8. Generation Expenses - Project
Development Division

8.1 SCE's Proposal

For the test year, SCE requests $4,950,000 in expenses to fund its Project Development Division (PDD). Costs are included in Accounts 506 and 549. According to SCE, the PDD's primary function is to analyze, develop, and propose for Commission approval, cost-effective, utility-owned generation opportunities consistent with SCE's long-term procurement plan. These opportunities could include new plant construction, repowering, joint-ventures, purchasing shares in new or existing facilities, or other commercial arrangements. SCE states that secondarily, PDD provides the Resource Planning and Strategy organization with data regarding construction costs, project economics and the commercial feasibility of future resource supply levels, as requested, to assist in long-term procurement forecasting. SCE lists PDD's activities to include the following:

· Identifying sites with the potential for development and construction of new utility-owned power generation projects;

· Conducting financial analyses and commercial evaluation of generation development opportunities and alternatives;

· Overseeing preliminary project engineering, permitting, and contract negotiations for potentially feasible projects;

· Managing regulatory approval processes at the California Energy Commission, California Public Utilities Commission, Federal Energy Regulatory Commission, and other state and local agencies;

· Developing and implementing plans to advance projects from the development phase to the construction and operations phase; and

· Providing ongoing support to resolve development-related financial, permitting, and contractual issues that may arise during construction or operations.

8.2. Positions and Other Parties

DRA opposes allowing SCE to recover the costs of this new Project Development Group as continuing expenses in base rates. DRA does not object to electric utilities owning generation or even procuring new "owned" generation, provided such ownership and development is on a level playing field with other generation developers. Ratepayer funding of personnel and contractor costs would essentially allow SCE a ratepayer-funded subsidy not available to any other entity seeking to develop additional generation.

Aglet states that allowing SCE to recover project development costs in base rates, while independent power project developers include such costs in their bids, would give SCE an unfair advantage in competition for future electric resources and could lead to higher rates for SCE ratepayers. Aglet recommends that, as a matter of public policy, the Commission must keep project development costs out of base rates -- specifically, SCE should record PDD costs "below the line" and include them in future resource bids as it chooses.

WPTF also states that it does not oppose the utility's proposal for creation of a PDD, indicating that, to the extent the utility decides that it wishes to engage in project development in the future, it will need to have personnel who are tasked with developing such options. However, WPTF recommends that the Commission should reject the SCE funding proposal for the PDD for the following reasons:

· First, the Commission has stated that it wishes to foster fair competition between utility-sponsored, turnkey, or buyout proposals and third-party generation power purchase agreements (PPAs). It would be highly inconsistent with that vision to permit utility project development efforts to be subsidized with ratepayer dollars. To the extent the project development costs were not included in SCE's bids, RFO results would be inappropriately skewed in favor of the utility.

· Second, this action would be in direct opposition to the Long-Term Procurement Plan decision that the Commission issued on December 16, 2004. That decision, D.04-12-048, specified that a utility would only be able to recover from ratepayers the amount of the utility's bid, should it win the bid.

WPTF recommends that, should SCE elect to establish a PDD, it should be specifically required to include in the costs of each of its bids all PDD costs associated with the development of the project that is being proposed by the utility; and SCE shareholders, rather than its ratepayers, should be solely responsible for any expenditure incurred by the PDD to develop projects that do not win a bid.

IEPA argues that the proposed PDD harms ratepayers in at least two ways. First, it undermines competition among project proponents that the Commission articulated as the model for utility procurement in D.04-12-048. Second, by requiring ratepayers to subsidize the development costs of only one of the competing project developers (i.e., SCE), the PDD proposal directly increases the ratepayers' costs of generation. IEPA urges the Commission to deny SCE's request to establish a PDD at ratepayers' expense.

IEPA referred extensively to D.04-12-048, indicating the Commission repeatedly endorsed "an open, transparent and competitive bidding process" and "greater head-to-head competition." IEPA asserts that SCE should face the same cost risks as independent generators and developers to the extent that it engages in the project development business. Otherwise, the utility will not only have an unfair competitive advantage over independent generators and developers, it will also have no incentive to manage such costs prudently. As a result, SCE's ratepayers could end up paying far more for the development of new generation than they would otherwise. IEPA also states that, if the PDD proposal is approved, independent power producers will see how the utilities are allowed to recover project development and other costs from ratepayers outside of the solicitation process, and may become discouraged by such an unfair process and decide to invest in generation elsewhere, resulting in a less competitive generation market in California.

8.3 SCE's Response

SCE notes that its PDD request is less than half of 1% of its total test year request. SCE states this is a modest ratepayer investment in a program designed to protect SCE's ratepayers against market abuse by electricity suppliers. SCE explains that a PDD will provide such insurance to ratepayers by keeping open the option of utility-built generation. Such utility-built generation will provide the Commission with a Commission regulated option for development of utility-owned cost-of-service generation. SCE states that this option is necessary so that SCE and ratepayers are not forced to rely on the hope that independent generators will make their supplies available in the market. SCE notes that Commission rejection of PDD funding will likely foreclose any future utility development of generation projects.

Regarding the uneven playing field argument, SCE has stated that it will include all costs of developing a project when conducting comparisons of development projects. The company indicates that it would do so by either tracking the specific costs associated with the development project and then adding it to the SCE estimated cost of the project, or by adding an agreed upon percentage of a project's total budget to the SCE estimated cost. SCE states that its proposal fully expects the ratepayer-funded PDD costs to be accounted for when SCE is comparing the projects it develops to independently developed ones.

SCE also states that the PDD was designed and proposed to support a number of utility needs that are integral with the future of generation in California, even if not one utility generation project is ever developed. Support functions that will be provided by the PDD include: (1) identifying locations for new generation, (2) evaluating generation technologies, (3) tracking regulatory and legislative generation-related initiatives, and (4) the development of the best option outside negotiation (BOON) for future generation needs. SCE makes the following points:

· A significant portion of a utility's generation planning effort is to identify its generation need, and more specifically, the need for locational generation. The PDD has been designed to identify specific sites for generation that can be used to support locational generation needs. This is an essential function, whether the generation is built, bought, or contracted, since locational needs are best served though specific pre-identification of sites within areas that have identified locational need.

· The PDD will also serve as the SCE generation technology characteristics and cost center. The PDD will establish and maintain the knowledge base of generation technologies, costs, and performance for use by itself and other SCE functions, including resource planning. This is also an essential function that serves the utility requirements of resource planning, project development, and RFO development and evaluation.

· Recent regulatory action in developing market price referents, incorporating carbon impacts into generation assessment, analyzing LNG supply impacts, assessing natural gas infrastructure, clean coal, and a host of other generation-impacting activities highlight the need for the PDD. A necessary part of the project development function is the understanding of, and participation in, the myriad of regulatory and legislative processes impacting generation. The PDD will serve this function and represent ratepayers' interests in the future development of generation.

· As a by-product of its project development role, the PDD will also serve to provide ratepayers with utility cost-of-service options that represent the BOON for new generation and supply options. The mere presence of the BOON will discipline the market from runaway RFOs by providing an alternative to the exercise of market power by generators, such as was observed during the energy crisis. Furthermore, the BOON, or more appropriately the family of BOON options,²⁹ will be a useful input and evaluation tool to RFOs, allowing for more precise crafting of requirements.

SCE states that currently, there is no clarity as to whether the Commission desires to have regulated utilities doing project development. According to the Company, while D.04-01-050 states that utilities are free to bring generation projects to the Commission on a case-by-case basis, D.04-12-048, without making reference to the previous decision, establishes a paradigm whereby utilities are to compete against independent projects on a "head to head" basis, but are allowed to recover initial costs in excess of their final bid price and any cost under runs must be shared 50/50 between ratepayers and shareholders. SCE states that this lack of clarity makes it impossible for regulated utilities, such as SCE, to determine whether they will be able to propose new generation projects. It is SCE's position that, in light of recent CEC and CAISO predictions of resource shortages, clarity with regard to the rules under which regulated utilities will be allowed to bring forth new generation projects is critical.

8.4 Discussion

All parties addressing this issue appear to agree that costs for project development must be included in any utility bid to provide new generation. As even SCE recognizes, to not do so, would create an uneven playing field for other potential bidders who have no other means to recover such costs. SCE proposes to track the costs for each project and include such costs when making project comparisons for any proposed utility project. However, the PDD costs would be funded by ratepayers as part of the GRC authorization. If the other parties' recommendations were adopted, there would be no ratepayer funding of any PDD costs except those associated with projects that are ultimately implemented and included in rates. Such recovery would be consistent with the capital recovery of the project itself.

We are not convinced by SCE's argument related to potentially abusive suppliers. With the framework established in D.04-12-048, a competitive all-source solicitation reduces such concerns. Project proponents compete with each other in solicitations and have every incentive to submit the lowest feasible bid. IEPA states that apart from the fact that RFOs to date have had very good results, even if there were to be a "runaway RFO," the Commission has expressly granted utilities the discretion to reject the results of a solicitation if the prices are too high: "If an IOU considers the bids from a particular solicitation too high they have the right to terminate the solicitation." We agree.

SCE's management decision to participate, or to not participate, in the process of developing projects for new generation will probably be determined by its priorities and interests as well as its interpretation of risks associated with Commission actions, including those in today's decision. While we recognize there is value in having more participants such as SCE in the process, we find it necessary to subject SCE to the same cost recovery risks as faced by independent producers. Independent producers' development costs associated with unsuccessful projects are not recoverable from ratepayers. It is a matter of fairness that SCE assume that same risk, if it chooses to participate.

On the other hand, SCE makes the argument that the PDD will support the future of new generation in California even if they do not develop any projects. Support functions include: (1) identifying locations for new generation, (2) evaluating generation technologies, (3) tracking regulatory and legislative generation-related initiatives, and (4) the development of the BOON for future generation needs. These support functions are desirable and it is reasonable that they be funded in rates. However, the specific costs have not been identified and therefore cannot be specifically included on a forecast basis.

For this GRC, we will exclude SCE's entire PDD request from rates. We will however allow rate recovery of costs that support new generation and that are not associated with proposed projects. SCE should track such supportive project development costs in a memorandum account. Such costs can then be recovered in future rates to the extent that they are incurred, to the extent that SCE can justify their supportive nature, and to the extent that the total recorded PDD costs do not exceed SCE's forecasted amount. We realize the amount of money at stake is relatively small. We also realize that under-expenditures in other areas could be used to fund development costs for specific projects. However, we will implement these procedures and restrictions, because from a policy perspective, we feel it is important that the project development costs for proposed new projects should not be specifically included in rates.

In SCE's next GRC, project development costs for specific projects should be excluded from the request. If SCE chooses to do so, it may identify appropriate support costs and include the forecast of such costs in its request.

Regarding SCE's concern regarding D.04-12-048, and the need for clarity with regard to the rules under which regulated utilities will be allowed to bring forth new generation projects, we note that D.05-09-022 granted SCE limited rehearing on this subject. In granting such rehearing, the Commission stated its basis for the sharing mechanism, acknowledged a lack of an evidentiary record to support the mechanism, and granted limited rehearing to develop a legally adequate record. For these reasons, it is not necessary to address the effects of the sharing mechanism on head-to-head competition in this proceeding.

²⁹ BOON will consist of a family of technologies and supply options, including but not limited to repowers, new development, and acquisitions with a variety of fuels and technologies.