Gas Prices

The gas prices used to calculate SCE's short-run avoided costs rely on published border prices at Topock.⁵ SDG&E's short-run avoided costs also rely on Topock indices. PG&E's short-run avoided costs are based on a 50/50 weighting of published border prices at Malin⁶ and Topock.

D.96-12-028, p. 15, provides that:

As the market continues to evolve, parties may wish to rely on new published indices. [Footnote omitted.] Parties may file petitions to modify this decision if they wish to change the indices adopted herein. Before making this request, parties should confer regarding the accuracy and robustness of such new indices. As a minimum, we require that there be four months of reliable information available.

According to its Petition, on July 18, 2000, SCE held a meet and confer session to discuss possible changes to gas price indices.⁷ SCE's Petition filed after that meeting did not propose replacement of gas price indices. In comments on the Petition, ORA proposed that the Commission consider replacing the Topock index because of concerns over market power abuse, and suggested that the Malin border price might serve as an appropriate replacement. ORA's comments argued that the Commission's Section 5 complaint at FERC (Docket No. RP00-241-000) "casts serious doubt on the continued legitimacy of the border indices in the SRAC formula." (ORA August 28, 2000 Comments, p. 8.) The ALJ provided parties an opportunity to comment on issues surrounding the border indices and propose alternative indices if so desired.

SCE states that it historically employed a portfolio approach to gas procurement. SCE argues that when the Commission adopted D.96-12-028, the Topock indices "represented a reasonable proxy for the commodity portion of SCE's avoided cost of gas" (SCE September 27, 2000 Comments, p. 16) because of their robustness and reflection of market dynamics. "Whether the Topock indices continue to represent a fair approximation of SCE's avoided cost of gas depends, therefore, on whether the `market determined prices' reflected in the Topock indices are the result of robust, competitive market dynamics." (SCE September 27, 2000 Comments, p. 17.) SCE argues that "the gas pricing components in the Transition Formula [are] no longer performing their intended function of representing a fair approximation of SCE's avoided fuel cost going forward." (SCE September 27, 2000 Comments, p. 5.) SCE presented an analysis to support its position that continued use of the Topock index price overstates its avoided costs.

SCE argues that Topock indices no longer meet the robustness criteria adopted in D.96-12-028 because of withholding of capacity on the El Paso pipeline. SCE alleges here, and this Commission has argued to FERC, that withholding of capacity on the El Paso pipeline has driven up the basis differential⁸ between the San Juan Basin (a producing basin) and the California/Arizona border. In addition, SCE argues that because many QF gas purchases are linked or tied to the Topock indices⁹ that many noncore gas users are now insensitive to the price of natural gas. (SCE September 27, 2000 Comments, p. 12.) SCE argues that this price inelasticity may be a contributing factor to the increase in Topock prices. (See SCE September 27, 2000, pp. 12-13.) In its December 15, 2000 Comments, SCE Declarant Eric Lavik states "It is my understanding from communications with representatives of these publications [list...] that fewer transaction have recently been reported at the Southern California border at Topock than has historically been the case." (SCE December 15, 2000 Comments, p. 26.)

QF Parties¹⁰ argue that basis differentials "between California border prices and producing region prices are influenced by many factors, including fundamental demand factors in California, supply disruptions such as the El Paso accident, and certain trading strategies of market participants." (QF Parties September 27, 2000 Comments, p. 2.)¹¹ QF Parties argue that high demand for natural gas in California, coupled with utilization of the pipeline system at close to capacity makes it unsurprising that prices at the border have risen. This price signal, QF Parties assert, serves the function of alerting the market that pipeline capacity should be expanded. (See QF Parties September 27, 2000 Comments, p. 12.) CAC argues that it is not the indices that are causing problems, but rather the market itself. (CAC September 13, 2000 Comments¹², p. 4.) QF Parties and CAC also point out that the Topock indices are used in performance based ratemaking mechanisms for Southern California Gas Company and PG&E and that ORA has not raised any issues about the continued use of the Topock index for that purpose.

SCE argues that market power abuse and QF pas procurement approaches render the Topock price no longer representative of SCE's gas purchases. Therefore, SCE argues that we must replace the Topock price in the Transition Formula with another index that has not been subject to market power abuse. In its September 27, 2000 Comments, SCE proposes two options to replace the Topock index, Malin or San Juan Basin plus $0.18/MMBtu. $0.18/MMBtu represents the average cost of interstate transportation between the San Juan Basin and Topock in 1997. SCE states that Malin has not been subject to the same market abuse that has occurred at Topock.

In its November 28, 2000 emergency motion, SCE withdrew its support for Malin to replace the Topock index. Instead, SCE now recommends replacing the simple average of the three published Topock border indices currently used in the SCE Transition Formula with an index consisting of (i) 10% of the simple average of three border indices at Topock (as published in Btu Daily Gas Wire, Natural Gas Intelligence, and Natural Gas Week) and (ii) 90% of Southern California Gas Company's ("SoCalGas") monthly published Schedule G-CS Cost of Gas. In a December 1, 2000 Ruling, comments were allowed on this new proposal and on two other options.

Most parties oppose use of any of the options identified by SCE or in the December 1, 2000 Ruling. Coral Energy Resources, L.P. and Engage Energy US, L.P. (jointly Coral) and QF Parties argue that SCE's avoided fuel costs should be based on a Southern California border receipt point, not a Northern California border receipt point. Therefore, although not supporting use of Malin in lieu of Topock, both Coral and QF Parties recommend that, if we adopt Malin as a replacement for Topock, we add intrastate transportation costs to bring it to Southern California. A review of PG&E's tariffs indicates that PG&E's G-AFTOFF or G-AAOFF from Malin to Off System on the Redwood Path would accomplish this proposed adjustment. QF Parties also identified other possible Southern California border indices, namely North Needles, Wheeler Ridge, and Kern River Station, that could replace Topock.

QF Parties argue that use of basin prices adjusted for interstate transportation is unlawful under § 390(b) because it does not rely on border prices as required by the statute. QF Parties also criticize SCE's proposal to adjust the San Juan basin price by the 1997 basis differential as violating the § 390(b) requirement to use current prices in comparing gas prices to the starting price of gas.

Discussion

FERC has the ultimate authority and responsibility to provide relief to California ratepayers should it concur with our complaint that market power abuse has artificially raised gas prices at the California border. We need not have a definitive ruling that market power abuse is occurring to find that the Topock border index no longer represents a robust market. The evidence that has been adduced in numerous rounds of pleadings on this matter has convinced us that the Topock index is no longer sufficiently robust to be utilized in the § 390(b) Transition Formula. Numerous QF parties have submitted declarations regarding how the gas they purchase is tied or linked to Topock prices. Based on the declarations submitted, it is clear that almost none of the QFs that submitted declarations actually purchase gas at Topock, and thus, their purchases are not reflected in the Topock price reported in various publications. Although no specific evidence was adduced regarding the size of the market at Topock (either in terms of number of transactions or volume) at the time D.96-12-028 was adopted or today, it is clear that a significant volume of purchases are not reflected in reported border prices. This reduces the liquidity of the Topock market, making it more susceptible to price manipulation. It is just this sort of reduced liquidity asserted by SCE in the December 15, 2000 declaration of Eric Lavik, paragraph 5.

The possibility of market power abuse on the El Paso pipeline coupled with reduced liquidity in the Topock market convinces us that Topock no longer meets the requirement of reflecting a robust market required in D.96-12-028. The question then becomes, are there alternatives to the Topock index that meet the requirements of § 390(b)? Are alternatives that pass the § 390(b) screen also consistent with PURPA?

Section 390(b) requires that the Commission adjust avoided costs monthly "to reflect changes in a starting gas index price in relation to an average of current California natural gas border indices." We approach our interpretation of this code section based on a plain reading of the statute. Any measure we use for this comparison must be an average. Most of the options considered rely on averages of some number of published indices and therefore this criterion does not eliminate options. Any measure we use for the § 390(b) comparison must be current. The statute does not define "current." Webster's Collegiate Dictionary, Tenth Edition, defines current as "presently elapsing," "occurring in or existing at the present time" or "most recent." Again, the majority of the options considered meet the definition of current because they would select a gas price that relies on information that is publicly available in the month for which the avoided cost is posted. In addition, "current" can be considered a modifier for the word indices. In that case, most of the options also pass this screen because they rely on some sort of published index price.

Because of the word order of the phrase "California natural gas border indices," it is somewhat more difficult to interpret using a simple definitional approach. Multiple locations on the California border have long been considered trading locations in the natural gas market and several published indices report on transactions that occur in those markets. The phrases "California border indices" and "border indices" generally carry the same meaning. (See generally, D.96-12-028 where these two phrases are used interchangeably.) Therefore, we interpret this section to require us to use a measure of natural gas to make the § 390(b) comparison, as well as a California border index. It is this latter requirement that eliminates several possible options from consideration because they do not rely on California border indices.

D.96-12-028 adopted California border indices to replace the index methodology, which derived a border gas price by relying on prices in the producing basins plus interstate transportation costs. ORA encourages us to interpret "California border indices" to allow us to develop a proxy for the border based on the cost to bring gas to the border market (basin plus transportation) rather than the cost of gas purchased in the border market. Such an interpretation is not consistent with the common understanding of the term California border index or the history leading up to development of the Transition Formula. We find that reliance on a basin price plus interstate transportation would violate § 390(b) requirements. Likewise, reliance on a tariffed core subscription rate would also violate § 390(b). Although both of these options derive natural gas prices at the California border, neither is a California border index as the term is typically understood.

The remaining option that is consistent with § 390(b) is to rely on Malin, either alone, or in combination with intrastate transportation costs to bring that gas to Southern California. When SCE owned gas-fired generating facilities, it purchased gas in the Southern California market, therefore if we no longer rely on a California border price at a Southern California market center, but instead use a different border index, the price must be adjusted to represent a Southern California market. We agree with QF Parties that adjusting Malin prices to include intrastate transportation to Southern California is appropriate. QF Parties themselves state that "[t]ypically, Canadian volumes from Malin that are transported to southern California receive a price at Kern River Station that is within one or two cents per MMBtu of the Topock price." (QF Parties September 27, 2000 Comments, p. 10.) We find that adopting a Malin border price plus intrastate transportation as a replacement for Topock meets the requirements of § 390(b).

Next we must determine whether the replacement for Topock meets the requirement of PURPA that it represent the purchasing utility's avoided cost. In its November 28, 2000 emergency motion, SCE asserts that if it still own gas fired generating facilities, it would not purchase gas solely at the border to meet its gas requirements and therefore a border price index cannot represent its avoided cost. We do not need to find that SCE would have purchased gas solely at the border to find that using Malin plus intrastate transportation is a reasonable proxy for SCE's avoided cost of gas and is consistent with PURPA. As SCE emphasizes in its September 29, 2000 Comments, in adopting the Topock indices, "the Commission clearly did not find that SCE had historically purchased natural gas at a price equal to the simple average of the Topock indices." (SCE September 27, 2000 Comments, p. 16, emphasis in original.) By making this statement, SCE acknowledges that in a given month its avoided cost of fuel will differ from the proxy relied on in the Transition Formula, but on average, the proxy will reasonably approximate its procurement costs.¹³ SCE itself argues that Malin indices have closely approximated what it believes the price of gas would be in an undistorted Topock market. (See SCE October 30, 2000 Comments, p. 12.) Over time, setting avoided cost based on a robust border price index can reasonably represent gas procurement costs under a portfolio procurement strategy and therefore will generally meet the requirements of PURPA.

Because we are convinced that the Topock border price does not presently meet the requirement of reflecting a robust market, we replace it with a simple average of the indices at Malin, Oregon plus PG&E's G-AAOFF (Redwood to Off-System Path) tariffed rate. This replacement index reflects an average, current California border index in a robust market. The Topock index should be replaced with this measure effective with the next regularly scheduled avoided cost posting for SCE, PG&E, and SDG&E following the effective date of this decision.

However, we must also harmonize our state statute with PURPA's requirements that rates for QF purchases "Be just and reasonable to the electric consumer of the electric utility and in the public interest". (18 CFR §292.304(a)(i).) We take official notice of FERC's December 15, 2000 order (93 FERC ¶ 61,294) where FERC found that California's market was yielding unjust and unreasonable rates. (93 FERC ¶ 61,294 at 7-8.) In that order, FERC also found that an average of historical utility embedded cost of generation would represent an appropriate benchmark for determining the prudency of forward contracts. (93 FERC ¶ 61,294 at 27.) FERC goes on to state that negotiated prices below this historic level are just and reasonable.¹⁴

Reliance solely on §390(b) to calculate QF prices has recently yielded prices far in excess of this reasonableness benchmark. FERC has found that such prices are unjust and unreasonable for short-term wholesale energy. PURPA requires that rates paid to QFs be just and reasonable. Therefore, although we conclude that, over time, setting avoided cost consistent with §390(b) meets the requirements of PURPA, at specific points in time, the §390(b) Transition Formula may yield prices that exceed FERC's reasonableness benchmark. Therefore, we will rely on the §390(b) Transition Formula as our primary QF pricing methodology but will establish a cap on prices posted under this methodology at the corrected FERC reasonableness benchmark ($67.45/MWh) to fulfill our obligations under PURPA that payments to QFs be just and reasonable. SCE, PG&E, and SDG&E are directed to file a revised short-run avoided cost posting, no later than January 19, 2001, for the remainder of January that implements this cap on a prospective basis. Given the current status of the electricity market in California, it is not clear how, in the long run, the statutory requirement to base SRAC on gas prices must be modified.