Discussion

The Preferred Policy Decision requires that for a defined period of time, Pacific Gas and Electric Company(PG&E), SDG&E, and SCE each bid all of its generation into the PX and procure electric energy for its full service customers by purchases from the PX. This requirement has become known as the "buy/sell requirement." (See 64 CPUC2d 1, 95, Ordering Paragraph 5.)

Under the pilot, SCE states that it will continue to bid all generation from facilities that it owns into the PX/ISO, just as it does today. Although the "must sell" portion of the buy/sell requirement is limited to energy from the generation capacity of the utility,⁵ SCE will, in addition, bid resources that it is able to procure by purchases under the pilot program into the PX market. SCE claims this is in step with the "must sell" requirement. Further, SCE states that, just as it does today, it will continue to bid its entire customer load into the PX/ISO market, and continue to procure all the electric energy required by its bundled service customers with purchases made through the PX or the ISO's imbalance energy markets. SCE argues that its proposal will have no effect upon SCE's compliance with the buy/sell requirement, and that it is akin to the utilities' participation in the PX day-ahead and ISO imbalance markets.

SCE acknowledges, however, that the Preferred Policy Decision discusses price transparency and market thinness in connection with the buy/sell requirement. The effect of the pilot on price transparency and market thinness underlies the protests filed against SCE's proposal.

Protesting parties argue that SCE's pilot undermines the purpose behind the adoption of the buy/sell requirement. Specifically, protesting parties argue that the purpose of the buy/sell requirement is achieving price transparency, mitigating market power, and reducing the regulatory burden.

We regard the buy/sell requirement as a means to an end. The Commission adopted the buy/sell requirement to achieve specific ends. The Commission stated that the buy/sell requirement will

"dramatically reduce the scope and burden of the regulatory issues associated with determination of the dimension of the assets which are non-competitive in a transparent market, ensure that those customers who elect to rely upon their distribution utility to procure their electric energy will receive the benefits of those competitive market prices, and provide a sufficient depth to the [PX] that its market signals may be relied upon as a benchmark for choices to opt for contracts for differences or direct access arrangements."

(64 CPUC2d 1, 38.) We agree with the protesting parties that we must consider the effect of the pilot proposal on price transparency, and the related market power mitigation and reduced regulatory burden arising from price transparency, in order to determine whether the pilot is in compliance with the Preferred Policy Decision.

We also agree with SCE that we must look at the specifics of the proposed transactions to assess whether the buy/sell requirement has been violated. When it established the buy/sell requirement, the Commission specifically considered allowing the utilities to opt for non-PX purchases and sales. It concluded that unless the utilities are obligated to bid their generation into the PX and procure the electric energy needed to supply their full service customers from it, both the transparency and reliability of the pricing signals would be seriously compromised. The Commission expressly considered the necessity of maintaining the buy/sell requirement in three specific timeframes:

1. the initial period when there is little if any experience with market conditions and function;

2. the five-year period identified as a transition between the regulatory order which is passing and the competitive climate we seek to foster; and

3. the post-transition period.

The Transaction In its application, SCE describes the mechanics of the pilot proposal as allowing SCE to purchase energy and ancillary services from suppliers other than the PX or ISO and bid such purchases into the PX or ISO markets. It states that SCE will enter into traditional types of power purchase agreements with sellers, which may include standard Western Systems Power Pool (WSPP) firm energy contracts, firm capacity contracts, return-to-service contracts, and ancillary service contracts. SCE would then bid such a bilateral power purchase agreement into the PX or ISO at a price equal to SCE's avoidable cost under the contract. Were the bilateral contract a firm capacity contract involving a must-deliver obligation on the part of the seller and a must-take requirement on the part of the buyer, for example, SCE's avoidable cost would be zero, so it would bid the contract into the PX at a price of zero.

In its brief, SCE emphasizes that these traditional, bilateral agreements would be bid into the PX or ISO, but would have the Commission ignore the underlying power purchase agreement and its effect on the goals of the buy/sell requirement. SCE describes the pilot as allowing it to purchase from suppliers other than the PX. It describes the purchases as being bid "on behalf of ratepayers." (see SCE's Application, p. 2.) Both SDG&E and SCE argue in comments that the transactions are wholesale and not retail, likening the proposed pilot transactions to existing qualifying facility and other wholesale power contracts. In the Preferred Policy Decision, we authorized certain treatment for existing qualifying facility and wholesale power contracts, largely on the basis of fairness given past commitments. (64 CPUC 1, 190, Conclusion of Law 9.) SCE and SDG&E argue that the pilot transactions are similar transactions and should be regarded favorably by the Commission. But the pilot transactions would be new commitments, made on behalf of ratepayers. Channeling such a purchase through the PX does not overcome the fact that SCE would be procuring power on behalf of its customers from an entity other than the PX, in direct conflict with the buy/sell requirement.⁶ The pilot would have SCE procuring supply outside the PX, and then scheduling that supply through the PX, rather than matching supply to load within the PX auction. The question is not one of retail versus wholesale markets. The question is, in what forum does the price determination process take place? Clearly it is not in the PX, it is in the forward contract transaction itself. SCE's transactions would occur outside the confines of the PX and ISO, which distinguish them from the utilities' participation in the PX day-ahead and ISO imbalance markets. The Preferred Policy Decision allows for the type of purchases SCE describes, but only after the transition period concludes. (Id.)

SCE asserts that the power purchase agreements would bring additional power or ancillary services to the PX market. SCE states that the proposed pilot, if successful, will attract new sellers and additional supplies of generation that otherwise would not be in the PX spot markets. However, SCE concedes that some or all of the 2000 MW bid into the PX as a result of power purchase agreements signed under the pilot may have bid into the PX spot market absent the program. There is no assurance that the pilot transactions will not displace non-pilot PX transactions.

The Goals As noted above, the buy/sell requirement was adopted with specific ends in mind: price transparency, and the related market power mitigation and reduced regulatory burden arising from price transparency, characteristic of a robust and efficient competitive market. SCE's proposed pilot works against these goals. As SCE concedes in its Reply to Responses and Protests, its "bilateral purchases are not `transparent' to the market in the sense that Edison would not publish its prices." (SCE Reply, p. 8.)⁷ To the extent the pilot displaces non-pilot PX transactions, the overall price transparency may be reduced even though the volume of PX transactions may not be reduced. Further, SCE states, and no party contests this, that the price bid into the PX would not be the cost of the power negotiated in the bilateral contract. Rather, it would be that fraction of the negotiated price which SCE could avoid (its avoidable cost under the contract).

Price transparency brings with it market power mitigation and consumer protection through the ability to monitor the results of the bidding process. (Supra, p. 39.) As the Commission stated in the Preferred Policy Decision, if the utilities made purchases on behalf of their full service customers through bilateral contracts, those customers most vulnerable to an abuse of market power would have no means of tracking the cost of electric power. SCE's proposed pilot has this flaw, and is therefore not in compliance with the Preferred Policy Decision.

A significant aspect of SCE's proposed pilot is its associated ratemaking treatment. SCE includes a new balancing account and sharing mechanism in lieu of traditional reasonableness reviews. The Commission's discussion in the Preferred Policy Decision about the increased regulatory burdens associated with utility non-PX purchases is relevant here, particularly with respect to resolving the appropriate charges to be passed on to full service customers. (See 64CPUC2d 1, 41.) As the Commission envisioned, the process of verifying the appropriateness of the charges would be complicated by the fact that SCE regards the power purchase agreement pricing terms proprietary. Although the proposed pilot probably does not raise the breadth of concerns about regulatory burden described by the Commission in the Preferred Policy Decision, it does increase the regulatory burden. A new and highly contentious review proceeding would be added to the gamut of electric restructuring activities already underway. On its own, this increased regulatory responsibility would not cause us to dismiss the application. It is, however, a stated goal of the buy/sell requirement. It is therefore appropriate for us to address the effect of SCE's proposed ratemaking treatment on our regulatory responsibilities.

Because SCE's proposed pilot works against our goals of price transparency, market power mitigation, and reduced regulatory burden, we conclude that it is in conflict with the Proposed Policy Decision.

Similarly, we find that SCE's proposed pilot constitutes a significant departure from the proposal FERC reviewed and approved when it authorized the operation of the ISO and the PX. The FERC characterized the buy/sell requirement as "critical to the entire retail restructuring proposal."⁸ It acted upon the buy/sell requirement "independently."⁹ As we recognized in our Preferred Policy Decision, close cooperation and coordination with the FERC is required for our restructuring effort to be successful. We are disinclined to embark upon piecemeal changes to the carefully structured market of the transition period, upon which the FERC predicated its conditional approval of the operation of the ISO and the PX. We note that in authorizing the PX's Block Forward proposal, the FERC allowed participants to use the bilateral market rather than the PX to effectuate their transactions, "to the extent that they are not otherwise obligated to use the PX."¹⁰ In dismissing SCE's proposal, we mirror FERC's determination and will not allow it to use the bilateral market to effectuate forward transactions.

Because we conclude that the proposed pilot conflicts with our Preferred Policy Decision, we must conclude that it undermines the goals of AB 1890. Like our Preferred Policy Decision, AB 1890 relies on the new market structures (the PX and the ISO) to provide a competitive energy-services market that will ensure the availability of lower cost power to all California consumers. Integral to achieving a functioning marketplace is the price transparency SCE concedes its pilot proposal lacks.

SCE's proposed pilot is not in compliance with the Preferred Policy Decision, may undermine the goals of AB 1890, and would make piecemeal changes to the market structure upon which the FERC predicated its conditional approval of the operation of the ISO and the PX. We will therefore dismiss SCE's application without prejudice to SCE presenting a proposal in compliance with the Preferred Policy Decision. After the transition period, an appropriate procurement strategy may include commitment to power purchases on behalf of full service customers, as SCE describes. This decision, however, makes no determination on procurement strategy or any other issue bearing on the market structure after the transition period concludes.

Some of the benefits SCE hoped to bring to customers through the proposed pilot may be achieved through other means without compromising the market structure supported in AB 1890, and so carefully put into place in the Preferred Policy Decision and the FERC Orders. In the Preferred Policy Decision, the Commission states that a customer who, for any reason, desires a price structure different from that provided by the PX will have the opportunity to purchase a financial hedge from any counterparty. The Commission recognized that financial hedging could be a part of the restructured marketplace, but opted to allow customers to choose whether and when to use a financial hedge. In the Preferred Policy Decision, the Commission envisioned that customers - not the utility distribution companies -- would make choices to mitigate price spikes. The PX application before FERC for approval of its Block Forward Market, granted May 26, 1999, should encourage development of forward markets, and in a manner consistent with our Preferred Policy Decision. We anticipate that the Block Forward Market will help mitigate price spikes as well.