The service territories of the California utilities Pacific Gas and Electric Company (PG&E) and Southern California Edison Company (SCE) are in the transition period before electric competition begins. The transition period began on January 1, 1998 and ends on March 31, 2002, or upon complete recovery of "uneconomic costs" (costs related to generation-related assets and obligations recovered in rates in a regulated environment, maintenance costs, and transition costs), during which time retail rates have been frozen. Another California utility, San Diego Gas & Electric Company (SDG&E) has recovered its allowable uneconomic costs, rendering its service territory deregulated. Being a default service provider, SDG&E has ongoing energy procurement responsibilities to provide service to its default customers. This summer, heat waves, a drop in reserves, and increased demand have accompanied a surge in wholesale energy costs. As a result of these increased wholesale prices, SDG&E’s ratepayers have experienced as much as an 80% increase in their retail rates.

In response to this situation, the California Public Utilities Commission (CPUC) on August 3, 2000 opened an investigation into the functioning of the wholesale market and its effect on rates in SDG&E’s territory. Among the issues the CPUC raised for investigation was whether SDG&E should be permitted to enter into bilateral contracts to procure supply in addition to its purchases through the California Power Exchange (CalPX) day-ahead, day-of, and block forward markets and the Independent System Operator (ISO) real-time markets. On the same day, the CPUC entered an order in another docket authorizing PG&E and SCE to purchase energy, capacity with associated energy, and ancillary services through bilateral contracts.

The CPUC’s August 3rd decision approved PG&E and SCE’s proposal to enter into bilateral contracts with energy suppliers and owners of transmission capacity which are not fully participating in the CalPX markets. The bilateral contracts would be used as a hedge against the price volatility seen this summer and attempt to minimize ratepayers’ costs by obtaining energy at below current market prices. The CPUC extended this authority to allow near-term and medium-term contracts, expiring on or before December 31, 2005, well beyond the end of the rate freeze.

This opportunity to make forward purchases and sales of energy and ancillary services for delivery in the CalPX market arose from Federal Energy Regulatory Commission orders dated May 26, 1999 and April 25, 2000. The May 26, 1999 order authorized a block-forward market in the CalPX and directed the CalPX to provide a bilateral delivery option for products. A division of the CalPX, the California Trading Services Division (CTS), operates a forward market for products and ancillary services and offers variety in delivery periods and delivery locations. The April 25, 2000 order authorizes the CTS to take ancillary services purchased and sold in the bilateral market to delivery in the CalPX market.

The CPUC established different methods for determining whether the bilateral contracts are reasonable. Prior to entering into bilateral contracts, PG&E will provide the CPUC Energy Division and the Office of Ratepayer Advocates with a target price range for its contracts and its sources of prices offered in the market for energy, capacity, and ancillary services used to establish its price range. Purchases by PG&E within this range will be deemed reasonable per se. For SCE, the CPUC may initiate a reasonableness review for near-term contracts (power delivered before December 31, 2002) in the event the average price of SCE’s bilateral transactions to be delivered over a one year period exceeds a "tolerance band" of 5% of SCE’s corresponding portfolio of transactions over the same year. The Energy Division will be able to pre-approve within a thirty day time period medium-term contracts (power delivered after December 31, 2002). Both PG&E and SCE must submit confidential monthly reports to the Energy Division of the CPUC containing detailed information regarding their bilateral transactions. The Energy Division is to monitor the transactions and report to the CPUC on a quarterly basis. In the event a transaction is deemed imprudent, rates will be subject to a refund. An application for rehearing this decision was filed with the CPUC on August 30th by The Utility Reform Network.

On August 9th, SDG&E filed a motion with the CPUC seeking the authority granted to PG&E and SCE to enter into bilateral power contracts. The CPUC has placed two proposed decisions addressing SDG&E’s motion on the agenda for its September 7th meeting. Each of the proposed decisions would authorize SDG&E to enter into bilateral power contracts and utilize the reasonableness standard used for SCE, but they differ in the term over which those contracts could extend. The August 25th proposed decision of an administrative law judge would limit the duration of SDG&E’s bilateral contracts to require that they expire on or before December 31, 2002 based upon the possibility that stranded costs could be incurred by SDG&E and the possibility that the default provider status of SDG&E could be revoked as a result of the docket investigating wholesale rates in the SDG&E territory. In an August 29th draft alternative decision, Commissioner Bilas proposed allowing contracts to extend until December 31, 2005 in the interest of granting SDG&E contracting authority identical to that of PG&E and SCE, reserving for a later proceeding any potential stranded cost issue. The draft decisions would also deny SDG&E’s request for waiver of the affiliate rules, which generally provide that transactions for products and services between a utility and its affiliate are limited to transactions governed by tariffs or conducted through an open, competitive bidding process.

California has responded to electricity price volatility in other ways. On August 21st, the CPUC ordered a rate stabilization plan, providing a rate cap to some SDG&E customers. By passing A.B. 265 on August 29 and 30, 2000, the California Legislature Assembly adopted the substance of an order the CPUC had rejected, which caps energy rates for SDG&E’s residential, small commercial, and lighting customers to 6.5¢ per kilowatt hour. Large commercial, agricultural, and industrial customers may likewise opt to pay the capped rate, with a true-up after a year.

A.B. 970, the California Energy Security and Reliability Act of 2000, was also passed by both houses of the California Legislature on August 31st and has been signed by the Governor. The Act expedites siting of power plants by requiring a six-month review process for thermal powerplants before the State Energy Resources Conservation and Development Commission and a four-month review process for simple cycle thermal powerplants that can be put into service by August 1, 2001. It also requires the CPUC to implement programs and guidelines to develop renewable energy (except hydroelectric development) by providing awards to reduce financing costs for the projects. A.B. 970 also provides that "uneconomic costs" shall not be passed on to certain cogeneration projects, including, after June 30, 2000, any load served by nonmobile cogeneration facilities onsite or in accordance with an over the fence arrangement.

Robert A. Olson is a partner in the law firm of Brown, Olson & Gould P.C. which maintains a nationwide practice in energy law, public utility law and related commercial transactions. He can be reached at:

Brown, Olson & Gould, PC
2 Delta Drive, Suite 301
Concord, NH 03301

rolson@bowlaw.com | (603) 225-9716