ALJ/RAB/avs Mailed 8/29/2005

Decision 05-08-005 August 25, 2005

BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA

Application of San Diego Gas & Electric Company (U 902 E) for Adoption of Cost Recovery and Ratemaking Mechanisms Relative to SDG&E's Acquisition and Operation of the Palomar Energy Center.

Application 04-11-003 (Filed November 1, 2004)

OPINION APPROVING APPLICATION

San Diego Gas & Electric (SDG&E) requests approval for the cost recovery and ratemaking mechanisms necessary to allow SDG&E to recover its reasonable and prudent costs of acquiring, owning, and operating a 500 megawatt (MW) (base load)/555 MW (peaking load) combined cycle natural gas-fired generation plant located in Escondido, California (Palomar Energy Center). SDG&E is obligated to acquire and operate the Palomar Energy Center pursuant to the Turnkey Acquisition Agreement between SDG&E and Palomar Energy, LLC (a subsidiary of Sempra Energy Resources) dated January 29, 2004, (the "Turnkey Acquisition Agreement).

The Commission approved the Turnkey Acquisition Agreement in Decision (D.) 04-06-011. SDG&E requested that the Commission, in that decision, also approve specific cost recovery and ratemaking proposals necessary for SDG&E to recover its ownership and operation costs for the facility. However, other than stating that "SDG&E is authorized to recover the costs of this generation-owned asset through the established 10.90% return on equity (ROE),"¹ the Commission declined to act on SDG&E's cost recovery proposals. Consequently, SDG&E proposes in this application a cost recovery plan in order to obtain certainty on the costs and expenses it can recover through rates for owning and operating the Palomar Energy Center before actually acquiring the facility. The plan essentially consists of a monthly revenue requirement and a variable operations and maintenance (O&M) rate that, collectively, will allow SDG&E to recover its costs. The plan incorporates the heat rate incentive mechanism approved in D.04-06-011. SDG&E assumes ownership and operation of the Palomar Energy Center June 1, 2006. SDG&E is not requesting either a rate increase or rate change in this application.

This application requests approval of: (1) a fixed monthly revenue requirement of $7,600,100 subject to update prior to going into effect on the first month of commercial operation of the Palomar Energy Center, (2) a variable O&M rate of $3.08 per megawatt hour (MWh) subject to update prior to going into effect on the first month of commercial operation of the Palomar Energy Center, and (3) an overall cost recovery regulatory plan addressing the length of time the foregoing will be in effect, the balancing accounts in which revenues from the foregoing will be accumulated, and how additional items like fuel costs, heat rate incentives, reliability must run (RMR) revenues, and imputed franchise fee payments to the city of Escondido will be handled.

SDG&E proposes that all Palomar Energy Center costs, consisting of actual fuel costs and authorized fixed and variable non-fuel costs, should be recovered in SDG&E's commodity rates through SDG&E's Schedule Electric Energy Commodity Costs (EECC) except for costs allocated to the RMR function which should be recovered from all customers through the reliability service (RS) rate component.² The non-fuel costs proposed for recovery from the in-service date of the Palomar Energy Center until the implementation date of SDG&E's next general rate case/cost of service case (GRC/COS) are: (1) a fixed monthly revenue requirement of $7,600,100, subject to adjustment prior to the Palomar Energy Center going into service for changes in certain cost components and updates to cost escalation factors; and (2) a variable O&M rate of $3.08 per MWh of generated output to recover variable O&M non-fuel costs that is also subject to adjustment (for updates to cost escalation factors) prior to the Palomar Energy Center going into service. The fixed monthly revenue requirement and variable O&M rate should be reset in SDG&E's next GRC/COS proceeding, projected to occur in 2008.

SDG&E proposes that, in compliance with D.04-06-011, any rewards or penalties associated with the adopted heat rate incentive for the Palomar Energy Center will be recorded in SDG&E's Energy Resource Recovery Account (ERRA) for recovery in commodity rates. Any Palomar Energy Center-related RMR revenues received from the California Independent System Operator (CAISO) will be recorded in SDG&E's Non-Fuel Generation Balancing Account (NGBA) to offset commodity costs. Finally, the "imputed franchise fees" paid to Escondido on gas delivered to the Palomar Energy Center will be recorded in the ERRA for recovery in commodity rates.

The components of the fixed monthly revenue requirement for the Palomar Energy Center are: (a) rate base; (b) return; (c) depreciation; (d) taxes; and (e) O&M expenses. Certain components of the fixed monthly revenue requirement will need to be updated immediately prior to the Palomar Energy Center going into service (and therefore the fixed monthly revenue requirement going into effect) to reflect (a) base purchase price adjustments that are generally described and permitted by the Turnkey Acquisition Agreement, (b) updated escalation factors, and (c) changes to inputs used to develop the fixed monthly revenue requirement to reflect recent Commission decisions adopting changes to those inputs.

SDG&E discussed the expected values for the Palomar Energy Center's O&M costs, both fixed and variable. The fixed O&M costs include, generally, costs for O&M staff (plant staff, payroll taxes, and home office services allocation), materials and services, and other items such as insurance and equipment modifications and replacements. Variable O&M costs consist of materials and services costs, which include costs for recycled water, a Contractual Service Agreement (CSA) with General Electric International, Inc. for major maintenance and overhauls, contingency for unplanned maintenance, consumables and catalyst replacement.

Prior to filing this application, The Utility Reform Network (TURN) and SDG&E discussed its contents and various issues of concern. When SDG&E filed the application certain changes were made to address some of TURN's issues. TURN and the Office of Ratepayer Advocates (ORA) conducted discovery in this proceeding. Eventually, TURN and ORA identified three items of concern. After some discussion, TURN, ORA, and SDG&E (the Parties)³ agreed on what they believe to be an equitable resolution of those issues such that the Parties can represent that Commission approval of the Palomar Application with the three modifications specified below is a fair, equitable, outcome and in the public interest. On that basis the Parties state that there are no longer any material issues of fact to be determined.

Summary of Palomar Application

The Palomar Application requests, and based upon the modifications addressed in B., below, the Parties recommend approval of: (1) a fixed monthly revenue requirement of $7,600,100, subject to update prior to going into effect on the first month of commercial operation of the Palomar Energy Center, (2) a variable O&M rate of $3.08 per MWh, subject to update prior to going into effect on the first month of commercial operation of the Palomar Energy Center, and (3) an overall cost recovery regulatory plan that recognizes that the fixed monthly revenue requirement and variable O&M rate will be reset in SDG&E's next GRC/COS proceeding, projected to occur in 2008.

The application states that all Palomar Energy Center costs, consisting of actual fuel costs and authorized fixed and variable non-fuel costs, should be recovered in SDG&E's commodity rates through SDG&E's EECC except for costs allocated to the RMR function which should be recovered from all customers through the RS rate component. Commodity rates that include the authorized fixed revenue requirement and the variable O&M non-fuel costs may lead to recorded revenues that are higher or lower than the authorized revenues due to higher or lower-than-expected customer sales and/or higher or lower-than-expected generation output from Palomar Energy Center. Such overcollections or undercollections of the authorized fixed revenue requirement and the variable O&M non-fuel costs will be recorded in the non-fuel Generation Balancing Account (NGBA). For each calendar year following the in-service date, the Palomar Energy Center NGBA balance will be included in SDG&E's annual NGBA advice letter filing (filed in the 4^th quarter) and annual consolidated electric rate change filing (filed in December) to be recovered in commodity rates effective January 1 of the following year.

The application also states that any rewards or penalties associated with the adopted heat rate incentive for the Palomar Energy Center should be recorded in SDG&E's ERRA for recovery in commodity rates. Any Palomar Energy Center-related RMR revenues received from the CAISO should be recorded in SDG&E's NGBA to offset commodity costs. Finally, as approved by the Commission in D.04-06-011, the "imputed franchise fees" paid to the city of Escondido on gas delivered to the Palomar Energy Center should be recorded in SDG&E's ERRA for recovery in commodity rates.

Certain components of the fixed monthly revenue requirement and the variable O&M rate will need to be updated immediately prior to the Palomar Energy Center going into service to reflect (a) base purchase price adjustments that are generally described and permitted by the Turnkey Acquisition Agreement, (b) updated escalation factors, and (c) changes to input used to develop the fixed monthly revenue requirement to reflect recent Commission decisions adopting changes to those inputs. That update advice letter filing will also serve to incorporate the agreed modifications to SDG&E's application addressed below.