6. Discussion

At the outset, we note that the two parties critical of the GCIM - Edison and SCGC - do not oppose incentive-based regulation of the gas procurement activities of SoCalGas. Neither do they urge a return to annual reasonableness reviews in place of the GCIM. For the most part, neither Edison nor SCGC opposes the changes proposed in the Settlement Agreement. Essentially, they urge more changes than those agreed to by the settling parties. Edison, in particular, urges the Commission to conduct a more exhaustive review of the GCIM and modification, as necessary, to provide additional safeguards to protect the interests of noncore entities.

6.1 Continuation of the GCIM

During the first six years of the GCIM, core ratepayers received gas at a cost $42 million below benchmark prices. In Year Seven, with skyrocketing prices in the winter 2000/01 months, SoCalGas was able to procure gas at an overall rate $223 million below benchmark. Most of these savings were passed on to ratepayers through retail gas prices that were substantially less than those charged by other California gas utilities.

These gains were accomplished without adversely affecting reliability. Indeed, the evidence shows that reliability has been enhanced by the Commission's guidelines on gas storage and core procurement activity and by the continuing review process conducted by our staff. ORA states that it is

convinced that the savings generated through the GCIM are the result of the in-house expertise and risk management tools that SoCalGas was encouraged to develop on the promise that the company would share in the savings. "Put simply," ORA states, "this is a program that has achieved all of the Commission's goals and should be continued." (ORA Opening Brief, at 7.)

We agree. While the sheer size of the proposed GCIM shareholder award in Year Seven has been the most targeted issue in this record, the settling parties have sought to deal with that by proposing a cap on the shareholder award for Year Seven and for all future years, including those in which prices are extraordinarily high.

Edison criticizes the GCIM, but it offers no persuasive evidence in this proceeding to support its speculation that the GCIM creates "perverse" incentives for SoCalGas to increase gas prices at the California-Arizona border. In Year Seven, Edison contends that higher gas prices in the winter of 2000/01 were caused in part by SoCalGas' reliance on 9.2 billion cubic feet (Bcf) in hub loan repayments as a substitute for storage. As ORA notes, however, the effect on prices of the 9.2 Bcf in hub repayments pales in significance to the 100 Bcf of increased demand by electric generators like Edison during this period. Moreover, the record shows that the hub transactions were voluntary and that no noncore customer has complained about a SoCalGas hub transaction or border purchase.

The record suggests that factors other than hub repayments contributed to high prices in winter 2000/01. These factors include an explosion on the El Paso pipeline in August 2000 and other reductions in El Paso capacity that

reduced deliveries to Southern California by 20 Bcf.¹ Colder than normal winter weather in Southern California increased heating load by 38 Bcf over average. By far the greatest factor affecting supply and demand was the unprecedented electric generation load. As a result of dry hydroelectric conditions, electric generation load during the third quarter of 2000 was 50% higher than average.

The evidence shows that SoCalGas engaged in trading activities designed to minimize core gas costs by making better use of two fixed assets that core ratepayers pay for: storage and interstate transportation capacity. Using core assets, the Gas Acquisition Department minimized its actual gas costs primarily by engaging in two types of trading activities: the "winter hedge program," which involved hedging instruments and reduced actual gas costs by about $70 million, and by short-term physical and financial trades, including sales of gas at the California border, which reduced gas costs by about $134 million.

Edison's suggestion that the core did not properly fill its storage in Year Seven is contradicted by the evidence. The Gas Acquisition Department has a Commission-established storage inventory capacity of 70 Bcf and aimed to get within 5 Bcf of full capacity storage by November 1, including gas repayable by the end of December. SoCalGas met its storage target with 68.6 Bcf of gas in storage, filling almost 85% of the capacity reserved for the core. By contrast, noncore storage inventory at the beginning of November 2000 (exclusive of wholesale core volumes) was only about 3 Bcf and filled only about 12% of the unbundled storage capacity that noncore entities had contracted.

Edison engages in antics with semantics when it claims that "GCIM profits in Year Seven were $223.6 million." (Edison Opening Brief, at 3.) The facts are that the net cost of gas for SoCalGas core customers was $223.6 million below the benchmark price for gas during Year Seven, and any reference to "profits" under the GCIM is a misnomer. If the Settlement Agreement is approved, SoCalGas shareholders will share $30.8 million of the $223.6 million in net cost savings, and the remainder will benefit core customers.

Finally, Edison's complaints about the Gas Acquisition Department's use of financial instruments, both hedges and swap transactions, on behalf of core customers seems inappropriate when Edison has asked for authorization to hedge its own fuel costs of up to $250 million as part of a recent settlement with the Commission. (Southern California Edison Company v. Loretta M. Lynch, et al., No. CV-00-12056-RSWL (C.D.Cal. entered 10/5/01).

We conclude that Edison's objections to the GCIM are speculative at best and are not supported by the evidence in this proceeding. Similarly, Edison has not persuaded us that yet another investigation of the GCIM is necessary. The Commission has investigated this incentive mechanism through its Energy Division evaluation and an ORA audit, and it continues to do so in this Year Six proceeding and in the Year Seven audit being considered in A.01-06-027.

The evidence at hearing overwhelmingly supports continuation of the GCIM with the modifications proposed by SoCalGas, ORA and TURN.

6.2 Settlement Agreement Changes

The Settlement Agreement jointly sponsored by SoCalGas, ORA and TURN incorporates most of the changes proposed by the Energy Division in its Evaluation Report. According to ORA, the settlement both "assures that the utility will remain a viable, aggressive buyer of natural gas for core customers with the incentive to minimize core procurement costs" and "keeps regulation of core gas costs under the purview of the Commission" to assure that ratepayers remain protected. (Exhibit 22, at 1-2.)

Revision of Sharing Bands

The Energy Division had recommended changing the ratepayer/shareholder sharing bands to reflect the relative difficulty of savings. The settling parties found it impractical to prioritize activities of the Gas Acquisition Department by range of difficulty. Instead, they agreed to substantially reduce the amount of potential shareholder benefits under the GCIM. Instead of the current 50/50 equal share when below the lower tolerance band, shareholders would only be entitled to a 25% share when savings are between 1% and 5% under benchmark and a 10% share when savings exceed 5% under benchmark. Conversely, ratepayers retain all of the savings in the 0-1% range, 75% of savings in the 1-5% range, and 90% of the savings that are more than 5% below the benchmark. Finally, shareholder earnings under the GCIM are capped at 1.5% of total gas costs.

ORA notes that in the first six years of the GCIM, savings typically fell within the range of 1-5% below benchmark, and ratepayers and shareholders each received 50% of these savings. Under the settlement, ratepayers would retain 75% of savings and shareholders 25%. ORA states that these revisions are clearly in the public interest "as they increase the benefit to ratepayers while still providing SoCalGas with a sufficient incentive to lower gas costs." (ORA Opening Brief, at 11.)

The settlement makes no change to the higher tolerance band, where costs up to 2% above benchmark are borne by ratepayers and costs over the 2% level are shared equally. ORA notes that in the seven years under the GCIM, gas costs have exceeded benchmark only once, in Year One, and then by a modest amount. Given this history, we agree with ORA and TURN that the risk to ratepayers of retaining the existing higher tolerance band is more than offset by the increased ratepayer benefit under the lower tolerance band.

Core Storage Targets

The settlement requires SoCalGas to meet storage inventory targets, similar to current targets, but with the clarification that the targets in Year Nine and thereafter would include physical gas in storage and not gas to be received through future hub loan repayments. The core November 1 storage inventory target would thus be 70.0 Bcf of physical gas supply in storage inventory with an accepted variance of +5 Bcf and -10 Bcf. If the November 1 target is not met, deliveries must be made to ensure that there is at least 60 Bcf of actual physical gas in the core's inventory prior to December 1 of that year.

ORA explains that the change to a physical storage requirement increases core reliability, since core customers will no longer be dependent upon noncore customers repaying loans in the winter months.

In a letter to the Commission dated May 15, 2002, the Settling Parties indicated that they would be willing to amend the settlement to provide a minimum core November 1 storage inventory target for Year 9 and beyond of 70.0 Bcf of physical gas supply in storage inventory with an accepted variance of +5 Bcf and -5 Bcf. Our order today conditions approval of the settlement on agreement by the Settling Parties of this change.

Elimination of NYMEX

The settlement eliminates the NYMEX program as a component of the GCIM benchmark, as recommended by the Energy Division. The settlement parties state that there has been much less market participant interest in the NYMEX program. The number of months in which the component has been included in the GCIM was reduced to only one month in Year Seven. The benchmark otherwise will remain unchanged in using monthly published indices from independent publications. Uncontested testimony at hearing described these publications as objective and showed that they represent liquid trading points and are based on hundreds of individual transactions. Also uncontested was testimony that SoCalGas trading activities represent, at most, 3% to 4% of volume monitored by the indices.

Application to Year Seven

An important aspect of the settlement is that SoCalGas has agreed to apply the modified GCIM to the results of the Gas Acquisition Department's Year Seven performance. As noted earlier, this will reduce the SoCalGas shareholder award for Year Seven from $106.1 million to $30.8 million, with the difference going to ratepayers.

A witness for SoCalGas explained at hearing that the utility "made this concession in recognition of the fact that the interests of both its core customers and its shareholders are best served by the continuation of the GCIM. SoCalGas realized that a protracted regulatory battle within a single year of the program would create uncertainty in current operations and potentially jeopardize the GCIM." (Exhibit 4, at 17.)

Uncontested Settlement Provisions

The following aspects of the Settlement Agreement have not been challenged or questioned by any party and, on their face, are reasonable and in the public interest:

1. Any transportation acquired by the Gas Acquisition Department in excess of retail core requirements is subject to review.

2. SoCalGas is required to maximize its utilization of firm pipeline capacity.

3. No capacity commitments in excess of two years will be made without consultation with ORA and TURN, and all other capacity commitments will be communicated to ORA and TURN.

4. SoCalGas will be required to file an advice letter to implement amendments to the GCIM required by the consolidation of SDG&E procurement functions, if that is approved by the Commission in a pending application (A.01-01-021).

5. SoCalGas will continue to file annual GCIM applications and ORA will continue to conduct an audit and prepare its annual monitoring and evaluation report.

6.3 Objections to Settlement

SCGC criticizes the Settlement Agreement on grounds that: (1) it provides inadequate incentives to seek the lowest price for purchased gas; (2) it fails to adequately address ratepayer risk associated with large losses; (3) it fails to provide an effective storage target, and (4) it fails to incorporate a sunset provision. These criticisms are without merit.

First, SCGC claims that the GCIM should encourage purchase of gas at the lowest price, rather than rely on "ancillary revenues" to reduce overall cost of gas. The evidence shows, however, that hub services, gas sales and financial transactions are not ancillary to the Gas Acquisition Department's activities but are essential tools and assets that can be used efficiently to benefit core customers. Moreover, SCGC has not shown a failure by SoCalGas to seek the lowest gas price. The Energy Division notes that purchases made in the four years prior to the GCIM were well above San Juan and Permian spot market prices, while purchases under the GCIM "were generally at or slightly below spot gas prices on average." (Energy Division Report, at 21.)

Second, SCGC presents only speculation about the risk to ratepayers if gas procurement costs are significantly above benchmark. The record shows that over the seven years of the program there has been only one year when a loss was incurred (Year 1), and that loss was relatively small. As we noted in analyzing the proposed settlement changes, retaining the sharing formula for costs above the benchmark appears to be a reasonable quid pro quo in obtaining substantial ratepayer gains for costs below the benchmark.

The contention that the settlement fails to provide an adequate storage target is misplaced. The storage target is 70 Bcf by November 1, with an acceptable variance of +5/-10 Bcf. If that target is missed, the settlement requires that sufficient deliveries be made to reach at least 60 Bcf by December 1. Additionally, as noted, we have conditioned our approval of the settlement on the Settlement Parties' acceptance of a +5/-5 Bcf variance.

Finally, the record does not suggest the need for a sunset provision. The GCIM will continue to require an annual application from SoCalGas and an annual audit by ORA. The Commission, of course, retains the discretion to modify or terminate the program at any time.

We reject SCGC's suggestion that Gas Acquisition Department dealings are comparable to those of the Enron Corporation. Enron was unregulated. By contrast, SoCalGas is regulated by the Commission, and Gas Acquisition Department activities are monitored by ORA and the Energy Division. SoCalGas provides confidential monthly reports of all its transactions to ORA, and ORA performs an extensive annual audit of those activities in each annual GCIM proceeding. At hearing, SoCalGas demonstrated that its trading practices are limited by an Energy Risk Management Oversight Committee.

6.4 Other Issues

SoCalGas, troubled by the extensive discovery sought by Edison, urges the Commission to limit Edison's role in GCIM proceedings, particularly the Year Seven proceeding in A.01-06-027. We agree with Edison that such a proposal is not properly resolved in this proceeding and is contrary to the Commission's intent that noncore interests be considered in GCIM evaluations. SoCalGas may make its discovery objections known in A.01-06-027 if necessary.

SCGC asks the Commission in this decision to consider the Larkin and Associates report, issued in July 2000, suggesting an imbalance penalty against SoCalGas shareholders for over-nomination days when the hub is in a "net-in" position. As SoCalGas notes, however, the Commission in a decision issued in December 2001, approved a Comprehensive Settlement Agreement that effectively adopted the objectives of the Larkin recommendation. (Re Gas Industry Restructuring, D.01-12-018.)