III. 2004 Gas Structure and Beyond

A. Summary of the Proposals

The Gas Accord market structure, which was implemented on March 1, 1998, established the rules for providing access to PG&E's backbone and local transmission system, and to PG&E's storage system.⁶ The main features of the Gas Accord market structure are the unbundled, tradable, firm rights to backbone transmission and storage capacity. The Gas Accord also established rules and standards for PG&E's role in core procurement. As a result of the Gas Accord market structure, gas marketers, and end-use customers and their agents were provided with a variety of tools to manage their gas commodity and transportation costs. The Gas Accord Settlement Agreement, which is attached to D.97-08-055 as Appendix B, describes more fully the market structure. (See 73 CPUC2d at 797.)

PG&E's application proposes to retain the basic market structure of the Gas Accord, with certain proposed changes. PG&E requests that the basic market structure be retained permanently, and that its proposed changes, rates and terms and conditions, as proposed in its application and supporting testimony, be adopted for the period beginning January 1, 2004. The most notable of the proposed changes are the following: (1) reducing the system load factor to 68.4% to reflect its demand forecast for 2004; (2) replacing the single average rate for noncore local transmission service with a four-tiered rate structure segmented by annual usage; (3) establishing a 1-in-10 year Winter Reliability Standard and Winter Firm Capacity Requirement; (4) the roll-in of 20% of Line 401 costs to the core; (5) replacing the current diversion procedure with a curtailment procedure in the event of a supply shortage; (5) selling 4.5 MMDth of non-cycle working gas, the profits of which would be retained by PG&E's shareholders; (6) including in rate base $80.5 million in non-cycle working gas in storage; (7) assigning new storage capacities to balancing, Core Firm Storage, and Standard Firm Storage; (8) cost recovery for the Gerber compressor station fire; (9) balancing account protection for noncore distribution revenues; and (10) imposing bypass reporting requirements on third-party storage operators.

PG&E is proposing to adjust rates for 2004 to reflect updated cost and throughput projections. If PG&E's cost and throughput projections are adopted, along with PG&E's proposals, PG&E's gas transmission and storage revenue requirement would increase from $424 million in 2003 to $454 million for 2004. Under PG&E's proposals, the rate of core customers (i.e., bundled residential, small commercial, and large commercial customers) would increase, on average, by $0.015 per therm. For retail core transport customers, the increase, on average, would be $0.013 per therm. For wholesale core transport customers, the increase, on average, would be $0.032 per therm. For noncore transport customers, depending on the tier, rates would increase or decrease, but the overall average noncore rate would remain the same.

Other parties have also proposed changes to various parts of the market structure, or to PG&E's proposals. The major proposals are: a backbone-only rate structure (also referred to as backbone-level rate); 100% roll-in of Line 401 to the core; increased demand forecast for electric generation and a higher system load factor; and that PG&E's Core Procurement Department be spun off to a separate entity.

Some of the parties advocate that the Gas Accord Settlement Agreement be extended for another year. Others favor the adoption of certain proposals, and that certain other proposals be rejected or deferred.

All of the proposals mentioned above are discussed in the sections which follow.

B. Continuation of the Gas Accord Structure

1. Introduction

The scoping memo identified the primary issue in this proceeding as whether the existing Gas Accord structure and rates should be extended for an additional two years. However, due to the adoption of the Gas Accord II Settlement Agreement in D.02-08-070, which extended the Gas Accord for one year only, the issue to be addressed in this proceeding is what kind of market structure and rates should be in place for PG&E's transmission and storage system beginning January 1, 2004. As the starting point for the market structure and rates for 2004, PG&E uses the framework that was adopted in the Gas Accord, along with certain proposed changes to the market structure and costs. The other parties to this proceeding either advocate that the Gas Accord structure be extended through 2004, or that the Gas Accord structure be used together with their proposed changes.

In addition to deciding what the market structure should look like for 2004, the second issue we need to consider is what kind of market structure should be in place beyond 2004, and for how long. Such a matter should be considered so we are not faced with the annual task, as we are doing here, of deciding the kind of market structure that should apply to PG&E's gas transmission and storage systems each year.

To address the issues of what kind of market structure should apply in 2004, and what kind of market structure should be in place for the future, and for how long, we need to consider how the Gas Accord structure has performed in the past, whether such a structure has conferred benefits, whether other viable market structure proposals exist, and whether the changes proposed by the various parties should be adopted.

Some of the parties have advocated that we simply extend the Gas Accord market structure and rates for 2004. Their reasoning for the extension is that there has been insufficient time to adequately analyze the proposals, or that the proposals were not identified as issues in the scoping memo.

2. Positions of the Parties

a. PG&E's Position

PG&E proposes that the Gas Accord structure be continued into 2004 and retained permanently. PG&E contends that the record established that the Gas Accord structure has performed well over the last five years under a wide range of operating and market conditions, resulting in reliable service, increased choices in gas procurement, a high degree of price stability, and the prevention of market power. The prices for intrastate transportation have remained at moderate levels, even during the difficult 2000-2001 period.

The Gas Accord market structure has facilitated the development of the citygate as an actively traded market in PG&E's service territory, which provides customers with additional services and procurement options. As a result of the unbundling of services, cross-subsidies have been reduced. This has led to increasingly transparent prices and values for natural gas at the citygate and for gas transportation on the Baja and Redwood paths.

PG&E also points out that under the Gas Accord market structure, firm capacity rights to the backbone can be traded in a secondary market. This reveals the value of the capacity, and allows those customers who place a higher value on such capacity to obtain that capacity. This reduces or eliminates the uncertainty, gaming, and reduced reliability over pipeline capacity. In contrast, under a market structure that lacks firm capacity rights, capacity may be assigned on a pro rata basis within priority classes during times of limited capacity regardless of the value of use for that capacity.

The value of holding firm rights on PG&E's backbone system is enhanced when market participants also hold firm rights for interstate capacity. This assures market participants that they can transport their gas all the way to end-use customers or to the citygate, and reduces the exposure to price increases for this capacity in the short-term market.

PG&E also asserts that the firm, reliable, tradable transportation rights available under the Gas Accord market structure, together with the adequate capacity, helps to minimize uncertainty about prices and the ability to deliver supplies, which reduces the potential for upstream price manipulation.

In addition to serving Northern California, PG&E's backbone transmission system delivers gas on a firm and interruptible basis to Southern California and other off-system markets under the Gas Accord market structure.

PG&E contends that the Gas Accord market structure sends long-term price signals, which facilitates the expansion of transmission and storage capacity, such as the expansion of the Redwood path by 218 MMcfd in 2002, the commercial operation of the Lodi Gas Storage (LGS) facility in 2001, the Kern River expansion in 2003, and other projects. Having a customer commit to a long-term firm capacity contract creates a price signal because the customers must accurately assess the magnitude and value of their future requirements, and the value they place on price stability. PG&E asserts that under a bundled system, there is little or no incentive to accurately forecast their requirements, which may result in inefficient expansion investments.

During the period of high gas prices in 2000 and 2001, the price of natural gas in the supply basins almost doubled. PG&E points out, however, that the price of intrastate transportation on PG&E's system rose only slightly. PG&E asserts that the Gas Accord market structure has provided firm reliable backbone service, and relatively stable and moderate market values for backbone service, even during times of market stress.

PG&E contends that the Gas Accord market structure is well suited for Northern California with its two distinct backbone transportation systems, access to multiple supply basins, and a variety of end-use customer types. In addition, the market structure has been in place for over five years without any major problems. The structure has also adapted, through incremental changes, to address new customer concerns and desires that have arisen. PG&E contends that the adoption of the market structure on a permanent basis will provide stability for the gas markets, for end users, and for all companies who have a role in providing gas supply, transportation, and storage services. Thus, the Gas Accord market structure should be confirmed as the chosen structure for PG&E's transmission and storage system for the indefinite future, and any new concerns and customer desires should be accommodated within the structure.

PG&E points out, that with the exception of The Utility Reform Network (TURN), no party prepared any analysis or comments opposing the Gas Accord structure, or developed an alternative to the existing structure. TURN is opposed to PG&E's proposal for the indefinite continuation of the Gas Accord structure, arguing that the continuing uncertainty about the future jurisdiction over PG&E's gas assets makes a long-term commitment to any particular market structure unwise. PG&E points out that if PG&E's system remains under Commission jurisdiction, the Commission will need a market structure, and it is within the scope of this proceeding to identify what that market structure should be. If PG&E's gas transmission system becomes subject to the FERC's jurisdiction in the future, the market structure issue would then be moot.

TURN suggests that PG&E, through the use of the intrastate basis differentials, was attempting to demonstrate that the citygate market provided price benefits for consumers. TURN's brief compared citygate prices and transportation rates, and concluded that on a weighted average basis, it was cheaper to hold firm capacity and buy at the border, than to buy at the citygate during the original Gas Accord period. PG&E contends that the point it was trying to make was that under the Gas Accord structure, the intrastate basis differentials suggested adequate intrastate capacity and competitive pricing, reliable firm backbone service, and relatively stable and moderate market values for backbone service even during the period of the energy crisis.

PG&E asserts that when border-to-citygate price differentials exceed transportation rates, it suggests that capacity is scarce, or there may be market power. When the border-to-citygate price differentials are lower than transportation rates, as they were during most of the Gas Accord period, PG&E contends that this suggests there is adequate capacity and competitive pricing. Parties holding firm capacity could have reduced their costs by simply buying at the citygate. However, by doing so, they would have given up the certainty about firm reliable service at a fixed price that the firm capacity holdings provided. PG&E also states that low basis differentials also occur when not all of the firm capacity is subscribed, in which case PG&E might not receive its revenue requirement.

Even if one accepts TURN's argument that the price differential is an indicator of the benefits of the gas accord market structure, TURN's claim that it shows the unbundled citygate market did not provide the benefit of lower prices is incorrect. Exhibit 12 shows that in all but one of the Gas Accord years, and on average over the entire period, it was cheaper to purchase at the PG&E citygate than to hold firm Baja Path capacity and purchase at the border. The Redwood Path capacity was more attractive relative to citygate prices due to the access it provided to low cost Canadian supply available at Malin. PG&E says that the Baja Path comparison is more meaningful, because Southwest supplies were most often the marginal supplies during this period.

PG&E contends that the primary benefits of the unbundled structure have to do with options, flexibility, the ability to ensure firm service and predictable costs, the ability to minimize cost by buying on the short term market (but with higher risk), accurate market price signals, efficient short-term allocation of supply, and efficient system expansion. TURN did not address these benefits, and TURN has not rebutted PG&E's showing of the substantial benefits of the Gas Accord market structure as described above.

b. California Cogeneration Council
and Calpine Corporation

Four parties have proposed simply extending the current Gas Accord structure and rates for another year. The California Cogeneration Council (CCC) and Calpine Corporation (Calpine) recommend that the proposal to extend the existing Gas Accord structure and rates for 2004 be rejected.⁷ CCC/Calpine assert that we should address in this proceeding those issues that were identified in the rulings, as well as the relatively uncontested issues,⁸ and the issues that were fully and fairly litigated such as the backbone-level rate, which was identified as an issue in the scoping memo.

CCC/Calpine contend that it may be appropriate to defer consideration of certain of the more controversial and detailed proposals made by PG&E. Such issues include PG&E's storage-bypass proposal, PG&E's proposal to replace the curtailment process with a diversion process, PG&E's proposal to offer long-term contracts for backbone capacity at non-guaranteed rates, PG&E's capital expenditures, and PG&E's proposed Gas Rule 27. Several of these proposals were not identified in the scoping memo or elsewhere as appropriate issues for consideration in this proceeding. The Commission should also require PG&E to hold informational meetings, which PG&E said it would, about proposed Gas Rule 27, and the storage-bypass and curtailment proposals, before adopting any of these proposals.

For parties to say they didn't have time to analyze the scoping memo issues is disingenuous. CCC/Calpine point out that the parties who now seek a one-year extension of the Gas Accord structure, supported the initial schedule for litigating the scoping memo issues that was set forth in the Gas Accord II Settlement Agreement. CCC/Calpine argue that it would be inappropriate for these parties to now seek further deferral of these issues.

CCC/Calpine also assert that the Commission should reject the parties' arguments that the present lack of certainty regarding the outcome of PG&E's bankruptcy proceeding merits an extension of the existing Gas Accord structure and rates for 2004. Even if the bankruptcy plan is approved in the next few months, CCC/Calpine state that it will take several years to fully implement the plan. By adopting a structure now, customers will have certainty about gas transportation, and PG&E will have certainty about the revenues it will recover and the kind of structure it will be operating in as it emerges from bankruptcy. CCC/Calpine also note that if a one-year extension is granted for 2004, the same kinds of issues will have to be relitigated again for 2005, assuming the Commission retains jurisdiction over PG&E's transmission and storage assets. Such an exercise would be an obvious and unnecessary waste of resources.

c. California Manufacturers and
Technology Association

The California Manufacturers and Technology Association (CMTA) was involved in the Gas Accord settlement. CMTA contends that the Gas Accord settlement has benefited all gas consumers. The system of firm tradable rights has provided rate and regulatory certainty, flexibility in procurement and choice, and the development of a citygate market. The Gas Accord structure has also allowed gas consumers to mitigate or avoid many of the problems experienced on other gas transportation systems during July 2000 to June 2001. In addition, the Gas Accord structure has provided market signals which have encouraged PG&E and independent gas storage providers to expand gas transmission and storage in Northern California.

CMTA supports the continuation of the basic Gas Accord structure on a permanent basis, with some modifications as described below. CMTA favors approving the Gas Accord structure on a permanent basis because it will create certainty for the transporters of natural gas and consumers. CMTA supports TURN's approach that this proceeding be addressed in two phases. The first phase could determine the structural components, and the second phase could address the rate case aspect of PG&E's filing. CMTA believes that the cost of service data submitted by PG&E warrants further scrutiny in this second phase because there has not been an adequate opportunity for parties to fully scrutinize PG&E's proposed cost of service data. CMTA points out that the Office of Ratepayer Advocates (ORA) agrees that the cost of service data submitted by PG&E clearly warrants further scrutiny, especially for periods beyond 2004.

TURN compared the citygate price to the price of supply at Topock plus the price of firm Baja capacity, and then to the price of supply at Malin plus the price of firm Redwood capacity. TURN asserts that "on average, the unbundled citygate market did not provide the benefit of lower prices." (TURN, Opening Brief at 9.) CMTA asserts that the point of PG&E's testimony was to demonstrate that the Gas Accord brought about a more liquid citygate market and the path-specific scenarios TURN chose to compare to the citygate price do not change that conclusion. CMTA also points out that TURN concedes the accuracy of PG&E's calculation which shows that "the average basis differential from the border to the PG&E citygate ($.28/Dth) was significantly less than the average undiscounted as-available transportation rate plus shrinkage ($.36/Dth)." (Ex. 1 at 3-15.)

CMTA states that TURN's attempt to dismiss the benefits of Line 401 for core customers ignores Line 401's contribution to making the citygate a liquid market which, in turn, lowered prices for buyers in that market including core customers. PG&E witness Gee said that PG&E's Core Procurement Department purchased 17 Bcf of gas from the citygate market for 2002. CMTA says that this is a direct, substantial benefit to core customers resulting from the availability of Line 401 capacity.

PG&E also provided testimony that during the crisis period of July 2000 to June 2001, the price of intrastate transportation on PG&E's system "rose only slightly, and reflected competitive pricing and little scarcity on PG&E's system." (Ex. 1 at 3-16.) Although TURN argues that this does not provide a sufficient link between the lack of price spikes in Northern California and unbundling, CMTA contends that PG&E has demonstrated the benefits of the Gas Accord structure to Northern California.

d. Canadian Association of
Petroleum Producers

The Canadian Association of Petroleum Producers (CAPP) supports the continued use of the basic framework of the Gas Accord structure. CAPP contends that the structure of unbundled backbone transmission services offer a flexible, market-responsive form of service for those seeking to bring gas supplies into PG&E's service territory to consume or sell. The unbundled services makes it possible to acquire, sell, and trade firm backbone transportation rights to capacity, which has created a variety of gas supply alternatives that did not exist before the Gas Accord.

CAPP points out that some deficiencies remain with the current Gas Accord structure. Most notable is the use of a rate design that uses a system-wide average load factor to derive rates. As a result, significant cross-subsidies among the transportation paths exist, which artificially favors one gas supply source over another. The continuation of such a rate design may distort price signals, which could increase gas costs in California. CAPP's rate design proposal is discussed later in this decision.

e. City of Palo Alto

PG&E has stated that simply extending current rates through 2004 will deprive PG&E of an opportunity to recover its costs, and such an extension is unlawful. Palo Alto argues that the Commission should not be misled by PG&E. Palo Alto contends that if the costs associated with the issues that were not identified in the scoping memo, or that were not supported by the record in this proceeding, are excluded from the revenue requirement, the revenues at present rates would be sufficient to cover the 2004 revenue requirement without any rate increase. Palo Alto contends that this should not be surprising because PG&E's original application was to extend the Gas Accord through 2004. Palo Alto asserts that PG&E would not have made such a proposal if it did not believe that the revenues would be sufficient to cover its cost of service and authorized return.

f. Department of General Services

The Department of General Services of the State of California (DGS) operates a natural gas services procurement program for the benefit of state agencies and local agencies.⁹ DGS agrees with ORA, TURN and others that given the timing and issues in this proceeding, the Commission should simply extend the existing Gas Accord Settlement Agreement through 2004. Although DGS advocated early on in this proceeding that the prudence of the Gas Accord and PG&E's cost of service should be examined, that hasn't occurred due to ORA's staffing constraints. As a result, there has been no comprehensive analysis of the impact that a backbone-only rate or PG&E's tiered local transmission rate structure will have on end-users. Due to the limited review of PG&E's proposals, and the particular interests of each party who provided testimony regarding the proposals, DGS recommends that the Commission extend the terms of the Gas Accord through 2004, and order PG&E to file a test year 2005 rate case.

g. Duke

Duke Energy North America and Duke Energy Trading and Marketing (collectively, "Duke") support the continuation of the Gas Accord structure, provided that there is an opportunity for periodic revision. Duke states that the Gas Accord structure has led to increased customer choice through the unbundling of transmission, storage, and balancing services. The Gas Accord also led to the establishment of path-specific transmission capacity, which eliminated the problem of overnominations that existed before the Gas Accord was implemented. The Gas Accord has also increased certainty for customers, and increased the value of transportation rights on interstate pipelines. The Gas Accord has also led to the development of a liquid, secondary market at the citygate. Duke contends that all of these benefits justify the continuation of the Gas Accord structure.

h. Indicated Producers

The Indicated Producers is an ad hoc coalition comprised of BP Energy Company, Chevron U.S.A. Inc., and Occidental Oil and Gas. The Indicated Producers support PG&E's proposal to extend the Gas Accord structure because they believe the structure has functioned well over the past five years to the benefit of the utility and its core and noncore customers.

i. Lodi Gas Storage, L.L.C.

Lodi Gas Storage, L.L.C. (LGS) generally supports the Gas Accord structure, and the market competition that it has resulted in. However, as LGS reviewed the testimony in this proceeding, LGS believes that the Commission should simply extend the existing Gas Accord structure for 2004. By the end of 2004, the jurisdictional questions raised by PG&E's plan of reorganization should be resolved. At that point in time, LGS asserts that a full-scale proceeding would make sense.

LGS points out that PG&E's proposals have implications which extend far beyond the end of 2004. Such changes include reconfiguring the assignment of storage capacity, instituting a bypass charge despite the fact that there is no proof that bypass currently exists, and the creation of new winter reliability standards. These proposed changes, which have long-term implications, should not be adopted in a one-year proceeding.

If, however, the Commission chooses to consider the various proposals raised by PG&E and others, LGS recommends that the Commission adopt the recommendations of LGS as set forth in the sections discussing the various proposals.

j. Mirant

Mirant Americas, Inc. (Mirant) operates three electric generating plants in the San Francisco bay area, which produce 3000 megawatts (MW) of electricity. According to Mirant, it is one of PG&E's largest purchasers of natural gas transmission service.

Mirant contends that this proceeding was an inadequate forum for a detailed analysis of the numerous and complex issues that must be addressed and resolved in order to arrive at a fair and reasonable revenue requirement for PG&E. This proceeding essentially amounted to a general rate case (GRC) for PG&E's gas transmission and storage services.

k. Northern California Generation Coalition

The Northern California Generation Coalition (NCGC) supports the continuation of the basic Gas Accord structure because it will promote regulatory and market certainty. In addition, the structure provides NCGC's members with the opportunity to purchase a mix of services consistent with their individual supply needs.

Although NCGC supports the continuation of the basic Gas Accord structure, changes and refinements should be implemented as market conditions and customer needs change. Such changes, however, should be well explained, well understood, well transitioned, and supported by the customers. Although PG&E has proposed a variety of changes to the Gas Accord structure and rates, NCGC contends that PG&E has not adequately explained its changes, has not provided sufficient evidence to support the changes, and that the proposed changes are not consistent with customer needs.

l. Office or Ratepayer Advocates

ORA points out that this proceeding originally began with PG&E seeking to extend the existing Gas Accord structure for two years, i.e., until the end of 2004. ORA asserts that the September 30, 2002 scoping memo stated that 2004 should be the focus of this proceeding. ORA contends that in PG&E's amended application, PG&E deviated substantially from the scoping memo by proposing to extend the Gas Accord on a multi-year basis with significant modifications to the current rate and structure.

ORA contends that many of PG&E's proposals are outside the scope of this proceeding, and have significant rate implications which cannot be adequately explored by ORA within the limited time frame of this proceeding. ORA recommends that the Commission adopt PG&E's original proposal to extend the Gas Accord through 2004.

For periods beyond 2004, ORA recommends that the remainder of the issues raised by PG&E in its amended application be addressed in a test year 2005 rate case that PG&E should be ordered to file. Since PG&E's proposals are likely to result in significantly higher core customer rates, sufficient time should be allowed so that the parties can prepare a comprehensive analysis of the issues.

Contrary to PG&E's suggestion in its opening brief at page 4 that ORA "decided to allocate minimal resources to this proceeding," ORA contends that PG&E's statement is incorrect. ORA asserts it was not able to fully participate in this proceeding because of the narrow window of time between the time PG&E's workpapers became available (during the first week of February 2003) and the date ORA's testimony was due (February 28, 2003). Even if ORA had allocated sufficient resources to this proceeding, ORA could not be expected to prepare a credible analysis of PG&E's voluminous submissions in the time allotted. Even PG&E's witness acknowledged that if PG&E were ordered to file a rate case for test year 2005, it would take PG&E several months to prepare its application and supporting testimony. In order for ORA to adequately review and analyze PG&E's various Gas Accord structure and rate proposals, it should be given a similar amount of time.

ORA also contends that the mere fact that PG&E has requested major rate changes, does not mean that the Commission should consider it. The ability of all parties, including Commission staff, to review a rate request is a relevant consideration in deciding whether to adopt a utility's request. In addition, ORA has identified several of PG&E's proposals as being unjustified and unnecessary. All of those factors provide compelling reasons why PG&E's proposals should be rejected.

ORA contends that PG&E's extensive rate proposals have the effect of substantially increasing core rates, while reducing the rates of noncore customers. ORA asserts there is no justification for the proposed changes, and it is inherently unfair that the rate of core customers will increase while noncore customers will realize a substantial drop in rates. Since ORA and TURN have not had the opportunity to adequately analyze the issues, including the full impact of the proposed rate changes on core customers, ratepayers have been denied the opportunity to effectively participate in this proceeding. ORA also notes that PG&E did not originally seek rate relief in this proceeding, and instead simply sought to extend the current rate structure for an additional two years.

ORA disagrees with PG&E's statement in its opening brief that its various proposals are just "adjustments to improve the reliability of PG&E's system under the Gas Accord structure, not changes to the fundamental structure." ORA asserts that this statement grossly understates the impact on core customers, who will be adversely impacted by the various rate and market structure proposals of PG&E. Much of what PG&E claims to be adjustments to existing Gas Accord structure shifts costs such that large noncore customers would see their rates decrease while, at the same time, the core class would experience a substantial rate hike without any corresponding benefits. ORA asserts that given the substantial impact that PG&E's proposed changes would have, they should be reviewed in a more comprehensive proceeding with sufficient time allotted to all parties to effectively participate.

m. The Utility Reform Network

TURN recommends that the Commission adopt a one-year extension of the current Gas Accord rates and structure, and that PG&E be ordered to file a new gas structure rate case once a plan of reorganization has been confirmed by the Bankruptcy Court.

TURN contends that the issues raised by PG&E have not been adequately reviewed in this proceeding. This proceeding was designed to address a one-year plan, in which intervenor testimony was served only six weeks after the company's primary showing. In addition, the uncertainty regarding the long-term jurisdiction of PG&E's gas assets makes a long-term commitment to a particular market structure unwise. TURN believes that it makes more sense for the Commission to take up the future of the PG&E gas system in a full-blown proceeding after a final plan of reorganization has been confirmed by the Bankruptcy Court.

TURN contends that PG&E has the burden of proof to show by clear and convincing evidence that PG&E's proposed cost of service for its backbone and local transmission and gas storage system are reasonable, and that the rates it is requesting are just and reasonable. TURN asserts that PG&E has not met its burden. TURN asserts that a conclusive, substantive determination of PG&E's cost of service and rates is almost impossible to make because ORA was unable to conduct a review of PG&E's proposed cost proposals.

TURN also points out that much of the increase in the revenue requirement has been contested, which raises substantial doubt about the validity of PG&E's proposals. The proposals which have been challenged include: the need for capital upgrades due to PG&E's proposed Winter Reliability Standard; the cost recovery for the Gerber compressor station fire; the validity of capitalizing non-cycle working gas; and the validity of expensing certain computer and levee reconstruction costs. TURN contends that these items represent a significant portion of PG&E's requested increase in the revenue requirement.

If the Commission chooses to address PG&E's proposals, TURN believes that the Commission should still find that several of PG&E's proposals, including the Winter Reliability Standard and the indefinite continuation of an unbundled structure, go beyond the scope of this proceeding, and should not be adopted based on the record. In addition, rates should only be authorized for one more year, or until a plan of reorganization is accepted by the Bankruptcy Court.

TURN states that it has not expended the time and resources to fully examine the impacts of the unbundled backbone and storage structure on the operation of the gas market in Northern California. However, since the "price benefits" of the Gas Accord citygate market was a major factor in the Commission's decision to adopt an unbundled structure for SoCalGas in D.01-12-018, TURN performed a limited evaluation of the claimed citygate "benefits."

TURN asserts that its evaluation shows that, on average over the Gas Accord period through June 2002, it was more expensive to buy at the citygate than to buy at the border and flow gas using firm capacity rights. This is shown in Exhibit 13 of PG&E witness Wilson's testimony, which provides a comparison between border-specific intrastate basis differentials and firm capacity costs including shrinkage. According to TURN, Exhibit 13 demonstrates that on average, it was more expensive to buy at the citygate than to hold firm Redwood capacity and buy at Malin. The basis differential exceeded the costs of firm Redwood capacity and shrinkage by 12.6 cents. Exhibit 13 also indicates that on average, it was slightly cheaper to buy at the citygate, than to hold firm Baja capacity and buy at Topock.

TURN contends that given that the Redwood path has a receipt capacity more than one-and-a half times that of the Baja path, and that the Redwood path was flowing at higher load factors during the entire time period between July 1998 and June 2002, on a weighted average basis it was cheaper to hold firm capacity and buy at the border than to buy at the citygate during the original Gas Accord period. The Commission should find that the unbundled market structure has not resulted in a citygate market that provides any price benefits to consumers.

The proponents of continuing the gas structure contend that it was the availability of firm capacity rights that caused prices for Southwest gas moving into PG&E's system (PG&E-Topock) to be considerably lower than for Southwest gas flowing into SoCalGas' system (SoCalGas-Topock). The premise of the argument is that the SoCalGas system was more constrained (meaning that the pipeline was flowing at a higher load factor, with less slack capacity), and that it was the difference in load factors that resulted in higher prices into the SoCalGas system. TURN asserts, however, that when this argument is examined in detail, no link has been established between the supposed cause of lower prices and the existence of unbundled backbone capacity rights. Nor have the differences in load factors between PG&E and SoCalGas been linked to unbundled backbone rights. TURN points out that both utilities expanded their capacities in 2001-2002, and both had a relatively fixed amount of capacity for awhile. TURN asserts that the factual data shows that at best, the Gas Accord provided some benefits during the crisis year, but on average, the city gate prices have exceeded the cost of border plus transportation.

TURN also asserts that the Gas Accord market structure had nothing to do with determining the need for, timing or amount of the capacity expansions that took place over the last two years. Instead, TURN contends that it was due to the dramatic increase in the value of gas services, combined with regulatory pressure by California state regulators which encouraged these projects.

TURN urges the Commission not to reach any long-term conclusions regarding the efficacy or desirability of continuing this unbundled structure into 2005. TURN suggests that the goal of ensuring short-term market certainty regarding transportation rights, balanced with the goal of minimizing unnecessary analysis and evaluation until the outcome of the bankruptcy process is resolved, is best accomplished by continuing the Gas Accord market structure for 2004 only.

C. Discussion

PG&E's backbone transmission, local transmission, and underground storage facilities are described in Chapter 2 of Exhibit 1. These PG&E facilities are currently operated under the rules set forth in the Gas Accord Settlement Agreement, found in Appendix B of D.97-08-055 (73 CPUC2d at 797-855), the Operational Flow Order (OFO)¹⁰ protocols set forth in D.00-02-050,¹¹ the Comprehensive Gas OII Settlement Agreement in D.00-05-049,¹² and the 2003 extension in D.02-08-070.

The first issue to address is whether the current Gas Accord structure and rates should be extended for 2004. The resolution of the first issue depends on how we address the arguments that the proposals of PG&E go beyond the issues identified in the scoping memo, that ORA and others were unable to devote resources to comprehensively review PG&E's application, and that the parties had insufficient time to fully participate in this proceeding given the issues raised in PG&E's application.

The scoping memo was issued at the time PG&E was requesting a two-year extension of the Gas Accord structure and rates. Thus, the scoping memo identified the ultimate issue as whether the Gas Accord structure and rates should be extended for 2003 and 2004. As a result of the adoption of the Gas Accord II Settlement Agreement in D.02-08-070, the September 30, 2002 ALJ ruling stated that "the focus of this proceeding is only on what the gas structure for 2004 should look like, and whether the existing Gas Accord structure should be continued in 2004." (ALJ Ruling, Sept. 30, 2002, p. 7.) However, the ruling also stated that the cost of service study that PG&E was to provide, and the issues identified in the scoping memo about "how the existing Gas Accord structure has performed, and whether it is in the best interest of the state to continue this kind of structure," provide "the Commission with the flexibility to review PG&E's gas structure on a multi-year basis, rather than just a one year view of what the gas structure should look like in 2004." (ALJ Ruling, Sept. 30, 2002, pp. 7-8.) As we stated in D.02-08-070 at page 18, the hearings in this proceeding "will address the viability of the Gas Accord structure."

Based on the rulings and our statement in D.02-08-070, we are not persuaded by the parties' arguments that the proposals of PG&E go beyond the issues identified in the scoping memo. Since the Gas Accord structure and rates, as extended by D.02-08-070, are to expire at the end of 2003, PG&E's application had to address the kind of market structure that should be adopted for 2004, and what rates should look like. In addition, we solicited testimony from the parties about the performance of the Gas Accord structure, and whether it was in the state's best interest to continue this kind of market structure. PG&E and other parties have provided evidence on these topics.

As for the arguments that ORA did not have the resources and time to do a comprehensive review of PG&E's application, or that parties had insufficient time to address the multitude of issues, we have considered those arguments in our analysis of the various proposals of the parties, as discussed in the sections which follow. In addition, the argument that the cost impacts of the various proposals have not been thoroughly analyzed, have also been considered in our analysis of the various proposals.

We agree with Mirant's statement that PG&E's application and the supporting testimony essentially amounted to a GRC for PG&E's gas transmission and storage system. However, since the Gas Accord structure expires at the end of 2003, and the parties did not mutually agree to settle on the kind of structure and rates that should be in place for 2004 and beyond, there was no alternative but to review all of the proposals of the parties in order to determine what kind of market structure and rates should apply to PG&E's gas transmission and storage system for 2004.

No one has proposed a different market structure for PG&E's gas transmission and storage system. Instead, all of the parties use the existing Gas Accord structure as the basis of their market structure. The proposals of each of the parties would change discrete elements of the Gas Accord structure, which could result in cost impacts. However, the basic foundation of the Gas Accord structure remains unchanged.

We will not adopt the recommendation to simply extend the current Gas Accord structure and current rates for 2004. However, we do adopt the Gas Accord market structure that was developed in the Gas Accord Settlement Agreement contained in D.97-08-055, as changed by D.00-02-050 and D.00-05-049, and as extended by D.02-08-070, and as changed by the specific proposals adopted by us in today's decision, as discussed in the various sections which follow. As a result of the adopted proposals, and the cost of service presented to us in this proceeding, we adopt rates for 2004 that differ from the 2003 rates.

The second issue pertaining to the market structure, is whether the structure we adopt for 2004 should continue beyond 2004. In order to address this issue, we must consider two factors. The first factor is that some parties suggest that the market structure be adopted for 2004 only. Another factor is how the gas structure has performed, and whether it is in the best interest of the state to continue the structure beyond 2004.

TURN is the primary proponent of not extending the gas structure beyond 2004. TURN's first reason in support of not extending the structure is that the Bankruptcy Court is likely to resolve the jurisdictional issue regarding PG&E's gas assets in early 2004. Although this is likely to occur, we believe there is a need to provide participants in the California gas market with more certainty about what kind of structure will be in place if the Commission retains jurisdiction, and to reduce the regulatory burden on the parties who participate in our proceedings.

If we continue the gas market structure beyond 2004, and the jurisdictional issue is resolved in favor of this Commission, we will have a gas structure in place for 2005. This will eliminate the need for a comprehensive application which addresses what kind of market structure should apply in 2005.

If we choose today not to continue the market structure beyond 2004, that will result in the filing of a comprehensive application to determine the market structure and rates that should apply in 2005, assuming the Commission retains jurisdiction over PG&E's transmission assets. That is, in a few short months, we would be faced again with a similar filing to resolve the same kinds of issues that we resolve today, for 2005.

Given the comprehensive review undertaken in this proceeding, and the evidence in this proceeding about the performance of the Gas Accord structure, we do not believe another comprehensive filing for 2005 would be a wise use of resources. In addition, extending the gas structure beyond 2004 will provide market participants with some certainty about what kind of structure will be in place in the event the Commission retains jurisdiction. In D.00-05-049 at pages 26 to 27, we stated the reasons why certain parties supported the Comprehensive Gas OII Settlement Agreement, including the statement that "Gas market participants have an interest in certainty and stability of rates and terms and conditions of service." If we extend the gas structure beyond 2004 in this decision, this will reduce the burden of having to relitigate the same issues within the span of one year, and provide the parties with an idea of what the gas structure will look like beyond 2004. Should the Bankruptcy Court decide to place PG&E's gas assets under the jurisdiction of the FERC, the gas structure issue will become moot.

TURN's second reason for not extending the gas structure beyond 2004 is because the cost impacts of certain proposals on future years have not been fully analyzed. That is, if certain proposals are adopted for 2004, the costs of such proposals could carry over to future years. As mentioned earlier, we have considered the cost issue in the sections which follow.

PG&E and some of the other parties presented evidence regarding how the Gas Accord structure has performed since its inception, including during the energy crisis period. This evidence is relevant in deciding what kind of gas structure should be in place beyond 2004 because the same kind of Gas Accord structure is being adopted for use in 2004. That is, the past performance of the Gas Accord structure provides relevant information about how the structure is likely to perform in the future if the same or similar kind of structure remains in place.

The evidence shows that the Gas Accord structure has resulted in many gas procurement options and strategies for core and noncore customers, and for gas marketers. Market participants can arrange to purchase gas supplies at the gas basins, and have their supplies transported over interstate and intrastate pipelines to the citygate or to the end-user. Or they can choose to purchase supplies at the border, and have the supplies delivered over the intrastate system, or they can choose to purchase their gas supplies at the citygate. The unbundled, firm tradable capacity rights has created a secondary market which allows market participants to sell or trade their rights to maximize their gas procurement strategies.

Although TURN contends that the data shows that citygate purchases are often more expensive than buying at the border and using firm transportation, no one disagrees that the Gas Accord structure has brought many other benefits to market participants in PG&E's service territory. ORA's own testimony states that "The current Gas Accord has proven to be workable and has provided substantial benefits to customers in the form of increased choice and lower city-gate prices." (Ex. 74, p. 3; PG&E Opening Brief, p. 7.)

The Gas Accord structure has also been the subject of some review by the settling parties in D.00-02-050 and D.00-05-049. In the OFO Settlement Agreement adopted in D.00-02-050, the agreement states in part:

"Experience under the Gas Accord has indicated that certain adjustments are appropriate, particularly with regard to customer balancing requirements and charges; to issuance of OFOs; to whether OFOs are issued on a system-wide or customer-specific basis; and to the operational information provided to the market and to individual shippers.

...

"This Agreement does not change the basic principles and structure of the Gas Accord as agreed to by the settling parties to the Gas Accord and as approved by the Commission in Decision 97-08-055. The operating guideline and gas tariff changes included within this Agreement, and made a part hereof, are intended to modify certain limited implementation parameters of the Gas Accord, and the Settlement Parties agree that such revisions are within the original bounds of the Gas Accord structure." (D.00-02-050, Attachment 1, pp. 1-2.)

When the settling parties reviewed the promising options for the continued restructuring of the California gas industry that were set forth in D.99-07-015, and settled the issues in the Comprehensive Gas OII Settlement Agreement, the Gas Accord was considered by the settling parties. (D.00-05-049, pp. 6-7, 18-19; Attachment A, p. 1.)

In addition, in our decision regarding the gas structure for SoCalGas and San Diego Gas & Electric Company (SDG&E), we stated that the Comprehensive Settlement adopted in D.01-12-018, "closely follows the structure of the PG&E Gas Accord, which, by all indications, has been working very well even under the extreme market conditions that presented themselves last year." (D.01-12-018, p. 9.)

Based on the evidence presented regarding the performance of the Gas Accord structure, and the structure that we adopt today for 2004, which is virtually identical to the Gas Accord structure that was previously adopted and extended, the same structure that we adopt for 2004 should continue for 2005. The rates for 2005 for PG&E's transmission and storage system shall be the subject of a PG&E application to be filed in the first quarter of 2004. We will also consider in that rate application whether minor changes to the gas structure are needed in order to improve the functioning of the gas structure in 2005.

In the event PG&E's gas transmission assets remain under our jurisdiction in 2004, PG&E shall file a comprehensive application no later than February 4, 2005, proposing the kind of market structure and rates that PG&E's gas transmission and storage system should operate under beginning January 1, 2006, and how long the rates and such a structure should remain in place. At that time, parties can raise the same proposals that we have analyzed in today's decision, but which we do not adopt, or they can propose other structural changes to the gas market structure for 2006 and beyond.