9. Functioning Properly Criteria

Pub. Util. Code § 390(c) states:

"The short-run avoided cost energy payments paid to nonutility power generators by electrical corporations shall be based on the clearing price paid by the independent Power Exchange if (1) the commission has issued an order determining that the independent Power Exchange is functioning properly for the purposes of determining the short-run avoided cost energy payments to be made to nonutility power generators, . . . "

The first question we must address as we develop criteria for whether the PX is functioning properly is the scope of our inquiry, in other words, is this a narrow review for QF pricing purposes only or is our review a judgment on the entire electricity market? As the PX points out, "(t)he narrow focus of the statute indicates that the Commission's inquiry here is not an assessment of the functioning of the Cal PX for all purposes." (PX Opening Brief, June 1, 2000, p. 2.) No party appears to dispute that our inquiry should be narrowly focused. We agree and take this opportunity to make clear that the criteria we adopt here are not the proper criteria for judging the broader electricity market success or failure. Our inquiry will focus on whether the PX is functioning properly only for purposes of determining SRAC prices paid to QFs.

The second question we must confront is raised by SCE, who states "the functionality determination is linked to implementation of a market-based SRAC. Thus, to the extent the SRAC methodology accounts for the market distortions identified . . . in this proceeding, the Commission may conclude . . . the market is `functioning properly' for the limited purpose envisioned by Section 390(c)." (SCE Opening Brief, June 1, 2000, p. 76.) In effect, SCE argues that we need not develop stringent criteria to measure whether the PX is functioning properly because the PX-based pricing methodology we adopt should correct for market distortions. ORA agrees with SCE (see ORA Opening Brief, June 1, 2000, p. 46). CCC, on the other hand, argues that "the best way to account for . . . claimed market distortions is to wait until those distortions have been largely mitigated through adoption and implementation of reasonable functioning properly criteria . . . ." (CCC Reply Brief, June 14, 2000, p. 10.)

The language of Section 390(c) does not instruct the Commission to establish a pricing methodology that corrects for market imperfections, rather it instructs us to implement payments based on the PX clearing price if we have determined the PX is functioning properly for the limited purpose of determining SRAC prices paid to QFs.

Parties have proposed numerous criteria for the Commission's consideration and generally support the following five criteria as the minimum necessary to find that the PX is functioning properly:

(1) PX market clearing prices result from a transparent process and are published for each day;

(2) PX market clearing prices are based on the bids of available demand and supply;

(3) There is enough liquidity so that PX market clearing prices reflect market conditions;

(4) Buyer and seller market power does not exist; and

(5) Monitoring and regulation of the PX market is occurring.

Criteria 1 and 5 are self explanatory and easily determined on their face. Criteria 2, 3, and 4 are more qualitative in nature. Parties have suggested various ways to measure whether Criteria 2, 3, and 4 have been met. For example, CCC proposes five specific measures designed to address market power, liquidity, and demand responsiveness. In addition, other parties propose various criteria that relate to transition period rules, the rate freeze, and the end of the requirement that utilities buy from the PX.

Criteria 2, 3, and 4 might be appropriate to judge whether the electricity market as a whole is functioning properly or whether the PX market is workably competitive, but neither of these tasks is before us. Instead we must determine whether the PX is functioning properly for the purpose of determining SRAC energy payments to QFs. Whether the market as a whole is operating efficiently is not a measure of whether the PX price represents utility avoided cost. As stated on brief, "PG&E interprets the `functioning properly' requirement to mean that . . . the PX's market-clearing price must accurately reflect the competitive price for energy in the new marketplace before the PX may appropriately be used as the proxy for the QF's contractually specified energy pricing." (PG&E Opening Brief, June 1, 2000, p. 3.) In its opening statement, SDG&E said "today 30 million California consumers are paying energy prices in their electric rates based on the PX price. Electric generators are being paid the PX price. . . . In such circumstances, if this Commission . . . finds that the PX isn't working even though generators are currently paid the PX price, the California consumers are paying the PX price, someone's going to have lots of explaining to do. It just flies in the face of common sense." (RT 7: 3-22.)

This proceeding is not intended to be a judgment of the overall fairness of the PX pricing mechanisms or the behavior of its participants. In recent months, prices in the PX day-ahead market and other wholesale electricity markets in California have skyrocketed. These high prices have caused considerable hardship for ratepayers in the SDG&E territory, and led to severe dislocations throughout the market. We have taken a number of steps to address the problems (D.00-08-021, D.00-08-023, D.00-08-037, and I.00-08-002), and we are working with the PX, the ISO, the Legislature and other organizations to craft responsible solutions.

Nevertheless, the instant proceeding is intended to determine if the PX is operating properly in a different sense, not directly related to the measurement of increased rates and volatility in the market. Instead, we consider here whether the PX, in particular, the PX day-ahead market, is doing what it is supposed to be doing: setting a market clearing price that allows utilities to purchase power for their bundled customers. In this regard, SDG&E is correct that our purpose is served by observing that this is exactly what has occurred. Since April 1, 1998, the PX has never failed to perform its assigned function. If this were our only criterion for determining the functioning properly question, we could answer in the affirmative here and now.

We note that the utilities have substantially been constrained to purchase nearly all of the their power needs from the PX day-ahead market until recently. In recent decisions (D.00-06-034 and D.00-08-023), this constraint has been lifted to some degree by allowing expanded use of the PX block-forward market and adoption of bilateral contracting authority within specified limits. Therefore, for purposes of determining if the PX is functioning properly, it is necessary, but not sufficient, to note that the PX has been performing its assigned function. Another element must be a comparison of the prices in the PX day-ahead market with alternative prices available to utilities. Clearly, it is possible that the PX day-ahead market continues to function, the utilities continue to purchase through it because of a continuing mandate, and the prices in that market are out of line with other available or potential wholesale electric markets. We therefore agree with PG&E's point that the PX's market-clearing price must also accurately reflect the competitive price for energy in California. Further, if the utilities are allowed to procure power beyond the PX day-ahead market, they may choose to use or not to use that market. It is appropriate to observe this behavior, for if the utilities choose not to use the PX day-ahead market, this is a good sign that that market is not functioning properly.

Therefore, we have reached the conclusion that, in lieu of the five criteria cited above or other criteria proposed by parties, there are three criteria that we will adopt in order to determine that the PX is functioning properly for the limited purposes of this proceeding. All of these criteria must be met to satisfy our inquiry. The criteria are: a) the PX day-ahead market must provide an ongoing market-clearing price, and b) the PX day-ahead market must be the market where utilities procure the majority of energy for their customers, and c) the PX day-ahead market must reasonably represent the costs of other allowable utility purchases. If the PX day-ahead market meets these criteria, then it fairly represents the utilities' avoided cost, and it is functioning properly for the purposes of QF payments. In Phase 2, we will evaluate whether these criteria have been met and review whether the utilities have met additional standards set forth in Section 390 (c). The assigned ALJ is directed to hold a prehearing conference within 45 days of the effective date of this decision to establish the schedule for Phase 2.