DISCUSSION

Compliance with the Rule governing protests. PG&E argues that the protests should be rejected as they each fail to meet the threshold conditions imposed on protests by Rule VII.E.3. The utility is incorrect and the protests are not rejected. Rule VII.E.3 requires that protestants provide the Commission with at least one of two things: either the specific Rule, law, decision, or Commission policy the proposal will violate, "with reasonable factual detail;" or an explanation of the harm the protestant will suffer if the Commission approves the proposal. ORA argues that PG&E's proposal violates D.99-04-021 in that the utility intends to include "imbedded" costs in its calculation of sharable net revenues. While PG&E denies this, if ORA is found to be correct the proposal would tend to understate the net revenues available to be shared with ratepayers. ORA has satisfied Rule VII.E.3 and the protest is not rejected.

Enron and PHASER each argue that the proposal is anti-competitive and that, as competitors or potential competitors, entry by PG&E into this market would harm them as well as the market. Enron further asserts that this sort of service was not envisioned by the Commission when it developed Rule VII, that the Rule was designed to exploit excess capacity of capital, not labor, and that the Commission's policy is to have such services offered through an unregulated affiliate if practicable. The question(s) of potential harm and conflict with Commission policies are sufficient to satisfy Rule VII.E.3 and thus these protests are not rejected.

UC also argues that this proposal is anti-competitive, as the utility already possesses "scale economies" in the provision of this service that would lower average costs as the utility expands the program.2 Thus the protestant argues that the Commission's policies against anti-competitive practices by the utility would be violated by this proposal. This satisfies the requirements of Rule VII.E.3 and thus the protest is not rejected.

The provision of this service by other utilities. PG&E argues in several places that other utilities are already providing this service and, as such, PG&E should be allowed to enter this market as well. The utility asserts that the services provided by the other utilities were "grandfathered" under Rule VII as they were offered to customers prior to the implementation of the Affiliate Transaction Rules (December 16, 1997). These services were listed in advice letters submitted to the Commission on January 30, 1998.

It is true that meter reading services are offered to the market in some form by other energy utilities, and as such this fact gives some merit to the argument that PG&E should be able to offer similar services. However, it is not true that any nontariffed services have been "grandfathered," as stated by PG&E. Rule VII.C lists requirements that must be met for all products and services offered by the utilities. If these conditions are not met, the utility must discontinue offering the product or service, even if it was offered before implementation of the Affiliate Transaction Rules. In addition, it is clear that the Commission is interested in ensuring that any new category of product or service is offered in the public interest. It is not sufficient that new offerings satisfy Rule VII.C, but they must also meet the additional conditions imposed by Rule VII.E. It is therefore a mistake to suggest that the Commission would allow the provision of a product or service simply because a similar product or service was offered by another utility at the time these Rules went into effect.

Compliance with Rule VII.C.4. Protestants have argued that this proposal does not comply with the following requirements for a nontariffed utility product or service:

a) The nontariffed product or service utilizes a portion of a utility asset or capacity;

b) Such asset or capacity has been acquired for the purpose of and is necessary and useful in providing tariffed utility services.

Enron argues that meter readers are not the type of assets envisioned by the Commission. This is true, although the parties advocating these Rules in R.97-04-011/I.97-04-12 list several examples of what they would consider acceptable nontariffed services, including "third-party use of technical employees on an `as available' basis. . . ." (D.97-12-088, mimeo p. 80) This suggests that the Commission did not consider surplus, "as available," labor to be unavailable for such services. It may be, however, that meter readers may not be considered "technical employees" and that exploitation of their labor may be beyond the scope of this Rule's applicability.

This is a moot point, however, as the utility has pointed out that most of the surplus capacity used to provide this service is not in labor, but in the trip to the meter. The increased efficiencies should be largely in the meter reader's ability to read multiple meters with one visit to the customer's premises. 3 As such, it is clear that this proposed service utilizes a portion of the utility's assets or capacity. Further, it is equally clear that this meter reading capacity was created to facilitate the provision of the tariffed utility service. Hence the proposed meter reading service satisfies Rule VII.C.4.a and b. The protest of Enron is denied on this point.

Anti-competitive concerns. What the utility does with these lower average costs is the crux of the issue here with many of the protestants and parties. There are essentially two types of parties filing protests or comments on this advice letter: Potential customers of this service and potential competitors to this service. The potential customers, UC and the cities, would like to see these lower average costs go to them in lower price. However, the potential competitors, PHASER and Enron, are concerned that such pricing would be anti-competitive in violation of Commission policy, Rule VII.C.4.e, or Rule VII.E.1.d. For instance, the Commission said in the decision implementing these Rules:

The Commission was concerned at the time of this decision that utilities might interfere with the development of competitive markets if they provide services themselves rather than through their affiliates. Such interference would happen through the exercise of market power by the utility. In a competitive market the firms charge the price determined by the interworkings of supply and demand. A firm with market power, however, has the ability to manipulate the price it charges to its advantage. The firm could, for instance, hold its price above average costs in an effort to make a long-run profit. Alternatively the firm could hold its price below the average cost to undercut what other market participants have to charge, thus preventing entry into the market. This latter action would clearly interfere with the development of this market, or could interfere with the efficient working of an existing competitive market. The Commission was concerned about such inefficiencies when it discussed the potential transfer of utility market power to the affiliates:

This same reasoning applies to a business unit of the utility when it creates an entry barrier through an artificially low price; i.e., a price that is lower than competitors' prices because not all costs are reflected, rather than a price that is low due to the internal efficiencies of the business unit. The utility seems to recognize the importance of a market-determined price when it says on page 4 of its advice letter, "The specific product and service offerings will be priced based on market rates." (AL 2166-G/1890-E, p. 4) PG&E reiterates this on page 6: "All pricing will be market-based." Thus, the utility suggests that its prices will reflect the price determined in the competitive market, not its own costs. PG&E does not, however, explain how this market price will be determined by the company.

The protestants recognize that prices based on cost advantages that are unique to the monopoly raise anti-competitive concerns. Enron suggests that the utility would "subsidize" the price of this service. Even some of the potential customers, the cities who wrote to the Commission on this matter, who say they want the lower price they believe will come out of this proposal, also say they want "the freedom to choose the best service provider. . . ." Two cities say "the market place should set the price for these services." Thus even the potential customers recognize the importance of having healthy markets for the goods and services they need.

In a written response to questions posed by Commission staff, PG&E explains that it defines a "market rate" as one set by willing participants "in a free and competitive market." (Response to Energy Division (Response), April 17, 2000, p. 2.) PG&E states that it "does not intend to provide an offer of service at less than its costs." (Id.) In fact, the company will "ensure that the prices it offers exceed the costs incurred in providing non-tariffed meter reading services." (Id., p. 3) PG&E explains that "[i]t is not anti-competitive for PG&E to enter the market for non-tariffed meter reading services, so long as PG&E charges a price that is greater than its costs." (Id., p. 4)4 PG&E has collected information from its potential customers regarding recent bids for this service by other meter reading services, and has conducted, and will continue to conduct, time and motion studies to determine actual costs. The company points to D.99-04-021 which, in establishing a revenue sharing mechanism for nontariffed products and services, grants limited pricing flexibility for these projects. The decision cautions that:

Thus, while PG&E has pricing flexibility, it must set prices that are not anti-competitive, and therefore do not discourage market competition or entry. Prices should reflect those found in the market charged by incumbents. All firms must cover their total costs in the long run in order to remain viable. This is true of PG&E as well. PG&E reiterates several times in its Response that it will charge prices which are higher than its costs. While the company is apparently referring to its "incremental costs" (see fn. #1 of its Response) as it defines in A.98-05-007 and to which the Commission refers in D.99-04-021, these should be total costs. "Incremental costs," while apparently including direct overheads, exclude other fixed costs such as the embedded costs as well as Corporate Administrative and General costs. Such fixed costs must be recovered in prices by PG&E's unregulated competitors if they are to survive. If the PG&E business unit offering this service is not required to cover these costs in its prices, it enjoys a cost advantage not derived from its own internal efficiencies. As discussed above, such cost advantages are anti-competitive and violate Commission policy. Although we approve this proposal, we will require PG&E to supplement its advice letter to clarify its pricing methods and to explain how it intends to ensure that the total costs, not just "incremental costs," of this service are recovered in the prices it charges. The protests of PHASER and Enron are granted on this point.

Should this service be offered by an affiliate? PHASER and Enron advocate that the Commission require PG&E to offer this service through an affiliate, that the Commission's policy is to prefer that nontariffed products and services be offered by the unregulated affiliate rather than by the utility itself. The protestants are correct on this point. This Commission's preference toward the use of affiliates to provide nontariffed products or services is suggested in its discussion in D.97-12-088:

This preference for the use of affiliates is further supported by the wording of Rule VII, which starts with:

Similar phrasing can be found at the beginning of Rule VII.C. Thus it appears that the Commission has a policy preference for the use of affiliates to provide nontariffed products and services, and does not want Rule VII to be used to circumvent the market safeguards and separation actions represented by the Affiliate Transaction Rules.

However, the excess capacity to be used to provide this service, primarily the initial trip to the customer's premises, is not easily transferable to an affiliate. Much of the efficiencies that would be gained by use of the current meter readers on their existing routes would be lost. Therefore, we will not require this service to be offered through an affiliate at this time. The protests of PHASER and Enron are denied on this issue.

The OOR sharing mechanism. D.99-04-021, which established an interim mechanism for sharing net OOR, adopts PG&E's proposal to allocate "all incremental costs related to the new offerings" except for "embedded asset costs and Corporate Administrative and General costs." PG&E argued that these latter "costs would not be affected by the new offerings. . . ." and thus should not be subtracted from the revenues raised by the new offerings (mimeo, p. 4). Neither the decision nor Appendix A, adopted by the decision, defines incremental or embedded costs further. PG&E's application, leading to this decision, gives the following definitions:

On p. 11 of the application PG&E says that incremental costs are "directly attributable to the NTP&S." ORA worries that under the current proposal costs already covered by ratepayers will now be subtracted from OOR to determine sharable revenues, thus counting these costs twice.5

The advice letter on pages four and five describe how PG&E will use time and motion studies to determine the incremental labor time required to perform this service for a particular customer. This additional labor will be multiplied by the appropriate labor rate which is in turn augmented for certain direct overhead costs:

_ Direct supervision and management

_ Benefits and payroll taxes

_ Vehicle costs

_ Personal office space

_ Personal materials or equipment (e.g., uniforms, hand-held tools, telephones, office supplies, computers, etc.)

Most of these direct overhead costs, while necessary to recognize when making pricing decisions and assessing the viability of the project, are not "incremental costs . . . attributable to the NTP&S" and are not appropriate for inclusion in the sharing mechanism approved by D.99-04-021. Certainly the cost of supervision and management, vehicles (except for the marginal cost of fuel and maintenance if additional trips are required), office space, uniforms and equipment is not affected by the marginal increase in the number of meters to be read anticipated by PG&E. The utility has 800 union employees, and can supplement this labor through its "hiring hall." To the extent that employees are paid by the hour, the additional cost of their labor to the company should be captured by a factor that includes benefits and taxes. If additional employees must be hired from the hiring hall to perform these services, some of the costs above, such as additional vehicles, uniforms, equipment and supplies, may be appropriately assigned under this mechanism. However, such costs should be minimal in many cases, according to PG&E's Response on page one: "In areas where PG&E already collects gas and/or electric meter data at every premise, the incremental labor requirements for PG&E to read third party meters are low. . ." and can be met through use of its current employees and the hiring hall.

We grant this advice letter but will require PG&E to file a supplemental advice letter which explains how the utility plans to limit the costs it allocates to this sharing mechanism to those that are incremental and directly attributable to this service. The protest of ORA is granted on this issue.

Notice It is important that companies that may be affected by this proposal, because they are competitors or potential competitors, be informed about it. Many of these companies are included in the lists of those served this advice letter, including the interested parties in OIR/OII 97-04-011/97-04-012 and interested parties in accordance with Section III of General Order 96A. However, there is no assurance that these lists include all or even many of the potential competitors for this service. In fact, two of the Protestants to this advice letter, PHASER and UC, are not included on these lists. In its Response, PG&E identifies two additional potential competitors.6 When PG&E files its supplemental advice letter, described above, it should serve the parties to R.97-04-011/I.97-04-012, the protestants to the advice letter, and other potential competitors and meter-reading industry associations, if any. These additional parties should be listed in the supplemental advice letter.

2 However, UC does not see this as sufficient reason to reject the proposal, but instead wants any resulting cost savings to be offered to ESPs as well as to the target customers identified by PG&E.

3 While the utility and others regularly refer to these economies as scale or scope economies, they are neither. These efficiencies are due to falling average costs, resulting from an increase in labor effort while holding the fixed inputs constant. These fixed inputs would be the trip, trucks, and other capital inputs. Rather than scale or scope economies, these efficiencies are due to the Law of Variable Proportions.

4 PG&E also points out that there are few cost-based barriers to entry in this market: "meter reading does not require advanced technical skills, significant capital plant, or other sunk investments, such as mass market advertising." (Response, p. 6) This fact would suggest that it would be unlikely that the utility could hold its price high enough to capture significant economic rents, as entrants would undercut the monopoly and reduce its market share.

5 PG&E mischaracterizes ORA's position when it asserts that ORA wants all costs, including imbedded costs, included in this methodology. To do so would, in fact, decrease the revenues shared with the ratepayers.

6 California Water Service Company and Golden State Flow Measurement. Response, p. 6.

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