III. Edison's May 6^th Motion

A. Request

Edison's "Motion for an Interim Decision Granting Approval of Process for Early Procurement of Capacity" (Edison May 6^th Motion) requests that the Commission issue an interim decision prior to June 15, 2002, that authorizes Edison to enter into multi-year capacity contracts using the credit of the DWR until Edison regains its investment grade rating. Edison claims that this approach would help bridge the gap to the procurement that it would conduct under a Commission approved procurement plan that is currently before the Commission for review. Edison contends that such authorization would allow it to begin procuring power prior to the Commission completing its review of the procurement plan and prior to Edison regaining an investment grade capacity rating.

Under this requested authority, Edison anticipates procuring capacity products that are dispatchable, together with related fuel and electric transmission where appropriate, to meet its anticipated need, defined as its RNS, in super-peak periods. Edison asserts that entering capacity contracts for up to five years in duration would be beneficial for Edison's customers because it would allow Edison to be less dependent on the volatile spot market for power purchases.

Edison states that each contract would be submitted to the Commission by advice letter for approval within 30 days of its execution. Edison's proposal would require the Commission `s Energy Division to approve the contract within 30 days, unless it provides specific reasons why the contract is not in the best interest of Edison's ratepayers.

On May 15, 2002, the assigned Commissioner and Administrative Law Judge (ALJ) issued a ruling (May 15^th Ruling) finding that the authority sought by Edison should not be considered outside of the full factual and evidentiary record being developed in this proceeding. The ruling provided a short extension to the procedural schedule to accommodate consideration of the motion in an expedited manner and required Edison, and any other utility interested in similar authority, to serve the additional testimony necessary for us to consider this request. Prior to Edison's motion, the scope of the procurement plans before us were limited to consideration of 2003 needs. As stated in the May 15^th Ruling, the critical part of the evidentiary record needed to evaluate Edison's proposal was a reliable forecast of its residual net short requirements for 2003 through 2008. Edison and the other respondent utilities had previously stated that they could not provide this forecast until there was resolution of issues related to the allocation of DWR contract power and ongoing coordination of DWR and utility supply activities; therefore, the ruling set forth a process for parties to meet and confer in order to develop a proposal to resolve these issues.

The utilities were not able to timely resolve the DWR allocation issues identified as critical in the May 15^th Ruling. Instead, in its May 24, 2002 supplemental testimony, Edison stated that the uncertainty regarding the effects of DWR contract allocation on its forecasted peak day shortages should be addressed by limiting the amount of megawatts (MWs) authorized under the motion.

On May 31, 2002, DWR wrote the Commission and parties a memo outlining its position on Edison's motion. This memo, received into evidence as Exhibit 131, states that DWR requires the following conditions for the proposed authorization to be consistent with its authority under AB1X:

1. DWR retains title to all power purchased by DWR.

2. DWR's costs for interim payment under the contracts are recovered through DWR's revenue requirement and are directly reimbursed by Edison's customers in the same manner as other net short purchases by DWR at present.

3. DWR and Edison would be signatories to any contract, providing for DWR to be removed from the contract upon Edison becoming creditworthy and assuming full responsibility for payment for energy under the contract(s) thereafter.

In addition, DWR states that the Commission should be aware if there are any contracts for energy payments which vary with the market price of fuel (presumably natural gas) or other market indices, such contracts could contribute to added volatility in DWR's payment obligations, thereby affecting the reserve fund balances and associated bond issue size. DWR further states that, to ensure the stability of rates, it is critical that the Commission adopt a contract allocation and resource dispatch policy as a part of its ruling on Edison's motion.

In its July 12, 2002 brief, Edison renews its request, with some modifications, under the Joint Principles for Interim Procurement dated July 12, 2002 (Joint Principles) it signed with CU, PG&E, and TURN. The Joint Principles proposes establishment of a Procurement Review Group whose members, subject to an appropriate non-disclosure agreement, would review and assess the details of Edison's overall interim procurement strategy and specific proposed procurement contracts and proposed procurement processes prior to Edison submitting filings to the Commission. Commission staff would be ex officio members of the group. Both renewable and non-renewable suppliers would be eligible to supply the capacity needs of Edison, with no accelerated or special consideration given to renewables or, more broadly, to QFs. The procedural process set forth in the Joint Principles requires the Commission to issue a resolution within 30 days of an advice letter filing. The Joint Principles state that this authorization should be granted no later than the end of July 2002.

Interested parties to the proceeding generally support a more limited transitional authority than that requested by the respondent utilities. Ridgewood and Aglet recommend the request be denied. Ridgewood claims that granting Edison's motion would prevent companies from developing new renewable resources in the state and cause many existing renewable facilities to shut down. Aglet states that the Commission should deny Edison's motion because the risks of unanticipated long-term consequences of hasty contract approval outweigh the benefits of current market opportunities. In the alternative, Aglet states that the Commission should impose restrictions of the type recommended by CEC. Examples of such limitations are a cap on on-peak capacity procured under Edison's motion, and dispatchability requirements. The recommendations of other parties on the amount and type of products will be discussed in a following section.

B. Applicability to PG&E and SDG&E

PG&E and SDG&E request similar authority to that requested by Edison, and also request that any interim procurement authority the Commission provides to one utility be extended simultaneously to all three utilities, to ensure fair and equitable opportunities for all California utilities to acquire reliable and reasonably-priced capacity for all their customers.⁴

SDG&E currently has an investment grade credit rating, and, therefore, a question exists as to whether the credit support of DWR should be provided, and if so, when SDG&E should assume financial and legal responsibility for the contracts from DWR. Edison and PG&E propose SDG&E assume this responsibility at the same time that either Edison or PG&E achieves an investment grade credit rating, whichever is earlier. SDG&E differs, requesting that it not assume full responsibility for the DWR contracts until both Edison and PG&E have achieved an investment grade credit rating.

SDG&E states that although it is creditworthy, its procurement needs are a small part of the market and it represents that the market does not distinguish between a creditworthy SDG&E and a non-creditworthy SDG&E because of the spillover effects stemming from PG&E and Edison. However, we note that SDG&E is distinguishable, for example SDG&E may fully participate in the CAISO market. Also, other creditworthy utilities operating in California such as PacifiCorp are able to procure for their customers, despite the financial situation of Edison and PG&E.

We are not persuaded that there is a need for DWR to "backstop" purchases for SDG&E. The purpose of DWR's involvement is to use the state's credit to assist the utilities, if necessary, and the state should not continue this relationship beyond its intended purpose. Therefore, we propose that SDG&E execute any contracts resulting from the authority granted today without DWR involvement. However, we will afford SDG&E other aspects of Edison's proposal, such as an expedited review process.

C. Should DWR Contract Allocation Be Completed First?

The May 15^th Ruling stated that the DWR contract allocation should be completed in order for the Commission to have an accurate forecast of each utility's RNS and set forth an expedited procedural schedule to accomplish this. In their supplemental testimony, the utilities stated that they could not complete this task in the time allowed and proposed that the Commission use a percentage of a conservative estimate of the RNS to compensate for the range of uncertainty. At the end of hearing, the ALJ asked parties to brief this issue.

The utilities continue to argue that transitional procurement can be authorized prior to allocating the DWR contracts by using a percentage of a conservative RNS estimate. ORA, CEC, and several renewable parties are more cautious, their concern being that the utilities may foreclose the opportunities to purchase renewable power by signing long-term non-renewable capacity contracts prior to January 1, 2003. These parties recommend that the amount of power authorized under the requested transitional authority be less than requested by the utilities, and that less of the authorized amount be available for long-term contracts.

We share the concern that the utilities not over-procure in the transition period, especially for five-year contracts that could have the effect of shutting out new renewable generation or demand reduction options. We will consider Edison's May 6^th motion here, but only in a manner that will not foreclose renewable generation in the final procurement plan. The specifics of this will be discussed in the following section.

When the decision on DWR contract allocation is final, both at the Commission and in any reviewing courts, the utilities may petition the Commission to increase the level of transitional authority if a need exists, and sufficient time remains in 2002 to exercise this authority.

D. What Types of Products Should Be Authorized and in What Amounts?

1. Parties' Positions

Most active parties in the proceeding were not permitted to review the underlying data submitted by the utilities because they did not meet the strict standard of "non-market participant" set forth in our May 1, 2002 Protective Order. And as market participants themselves, the respondent utilities did not have access to each others' confidential material. With many parties unable to review the evidence, we need to be very cautious in assuring that the underlying forecasts of RNS and the assumptions they are based on, have been vigorously examined, tested, and verified. We give particular weight to the testimony of ORA, CEC, Aglet, and TURN because they are parties with full access to the evidence and possess the technical expertise to understand and assess it.

We are particularly mindful of the needs of parties representing renewable resources because they do not have access to the confidential evidence. The renewable resources parties express strong concerns that the authority we authorize here does not foreclose, or in any way harm, the utilites' ability to meet their potential obligation under AB 57 to increase the amount of eligible renewables presently in their portfolio by 1% annually, beginning in 2003.

The specific amount each respondent utility is requesting is a confidential number, based on a percentage of a conservative forecast of its RNS energy needs in 2003 through 2007.⁵

The utilities assert that if multi-year dispatchable capacity or forward energy hedges can be purchased in these amounts at favorable prices, they will be far superior to reliance on short-term transactions in protecting electricity customers from the risks of volatile power prices. Edison states that it would be inappropriate for the Commission to specify precisely the types of contracts which it and DWR can jointly enter because the utilities will have less than six months to negotiate and gain all approvals of complex contracts before DWR's authority to contract expires.

Edison proposes that each contract be "either a capacity contract, an energy contract, an energy exchange contract, or a financial transaction that provides a hedge similar to that provided by any of the above types of contracts." (Ex. 119, Appendix A.) PG&E and SDG&E request they be granted the same terms and conditions as those approved for Edison. In addition, PG&E requests it be granted explicit approval to enter gas hedge contracts, an authority that Edison now has under the terms of its settlement agreement with the Commission.

2. Discussion

a) Establishing a Procurement Limit

On May 24, 2002, PG&E, Edison, and SDG&E filed supplemental testimony providing capacity limits to be used under an interim procurement framework. Edison and SDG&E's testimony explicitly states that the capacity limits are based on low-case RNS scenarios (e.g., assuming low load, high direct access, and high allocation of DWR contracts) to produce conservatively low estimated procurement limits. The purpose in proposing a conservatively low limit for interim procurement is to establish a limit such that even though DWR contracts have yet to be allocated, the utilities will not over commit their RNS once contract allocation is resolved. PG&E's supplemental testimony does not explicitly acknowledge that its proposed procurement limit is based on a modeling scenario aimed at producing a conservatively low estimated capacity limit for purposes of interim procurement.

Numerous parties raise concerns with respect to the amount of the procurement limits proposed by the utilities. CEC comments that Edison's proposed interim procurement limit is too high and would obviate the need for procurement under Phase 2 of this proceeding as the level of capacity contracting requested would essentially cover all of Edison's RNS. CEC urges us to authorize the utilities to procure for a more limited quantity of resources, between one-fourth and one-third of their respective on-peak RNS requirements. Aglet also supports more restrictive limits. ORA indicates that its examination of Edison's residual net short requirement shows that if interim procurement is allowed, "only a relatively small number of on-peak hours in the reference case RNS and a limited number on peak hours for the high-case RNS for 2003 and 2004 are projected to have RNS greater [than] SCE's proposed limit."⁶ ORA advises that we consider the actual number of hours that would remain uncovered as the Commission decides the merits of Edison's Motion. SDG&E also cautions that the amount of power to be procured on an interim basis should be conservative in order to allow additional procurement to be guided by the Commission's final decision adopting the utilities' final procurement plans.

CEC also points out that Edison's estimates of its RNS energy requirement are highly sensitive to how the DWR contracts are allocated among the three utilities as well as to the outcome of the state's contract renegotiations efforts. Given that final allocation remains undecided and that contracts are subject to ongoing renegotiation, utility RNS estimates are "uncertain and speculative."⁷

Energy Division is in possession of the utilities' confidential data supporting their respective requests for capacity limits. A basic assessment of the supporting data shows that if the utilities are authorized to procure up to their conservatively estimated capacity limit (capacity without ancillary service capability), the number of hours that Edison is still short is reduced from roughly 45% of the total number of hours in 2003 to about 13%. For SDG&E, the decrease is more modest, dropping from 38% of total hours in 2003 to about 28%. Unlike Edison and SDG&E, PG&E did not explicitly make a showing in its Supplemental Testimony that its requested capacity limit for interim procurement is based on a methodology aimed at producing a conservatively low estimate for interim procurement. (See Exhibit 48C.) Edison and SDG&E present an alternative capacity limit that includes self-provision of ancillary services. Energy Division's review of the proposed capacity limits with ancillary services capability shows that the number of hours left uncovered in 2003 (i.e., the remaining RNS) drops to about 7% of total hours for Edison and 11% for SDG&E.

For transitional procurement authority, we adopt a capacity limit for each utility that reflects a cautious approach. First, we adjust PG&E's proposed capacity limit to reflect a comparable methodology to Edison's and SDG&E's conservative low RNS forecast. We do this by removing from total load adjustments the amounts PG&E shows for ancillary services and planning reserves. With this revision, we authorize Edison, PG&E, and SDG&E to procure up to 65% of their forecasted on-peak hourly RNS requirement reflected in a low-case RNS scenario for products with a contract duration up to one year and without self-provision of ancillary services included.

We find that 65% of the on-peak hourly RNS requirement based on a low-case RNS forecast strikes a reasonable balance that allows the utilities to procure on a transitional basis, but also does not commit all RNS requirements. In addition, this approach allows for the final procurement plan to consider changes in the RNS requirements.

Our adopted 65% figure is intended to not foreclose opportunities for the utilities to procure additional power under the 2003 utility procurement plans pending with the Commission, but also to be of a sufficient amount to generate robust interest in the supplier community. The limit we authorize here is not higher than that requested by any respondent utility. Further, the limit we authorize for Edison is below the maximum MW authorization recommended by CEC in its July 12 brief at page 2. In their applications for pre-approval of products, the utilities shall demonstrate that this 65% limit is adhered to.

Edison's May 6^th Motion also requests authority to procure contracts with terms up to five years. Edison asserts that multi-year procurement authority is needed because:

"...the availability in the marketplace of capacity contracts for a one-year term is highly unlikely and, to the extent they are available at all, SCE believes they will not provide a reasonable cost to our customers. Capacity contracts are more complex than other contracts and may require the seller to make a significant investment in generation to provide the service."⁸

Edison adds that:

"Mutli-year capacity contracts may also be used, if approved by the Commission, to firm up investment in new generation which can help meet customer demand that currently must rely on the uncertain spot market. The contracts may help to assure that capacity additions that are now being differed, or at risk of being differed, will actually be completed when needed."⁹

In supplemental testimony filed by the utilities, each utility proposes a procurement limit that reflects a significantly increasing amount of power annually between 2004 and 2007.

Several parties object to Edison's request for multi-year contracting authority. ORA argues against multi-year procurement citing: (i) uncertainty associated with wholesale market redesign issues; (ii) the fact that the utilities' procurement plans are pending at the Commission; (iii) the Commission possesses limited time and resources to review such contracts; and (iv) multi-year contracts with suppliers that do not have generation installed to meet 2003 needs will not satisfy near-term capacity needs of the utilities. CEC recommends that multi-year capacity products be limited to "a safe quantity assured to be required."¹⁰ CEC comments that the substantive benefit provided through multi-year contracts is the revenue assurance it provides to a new generator. Like ORA, CEC points out that it takes about two years for a new generating facility to come on-line following commitments; therefore ratepayers won't receive the "majority of the benefits"¹¹ of such a contract in the near-term.

SDG&E proposes what it calls a "50/50 rule" for multi-year contracting whereby half of the total amount of capacity that is authorized for procurement under interim procurement be contracted for a term of up to five years. The remaining half could be contracted for a term not to exceed one year.¹² SDG&E witness Resley provided context for this proposal during evidentiary hearing:

"...this [50/50 proposal] derives from our concern about making too many commitment too soon for too long. We've learned some things in the past few years, and we have learned that some hedging, some time between commitments, some ability to see how things evolve is better than putting all your bets on a single outcome at a single time."¹³

We find merit in authorizing multi-year procurement. The prospect of signing multi-year procurement contracts will help attract suppliers to utility solicitations and will help attract capital investment in new generating projects. However, we are not convinced that authoring procurement up to the levels requested by the utilities is appropriate at this time. Given the uncertainty that exists surrounding final allocation of DWR contracts and the uncertain net effects of DWR contract renegotiation on the aggregate size and shape of DWR's supply portfolio over the next five years, as well as the concerns voiced by ORA and SDGE, we find that it is reasonable to adopt SDG&E's recommended 50/50 proposal. This limit will ensure that a significant remainder of procurement requirements will be guided by future Commission decisions and re-examination of utility RNS positions and market conditions.

b) Product Types

Edison proposes to enter into contracts for "dispatchable capacity, and for related fuel and transmission, where appropriate, of up to five years in length."¹⁴ Edison also seeks to secure natural gas hedging in support of the capacity contracts negotiated through interim procurement. PG&E states that it needs the same types of procurement products described by Edison, but also requests authorization to purchase natural gas hedges to hedge the fuel price of its fossil-fuel Utility Retained Generation (URG) assets and QFs contracts whose energy payments are indexed to natural gas prices. SDG&E indicates that in addition to dispatchable capacity, one of its "significant residual net short needs" is for energy products to replace San Onofre Nuclear Generation Station (SONGS) Unit 3 during its scheduled refueling in early 2003.^15,16 Edison's testimony lists energy products without making a specific showing of need for them.

With the exception of ORA, parties do not dispute the utilities' identified need for capacity products. ORA characterizes Edison's proposal as an "unspecified need for capacity contracts" and argues that Edison's proposal fails to adequately define what it means by capacity.¹⁷ Additionally, ORA recommends that the Commission should explicitly encourage energy for capacity transactions given that "the utilities generally appear to be long in energy supplies and short in electric capacity."¹⁸ CEC points out that the utilities should be encouraged to foster the development and trade of energy products that satisfy RNS requirements during "super-peak" periods.

Given the flexibility that capacity products provide in meeting a range of variously shaped residual net short requirements during certain hours in a month, we agree with Edison's proposal that capacity contracts should be allowed under transitional procurement process. For purposes of addressing ORA's concern that Edison has failed to precisely define the term capacity product, we adopt a combination of ORA's proffered definition¹⁹ as well as PG&E's definition:²⁰

A capacity contract is one in which the buyer has the right to take energy at a known price in exchange for a capacity or reservation charge. The energy charge could be fixed or indexed to gas prices. Under this type of contract, the buyer has the right, but not the obligation to schedule energy up to the maximum number of MWs provided for in the contract.

Gas tolling agreements will be allowed as a subset of capacity contracts. Recognizing the scheduled refueling of SG&E's SONGS Unit 3 in 2003 and in consideration of CEC's recommendation for promoting peaking energy products, we are also authorizing the use of forward energy products under interim procurement process. Additionally, we find the it is reasonable for the utilities to arrange for the transportation of the physical commodity portion to be deliver pursuant to capacity and energy contracts. Related fuel products, natural gas supply, transportation, and storage are also authorized to the extent the utilities make a showing that such arrangements are in support of the specific electric capacity transactions brought forward pursuant to this decision.

Energy exchanges, such as the energy for capacity transaction recommended by ORA, peak for off-peak exchanges, and seasonal exchanges, are authorized for interim procurement. As noted by ORA, these types of transactions have proven to be cost effective in the past plus the Commission and the utilities have significant previous experience with these types of transactions.

We do not provide additional authority to the utilities for the use of financially-settled hedging instruments for interim procurement, including natural gas hedges. Such transactions are likely to add a level of complexity to the interim procurement review process that could potentially overwhelm staff resources. Under this interim procurement framework, we are only authorizing physical transactions. Financial transactions will be addressed further in a future decision adopting utility procurement plans. The requests of PG&E and Edison for additional authority to transact for natural gas hedging as part of this short-term interim procurement mechanism is, therefore, denied. We also deny PG&E's specific request to procure gas hedging to hedge the fuel cost risks associated with its URG and QFs contracts. We reject PG&E's request for two reasons. First, the request goes beyond the scope of this proceeding. PG&E's gas hedging proposal is focused on hedging fuel costs associated with existing generation resources whereas this proceeding addresses the utilities' going-forward RNS procurement needs for 2003.²¹

We find that granting transitional authority, under the terms and conditions adopted here, is beneficial for both the utilities and their customers. Edison and PG&E will benefit by being able to enter procurement contracts prior to regaining an investment grade credit rating and to demonstrate to the financial markets that they can successfully resume their full procurement responsibilities under the Commission's regulatory oversight. All three utilities will benefit by reducing the amount of purchases they will need to make beginning in 2003 and beyond. Finally, customers of the utilities will benefit from the utilities receiving and exercising this authority in a manner that promotes reliable service at just and reasonable rates. We next discuss the process that should be used by the utilities to make this showing of ratepayer benefits.

The utility/DWR agreement proposed by Edison should be modified to meet the concerns expressed by DWR in its May 31^st memo. The revised agreement should be submitted to the Commission by each respondent utility by a compliance filing within five days.

E. Procedural Process

1. What is Being Requested?

In their July 12^th briefs, CU, PG&E, Edison, and TURN advocate that the Commission adopt their proposed expedited advice letter process. This process would have the Commission commit to approve or disapprove the contract and/or procurement process by Commission resolution within 30 days of filing. Approval would constitute a determination by the Commission that costs incurred by the utility under the contract itself and/or under contracts conforming to the procurement process are "reasonable" and "prudent" for purposes of recovery in retail rates under the Public Utilities Code for the full term of the contract or contracts. Utility administration of such contracts would remain subject to reasonableness review by the Commission under reasonableness criteria or incentive ratemaking, as appropriate. If the Commission rejects a proposed contract or procurement process, it would designate alternative procurement choices that would be recoverable by the utility for ratemaking purposes without further reasonableness review.

ORA is the only other party proposing an alternative procedural process. ORA discusses the complexity of the issues it expects to confront and, therefore, states that the Commission should authorize only one application for each utility, and there should be a minimum review period of 30 days before parties need to respond by filing a protest. It recommends the Commission process these contracts by advice letter and if there is a protest, the Commission would resolve the dispute by a resolution.

The advice letter procedure proposed by the parties to the Joint Principles has the Commission approving by resolution the utility's filing within 30 days. The only likely way this can happen is if the utility's filing takes effect without Commission action.²² Under our current procedures, the Commission cannot commit to issuing a resolution within 30 days, especially if there are protests and disapprovals as provided for under the Joint Principles proposal. It generally takes approximately 60 days to adopt an advice letter by resolution. For the Commission to meet the Joint Principles' timeline, it would mean having the resolution written by the protest date, receiving no protests, and having an upcoming Commission meeting date within the next 10 days. The advice letter process is shown at Appendix B, which sets out the timeline for the joint proposal next to our existing advice letter process.

2. What Has the Commission Previously Done?

At the hearing, the assigned ALJ asked parties to consider an expedited application process, one that would either use our current process in a quick manner or that would use a process similar to the Expedited Application Docket (EAD) process we previously used to review and approve gas and electric special contracts for large customers with bypass options. PG&E and Edison prepared Reference Items 4, 4A, 4B, and 4C showing the Commission decisions issued under the EAD procedure. As PG&E's attorney noted, applications processed under the electric EAD process were significantly quicker than those processed under the gas EAD process. A major difference is that the gas EAD process had the Commission make a finding of reasonableness in the decision whereas in the electric EAD process the reasonableness review was undertaken in later proceeding.²³ The EAD process for gas and electric contracts, and the resulting decisions, are set forth in Appendix C.

Our discussion here will focus on the electric EAD process as a means of understanding the policy implications of adopting expedited procedures. There are both similarities and differences between the contracts considered under this process and the utilities' relief requested here. Briefly, these are:

1. Purpose. The electric EAD process was designed to review contracts for individual utility customers rather than major procurement contracts to serve all utility customers. The specific dollar amounts under the EAD contracts are not discussed. The request before us here will involve individual contracts in the hundreds of millions of dollars. The contracts were for a similar length of time as those being considered here.

2. Guidelines/Standards. Specific guidelines for EAD contracts were adopted in D.88-03-008 in order to accelerate review under the EAD procedure. We adopted a standard for approval to ensure that all other customers would be indifferent to the granting of the contract. Recognizing that this was not a high standard, the Commission stated that EAD approval "merely indicates that the contract's prices are high enough so that other classes of ratepayers are not unreasonably harmed." (Id.) However, in the request before us now, a finding of ratepayer benefit rather than indifference must be made. Further, Edison states that the Commission should not adopt guidelines as the contracts proposed here are "nonconforming" contracts.

3. Risk Allocation. The electric EAD process used a forecast of revenues that placed the utilities at risk for revenue losses. The request before us is for the utilities to be held risk-free.

4. Reasonableness Review. The Commission did not undertake a reasonableness review under the EAD process, stating "the nature of the review that occurs in the Expedited Application Docket...is not one that results in a finding that the level of prices in the special contract is reasonable and prudent." (D.88-03-008, at p. 40.) Edison sought, and was denied, a finding of reasonableness under the EAD process in D.88-12-097. In the request before us here, the utilities' request a finding of reasonableness on an expedited basis is requested.²⁴

In summary, the electric EAD process had a narrower scope, adopted guidelines for review, a lower standard for approval, and required the utilities to bear the risk of revenue losses and future reasonableness reviews. The Commission processed only five applications under the EAD procedure, all between 1988 and 1989. After this period, the Commission processed two applications, two advice letters, and four "Approval Letters" drawing on the EAD guidelines and standards. (See D.94-03-075, D.95-06-055, Resolution E-3370 dated March 9, 1994 and Resolution E-3423 dated October 18, 1995, and Approval Letters set forth in Reference Item 4C.) The electric EAD process was not used extensively and the Commission did not apply the process to other types of applications. As testified at hearing by Mr. Weil, the expedited nature of the process left the Commission staff with serious reservations.

3. What is Required Now?

We agree it is reasonable to implement a transitional approach to procurement, but we should modify Edison's proposal. We need to develop a process that is balanced: one that meets the needs of the utilities for timely decisions that reduce regulatory uncertainties while at the same time ensuring that the Commission has exercised its statutory responsibilities to protect consumers from unreasonable costs through effective oversight and regulation. We must set forth the minimum procedures needed to ensure our responsibilities are met. Then, it is the utilities who have in their control how expedited the review and approval process will be based on the transitional procurement strategy they employ, the early and collaborative role they give staff and interested parties in reviewing their analysis and recommendations, the contracts they chose to enter, the quality of the application package they submit, and their responsiveness to requests for additional information.

We are confident the utilities can do what is needed to make the requested transitional procurement period a successful bridge to resumption of their full procurement responsibilities. At hearing, all the respondent utilities, and in particular Edison, made a strong showing that they had highly competent individuals managing their procurement function and that they had sufficient qualified staff and a formal senior management review procedure in place.

In order to ensure an adequate review period, the utilities should use an application process for nonstandard contract review and approval, especially as we undertake to quickly examine and provide, for the first time, up-front reasonableness approval to electric procurement contracts that are represented to be quite complex multi-year transactions. The advice letter process should be used primarily for ministerial matters, where staff is following established Commission policy or clear directives that do not require the exercise of discretion. The advice letter process provides a quick and simplified review of the types of utility requests that are expected to be neither controversial, nor to raise important policy questions. The primary use of the advice letter process is to review a utility's request to change its tariffs in a manner previously authorized by stature or Commission order, to conform the tariffs to the requirements of a statute or Commission order, or to get Commission authorization to deviate from its tariffs.²⁵

An application should be required in matters that require the exercise of discretion. In this instance, the respondent utilities are requesting to have large dollar, long-term contracts approved with a final decision on reasonableness. Edison testified that under its proposal its base case residual net short for 2003 is about $500 million. Assuming a request to cover one third of that with a five-year contract, the approval sought here would total $750 million. Thus, these are obviously matters that require an application process.

In designing an application process that is responsive to the utilities need to quickly know that the procurement transactions they enter will be fully recoverable in a timely manner, the key will be to ensure that each utility has sufficient qualified staff who together with the active oversight and documentation of senior management, develop and implement an appropriate risk management strategy. This risk management strategy would provide a diversified portfolio mix of energy products that provides customers reliable service at just and reasonable rates.

The Commission, its staff, and interested non-market participants must be able to review an application that clearly and thoroughly documents the steps followed by each utility's procurement staff, the risk management package presented to its senior management, the specific approvals and conditions given by management, the competitive bidding process undertaken, and criteria used to evaluate the bids, and the method of ranking the winning bid(s). Any requests by staff or other interested parties for further information or explanation must be expeditiously handled. Furthermore, the Commission must be assured that no conflicts of interest exist by prohibiting transactions, personnel movements, and communications between the utility procurement function and holding company entities, since we will not be able to take the time necessary to conduct comprehensive after-the fact auditing to detect and address any affiliate abuses.²⁶

The expedited schedule of the electric EAD process was not designed to address reasonableness reviews. In order to ensure fairness to ratepayers and the utilities, we will adopt two of CU's principles: structural regulation and process regulation. As Mr. Ahern of CU states, the essential elements of the process must be wide publication of the product needed, arms-length solicitation and negotiation, and objective selection of the best supplier by skilled utility staff with no conflicts of interest. In addition, to avoid the appearance of conflict, we will prohibit utility staff from being involved in the procurement function if they have worked for a market participant eligible to bid for a contract within the last two years. As the utilities did not deem it appropriate to propose benchmarks for the products they intend to purchase under their requested transitional procurement authority, we should require products to be purchased using a competitive process.

Under the competitive process, we direct the respondent utilities to provide wide dissemination of the request to members of the generation community, to include renewable resource suppliers. The specifications for capacity and energy contracts should not be fuel or technology specific. We term this an "all-source solicitation."

Because the utilities have not provided us with the specific terms, conditions, selection criteria, and process of any requests for proposals (RFP) they intend to undertake, this process will also be subject to Commission review. For the first time in their July 12^th filing, Edison and PG&E ask that we provide pre-approval of proposed procurement processes that would allow the utilities to be free from any further reasonableness review for any contracts entered into under the procurement process proposed. The utilities may file an application for pre-approval of a procurement process but unless it is very detailed and specific, the Commission reserves the right in its decision to require that the contracts that result from that procurement process also be subject to the application process we adopt here.

The process we adopt here is as follows:

1. Application. Edison, PG&E, or SDG&E file an application that conforms to the quantities, products, terms and conditions we discuss earlier for transitional procurement. The application should demonstrate it meets our standard for approval by a showing that entering into the contract(s) should result in favorable and stable rates for ratepayers relative to alternative options. An application may contain all winning contracts from a single RFP solicitation. SDG&E cannot use DWR's credit to undertake transitional procurement.

2. Master Data Request. We find the master data request proposal by ORA to be beneficial and will adopt it. The application must contain all information required under our adopted master data request. The specifics of this are attached to this decision as Appendix D. Each application should include documentation of the steps followed for each transaction, such as including at a minimum the risk management package presented to senior utility management, the specific approvals and conditions given by management, and the rationale and procedures of the selection process undertaken. The respondent utilities must also respond to all data requests within five working days, either by producing the requested material or by filing an objection under our Law and Motion procedures.

3. Procurement Review Group (PRG). Use of the PRG recommended in the Joint Principles. This group would meet prior to the application being filed and should be convened early on to assess any proposed RFP process before it is implemented. The PRG would meet again to assess the resulting bids, the winning procurement contracts, and reasonableness criteria with each respondent utility. The group would be open to parties designated under our Protective Order to review confidential information and would include representatives of the Commission's Energy Division and ORA as ex officio members.

4. Protests. A 30-day protest period with replies due in five days.

5. Workshop. A workshop will be held approximately 40 days after the application is filed. After the workshop, the assigned ALJ, in consultation with the assigned Commissioner, shall issue a ruling designating whether there are issues of substantial controversy or importance to require the scheduling of hearings. The ruling shall also state whether the ALJ intends to prepare a draft decision which meets the criteria set forth in Public Utilities Code Section 311(g)(2) of being an uncontested matter in which the decision grants the relief requested, a criteria that allows the 30 day public review period to be reduced or waived.

6. Current Filings. The requirement that each respondent utility shall have only one application pending at a time. However, if the assigned ALJ issues a ruling stating that the ALJ intends to prepare a draft decision that meets the criteria of 311(g)(2) and that will not be issued for public review and comment, then another application may be filed.

7. Denial. If the Commission rejects a proposed contract or procurement process, it should not designate any alternative procurement choices that would be recoverable by the IOU for ratemaking purposes without further reasonableness review.

8. Reasonableness Review. In its decision on an application, the Commission shall apply the same reasonableness standards it used in the ECAC proceedings and prudency of contract administration shall be at issue over the life of the contract.²⁷ Similar to the gas EAD process, which provided an expedited procedure for reasonableness review of gas contracts, approval of the contracts shall be dispositive of all prudence questions which might arise at a later date regarding the contracts, absent a showing of: (a) misrepresentation or omission of material facts of which the utility is aware in connection with the utility's request for contract approval; and (b) imprudence in the utility's performance under the negotiated contract.

The procedural process set forth above is shown in Appendix E. It provides the utilities an opportunity for an expedited review and approval process while ensuring that the Commission, its staff, and all interested parties have the time and resources to fully analyze and consider each application and, where appropriate, hold an evidentiary hearing. Our reasoning here is based on the years of experience the Commission has had in doing reasonableness reviews and reviewing complex contracts. As ORA states in discussing the minimum length for a protest period:

"ORA requires a minimum of 30 days. Review of contract restructuring of QF contracts, where the Commission and ORA has significant expertise in both contract form and evaluation, requires significantly more than 15 days. The Commission and ORA will be reviewing contracts which according to Edison are likely to require substantial time just for the utility to negotiate, contracts that do not offer standard industry terms, [and] contracts that involve evaluation which is based on risk management principles,
. . . ." (July 12 brief, page 7.)

We do not commit to complete our process within a set timeframe because we must take the time necessary to make a finding that the contract is reasonable and will result in just and reasonable rates for ratepayers. As previously discussed, the pace at which we can proceed is largely within the utilities' control as it is governed by the contents of the application filed. In addition, we will not adopt a default mechanism that allows for contracts to be considered approved if the Commission fails to take action. This approach would provide a perverse incentive for the utilities not to provide all the necessary information in a timely manner. ORA testified at hearing that utility responses to some of its data requests were either not given in a timely manner or were simply still not answered.

ORA testifies that each utility should be authorized only one contract under the transitional authority and that to allow more filings would create a regulatory burden that would preclude genuine regulatory oversight. We find that allowing only one application in the review process at a time sufficiently addresses this critical issue. The Commission is committed to giving these applications a high priority and to proceeding as expeditiously as possible given its staff resources and other responsibilities.

If the utilities provide the Commission a complete and clearly laid-out application that is uncontested and meets our standard for approval, the Commission could place a decision on a Commission agenda within 60 days. The findings made in the first decisions will provide guidance that should facilitate future filings. Moreover, the utilities can include multiple contracts in the same application to further expedite the process.

The utilities have requested that the Commission pre-approve each contract. The utilities testified at some length that they were unwilling to accept any procurement risk. The record shows, however, that a cost premium may attach to a pre-approval process because the utilities may need to pay a fee to keep an offer open or pay a premium to "refresh" the offers after the Commission grants approval. If the utilities seek pre-approval, they should carefully monitor and report any cost premium paid for this. We are reluctant to allow a pre-approval process and will revisit this issue in the 2003 procurement planning proceeding. To minimize any cost premium, any contracts under which a utility is seeking pre-approval must be filed by application within 30 days of signing a selection.²⁸

A consistent theme heard from the utilities over the years is that the Commission should not micromanage their activities, and the utilities may charge that we do so through our adopted review process. However, previous Commission decisions regarding procurement proposed a portfolio approach to procurement which gave broad discretion to the utilities. (See D.00-12-065 in R.94-04-031 and I.94-04-032.) Under this approach, the utilities would achieve an overall procurement portfolio at a Commission-approved price per megawatt, which means that the utilities would have the discretion to sign contracts above and below that price, provided the overall portfolio costs were at the Commission-approved price. If the utilities' portfolio exceeded the adopted price per megawatt, the utility would still have the discretion to file an application demonstrating the reasonableness of its proposal. Notwithstanding the broad discretion afforded them, the utilities opposed this proposal as too risky.

In the hearings, Edison demonstrated that it employs a large number of very well-paid staff for its resource procurement activities, and that it takes these employees months to assess and negotiate the resource contracts. Nonetheless, the utilities believe the Commission, with far fewer resources than the utilities, should effectively rubber stamp approval of these transactions without meaningful review, which is what would undoubtedly happen with a 30 days review process. We would be remiss to our duty of safeguarding the public interest to adopt such a proposal. Rather, the proposal we adopt today will expeditiously give the utilities the requested certainty regarding the reasonableness of their procurement decisions while exercising our duty to meaningfully review the contracts.

Without effective oversight, adoption of Edison's request would transfer the risks of procurement from the utilities that negotiate the transactions to their customers. These customers, unlike the utilities, have no ability to control procurement risk. The utilities acknowledge the shifting of risk but state that this is appropriate due to their weakened financial condition. They also state that the transitional authority requested can reduce overall procurement risk by lessening the reliance on volatile spot markets to meet customers' needs in 2003.

The procedural process laid out above is an ambitious one for the Commission. Our past experience with trying to review and approve large contracts in an expedited manner has not been entirely successful. However, we find there are policy reasons for adopting Edison's motion for transitional procurement authority, with modifications, and believe the process we adopt here, which adjusts for changes in the scope and standards of our former electric EAD process, is a workable process.