II. Background

A. Events Leading to this Decision

This decision addresses the requests of PG&E and SCE for immediate rate increases in response to extraordinary circumstances in California's wholesale power markets. We consider their requests in the context of current state law and the state's dysfunctional wholesale energy markets that have led to unconscionable, unlawful wholesale prices and an increasingly unstable supply situation.

The current industry structure evolves from Chapter 854 of the Statutes of 1996 Assembly Bill (AB) 1890 (Brulte), passed in 1996 to promote competition in California's electric market by opening generation markets. AB 1890 turned over operation of the state's transmission system to the Independent System Operator (ISO) and the pricing of unregulated generation to the Power Exchange (PX), both private nongovernmental corporations regulated by the Federal Energy Regulatory Commission (FERC), not the State of California. AB 1890 also required the utilities to file with this Commission rate plans that set electric utility rates at June 10, 1996 levels, except that bills for residential and small commercial customers were discounted by 10% from those levels, through the issuance of Rate Reduction Bonds approved by the Commission. The frozen rate levels were initially high enough to allow PG&E, SCE, and San Diego Gas & Electric Company (SDG&E) an opportunity to recover uneconomic generation costs within a specified period.

The original expectations of California decision-makers - that competitive markets would reduce power purchase prices - have not been fulfilled. Rather than dropping in response to competitive market forces, wholesale electricity prices have risen by staggering proportions since the summer of 2000. These increases accelerated their rate of ascent after the FERC eliminated wholesale electricity price caps in California markets in November and December, 2000. The uncontrolled price increases in wholesale markets have created enormous outstanding liabilities for PG&E and SCE. Indeed, SCE's and PG&E's continued financial viability and ability to serve their customers has been seriously compromised by the dramatic escalation in wholesale prices since.

B. Procedural Background

After the FERC refused to extend wholesale electricity price cap authority in California, the utility respondents filed Rate Stabilization Plans (RSPs) proposing to end the rate freeze and increase rates by 10 percent.

On December 8, 2000, the Federal Energy Regulatory Commission completely eliminated price caps in California, despite concluding that the market was dysfunctional and was being subverted by sellers' market power. Wholesale electricity prices immediately soared, peaking at $1400 per megawatt hour on December 14th. The utilities filed emergency motions to modify RSPs to provide for 30 percent rate increases on December 14, 2000. The next week the Commission issued an emergency order on December 21, setting out a schedule to address rate relief in the context of the FERC-created wholesale price emergency.

In the December 21^st order, D.00-12-067, the Commission determined that expedited action was necessary to fulfill our statutory obligations to ensure that the utilities can provide adequate service at just and reasonable rates. We consolidated the applications of PG&E and Edison with TURN's Petition to Modify Resolution E-3527 and conducted hearings during the week of December 26, 2000. Those hearings were narrowly focused on PG&E's and Edison's claims that existing rates did not yield revenues sufficient to meet their cost obligations. The commission also engaged independent auditors to verify the extent of the utilities' financial hardship and cash positions.

The Commission issued D.01-01-018 on January 4, 2001, authorizing an interim rate increase to both PG&E and Edison, subject to refund, of one cent per kilowatt-hour (kWh). The decision exempted low-income customers eligible for the California Alternative Rates for Energy (CARE) program. We authorized this surcharge to be applied to recovery of future electricity procurement costs and to be in effect for 90 days, during which time independent consultants engaged by the Commission would review the utilities' financial circumstances and all parties would have the opportunity to submit evidence and testimony regarding the proposed rate increase.

The assigned Commissioner designated the following issues as within the scope of the hearings:

(1) Review of the independent audits of PG&E and Edison, ordered in D.00-12-067, and determination of whether or not the Commission should grant further rate increases;

(2) TURN's accounting proposal to reconcile the Transition Revenue Account (TRA) and Transition Cost Balancing Account (TCGA) accounts and the Generation Memorandum Accounts (GMA);

(3) Consideration of whether the rate freeze has ended on a prospective basis only, including interim valuation of retained utility generating assets;

(4) Greenlining/Latino Forum's CARE proposal;

(5) Parties' proposals for tiered residential rates.

C. Recent Legislative Action Provides the Commission With Enhanced Authority to Raise Rates

On January 19, 2001 the Legislature passed and the Governor signed Chapter 3 of the Statutes of 2001. (Senate Bill 7x (Burton) from the First Extraordinary Session). SB7X appropriated $400 million from the General Fund to the Department of Water Resources to purchase energy for the use of utility customers. This action was necessitated by a concerted refusal of wholesale sellers to sell energy to the utilities or to the Independent System Operator, thereby endangering the supply of power for California. The legislation directed the Commission to implement emergency regulations governing the utilities' collection and remittance of customer payments for the energy purchased by DWR. The Commission's decision implementing SB7X was issued on January 31, 2001. It allocated revenues collected by utilities to DWR in proportion to the energy delivered by DWR, and it ordered the utilities to establish accounting and billing procedures to pay DWR directly for the proportion of power DWR purchased and delivered to utility customers.

On February 1, 2001, the California Legislature enacted and the Governor signed Assembly Bill No. 1 from the First Extraordinary Session (Ch. 4, First Extraordinary Session 2001, hereafter referred to as AB1X). AB1X adds Division 27 to the Water Code, California Water Code sections 80000 et seq., which:

· Authorizes the California Department of Water Resources (CDWR) to purchase power and sell it to retail customers of PG&E, Edison, and SDG&E, as well as municipal utilities, Water Code section 80100.

· Establishes the Department of Water Resources Electric Power Fund in the State Treasury, into which are placed proceeds from power sales as well as bond proceeds and appropriations, Water Code section 80200.

· Authorizes CDWR to sell bonds to finance its power purchases, Water Code section 80130.

· Requires CDWR to establish a revenue requirement to defray the costs of its activities and to communicate that revenue requirement to the Commission, Water Code section 80134.

· Allows CDWR to recover its revenue requirement after it is communicated to the Commission, Water Code section 80110.

Pursuant to AB1X, the Commission is directed to designate a portion of the existing generation rates of PG&E, Edison, and SDG&E in effect as of January 5, 2001 as the California Procurement Adjustment (CPA). The statute anticipates that the utilities will collect the CPA revenues from retail customers and transfer some portion of those revenues to CDWR as the Fixed Department of Water Resources Set-Aside.³ In describing the calculation of the CPA, AB1X refers to the rates that are in effect as of January 5, 2001 as the beginning point for the calculation. In accordance with the Legislature's clear intent, we therefore make permanent the one-cent rate surcharge that the Commission authorized in D.01-01-018, which was included in the rates in effect as of January 5, 2001.

AB1X authorizes CDWR to establish revenue requirements sufficient to recover its costs and to communicate those requirements to the Commission. As AB1X requires the Commission to provide for recovery of DWR's revenue requirements, it necessarily authorizes the Commission to impose an increase in customers' electric bills, whether the increase is technically described as an increase in "rates" payable to utilities or an increase attributable to DWR's deliveries of electricity to customers.⁴ AB1X somewhat limits our authority, by providing that residential customer rates cannot be increased for usage up to 130% of baseline quantities. Water Code section 80110.