VI. Reasonableness of the Settlements

A. Standard of Review

This application presents a settlement package opposed by Aglet. (Specifically, Aglet opposes the AES settlement and takes no position on the other settlements.) Therefore, we review the package of settlements pursuant to Rule 51.1(e) of the Commission's Rules of Practice and Procedure which provides that, prior to approval, the Commission must find a settlement "reasonable in light of the whole record, consistent with the law, and in the public interest." As we discuss below, we find that this settlement package meets this criteria, and therefore approve it.

B. The July ACR

The July ACR memorialized the goals and objectives of the settlement process which the Commission unanimously encouraged at its June 21, 1995 meeting.

"First, each settlement should eliminate litigation - in any agency or court - flowing from the auction. Additionally, the settlements each utility reaches with individual bidders, should, when considered as a package, (1) achieve the resource procurement statutory mandates, including mandates for diversity provided by renewable resources; (2) add capacity which lowers the operating cost of the system; (3) add capacity which meets the reliability needs, if such a need has been identified." (July ACR at 7-8.)

The July ACR also memorialized a number of settlement options (without intending to make an exclusive list), such as "the option," "the buyout," and "the contract." (Id. at 8.) The July ACR recognized that FERC also encouraged the utilities and the QFs to achieve settlements consistent with PURPA. However, it cautioned that the Commission did not encourage settlements at all costs:

"The surest way to achieve settlement would be to assure parties that any costs of settlement would be fully recovered from ratepayers so that QFs merely needed to tell utilities how large a check to write. We are decidedly not encouraging such settlement, nor are we preapproving recovery of settlement costs. Commissioner Conlon said it best during our public discussion: we want to see value received for payment given." (Id. at 9.)

In the July ACR, we defined (1) "the option" as a settlement which forms a contract that provides the utility an option to have additional capacity built at a future time; (2) "the buyout" as a settlement which makes an otherwise winning bidder whole for reasonable bid preparation or reliance costs; and (3) "the contract" as an agreement between a winning bidder and the utility to sign an FSO4 or a modified FSO4. (Id. at 8.) The Assigned Commissioner elaborated that he would view with disfavor buyout contracts which pay QFs more than their bid preparation or reliance interest, stating: "This means that I will not look with favor on buyout agreements which seek to go beyond the recoupment of a reliance interest to approximate an expectation interest. The reason is plain: in a buyout strategy ratepayers will not gain the advantage of capacity additions." (Id.) In assessing the reasonableness of the settlement package, we are guided by the July ACR, as discussed further below.

C. Reasonable Bid Preparation Costs or Reliance Costs

The July ACR memorialized the goals and objectives of the settlement process and a number of settlement options which the Commission unanimously encouraged at its July 21, 1995 meeting. Thus, it carries more weight than an individual ACR expressing the views of only one member of the Commission. (See e.g., D.98-12-074 at 16.)

In D.98-12-074, we approved three of SDG&E's Update settlements as reasonable and in the public interest on the basis that SDG&E followed the direction of the July ACR and achieved settlements with the three settling bidders for amounts based on reasonable bid preparation or reliance costs. (D.98-12-074 at 17.) We further stated that in our assessment of litigation risk, the bidders SDG&E designated as "winning bidders" were not somehow legally entitled to receive their reliance interest.

"Footnote 4 of the ACR elaborated on the full Commission's definition of a `buyout,' and we reaffirm this footnote today, for our review of settlement packages such as this, in which all settlements were executed after the February 23 FERC Order and the July ACR. This does not mean that, in our assessment of litigation risk, we believe that all bidders designated by SDG&E as `winning bidders' are somehow legally entitled to receive their reliance interest. Rather, we view such payment as equitable, in light of the time and resources these particular bidders have committed to the lengthy and contentious Update proceeding, which has not yet terminated, as well as their cooperation in engaging in this settlement process as directed by the July ACR." (Id. at 16-17.)¹¹

In this application, PG&E has reached a settlement with all three bidders based on the bidders' reasonable bid preparation or reliance costs. PG&E did not, in all instances, determine and then settle for the bidders' bid preparation or reliance costs. Rather, PG&E determined what costs were reasonable by, for example, removing AES' claimed interest charges from its claimed costs. PG&E then reached individual settlements where the bidders' reasonable bid preparation or reliance costs served as a cap for the negotiated settlements. Because PG&E followed the directives of the July ACR and achieved settlements with the three settling bidders for amounts based on reasonable bid preparation or reliance costs, we find the settlements reasonable and in the public interest, as well as consistent with prior Commission decisions approving a similar settlement.

As in SDG&E's case, our approval does not mean that we believe that all of the bidders designated by PG&E as winning bidders are somehow legally entitled to receive their reliance interest. Rather, we view such payment as equitable in light of the time and resources these particular bidders have committed to the lengthy and contentious Update proceeding, which has not yet terminated, as well as their cooperation in engaging in this settlement process as directed by the July ACR. (See D.98-12-074 at 16-17.)

D. The PG&E/AES Settlement

The PG&E/AES settlement does not pay AES all of its claimed bid preparation or reliance costs, but is framed within the parameters of what the parties believe to be AES' reasonable bid preparation or reliance costs. Prior to filing its application, PG&E engaged a certified public accountant (CPA) to review AES' cost data. The CPA found a few booking mischaracterizations and, after making adjustments to reflect a change from a cash to an accrual basis, and removing AES' claimed interest costs, confirmed that the costs AES claims were incurred on the Hunters Point Project. PG&E generally based its settlement on AES' recorded costs through September 1995, and discounted costs from October 1995 through March 1996.

The principal dispute between AES and PG&E in reaching this settlement concerned whether AES' continued expenditures after certain significant events during the project development were reasonable. This is the same principal issue that concerns Aglet. The fact that AES incurred the costs described in the application and when those costs were incurred are both undisputed.

Aglet believes AES' costs should be discounted as presented in its brief, and that its adjusted costs should serve as a cap for any PG&E/AES settlement. Aglet begins by using AES' costs, as adjusted by PG&E's expert CPA witness. Then, as did PG&E, Aglet also removes interest charges from AES' costs. Aglet recommends further adjustments which we discuss below.

1. Costs incurred before PG&E declared Aglet a "winning bidder" in the Hunters Point auction

Aglet believes that the costs AES incurred before PG&E declared Aglet a winning bidder in the Hunters Point auction should be removed because such costs were sunk. Aglet in large part bases its argument on the July ACR which referred to bid preparation costs or reliance costs, and argues that they are two mutually exclusive categories.

We disagree. Neither the July ACR nor D.98-12-074 define exactly what reliance costs include. However, as discussed earlier, the July ACR draws a distinction between a contracting party's reliance interest and expectation interest. (See also July ACR at 9, footnote 4.)

General legal principles in remedies provide that a contracting party's expectation interest refers to the expectation that the contract will be performed. A reliance recovery is based on what a contracting party spent in reasonably relying on the contract, even though what he spent did not benefit the defendant. This includes costs where a party to a contract, relying on the performance of the other party's promise, has spent money preparing to perform a contract. (See generally Dobbs, Remedies (1973) § 12.1 at 786-788.) Although both general principles cited above refer to the existence of a contract, the July ACR did not limit reliance interest recovery to cases involving contracts because the Commission did not rule whether any claimant had an enforceable contract. (In fact, as stated above, the Commission made clear in D.98-12-074 at 16, that we did not, in assessing litigation risk, believe that all of the bidders designated by SDG&E's as "winning bidders" were somehow legally entitled to receive their reliance interest.) Therefore, the reliance interest costs we refer to here include reasonable costs a bidder incurred in preparing to perform an anticipated contract.

A bidder would incur bid preparation costs as part of its preparation efforts to perform an anticipated contract. Therefore, bid preparation costs are a category of reliance interests, and we approve their inclusion as part of AES' reliance costs on which a settlement can be based.

2. NOx Offsets

Aglet believes the NOx offset costs should not be included as reliance costs because the offsets have market value. Aglet recommends removing only the original offset costs, and not their market value, under the theory that offset profits have the character of expectation costs. We agree with Aglet that such costs should be removed. However, as PG&E points out, the settlement is still reasonable because even if the value of NOx offset costs is deducted from AES' costs, AES' reasonable reliance costs still exceed the settlement.

3. Letter of Credit Fees

Aglet does not believe it reasonable to include letter of credit fees in AES' costs because such fees are similar to interest charges. However, the letter of credit was one of the prerequisites for executing an FSO4 contract. (See 55 CPUC2d 292, 294 and 296.) Therefore, the letter of credit fees are a reasonable reliance cost upon which to base a settlement.

4. Discounting of AES' costs

Aglet also argues that AES' costs between 1994 and 1996 should be further discounted for the risks in existence at that time, in order to determine whether the settled amount is reasonable in relation to the risk that each party would obtain its desired result through litigation. Aglet believes that such discounting is a reasonable method for testing the settled amount because there was a risk that the AES project would not be completed. Aglet recognizes that PG&E has already discounted or scaled back AES' costs before reaching this settlement, but believes that its own discounting is superior to that of PG&E's.

Aglet argues that the Commission should take into account the project's viability over time, referencing the Commission's final guidelines for contract revisions which state that where a project would not be viable, then contract modifications should not be accepted, and if there is a genuine question of viability, then negotiated modifications may result in a reasonable settlement. Aglet recognizes that AES did not have a signed contract with PG&E, and that the final guidelines do not strictly apply, but maintains that the principle that ratepayers should not support projects that are not viable is valid. In other words, Aglet is arguing is that AES' project costs should be discounted at certain points in time to reflect the risks of hurdles not overcome, and to reflect the likelihood that the project would not ever have become used and useful.

PG&E and AES believe that if Aglet's recommended discount method is defensible at all, it would only be so in the context of applying a discount to AES' expectation interest of expected profits. PG&E argues that by applying the performance risk discount to an amount that does not include an expectation component, Aglet would assign to AES all of the downside associated with performance risk with no potential for any upside recovery.

In reviewing Aglet's arguments, we must determine whether it was reasonable for AES to make particular reliance expenditures at given points in time based on facts that AES knew or should have known at the time the costs were incurred. Our findings with respect to AES do not mean that the settlement should be for the full amount of AES' reasonable bid preparation or reliance costs, but that these costs can serve as a ceiling for a settlement. Furthermore, our findings are unique to AES and should not serve as precedent for any other bidder in any utility's Update solicitation, because of the unique facts surrounding the Hunters Point solicitation which are more fully discussed below. Thus, our assessment of the reasonableness of AES' reliance costs at a given point in time should not be used by any other utility or bidder as precedent, because no other bidder was similarly situated to AES.

a) January 10, 1994, when PG&E announced AES as a winning bidder

Aglet believes AES' costs should be discounted beginning in January 1994 when PG&E announced the winning bidders. Aglet believes that this discount reflects the general risk of AES going forward without a contract with PG&E and the risk that some costs were not prudently incurred.¹²

In January 1994, the Commission issued D.94-01-020 in response to a request from PG&E for guidance about the Update auction regarding the acceptability of a certain wind bid. The Commission directed that PG&E should not announce the FSO4 auction winners for its wind project until further order from the Commission, but in all other respects, PG&E's auction should remain on schedule. Specifically, the Commission directed PG&E to announce the FSO4 auction winners for the Hunters Point project as scheduled. (D.94-01-020, 53 CPUCed at 36.) Several days later, PG&E announced AES as the winning bidder for the Hunters Point solicitation. Because the Commission had just directed PG&E to announce the FSO4 auction winners for the Hunters Point project, it is reasonable for AES to have incurred reliance expenditures at this date and these expenditures need not be further discounted as the basis for a settlement.

b) April 20, 1994, when the Commission commenced electric industry restructuring efforts

Aglet argues that AES' costs should be discounted by 30% beginning May 1994, the month after the Commission issued the Blue Book which began what is now known as electric industry restructuring.¹³ Aglet argues that the Commission committed to policies that include market-based regulation, direct access and replacing the Update process with competition, and therefore project completion risks for QFs rose markedly.

On April 27, 1994, shortly after the Blue Book issued, PG&E filed a motion requesting that the Commission immediately suspend the Hunters Point solicitation while the Commission considered the remaining Update schedule in light of the Commission's electric industry restructuring efforts. In D.94-06-050, 55 CPUC2d 291, the Commission directed that the Hunters Point solicitation should continue.

"To date, we have not suspended the Hunters Point solicitation, and we will not do so now given the unique procedural posture of this portion of PG&E's solicitation.

"We also see a ratepayer benefit in allowing this portion of the solicitation to go forward." (55 CPUC2d at 296.)

The Commission did not modify D.94-06-050 as applied to Hunters Point in D.94-12-051, 58 CPUC2d 300, 305-306. A bidder in AES' position could reasonably interpret these decisions as encouragement to proceed in the Update process. Therefore, it is reasonable for AES to have continued to incur reliance expenditures at this date and these expenditures need not be further discounted as the basis for the settlement.

c) February 23, 1995, when FERC concluded that the Update auction violated federal law

Aglet argues that AES' costs should be discounted by 60% beginning March 1995 which is the month after FERC found that the Commission's solicitation program violated federal law, and when the Commission issued an order staying the solicitation. Aglet states that the combination of FERC's determination and the Commission's commitment to competition for generation made it unlikely that the Commission would try to restructure its past solicitation to lock the utilities into long term contracts.

PG&E and AES argue that Aglet overlooks that FERC's order was subject to reconsideration, and also that the order expressly stated that FERC did not believe it to be in the public interest to invalidate preexisting contracts, and that AES believed that it had an existing FSO4 contract. They also point out that FERC encouraged the utilities and certain bidders to reach a settlement consistent with PURPA.

In March 1995, AES believed it had an FSO4 contract, while PG&E argued that AES did not. (AES requested that the Commission find it had a contract in May 1994, but the Commission found it was unnecessary to reach that issue because it had the discretion to permit the parties to complete the contracting process. (See 55 CPUC2d at 296.) ) In its order staying the solicitation, the Commission in March 1995 again did not reach the issue of whether there were any preexisting contracts between the utilities and the QFs in the FSO4 solicitation. Furthermore, in March 1995, parties to the Update were briefing various options including whether to continue the existing Update process by shifting reliance from an attempted implementation of federal law to intrinsic state authority. Given all of these events and the prior Commission decisions particular to AES, it is reasonable for AES to have continued to incur reliance expenditures at this date and these expenditures need not be further discounted as the basis for the settlement.

d) June 1995, when FERC denied reconsideration

Aglet believes costs should be discounted by 70% in June 1995 to reflect FERC's denial of appeals by AES and other parties because the likelihood that AES would ever produce power under contract with PG&E was reduced materially.

PG&E and AES argue that this argument fails to consider the facts discussed above (that the FERC order did not apply to existing contracts, AES' belief that it had a contract, and that the Commission was still considering various options for resolving the Update). At this time, AES had already incurred most of the reliance costs which serve as the basis for the settlement. We agree that at the time these events occurred, it was reasonable for AES to have continued to incur reliance expenditures at this date and these expenditures need not be further discounted as the basis for the settlement.

e) July 5, 1995, when the July ACR issued

Aglet also argues that AES' costs should be discounted beginning in July 1995 when the July ACR issued, because the ACR encouraged settlement of disputes such as the one between PG&E and AES. Aglet states that there was only a remote chance that the project would go forward at this point, and that AES should have sharply curtailed its spending.

PG&E and AES argue that under the July ACR, two of the settlement options expressly contemplated power purchase contracts. At this time, AES had already incurred the bulk of the reliance costs which serve as the basis for the settlement. Because a reasonable bidder in AES' situation, given prior Commission decisions particular to AES, may likely have continued its development efforts at this point (at least for several more months) with the expectation that it could either convince the Commission or PG&E that it had an FSO4, or PG&E to negotiate a power purchase agreement as a settlement option, it was reasonable for AES to have continued to incur reliance expenditures at this date and these expenditures need not be further discounted.¹⁴

f) June 19, 1996, when the San Francisco Board of Supervisors urged the mayor and all city agencies to refrain from action that would result in development of the AES project

Finally, Aglet believes that all costs should be discounted in July 1996, the month after the San Francisco Board of Supervisors apparently stymied further development of the AES project. Aglet states that the combination of Commission policy on generation competition, FERC disapproval of the solicitation process and strong local opposition made continuation of the AES project pointless.

AES argues that even these expenditures might be deemed reasonable, because the Board's action was non-binding and subject to change, and could attempt to reverse the San Francisco Board of Supervisors' resolution. We agree with Aglet that AES' actual reliance expenditures at this point should have been heavily discounted. However, the settlement amount is less than AES' reasonable reliance expenditures as of June 1996. (In fact, PG&E began discounting AES' reliance costs on which the settlement is based shortly after the July 1995 ACR issued.) Thus, the settlement amount falls within the bounds of AES' reasonable bid preparation or reliance costs.