Discussion
The purpose of this decision is to establish prudency standards for bilateral forward contracts. After reviewing the comments, we have concluded that we should not evaluate the prudency of bilateral forward contracts in isolation, but rather as a component of a total generation portfolio. A reasonable provider of electricity will engage in a variety of strategies to serve its energy needs including owning generation, entering into long term, medium and near term contracts, purchasing in the open market, and utilizing various financial instruments to ensure a stable electricity supply at reasonable rates. The prudency standard we adopt today must encourage utility management to exercise good judgement in making procurement decisions and give them flexibility to adjust to changing times.
After reviewing the comments, we are convinced that the approach that will best promote achievement of this goal is adoption of a total generation cost benchmark as recommended by TURN. As recommended by TURN, we will adopt a total generation cost benchmark of 6¢/kWh for 2001. The total generation cost benchmark should be compared to the 2001 annual average generation costs, including the cost of generation from retained assets, contracts, spot purchases, and financial instruments. We will not specify the resource or product mix that utilities should enter into to achieve this benchmark but will allow utility management to exercise its judgement to reach this benchmark. As such, we do not need to adopt specific balancing criteria for the bilateral forward contract portfolio as we proposed in D.00-12-065.
In order to provide flexibility, we confirm that the requirement that the utility buy its full requirements from the Power Exchange that was adopted in D.95-12-063 and confirmed in D.99-07-018 and D.00-06-034 is eliminated.4 In Resolutions E-3618, E-3620, E-3658, E-3666, E-3672, and E-3683 we authorized PG&E, SDG&E and SCE to utilize the PX BFM products subject to certain limits. These decisions and resolutions allow the utilities to procure their net-short position, which constitutes the entirety of the utility load in excess of utility controlled supply (i.e., retained assets and existing contracts). We clarify here that utilities may procure their entire net short position through bilateral contracts regardless of any MW limits previously specified.
The parties unanimously recommend that utilities have the authority to utilize financial instruments as tools to manage their energy costs, and we grant that authority today for the utilities' net-short position. The utilities are encouraged to utilize financial instruments purchased through recognized exchanges, rather than over the counter products. Any contracts or financial instruments entered into by a utility with its affiliates must comply with all Affiliate Transaction Rules adopted by D.97-12-088, and modified by D.98-08-035 and other Decisions.5
In its comments, PG&E asks for authority to enter into gas-based financial instruments, noting that its authority to use such tools expired on December 31, 1999.6 Conceptually, we support renewing this authority and direct PG&E to follow up with a request for authority to use such tools as set forth in its comments.
We will not evaluate individual contracts or purchases for reasonableness, assuming the utility meets the benchmark.7 Instead, no later than February 15, 2002, each utility should file an application to allow for audit and verification of its 2001 generation costs. Assuming the utility meets the cost benchmark, no reasonableness review will be conducted. In order to provide the utilities with the proper motivation to meet and beat the benchmark, we adopt the following incentive framework, which is a variant on that proposed by TURN. If the annual average cost is between 5.5¢/kWh and the adopted cost benchmark, the utility will be allowed to apply that difference to past PX costs incurred between August and December 2000. If the annual average cost is below 5.5¢/kWh, the difference between the annual average and 5.5¢/kWh will be refunded to ratepayers. If the annual average cost exceeds the adopted price benchmark, the utility may choose to undergo a reasonableness review of its full portfolio or absorb costs in excess of the benchmark. If a reasonableness review is conducted, the standard that will be applied is whether the action (or inaction) to enter into a particular transaction or strategy was reasonable based upon what was known, or should have been known, at that the time the transaction was finally executed.
The approaches to forward contract prudency proposed by SDG&E, SCE, and PG&E would require the Commission to micromanage procurement decisions by specifying the appropriate resource mix, product mix, contract terms, as well as approve contracts prior to utilities entering into them. This criticism is not to say that the utility should not develop procurement or risk management plans, only that this Commission should not approve such a plan. Instead, we choose to adopt a price benchmark as we have described above. Parties unanimously argued that 5¢/kWh was too low a standard for prudency of bilateral forward contracts in today's market, and thus we have adopted 6¢/kWh as our benchmark for the annual average cost, including retained generation. We recognize that this standard may be challenging to achieve, but we have confidence that, given the tools we have given the utilities, steps we have taken to reform qualifying facility pricing, and developments federally, this will be an achievable goal.
We are not wedded to this approach for 2002 and certainly if it were to be retained in 2002, the benchmark would need to be adjusted. Rather than adopting a particular framework for 2002, we prefer to hear from parties about the best approach to take to ensure that the utilities have the proper incentives to pursue the lowest total portfolio costs possible. We encourage the parties to engage in discussions about how to structure the 2002 benchmark. On April 23, 2001, PG&E, SCE, and SDG&E should file, and other parties may file, proposals for a 2002 total generation cost benchmark in this docket.
4 D.00-06-034 allowed the utilities to purchase from qualified exchanges but was not implemented because subsequent legislation preempted that aspect of the order. 5 A complete copy of the Affiliate Transaction Rules can be found in Appendix A of Rulemaking 01-01-001. Rule III.B. appears particularly relevant for these transactions. 6 PG&E was granted authority to use gas based hedges in D.98-06-76. No petition to modify that decision has been filed with the Commission. 7 Notwithstanding the fact that such transactions may not be reviewed for reasonableness, transactions between a utility and its affiliate will continue to be subject to scrutiny for compliance with the Affiliate Transaction Rules in other proceedings.
