IV. Discussion

In Decision (D.) 87-06-021, we defined reasonable to mean that at a particular time any of the practices, methods, and acts engaged in by a utility follows the exercise of reasonable judgment in light of facts known or which should have been known at the time the decision was made. The act or decision is expected by the utility to accomplish the desired result at the lowest reasonable cost consistent with good utility practices. Good utility practices are based upon cost effectiveness, reliability, safety, and expedition. A reasonable act is not limited to the optimum practice, method, or act to the exclusion of all others, but rather encompasses a spectrum of possible practices, methods, or acts consistent with the utility system need, the interest of the ratepayers and the requirements of governmental agencies of competent jurisdiction.⁴

We have used this standard to address the reasonableness of utility contracts throughout the years, such as in San Diego Gas & Electric Company's Southwest Power Link arrangement.⁵ We use this same standard in our evaluation of SCE's 2002 and 2003 hedging options and costs.

ORA has provided testimony, but neither affirms nor disavows the reasonableness of SCE's hedging expenses or reasonableness of the proposed cost recovery.⁶ The purpose of its testimony is to "lay out the background in this proceeding,"⁷ which is also set forth in the application. Irrespective of its informational testimony, ORA recommends that:

· SCE and ORA collaborate to actively manage SCE's QF hedging portfolio.




· SCE's QF hedging be integrated with its overall portfolio management of electricity and natural gas price risks.




· Any additional expenditures resulting from modifying the hedge agreed upon by SCE and ORA be deemed reasonable.




· SCE work collaboratively with ORA if it desires to hedge QF-related risk in 2004.

ORA's testimony addresses future hedging costs and proposes an approach to be used prospectively. Unfortunately, ORA does not address the identified issues and its recommendations apply to issues outside of the scope of this proceeding. Hence, we must reject consideration of ORA's testimony and recommendations in determining whether SCE's hedging costs in its RMMA are reasonable and whether such cost should be recoverable.

a. Hedging Options

With only SCE testifying on the reasonableness of its hedging options, that testimony must reasonably substantiate that SCE hedging options was the appropriate vehicle to avoid volatility in gas prices and to create more certainty regarding its QF payments and procurement related obligations.

SCE identified swap contracts and hedging options as viable means to stabilize its gas prices. Swap contracts would require SCE to pay a fixed price each month for a specified volume of gas. In exchange, the counter party to swap contracts would pay SCE the SoCalBorder index price for gas each month for the same volume. Although cash settlements would occur each month, there would be no physical gas changing hands. As the price of gas fluctuates, the contract becomes more or less valuable. If the price of gas falls, SCE would be required to post collateral. This collateral could consist of either cash or a letter of credit.

Hedging options do not have any collateral requirements. However, SCE must pay up front. In return, SCE receives the difference between the gas price and a strike price multiplied by the volume of gas covered by hedging options if the price of gas rises above that strike price for the period covered by those options.

SCE selected hedging options because it was not able to post any collateral for swap contracts. In support of its selection of hedging options, SCE

explains that its ratepayers have already received benefit. For example, on February 8, 2002, Moody's Investment Service (Moody's) assigned a (P)Ba2 rating to $1.5 billion of secured credit facilities being arranged by SCE. In the publicly released rationale of its rating, Moody's stated that it views the cash flows of procurement related obligations to be fairly predictable because most of the volatility has been eliminated or reduced by actions of SCE and others, such as SCE hedging its exposure to natural gas price increases.

We recognize that SCE's financial situation in 2001 precluded SCE from posting collateral (cash or letter of credit) for swap contracts. That is because SCE was nearing bankruptcy by incurring a large debt burden to purchase power. If SCE had tried to post collateral, it is possible that such an action would have been deemed a termination event under the forbearance agreements between SCE and its bank lenders, thereby enabling the lenders to accelerate the repayment of $1.65 billion of SCE's then outstanding bank borrowings.

SCE's 2002 and 2003 hedging options did limit its exposure to high gas prices while retaining the benefit of any price decrease without being required to post collateral, a condition it was not in a position to satisfy. That exposure amounted to $208.8 million, as represented by the balance in its RMMA. In light of the financial facts known at the time of its decision to participate in hedging options over swap contracts, SCE exercised reasonable judgment in utilizing hedging options.⁸

b. Recoverable Cost

SCE submitted testimony under seal to support the reasonableness of the $208.8 million cost it incurred from hedging. SCE deems such information confidential because it is not currently available to the general public and, if

disclosed, would provide competitors an insight into SCE's hedging strategy and bargaining position. If disclosed, it would also place SCE and its ratepayers at a disadvantage in seeking future hedging options. The Administrative Law Judge (ALJ) affirmed that this information is confidential and ruled that SCE's confidential information should remain sealed and not be disclosed to anyone other than Commission staff except on the execution of a mutually accepted non-disclosure agreement or further order or ruling of the Commission, the ALJ, or the assigned Commissioner.

We scrutinized SCE's sealed testimony to determine how much of the RMMA balance should be recoverable. That sealed testimony provides substantial information on the details of the volumes hedged, price-per-option, transaction structure, and competitive quotes. Based on that sealed testimony and informed judgment, we find that the entire cost in the RMMA complies with the reasonableness criteria set forth in D.87-06-021. SCE should be authorized to recover its $208.8 million hedging cost.

SCE seeks authority to transfer its hedging costs deemed reasonable to the SRBA from the RMMA. Its recommendation is based on Resolution E-3765. That resolution established a Procurement Related Obligation Account (PROACT) and associated ratemaking structure, including treatment of hedging costs recorded in the RMMA as "Recoverable Costs" in the operation of the PROACT. That resolution also provides for all recoverable hedging costs to be recorded in the SRBA until the Commission renders a final decision with respect to SCE's URG ratemaking proposal in Application 00-11-038. Consistent with Resolution E-3765, the hedging balance in the RMMA should be transferred to the SRBA and the RMMA should be closed.⁹