3. Framework for Considering Plan to Accelerate DWR's Departure
3.1. Scope of the Inquiry
The threshold issue in this phase of the proceeding is whether, and if so, how the Commission should support measures to expedite the removal of DWR from its role of supplying power under AB 1X. Alternatively, we consider whether it is in the public interest simply to refrain from any further efforts in this regard. Our decision has implications for the timing of subsequent phases of this proceeding with respect to the possible reinstitution of Direct Access. The Commission previously recognized in D.02-12-069, however, that there are broader policy reasons for expediting the removal of DWR from its power supplier role. DWR's authority to procure power was not perpetual, but was an emergency measure designed to stabilize a crisis. DWR's authority to contract for power purchases expired on January 1, 2003,5 and the IOUs concurrently resumed procuring power to meet the load demand for their respective customers. In D.02-06-029, we allocated the power supplied under the existing DWR contracts among the three IOUs portfolios. The IOUs now perform all day-to-day scheduling and dispatch functions for the DWR contracts allocated to their portfolios, just as they do for their existing resources and new procurement.
As determined in D.08-02-033, however, DWR continues to supply power under contracts entered into prior to 2003. Legal title to the DWR contracts still resides with DWR. Financial reporting responsibilities, including those associated with the DWR revenue requirements proceeding and Trust indenture reporting requirements, also remain with DWR. Assuming no further changes to existing contracts, the last of the DWR contracts is scheduled to expire in 2015.
As noted in D.02-12-069, relieving DWR from its responsibility to perform energy supply functions is one of this Commission's fundamental short-term goals. Transitioning full responsibility for energy market-related activities back to the IOUs as soon as possible is consistent with the principle that the utility, and not DWR, continues to have a statutory responsibility to serve its customers.
In recognition of such broad policy considerations, the scope of our inquiry here considers the full range of potential effects of expediting the removal of DWR from its power supply role (not just the legal implications relating to Direct Access). Consideration of the impacts of removing DWR from its power supply role therefore include both potential costs as well as any positive benefits. As a framework for this evaluation, we first identify the available options to facilitate the early release from its contracts.
3.2. Options to Facilitate and Expedite DWR Release from Contracts
The number of active DWR contracts has been progressively declining, from an original number of 59 down to 26 contracts today, with 15 counterparties. By 2010, the cost of the remaining contract portfolio is expected to be about $6.1 billion, or about one-seventh of the original liability. In 2001, DWR contracts covered 35% of the IOU's peak demand and energy requirements. The remaining long-term contracts in effect as of 2010 would cover only about 15% of the IOU projected requirements. The vast majority of DWR contracts expire by 2011.6 Assuming no further action to accelerate the time when DWR no longer supplies power, the DWR contracts will expire under their existing terms, gradually reducing the amount of power that DWR supplies down to zero by 2015. Appendix 1 of this decision summarizes the DWR contracts by expiration date.
Three potential options have been identified whereby DWR could seek release from supply obligations under its existing contracts, namely: (1) novation; (2) renegotiation; or (3) assignment. We describe each of these options below.
"Novation" refers to the "[substitution] of a new obligation for an existing one" and "may be accomplished either by the substitution of a new debtor or a new creditor."7 Novation "wholly extinguishes the earlier contract."8 DWR has already successfully renegotiated 22 of its 26 remaining contracts to include "novation" provisions. These provisions allow DWR, working in conjunction with the Commission, to transfer its contracts to the IOUs. Accordingly, upon execution of a novation of a DWR contract, DWR would be released from all rights, obligations, and ownership interests in the contract and the power supplied under that contract.
Although the specific novation clauses differ somewhat from contract to contract, the clauses generally provide DWR with the option to a request that the counterparty to the contract enter into a "Replacement Agreement" with one or more "Qualified Electric Suppliers."9 The execution of the "Replacement Agreement" constitutes a "novation," relieving DWR of any liability or obligation arising under the new agreement.
The novation clauses in the DWR contracts are specifically crafted so as to require the Seller to enter into a Replacement Agreement with a "Qualified Electric Supplier," once DWR so requests. That requirement is subject only to the fulfillment of certain conditions precedent outside of the control of the Seller. Thus, for contracts with a provision for novation, the Seller is not in a position to refuse to agree to the novation or to insist on unilateral terms which would be detrimental to ratepayers. DWR agrees to work with the Commission and the IOU likely to take on the replacement contract after a novation has been negotiated and executed.
3.2.2. Renegotiation of Contracts that Lack Novation Clauses
Four DWR contracts do not currently have novation provisions, namely: Coral Power LLC, Sempra Energy Resources, City and County of San Francisco, and PacifiCorp Power Marketing, Inc. (PPM). In the case of these contracts, DWR and the IOUs cannot unilaterally require the counterparty to enter into a "Replacement Agreement" as provided for under a novation. Some additional negotiations with the counterparties would be necessary before DWR could end its obligation to supply power under the existing contracts. DWR and the IOUs cannot unilaterally require any of these counterparties to renegotiate their contracts. Except for one counterparty that spoke at the Commission's workshop, none of the four counterparties have given any indication in this proceeding as to whether, or under what conditions, they may be willing to negotiate.
Another possible option for the transfer of DWR contracts to another entity is through contract assignment. All of the DWR contracts contain some form of assignment provision. Unlike novation provisions, however, the assignment of a contract to another party would not relieve DWR of its liability for performance under the contract without a waiver by the counterparty. Without such a waiver, even if the contract was assigned DWR would not be relieved of its role of supplying power under the contract. The CalPeak contract, in particular, permits assignment only if there are no Section 206 complaints at the Federal Energy Regulatory Commission (FERC), and requires a release of all Section 206 complaints.
Reliant argues that for those contracts with novation clauses, there is no basis to pursue assignment of the DWR contracts given the superior advantages offered by novation. With respect to the four contracts without novation clauses, Reliant believes that while assignment remains open as a potential option, seeking renegotiation of the contracts may be a more effective solution.
PG&E likewise argues that there is no basis to assume that any of the four counterparties without novation clauses would be willing to grant DWR a release from liability without some additional consideration.
Given the uncertainties as to whether DWR could obtain a release from liability from all counterparties as a result of an assignment, we conclude that pursuing assignment of the DWR contracts does not offer a viable means of removing DWR from supplying power under existing contracts.
3.3. Merits and Feasibility of Pursuing Contract Revisions
In order to achieve the goal that DWR no longer supply power, DWR will have to be removed as a party to its existing contracts either through (a) novation or (b) renegotiation of the existing contracts. Parties' disagree considerably on whether (or how soon) this goal could be attained.
While DWR recognizes that the timing of the process depends on several considerations, DWR suggests that January 1, 2010 is a realistic time by which a novation process could be complete if the Commission acts expeditiously.10 DWR believes it can secure an agreement with counterparties to add a novation clause to the four contracts that currently lack such a clause. DWR expresses optimism that the counterparties to those four contracts will accept novation without demanding concessions that would be detrimental to ratepayers. DWR notes that no party has taken issue with the consideration that DWR provided in return for adding a novation provision in any of the 22 contracts that currently have such a provision.
AReM/CACES and Reliant likewise support the goal of January 1, 2010 as a target date for completing novation of all DWR contracts. Reliant argues that, as a practical matter, the Commission cannot ascertain with certainty that novation, assignment, or renegotiation can be accomplished, but can only make an informed judgment based on the record. Reliant values DWR's assessment of success, however, since DWR is most familiar with all of the contracts and the counterparties. Reliant argues that the Commission should allow novation of the contracts to proceed as stakeholders work towards assuring that all 26 contracts are timely novated.
The IOUs and consumer groups, however, believe that it will likely not be feasible to effect novation of all of the contracts under terms that are beneficial to ratepayers. Thus, while the IOUs estimate net savings to ratepayers from DWR contract novation, those estimates are based on the underlying assumption that all DWR contracts could be successfully replaced with new agreements by 2010. The IOUs and consumer groups argue that because achievement of full novation of contracts by 2010 is highly unlikely, the ratepayer savings will likely not materialize.
In particular, provisions in the PG&E Bankruptcy Settlement11 may limit the feasibility of PG&E taking over any DWR contracts. Parties also point to uncertainty as to how the Commission will decide how the costs of any replacement contracts taken over by an IOU would be allocated among the three IOUs and their customers. Since existing DWR contract costs are allocated among all three IOUs, an IOU would not be inclined to take on a "Replacement Contract" if it resulted in an inequitable cost burden as a result of changes in how costs are allocated.
The IOUs and consumer groups also identify the four contracts without novation clauses in their contracts as another significant impediment. Novation of those contracts will not be possible unless the contract counterparties agree to it. The IOUs and consumer groups argue that the four counterparties without novation clauses will likely try to negotiate greater compensation in exchange for accepting a novation clause, based on their perceived bargaining leverage.
Reliant argues that even if contract suppliers expect to benefit from contract renegotiation, there is no reason why ratepayers must necessarily be disadvantaged. Reliant suggests that provisions might be negotiated that benefits both the supplier and ratepayers. For example, a supplier might be willing to accept a price reduction in exchange for negotiating a longer contract duration, granting more favorable payment terms, or more flexible delivery requirements.
PG&E contends that any renegotiation of contracts will be time-intensive and costly based on its experience in negotiating contracts in recent years. PG&E doubts whether DWR and the IOUs will be able to novate, assign, or renegotiate all of the DWR contracts given the hurdles involved. PG&E does not assert categorically that no net benefits are possible or that further efforts to negotiate with suppliers should be abandoned. PG&E believes, however, that such efforts are still at a very preliminary stage. PG&E argues that before the Commission considers supporting any effort to novate, assign or renegotiate the DWR contracts, it should be determined if all of the existing contracts as a legal or practical matter can be novated, assigned, or renegotiated while producing customer benefits.
Reliant disagrees with PG&E's assertions that the benefits of novation lie, to a large extent, with all of the DWR contracts being novated. Reliant argues that there will be a concomitant benefit to ratepayers with the novation of each contract.
SCE believes that the probability that DWR will be able to novate or assign all of the DWR contracts is low. SCE identifies (1) the constraints of the PG&E Bankruptcy Settlement and (2) the lack of novation clauses in four of the DWR contracts as particular impediments to successful novation of all contracts. SCE believes, in any event, that a 24-month timeframe would be more realistic for completion, assuming all other potential impediments could be otherwise overcome.
Representatives of consumer groups, DRA, TURN, and CFC likewise believe that successful novation of all of the DWR contracts is unlikely, particularly as early as January 2010. They claim that outcomes are too uncertain to conclude that novation would benefit ratepayers, and argue that the Commission should reevaluate its goal of pursuing novation or assignment of the DWR contracts.
DRA argues that while some impediments to novation may be surmountable, others very likely are not. DRA doubts that all of the impediments can be resolved by January 2010. Given the perceived difficulty of achieving novation of all existing contracts, certain parties suggested limiting the focus only to those contracts that expire after a date certain. DRA suggests it may be more feasible to renegotiate the small number of contracts that expire after June 30, 2012, assuming there were net benefits to ratepayers.
TURN believes that if the Commission moves forward with efforts to expedite the transfer of DWR contracts, the earliest feasible date for completion would be either September 30, 2011, the expiration date of the Sempra contract, or June 30, 2012, the expiration date of the Coral contract. At that point, only about 500 megawatts (MW) would remain under contract with DWR.
In deciding whether or how to move forward with a plan to facilitate the expedited removal of DWR from its role as supplier of power, we must determine whether it is in the public interest to implement such a plan. In particular, we must assess whether the potential net benefits for ratepayers of pursuing such a plan outweighs potential downside risks.
Certain parties frame the question before the Commission as a choice between two extremes, either: (1) conclude with 100% assurance that DWR will successfully get out of all its contracts by January 2010 or else (2) immediately close the entire proceeding, and abandon any further exploration of ways to facilitate DWR's early release from its contracts.
Such extremes imply an artificial dichotomy, and do not realistically characterize the broader range of outcomes that are possible. The question is not whether we know with 100% certainty the ultimate success of efforts to remove DWR from its role as power supplier by a certain date. Rather, the question is whether the potential benefits to ratepayers are sufficient to justify moving to the next phase of this proceeding, incorporating appropriate safeguards so that such action remains cost-effective.
No party has demonstrated that the likelihood of failure is so compelling that no further efforts should even be attempted to accelerate the removal of DWR as a supplier of power. Likewise, no party has provided a credible argument that this entire proceeding should be closed immediately. While uncertainties must be addressed in order to achieve the ultimate goal, we are not persuaded that such uncertainties are reason to abandon further efforts to secure any ratepayer benefits.
On the other hand, no party has presented a compelling showing that achieving full novation of all contracts by January 1, 2010 will be easy. Challenges do exist that could affect the achievement of the goal, or potentially extend the time line for implementing replacement of all DWR contracts. Our goal instead, is for a balanced approach, providing the opportunity for contract negotiations to provide benefits, but with safeguards to limit or redirect negotiation efforts if, or to the extent that such negotiations do not progress in a positive direction.
On balance, we thus conclude that the potential benefits of going forward with contract negotiations outweigh the potential downside risks, subject to appropriate safeguards. Accordingly, we adopt measures to ensure that any negotiations in contract terms proceed in a cost-effective manner. As discussed in Section 4, while the specific magnitude of net savings from this process is uncertain, we conclude that the potential prospects for at least some net savings justify going forward with a plan of action. As discussed in Section 5.5, we also provide assurance that retail customers will be protected against any cost shifting attributable to inter-IOU cost allocations associated with taking over a "Replacement Contract."
Pursuing a plan to accelerate DWR's removal from the role of supplying power under AB1X is consistent with the general Commission goals as previously articulated in D.02-12-069, stating:
Both the Commission and the Legislature have expressed their intent to eliminate the need for DWR to continue procuring power for the utilities after January 1, 2003, consistent with the utilities' statutory obligation to serve their customers.
Consistent with the intent of AB1X, one of this Commission's fundamental short-term goals is to transition full responsibility for energy market related activities back to the utilities as soon as possible. We should therefore make every effort to relieve DWR from the responsibility to perform any functions that should be performed in the long term by regular market participants. We note that this direction is consistent with the fact that the utility, and not DWR, continues to have a statutory responsibility to serve its customers. The utilities' obligation to serve their customers is mandated by state law and is part and parcel of the entire regulatory scheme under which the utilities received a franchise and under which the Commission regulates utilities under the Public Utilities Act. (See, e.g., Pub. Util. Code §§ 451, 761, 762, 768, and 770.) [Footnote omitted] (D.02-12-069 at 7-8.)
In D.02-12-069, the Commission thus expressed a preference for returning the IOUs to their traditional role of supplying power as a matter of public policy. This proceeding, however, provides a forum to address more analytically whether (or how) such an undertaking can be made cost-effective. Consistent with the goals articulated in D.02-12-069, we hereby adopt specific measures to expedite DWR's departure from the role of supplying power to retail customers.
In Section 4 below, we discuss our specific findings as to the likelihood of costs and benefits associated with various assumptions as to the outcome of contract negotiations. Based on this analysis, we adopt a plan of action, as detailed in Section 6 below, for moving into the next phase of the proceeding with a framework as a guiding principle to maximize ratepayer benefits in the most cost-effective manner.
5 Water Code § 80260 provides that:
On and after January 1, 2003, the department shall not contract under this division for the purchase of electrical power. This section does not affect the authority of the department to administer contracts entered into prior to that date or the department's authority to sell electricity.
6 See the DWR Revenue Requirement Determination for 2007, submitted to the Commission on August 2, 2006, pursuant to Sec. 80110 and 80134 of the Water Code, pp. 22-24, TABLE D-5 LONG-TERM POWER CONTRACT LISTING.
7 Fanucchi & Limi Farms v. United Agri Products, 414 F.3d 1075, 1081 (9th Cir. 2005), as cited in PG&E's comments dated August 25, 2008.
8 Id.
9 In order to be qualified to take over the rights and obligations of a DWR contract, the supplier's long-term unsecured senior debt must meet specified minimum credit rating standards.
10 See DWR Memorandum to the Assigned Commissioner and Assigned ALJ dated June 9, 2008, page 4. See also the comments of DWR representative, John Pacheco, at the July 1, 2008, workshop, stating that although a January 1, 2010 target may be "a very aggressive schedule," DWR sees it as possible to have all of its contracts novated by January of 2010. (Transcript at 180).
11 See D.03-12-035, Appendix C, Section 7 in I.02-04-026 regarding the investigation of ratemaking implications of PG&E's Plan of Reorganization.
