6. DWR Contracts, Economic Dispatch and Cost Allocation Issues

As described below, under the existing two-tiered procurement system in California, the utilities dispatch their own generating assets and contracts first to determine their net short position, and DWR dispatches its contracts and procures additional resources as necessary to meet the combined net short of all three utilities. This changes with the allocation of specific DWR contracts to each utility as they resume their procurement responsibilities. Now each utility must operate with a resource portfolio that includes (1) its own generating assets and existing power contracts, (2) the must-take and dispatchable DWR contracts allocated today, and (3) new resources that it procures in the market.

Least-cost or "economic" dispatch should be the operating rule for the utility's portfolio of resources, including the DWR contracts. All parties agree with this policy, in concept. However, SCE and SDG&E argue that the total costs of the DWR contracts must follow the allocation of contract power for operational purposes in order to achieve an economic dispatch.

We disagree. Economic dispatch entails analysis of the marginal costs of the available energy and dispatching the least-cost incremental resource. An important element of least cost dispatch is that the fixed costs associated with resources are considered sunk for dispatch purposes. Variable costs are the only ones that are incurred or avoided as a result of operating decisions. As DWR, ORA and PG&E point out, to achieve economic dispatch the operating utility needs only to see the variable costs of each DWR contract (or of any other resource in its portfolio).⁴⁵ We agree with PG&E's observation that "[d]ispatch and operation of the DWR contracts does not require the allocation of total costs, any more than a utility requires the consideration of its total costs to dispatch its own utility retained generation."⁴⁶

Our allocation of DWR revenue requirements may or may not assign the total costs of each contract to the utility to which that contract is allocated. We leave that issue open to be decided when we have all the relevant information concerning DWR's total revenue requirements and can carefully examine cost allocation alternatives. However, based on the record in this proceeding, we believe it is reasonable to require that the variable costs of each contract follow contract allocation. This will ensure that utility dispatch decisions are based on the appropriate operating cost information. Accordingly, in developing its revenue requirements proposal, DWR should present a contract-by-contract delineation between fixed (or sunk) and variable costs for our consideration.

In its comments, DWR proposes that we establish a dispatch priority for the utility's portfolio whereby the DWR must-take contracts would be dispatched first under all circumstances.⁴⁷ In essence, DWR is asking that these contract quantities be first in line to be sold to the utility's customers, and last in line for any reductions in output or sales of surplus energy in the market.

DWR's position stems from its concern that the actual revenues from contract quantities will not match its revenue requirement projection for ratemaking purposes, unless such a priority is given.⁴⁸ DWR's revenue requirement consists, in large part, of DWR's forecast of the cost associated with the long-term contracts, taking into account forecasts of the utilities' load and the fixed and variable costs of the contracts that will be dispatched to meet those loads. The revenue requirement also takes into account a forecasted amount of revenues from system sales of surplus capacity. The rate that DWR is authorized to charge utility customers is calculated by dividing the authorized revenue requirements by the expected sales to utility customers. If actual sales to DWR customers are less than projected (either because output from the contracts is less than forecasted or because more sales of surplus energy takes place than projected, or other factors), DWR will not recover its forecasted revenue requirement with the authorized rate, and may need to return to the Commission to request a higher average rate.

In our view, the utilities' dispatch protocols should not be driven by considerations of whether or not DWR will end up with a higher or lower computed average rate. At the end of the day, as SCE points out, DWR will collect its revenue requirement.⁴⁹ However, under certain circumstances, economic dispatch will mean supplying incremental power from lower-cost utility generating assets to customers, even if this means that DWR contract power is to be sold on the market at a "loss." This is exactly the kind of balancing that must be performed in determining least cost dispatch. Therefore, we believe it is inappropriate to establish the dispatch priority that DWR recommends.