate headroom calculation from Transition Revenue Account (TRA); authorize headroom credit to TCBA

Function: Streamlining of other balancing accounts and implementation of ratemaking mechanisms for end of transition period

Function: Revenue allocation and rate design"²⁶

Thus, the Commission established firm parameters at the start of this series of proceedings that did not include a reexamination of marginal cost methodologies in this proceeding. This proceeding has followed these parameters and made it clear that we did not intend to reexamine marginal cost methodolgy.

Moreover, no party requested that the Commission expand the scope of the proceeding to review marginal cost methodology. In particular, ORA's briefs, its oral statements in the public participation, and its testimony provide no legal argument for ignoring the Commission decisions and previous rulings that set the marginal costs that PG&E must apply and the Commission should use to determine the reasonableness of its special contracts. No party has filed either to modify or rehear either D.97-03-017 or D.90-12-128. With no request for a new examination of this issue, and no notice to the many parties to prior proceedings, there can be no other conclusion but that the Commission expects PG&E to calculate the CTM using Commission adopted marginal costs, specifically those adopted in D.97-03-017.

PG&E's testimony concerning the reasonableness of the special contracts and rate design window contracts follows the Commission-adopted methodology. PG&E uses the Commission-adopted marginal energy, capacity (generation, transmission and distribution) and customer costs in effect during 1999 and 2000 to calculate floor revenues and the CTM of its special electric and rate design window contracts during the time frame covered by our review. Although ORA urges that the Commission use an alternate cost methodology, ORA does not provide any facts that cast doubt on PG&E's fidelity to the Commission's assessment rules.

Specifically, PG&E administered seven special electric contracts during 1999 and 2000 that are subject to review in this proceeding. These contracts are between PG&E and each of the following: Mills Hospital, Peninsula Hospital, Sequoia Hospital, Semitropic Water Storage District, Avenal State Prison, Genentech Inc. and Exxon. PG&E used the marginal costs in effect during 1999 and 2000 to calculate the floor revenues and determine the CTM for each of these contracts during the time frame of our review. In particular, PG&E determined the floor revenues for each of its contracts by multiplying the adopted marginal energy, capacity (including generation, transmission and distribution) and customer costs in effect at the time by customer usage. Further, to ensure an accurate comparison of floor revenues and contract revenues, PG&E escalated the marginal costs adopted in D.97-03-017 to 1999 and 2000 dollars by applying escalation factors supplied by an economic consultant.²⁷ Using the Commission-approved methodology (modified to include escalation factors), PG&E has demonstrated that, with the exception of Sequoia Hospital in 1999 and Peninsula Hospital in 1999 and 2000, all of PG&E's special electric and rate design window contracts generated positive CTM. During 1999 contract revenues from Sequoia were $10,666 below the floor revenues required for that contract and contract revenues for Peninsula were $11,986 below the floor revenues required for that contract. In 2000, the contract revenues from Peninsula were $10,513 below the floor revenues required for that contract. These calculations result in a net disallowance (and shareholder credit) of $33,166.²⁸

Although electric markets were extremely turbulent during 1999 and 2000, this fact provides no justification either for a $40 million disallowance or for ignoring prior Commission decisions. Factually, PG&E testified, and ORA did not controvert, that the difference between what customers holding these contracts paid and what they would have paid if they simply bought power at the frozen, full tariffed rate, was $1.7 million. This is clearly far below ORA's proposed shareholder credit of $40.2 million, which is based on a recalculation of floor revenues using the PX prices as marginal cost.

Similarly, the distorted electric markets do not justify abandoning prior Commission decisions in this area. ORA argues that "The actual cost of procuring electricity during the record period is captured in Schedule PX."²⁹ This argument is not persuasive. Indeed, even the Federal Energy Regulatory Commission has found the Schedule PX prices unreasonable, and is actively investigating allegations of market manipulation by energy companies.³⁰ Thus, there is no basis for concluding that what PG&E and other California utilities paid for electric power in this period had any relation to cost. It is even less plausible to use these prices as an acceptable "marginal cost" methodology for reviewing the reasonableness of contracts and supporting a $40 million disallowance.

In addition to the factual implausibility of using Schedule PX as the marginal cost methodology, there is no legal basis for this action. ORA's proposal to require PG&E to re-calculate the floor revenues and CTM for the 1999 and 2000 CTM of its special electric and rate design window contracts by substituting the average annual PX price for the adopted energy and generation capacity marginal cost violates Commission decisions governing the marginal costs used to calculate floor revenues and determine the CTM. Indeed, if we were to accept ORA's proposed reasonableness standard and methodology, PG&E could only have avoided a disallowance by charging approximately $40 million more for power over this period. To do so, however, PG&E would have had to 1) predict that the Commission would adopt new marginal costs in the RAP, 2) predict that the Commission would require PG&E to apply them retrospectively, and 3) write a contract that permitted PG&E to violate the statutorily-based Commission decisions implementing the rate freeze.

PG&E has replied to ORA's proposal, stating that "ORA's request that the Commission find PG&E's administration of special electrical contracts unreasonable because PG&E didn't use the energy and generation capacity marginal cost ORA proposed in this proceeding holds PG&E to an impossible standard."³¹ There is much merit to PG&E's remarks.

ORA's request similarly put the Commission in an impossible position - it asks the Commission to ignore the clear orders of the Commission's previous decisions to alter the Commission adopted marginal cost despite the fact that it is clearly beyond the scope of this proceeding.

In summary, we find PG&E's evaluation of its special contracts and rate design window contracts as consistent with the Commission's methodology for calculating revenue floors and CTM as required by D.90-12-128 and D.97-03-017. Thus, PG&E's CTM calculation and proposed shareholder credit entries are reasonable and are adopted. ORA's marginal cost proposal is outside the scope of the RAP and inconsistent with D.90-12-128 and D.97-03-017. As a consequence, we reject ORA's recalculation of floor revenues as unreasonable and decline to order PG&E to conduct any recalculations using Schedule PX prices.³²