III. APPLICATION FOR REHEARING OF SAN DIEGO GAS AND ELECTRIC COMPANY

A. Summary

SDG&E contends that our order regarding the use of utility retained generation at cost-based rates does not lawfully apply to the electricity it has acquired pursuant to three sets of wholesale purchase contracts with Illinova Electric Power Marketing (Illinova), Louisville Gas & Electric Power Marketing, Inc. (LG&E Marketing), and Pacificorp. ³ SDG&E first contends that these contracts are not within the jurisdiction of the Commission because they are "FERC-jurisdictional wholesale, sale for resale contracts." Second, SDG&E claims that the Commission has already approved the contracts as speculative contracts impacting shareholder gains and losses only. Third, SDG&E argues that requiring it to sell the electric power it acquires under these contracts at cost-based rates, rather than at current, inflated unregulated wholesale prices, for the benefit of its shareholders only, constitutes a "taking" in violation of the Fifth and Fourteenth Amendments of the U.S. Constitution.

In a filing opposing SDG&E's rehearing application, the City of San Diego argues that the electric power acquired by SDG&E under the purchase contracts should not be exempt from the Commission's URG ruling and emphasizes that these contracts are subject to further review by the Commission in Docket No. A.00-10-008 concerning SDG&E's electric power procurement practices. The City of San Diego also argues that the contracts are subject to review in Docket No. A.00-10-045 regarding the implementation of the recently codified provisions in Section 332.1 of the California Public Utilities Code (AB 265), and in Docket No. 01-10-044 regarding SDG&E's application to modify the rate ceiling imposed by Section 332.1.

As we discuss herein, SDG&E's claims of legal error in D.01-01-061 are without merit. The City of San Diego is correct, moreover, where it states that the SDG&E's electric power purchase contracts are subject to further review. The Illinova, LG&E Marketing, and Pacificorp contracts will be part of the subsequent rate review in this proceeding that will be coordinated with our consideration of the impact of the accounting provisions of Section 332.1 of the Public Utilities Code (Docket Nos. A.00-10-044 and A.01-01-045).

Also, with respect to Docket No. A.00-10-008 referenced by the City of San Diego, the record period under consideration in that power procurement proceeding post-dates the 1996 and 1997 execution dates of the purchase contracts in question. We clarify, therefore, that if the Illinova, LG&E Marketing, and Pacificorp contracts are found to be outside the scope of Docket No. A.00-10-008, any approval that may be granted SDG&E's accounting and contracting in that proceeding shall not implicitly or otherwise apply to the three sets of purchase contracts.

In addition, SDG&E contracted to purchase the electric power in question in wholesale, interstate transactions under FERC jurisdiction. There is no legal authority, however, and SDG&E does not cite to any, for the proposition that the FERC has ordered, or has preemptive jurisdiction to order, that SDG&E must resell the power only in another wholesale interstate transaction at a FERC-authorized rate. There also is no legal authority, and SDG&E does not cite to any, for the proposition that this Commission does not have jurisdiction to require that the electric power purchased at wholesale by SDG&E be used to help reduce the current critical shortage of electricity for California's businesses and individual citizens. Further, since the Commission has ordered, for the purpose of the present emergency measures, that SDG&E is to account for the costs it incurred in acquiring the electricity, there is no unconstitutional taking of property involved. (See, Federal Power Commission v. Hope Natural Gas Company (1943) 430 U.S. 591; Duquesne Light Company and Pennsylvania Power Company v. Barasch, et al. (1989) 488 U.S. 299.)

B. The FERC Did Not Require Wholesale Resales At Market Prices

In face of a dysfunctional wholesale market and crippling energy prices, the FERC issued "Order Directing Remedies for California Wholesale Electric Markets, 93 FERC ¶ 61,294, Docket No. EL00-95-000 (December 15, 2000). In this order, the FERC vacated the requirement that all electric power resources and power needs of the California utility companies be sold to and bought from the Power Exchange. SDG&E argues that this order does not apply to the contracts in question because the electric power from those contracts had previously been exempt from Power Exchange transactions by a FERC order in 1999, "San Diego Gas & Electric Company," 88 FERC ¶ 61,212, Docket No. ER99-3426-000 (September 10, 1999). (SDG&E Application for Rehearing, at 3, 5.) SDG&E misplaces reliance on this 1999 FERC order and creates a distinction without a difference among its electric power resources.

The 1999 FERC order was prompted by a filing of SDG&E requesting immediate elimination of the then prevailing requirement that it sell all its acquired or produced generation to the Power Exchange and that it buy all of the electricity needed for its customers from the Power Exchange. ⁴ In that request, SDG&E did not distinguish one kind of electric power resource from another. SDG&E claimed that the sell requirement was to last only during the restructuring transition period, which was to end the earlier of March 31, 2002, or the date on which SDG&E recovered its stranded capital costs. SDG&E asserted that because it had recovered its stranded capital costs and divested all of its fossil fuel generators, the sell requirement should be removed from its FERC tariff.

SDG&E's request included all of its electric power resources, those generated by the facilities it retained, electric power acquired from Qualifying Facility (QF) contracts, and what was described as various other purchase contracts. (88 FERC, at pp.61,713- 61,714.) ⁵ In response to objections raised by parties in the FERC proceeding, SDG&E offered what the FERC considered a "compromise." SDG&E proposed that it continue to sell into the Power Exchange the electricity produced from its remaining generators and provided under contracts with QFs, but that it be allowed to sell outside the Power Exchange the electricity it acquired from the "various other purchase contracts." The FERC granted the proposed "compromise" request. (88 FERC, at p.61,714.) We assume SDG&E included the three sets of contracts now in question among the "various other purchase contracts."

However, we see nothing in the 1999 FERC order mandating that SDG&E sell the electricity acquired under the "various other purchase contracts" only into the wholesale markets. Although SDG&E asserts that the FERC exempted "wholesale, sale for resale" contracts, there is no specific reference to these contracts in the FERC order. ⁶ The order says nothing about exercising federal jurisdiction to transform SDG&E's non-Qualifying Facility purchase contracts into speculative contracts to be used for wholesale transactions solely on behalf of shareholders. SDG&E's rehearing application also fails to demonstrate that the FERC has the authority to restrict the resale of SDG&E's purchased electricity in that way, or, more particularly, to prohibit SDG&E from serving California's retail customers with the electric power acquired from those contracts pursuant to this Commission's regulations and orders. ⁷

The effect, furthermore, of the subsequent FERC order of December 15, 2000, referenced by SDG&E, was to put all of SDG&E's generation resources in the same position as the "various other purchase contracts" previously exempted from the sell requirement by the 1999 order. Just as SDG&E had originally grouped all its resources together in seeking an exemption from the Power Exchange in 1999, the December 15, 2000 FERC order effectively regrouped all of SDG&E's electric power resources in the same category by terminating the sell requirement for all of them:

"We hereby terminate the authority of PG&E, SoCalEdison, and SG&E to sell their resources into the PX effective as of the date of this order." (Ordering Paragraph (B), 93 FERC, at p.62,020.)

Thus SDG&E's QF contracts and its remaining generators joined the "various other purchase contracts" which had been exempt from the Power Exchange sell requirement in the FERC's 1999 decision. All of SDG&E's resources became available to meet the needs of its retail customers, and reverted to this Commission's direct ratemaking authority. FERC expressly stated that it would retain jurisdiction only to the extent there was surplus electricity, i.e., resources exceeding load, to be sold at wholesale. (93 FERC, at p.62,001.) A surplus of electricity does not exist in California presently. When we issued D.01-01-061, therefore, there was no distinction between the electric power acquired from the purchase contracts in question and other SDG&E electric power resources that would place the purchase contracts beyond our jurisdiction.

C. The Commission Has Not Previously Approved The Purchase Contracts For Shareholder Benefits Only

In the absence of the Power Exchange, the Commission necessarily exercised its broad constitutional and statutory electric powers with respect to all of SDG&E's electricity resources. Responding to the declaration of an emergency by the Governor of California on January 17, 2001, we directed SDG&E, and PG&E and Edison to fulfill their obligations to serve California retail customers in order to help remedy the acute problems of an electric energy shortage and distorted market prices. A fundamental duty of the Commission is to enforce that obligation to serve.

Section 451 of the Public Utilities Code is a prevailing cornerstone of the regulation of franchised utilities. It requires that the public utilities under the Commission's jurisdiction provide the service necessary to protect and promote the public's safety, health and welfare.

"Every public utility shall furnish and maintain such adequate, efficient, just, and reasonable service, instrumentalities, equipment, and facilities, ...as are necessary to promote the safety, health, comfort, and convenience of its patrons, employees, and the public."

The obligation to serve remains in force within the electric restructuring statutory scheme. Section 330, for example, states, in part, at subparagraph (g):

"Reliable electric service is of utmost importance to the safety, health, and welfare of the state's citizenry and economy." (Cal.Pub.Util.Code §330(g). See also, Cal.Pub.Util.Code §330(h).)

Despite this obligation to serve its customers, SDG&E objects to doing so at cost-based rates. Instead, SDG&E wants to take advantage of the contracts in question and reap a profit from the extraordinarily high wholesale prices presently in effect. SDG&E contends, furthermore, that its shareholders rather than its ratepayers should benefit from these market conditions.

In support of this contention, SDG&E argues that the Commission implicitly approved assigning to shareholders the gains, or losses if any, from the sale of electricity acquired under the Illinova, LG&E Marketing, and Pacificorp contracts. SDG&E refers twice to our decision D.00-10-011 as evidence of this approval. (SDG&E Application for Rehearing, at 4.) Though twice cited, the decision cited is irrelevant since it pertains to a transportation company, not an electric or gas utility company.

We did, however, issue a decision in the Annual Transition Cost Proceeding of 1999, D.00-10-048, which may be the "1999 ATCP" decision SDG&E has attempted to reference. It is correct that in that decision we stated in Conclusion of Law 1: "SDG&E's entries to its TCBA for the record period July 1, 1998 through June 30, 1999 (record period) are reasonable." However, SDG&E does not explain the relevance of this conclusion to its present claims. As we have discussed, SDG&E's argument is that the purchase contracts in question were ipso facto transformed into speculative contracts for shareholder benefits only when the FERC accepted SDG&E's compromise to eliminate these contracts from the Power Exchange sell requirement. The record period involved in our 1999 ATCP decision, however, predates the FERC's order issued September 10, 1999. ⁸ Prior to the FERC decision, therefore, SDG&E was and should have been accounting for the purchase contracts as it did other electricity resources for customer service. The 1999 ATCP decision is, therefore, irrelevant.

Furthermore, contrary to SDG&E's claim, we see no express or implied approval of SDG&E accounting for gains or losses as "shareholder impacts" from the Illinova, LG&E Marketing, and PacifiCorp contracts. (SDG&E Application for Rehearing, at 4.) As we have indicated, the purchase contracts and the accounting for them are properly the subject of our further review.

SDG&E, therefore, not only has failed to establish a line of authority exempting the purchase contracts from our interim order in D.01-01-061, it also relies on an argument that is inconsistent with a prior rationale it offered when seeking authority for speculative contracts. In Docket No. A.97-04-039, SDG&E requested authority to use financial "derivative" transactions to manage market risks. (Application in A.97-04-039, at 1.) SDG&E proposed that these hedging and option type transactions be accounted for "above the line," i.e. included in determining its revenue requirement. SDG&E stated:

"SDG&E's physical Electric Rate Cap transaction costs are already included in SDG&E's authorized revenue requirement. Gains, losses, and expenses from SDG&E's financial Electric Rate Cap derivative transactions should be as well. Both physical and financial transactions represent a legitimate cost of providing fixed-price utility service in today's volatile and uncertain energy marketplace, ... The costs of financial Electric Rate Cap derivative transactions (including any gains or losses associated with such transactions), should be included in SDG&E's authorized revenue requirement, and exempted from any further reasonableness review." (Docket No. A.97-04-039, Application, at 11. Emphasis added.)

SDG&E here explained that the financial "derivative" agreements, for which it sought authority, should be treated like "physical transactions," meaning contracts pursuant to which SDG&E bought and actually received delivery of electricity (e.g., the Illinova, LG&E Marketing, and Pacificorp contracts). Gains or losses, according to SDG&E, were to impact ratepayers, not shareholders.

The Commission did not issue a decision on SDG&E's request to engage in "derivative" financial transactions, though we rejected a similar request by PG&E. ⁹ It appears, nonetheless, that SDG&E's application was consistent with two important regulatory rules: one, authorization from this Commission is required before engaging in speculative contracting; and two, the impacts of contracting, i.e., gains or losses, are to be specifically assigned by the Commission. SDG&E should now also recognize that the purchase contracts it contends are speculative contracts are within the Commission's jurisdiction, that they are subject to our URG orders in D.01-01-061, and that they shall be further reviewed for ratemaking purposes as we have indicated.

We should also point out that our jurisdiction extends to considering the reasonableness of off-system electric power sales. For example, in D.96-08-030, the Commission determined that Edison had prudently negotiated certain off-system sales. (D. 96-08-030, "Re Southern California Edison Company" (1996) 67 CPUC 2d 390, 392-395.) The benefits of those sales were assigned to ratepayers. (67 CPUC 2d, at 397, Finding of Fact 8: "Edison's off-system wholesale electric power marketing strategy was intended to maximize revenues for its customers.")

We are not, however, presently dealing with conditions of excess electric power. Power shortages require that SDG&E use the electric power from the purchase contracts according to the priorities and accounting set forth in D.01-01-061. Our consideration of SDG&E's sale or bartering of that power in wholesale markets would arise, therefore, if the third level of our ordered prioritized use of utility generation were reached, and we had to determine whether SDG&E reasonably minimized costs for its customers.

D. Recovery of Costs Plus Rate of Return Is Not A "Taking."

It is within the Commission's jurisdiction to require that SDG&E account for the electric power it acquired under the three sets of purchase contracts on the basis of its costs. Under federal law, recovery by SDG&E of a FERC-approved purchase price is the maximum recovery required, assuming the contracts were entered into reasonably. (See, Mississippi Power and Light v. Mississippi ex rel. Moore (1988) 487 U.S. 354, 372-373. ¹⁰

The Federal Power Act, moreover, reserves for state commissions jurisdiction over intrastate, retail sales of electricity. (16 U.S.C.§ 824(a) and(b).) There is no conflict, therefore, between the FERC's and this Commission's jurisdictions when SDG&E is ordered to record its costs, as provided in D.01-01-061, for the electric power purchased from Illinova, LG&E Marketing, and Pacificorp and used to serve retail customers.

In addition, contrary to SDG&E's claims, the Fifth and Fourteenth Amendments of the United States Constitution do not require more. As has been well-established by the U.S. Supreme Court, shareholders of a public utility do not have a constitutional right to the appreciation in value of an investment, such as the power purchase contracts. The view that a public utility must receive the fair market value of an asset has been repeatedly rejected. In the landmark decision of Federal Power Commission v. Hope Natural Gas Co. (1944) 430 U.S. 591, the Court held that the proper basis for determining the rate charged customers is the historical, or original cost, and if a capital investment is involved, a reasonable return on the investment. (430 U.S., at 602, 605.) The standards expressed in Hope for determining whether a regulatory rate constitutes an unconstitutional taking were reaffirmed in Duquesne Light Company and Pennsylvania Power Company v. Barasch, et al. (1989) 488 U.S. 299, 310- 312.

The Court in Hope and in Duquesne also looked to the total effect of the rate order to determine whether a reasonable balance was struck. (488 U.S., at

310.) The Court in Duquesne summarized the applicable view as follows:

"The Constitution with broad limits leaves the States free to decide what ratesetting methodology best meets their needs in balancing the interests of the utility and the public." (488 U.S., at 316.)

Pursuant to these well-established standards, SDG&E cannot substantiate an unconstitutional taking in our decision. It is well within the bounds of reasonableness, as expressed in Hope and Duquesne, to account for reasonably incurred contract costs. Our interim accounting order in D.01-01-061 thus provides the basis for just compensation should the contracts be found reasonable upon our further review. (Duquesne, 488 U.S., at 308, citing Federal Power Commission v. Texaco Inc. (1974) 417 U.S. 380, 392-392.)

E. SDG&E's Refusal To Comply Is Subject To Enforcement Rules

Finally, SDG&E declared in its rehearing application that pending the Commission's response to its rehearing application, it would ignore our orders in D.01-01-061 pertaining to the cost-based rates for the utility's retained generation. (SDG&E Application for Rehearing, at 7.) However, those orders were not stayed by SDG&E's rehearing application that was filed February 18, 2001. (See Cal.Pub.Util. Code Section 1733.) SDG&E has, therefore, acted in violation of our decision and is thereby subject to the penalty provisions of Sections 2100 et seq. of the Public Utilities Code for each day of non-compliance. Accordingly, SDG&E shall make the accounting changes required by our orders in D.01-01-061. SDG&E is also immediately obligated to provide the electric power from the Illinova and Pacificorp contracts pursuant to the priorities we established. SDG&E shall, in addition, submit advice letter modifications reflecting our orders within seven calendar days of the effective date of this decision. The advice letter shall include copies of the account changes, including explanatory notes.

With respect to the LG&E Marketing contracts, SDG&E stated that they were "later assigned to Avista." (SDG&E Application for Rehearing, at 4.) In its accounting, SDG&E shall clearly identify all details related to the electric power purchased under the LG&E Marketing contracts and to the later assignment to Avista. SDG&E shall also provide forthwith to the Energy Division copies of all agreements and contracts of the assignment.