4. Discussion

Both ORA and TURN agree that SCE should be allowed to hedge some portion of its natural gas price risk associated with 2004 QF contracts but that additional mechanisms need to be in place to ensure value to ratepayers. SCE proposes a specific methodology for setting maximum volume limits on trading, as set forth in Appendix A to its motion, but does not specify the criteria it will use to determine the value of a hedge or the price to pay for a hedge. ORA's proposed modification is designed to ensure that SCE buys reasonably priced hedges at the time of purchase. TURN, while supportive of ORA's concerns, is more interested in SCE's hedging "philosophy."

We see TURN's concern going to the issue of whether there is a value to ratepayers in each hedging transaction. TURN addresses its concern by requesting more detailed PRG consultation, a proposal that SCE rejects. We find that a better remedy here is to adopt quantifiable, up-front standards.

The value to ratepayers of whether to engage in specific hedging transactions should be measured by a cost-effectiveness test, as was required for interim procurement contracts already approved by this Commission. Accordingly, the value of a hedge should at least be commensurate with (and would preferably exceed) its price at the time of purchase. It should be noted that risk reductions beyond certain points can become de minimis but at significant cost. Consequently, ratepayers should not be asked to fund utility risk reductions that are not cost-effective.

ORA proposes that the price of a hedge transaction at the time of purchase must meet a market benchmark. ORA does not, however, explain how the NYMEX data sources which reflect gas transactions at the Henry Hub in Louisiana relate to gas transactions in California. While the concept of using a benchmark has validity, that benchmark must be applicable to the relevant market. We, therefore, reject ORA's recommendation using the NYMEX data sources for the reasonableness of the price of SCE's hedges.

A cost-effectiveness test allows the Commission to ensure that SCE does not choose to enter hedges at too high a price or for too little value. We faced a similar issue in addressing SCE's November 5, 2002 request in Advice Letter 1660-E for approval of proposed energy and capacity procurement contracts. On December 5, 2002, in Resolution E-3802, we modified SCE's proposed selection criteria to address our finding that SCE's proposed threshold for contract approval was too low, and further refined this process by specifying a specific model and threshold to be used. (See Energy Division's confidential letter of December 6, 2002 regarding Resolution E-3802.) We direct SCE to use this model for a hedge transaction performed under this interim authority or to nominate an alternative, commercially available model that it now uses, to perform the cost-effective test.

With regard to an appropriate threshold, we require that the value of a hedge at least be commensurate with the price of the hedge at the time it is purchased. This upfront standard and criteria is clearly in-line with Public Utilities Code Section 454.5, especially Section 454.5(b)(7) which states that "the acceptability and eligibility for rate recovery of a proposed procurement transaction will be known by the electrical corporation prior to execution of the transaction."

We expect SCE and California's other investor-owned electric utilities to have extensive knowledge of natural gas markets and more expertise about hedging in those markets than we do in the regulatory sphere. The utilities have the responsibility of providing reliable service to their customers at just and reasonable rates; the Commission has the responsibility of adopting a regulatory framework that best ensures customers receive this service. Given the constraints upon the Commission with regard to ex-post review of SCE's actions, it is necessary for us to set some standards for the utility's actions beforehand. The Commission must be able to be satisfied that the ratepayers' interests are being served through the methods chosen by SCE to hedge, or not hedge, its gas price risk exposure. By acting according to rules set in place in advance, SCE can make a positive showing of expected benefits, and the Commission can affirmatively conclude that the company has acted reasonably.

We act knowing that denying SCE more complete freedom may be costly to ratepayers in a few cases where standard modeling procedures do not show a benefit, but SCE traders nonetheless claim to see benefits. However, it is our belief that those cases will be few, and the benefits to the ratepayers from relying on standard rules will be many. Moreover, there will be times when markets turn, and previously contracted for hedges will be found, in retrospect, to have been overly expensive or even useless. Far better for SCE and for the Commission to be able to demonstrate that objective and clear standards were used in selecting the hedges at the time of transaction, and that those hedges were judged at the time, through standardized procedures, to be proper and reasonable.

We find that with the addition of the upfront standard for cost-effectiveness discussed above, SCE should have interim authority to hedge the natural gas prices risks for it 2004 QF contracts. Therefore, we should grant SCE's request with this modification.

We are concerned that SCE requested expedited consideration rather than submitting its formal request earlier. Informal discussion with the PRG group is to augment, not substitute, for formal Commission review and a full public review and comment period. SCE could, and should, have filed in sufficient time to provide for a normal review period.