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Today's policy decision in context: On May 24 we advanced the policy deliberation phase of this proceeding by releasing for public comment two proposed sets of policy preferences enunciating views of a restructured electric services industry. Consistent with our unprecedented attempt to achieve the broadest base of public and stakeholder participation, we have held full panel hearings and received voluminous written comments on both sets of policy preferences. Most recently we used the vehicle of "Coordinating Commissioner Rulings" to pose questions and seek further clarification on critical points.(Fn. 1) Having completed this deliberative phase of our proceeding we are now prepared to announce our policy decision.

A. Our Goal

In this opinion we advance a much matured description of market institutions and a much clearer view of the role of customer choice. The reader will find a more in depth discussion of both vertical and horizontal market power issues which must be resolved before either we or our counterparts at the Federal Energy Regulatory Commission can be expected to entrust the well being of this state's economy to market forces. We build upon our call in May for an era of Cooperative Federalism to set forth the foundation of a California Consensus position on the structure of those institutions committed under our federal system to the stewardship of the national government.

The issues of transition cost, their identification, calculation and recovery are discussed from a policy perspective but also in sufficient detail to enable those with existing interests to determine our expectations respecting their opportunities and obligations as we work together to achieve a more sensible and sustainable future. Our objective continues to be the collection of transition costs through the imposition of a non-bypassable Competitive Transition Charge (CTC) that is competitively-neutral, fair to various classes of ratepayers and which does not increase rates beyond the revenue requirements we have established on January 1, 1996 without adjustment for inflation.

To assure the continued financial integrity of California's investor owned utilities, and give them an opportunity to be vital participants in the restructured market following the transition, we will allow them to recover 100% of the CTC. We propose to complete the valuation of the CTC by 2003, after which time no further accumulation of transition costs will be allowed unless derived from existing generation contracts and related ongoing contractual payments. With this exception, we will complete the collection of the CTC by 2005. The CTC will include regulatory assets, existing contractual obligations for generation, including Qualifying Facilities, and the undepreciated book value of a utility's generation plant as reflected in rate base as of this decision date. Our methods for valuing the CTC will rely to the extent possible on market mechanisms and will seek to minimize the burden of regulatory proceedings and the economic cost to California's economy.

California's commitment to public purpose and social aspects of the provision of energy services to all of our citizens has been marked by legislative, commission inspired, industry based and community prompted initiatives in the past and we fully anticipate such aspirations and effort to mark our state's future. In today's decision we set the stage for these developments by speaking directly to the fate of renewable resources, demand-side management, and public purpose research, development and demonstration efforts. Low income assistance, Women, Minority, and Disabled Veteran Business Enterprises, baseline rate, economic development programs, special rate discounts, low-emission vehicle and under grounding are all implicated in the reforms which are now launched, and today's discussion furnishes those constituencies with vitally affected interests with a more fulsome statement of our vision.

Throughout this proceeding we have acknowledge the applicability of the California Environmental Quality Act and the need for compliance once our deliberations had advanced to the stage that a project could be assessed. We believe that today's decision brings us to this critical juncture and so we define and discuss our compliance strategy.

Each of the general subjects covered by chapter heading in today's opinion is vital, and yet the focus of most debate and controversy has centered on the role of customer choice and the market mechanisms and institutions which must be developed to ensure an array of informed customer options. It is thus to these allied topics that we turn briefly in summarizing our actions of today.

B. Customer Choice and Consumer Protection

In the absence of well understood and easily exercised consumer options the genius of competition is thwarted. We began this Rulemaking and Investigation by declaring our single minded dedication to discovering and deploying strategies and mechanisms which would place sustainable, downward pressure on the cost of electricity to all classes of California ratepayers. From the beginning, our policy preference has inclined strongly in the direction of competition and market mechanisms. As we move from the realm of theoretical discussion toward deployment, our task is to ensure that the competition is genuine and market mechanisms are open to competitive entrants and transparent to those who must depend upon their function. With today's decision we believe that we have opened the door to the broadest possible array of choice in which the former "ratepayer" can function as an intelligent, self-interested "customer." We will briefly summarize those choices before detailing the market structure which will support their availability.

Customers for electric services in California reflect the diversity of our economy and society. They range from large industrial and commercial users to the smallest householder. They include agricultural users of every variety of description and husbandry. These differences in circumstances produce radically different load profiles and usage patterns. What we have termed as an "electric services industry" includes a basic commodity---electric energy---as well as a host of services in their generation, transmission and distribution. (Fn. 2) Over time Californians have achieved world class leadership in the development of conservation strategies aimed at cost containment as well as environmental concerns. But there has been one aspect of the industry in which we have conspicuously failed to maintain a competitive presence and that is in the cost of electric energy. Our debates have revealed the broadest consensus that our rates are too high and must be brought into alignment with regional averages if California is to sustain a competitive posture as we enter the twenty-first century. Equally strong is the consensus that if market mechanisms can be developed that send strong, sustained and easily comprehended price signals both new market entrants and consumers will react with intelligent choices.

If our vision of the near term reform is realized, shortly after the first of January, 1998, customers in California will face an impressive array of choice. Ranged along a continuum of the degree to which the customer desires to become proactive in taking charge of cost containment, the essential choices will be made from three broad categories.

1. Retain the traditional relationship as a full service customer of the local electric utility:

A customer of any class is free to elect continued reliance upon the local distribution utility to procure as well as deliver electrons. Yet even here there is choice as to how the customer's bill will be calculated. Those who prefer to retain an exact replica of the status quo can opt to have their volume of usage multiplied by a rate which reflects the average cost to the distribution utility of procuring the electric power. Customers who are willing to shift load in response to hourly or half-hourly price signals can elect what we have termed "virtual direct access", a rate structure which takes into account not only their volume but also the time of their usage.

2. Financial hedges:

Many customers may be disinterested in the choice of generation but desire price stability and predictability over a defined period of time. Such customers are free to elect hedging contracts which may be concluded with any individual or entity willing to take the counter-part risk. A customer who has formed such a contract continues to receive a bill from the local utility which reflects both the cost of electric power and distribution services. Periodically such a customer totals the amount of these payments to the local utility and determines whether they exceed the price guarantee concluded in the hedging agreement. In that event a bill is submitted to the other party who reimburses the customer so as to bring the cost of electricity for the period to within the agreed maximum. In the event that excess outlays have not been experienced the party who sold the guarantee keeps the premium for taking a risk that was never realized.

In our view parties agree to accept the risk in a hedging contract may have generation facilities or contracted rights to generation but we see no need to restrict their qualification or to in any manner make hedging contracts, termed "contracts for differences" in much of the literature, the object of Commission concern. Both entry into and exit from such a business, as well as the terms of such contracts are left to the genius of the marketplace and the will of market participants.

3. Direct access through physical, bilateral contracts:

With today's decision we propose to advance the availability of a direct access customer option even as we seek to clarify its consequences. While some have contended that, in the final analysis, such contracts represent but a variant upon the purely financial transaction, this view is disputed by those who see in them a genuine advantage and a distinct choice. We need not settle this debate for, in the final analysis, the decision will take place in the marketplace. In one clear respect this option differs from the hedging arrangement described in the second set of choices. In a direct access contract the parties seek to dispatch specific generation on the part of sellers as well as provide fixed financial terms to the consumer of electricity. To the extent that the dispatch matches a correlative customer load, the net impact of such contracts is to reduce the amount of electricity which will be procured on the spot market which will serve the needs of those customers who elect from the first and second categories.

Our evolved willingness to begin a phased availability of direct access contract options simultaneously with the introduction of the wholesale spot market stems from a hard won understanding of their true nature. A customer who forms a physical, bilateral contract directly with a generator, or an aggregator who will then delegate the task of generation to those actually in that business, forms a contractual arrangement which will influence the dispatch of generation and govern the financial consequences of consumption. However, save for those extraordinary circumstances in which the contracting parties bear the economic and societal costs of constructing a discrete, private means of transmitting the electricity from the contracting generator to the contracting customer, the bilateral contract does not control the actual physics of the generation, transmission and distribution of the electricity the buyer consumes. Such a customer will take physical service from the local utility which will deliver power commingled from an undifferentiated array of generators who are making common, simultaneous use of the transmission grid and distribution facilities.

The financial consequences of direct access contracts involve, at a minimum, four interests, three of which are readily identifiable: those of the customer who consumed a quantity of electricity, those of the generator who simultaneously supplied to the transmission grid a correlative quantity of electricity, and the local utility which delivered an equivalent amount to the customer's physical premises. (Fn. 3) So long as the expectation interests of both parties to the bilateral contract are realized, and a settlement is made with the utility for all costs incurred other than that associated with the generation of the electrons, we see no need for the Commission to take a proactive role in defining these settlement arrangements.

C. Market Structure

The variety of customer choice which we seek for Californians after January 1, 1998, is currently unavailable any where in the world. To attain it will require the efforts of virtually every present and aspirant industry stakeholder, our staff, and the members and staff of the Federal Energy Regulatory Commission. Much of the common labor will be directed toward framing the structure, fixing the rights and duties, and the deployment of two critical institutions: the Independent System Operator (ISO) and the Power Exchange (Exchange).

1. The creation of two distinct entities to handle transmission and the spot market represents a change from the positions set forth on May 24:

We affirm a key policy decision and announce an amended position on a critical implementation strategy. In the statement of proposed policy preferences the majority declared its conviction that the vertically integrated electric utility is not compatible with the institutions of a competitive market for electric services. Today we are even more firmly convinced with respect to this belief. We also affirm our conviction that the interests of all Californians requires the creation of a transparent, visible spot market for electric generation and that operating control over all transmission assets be divorced from the underlying pattern of ownership and vested in the hands of an independent system operator which will operate these combined assets as a single, state-wide grid. However, unlike the majority's proposed policy preferences of May 24, we are now persuaded to vest the spot market pool and transmission grid operations in two distinct entities. We also adopt the suggestion that the spot market pool be termed the "Power Exchange" and that we refer to the operator of the transmission grid as the "Independent System Operator." The basic structure and function of these two entities and their critical inter-relationship are defined in this opinion. They may be briefly outlined.

2. The Power Exchange:

The Power Exchange will foster and sustain the development of a transparent spot market for the generation of electricity. Under the terms of the policy decision we announce today, the Exchange will have no financial interest in any source of generation nor will it have any ownership ties to the Independent System Operator. It will determine on a forecast basis the needs of those California customers with loads that are not being met by generators under the terms of direct access contracts. As a market institution it will function as a clearinghouse by providing a transparent auction for generation with hourly or half-hourly price signals evident to immediate users and long-term investors. We anticipate that the performance of this function will provide critical assurances to generators, wholesale buyers, and consumers.

a. The Exchange will facilitate open competition among generators:

The integrity of competition at the wholesale level will depend upon the formulation and continuous deployment of nondiscriminatory rules which permit rival generators to compete on common grounds using transparent rules for bidding into the Exchange. Generation units outside of California, including those operated by municipal utilities or public power entities, will be welcome to bid into the Exchange. Over time the ability to observe the price information will send the most reliable signals respecting the need for additional generation as well as cost-cutting steps required to keep existing units competitive.

b. The Exchange will provide invaluable services to consumers, including those who elect to contract directly for generation dispatch:

From the perspective of both wholesale and retail customers the most critical contribution of the Exchange lies in the auction determination of real time pricing of electricity and the transparent manifestation of these price signals. In the absence of such an institution the market will be hidden and the price signals obscured or subject to selective, discriminatory dissemination. If the California economy is to realize the efficiency gains brought about by competition among generators, the impact of that competition on the price of electricity must gain the broadest customer awareness.

Compared to the present practice of receiving and paying a totally unexplained utility bill, those customers who elect to remain with their local utility for purposes of generation procurement and distribution services gain the most startling advantage. They will be direct beneficiaries of the wholesale competition among generators in that the local utility will simply pass through to its customers the prices which it has paid to procure power through the Exchange. Customers who have chosen to have their bills computed on the average cost of power times consumption receive the benefit of the average pool price. Those who are willing to consider shifting load in response to the hourly or half-hourly price signals will have a rationale basis for electing the virtual direct access billing option.

Revelation of pool prices is also the key to the intelligent use of hedging or contracts for differences. The market for such contracts will be premised on the revelation over time of the spot price for electricity. Only by assessing the risk of spot market volatility can a consumer make a rationale decision that the vagaries of the pool price warrant the formation of a contract with a counterpart party who will guarantee a price over an agreed span of time.

We anticipate that the maturing market for energy conservation will also benefit from the price revelation of the avoided cost of energy.

By the same token, knowledge of the cost of receiving energy from the spot market will provide both end users and generators will the information from which they can calculate the relative advantages of forming physical, direct access contracts.

3. The Independent System Operator (ISO):

Reform of California's electric services industry begins with the creation of the Exchange and transparent spot market for generation. The creation of an Independent System Operator provides the essential entity to coordinate the daily scheduling and dispatch activities of all market participants as required to meet the critical objectives of providing open, nondiscriminatory access to the transmission grid while preserving reliability and achieving the lowest total cost for all uses of the transmission system.

The unavoidable interactions in the transmission network require the services of a system operator to coordinate the actual use of the system and apply a pricing structure that supports competition and avoids cost shifting. The central importance of these functions demands the confidence of all participants that the system operator is truly independent and that the protocols for pricing and operations are both economically efficient and compatible with the competitive market. We have described in some detail the minimum requirements to make fully clear our intent that these prices and procedures will be fair and economically efficient.

The ISO will take no position in the market nor have any economic interest in any load or generation. Its coordination functions will be limited to the short term, including the facilitation of day-ahead scheduling and hourly redispatch in order to balance the system and respect transmission constraints. Of necessity, the independent system operator must have the final responsibility for redispatch of the system needed to integrate the nominations from the Power Exchange and from direct access transactions. In executing these limited but fundamentally important responsibilities, we are dedicated to the view that the ISO must be indifferent to the status of generation or load as from the Exchange or from a bilateral transaction. Furthermore, the ISO must determine the rational economic prices to apply to all uses of the transmission grid to ensure that the associated incentives are consistent with the competitive market and least cost use of the transmission system. We have specified the elements of such an efficient pricing system that ensures that charges for transmission use avoid any bias for or against participation in bilateral transactions or in the Exchange. The essence of this pricing system stands on the well established foundation of the competitive market principles of marginal cost pricing. The ISO will determine the marginal cost prices, differentiated by location and time, that will apply to all uses of the transmission system. These locational, hourly prices will apply to purchases and sales through the Exchange and the equivalent differences in prices between locations will apply as the transmission prices for bilateral transmission. The implementation of this efficient, nondiscriminatory pricing system could be achieved simply through a so-called "hub and spoke" system that would organize transmission grid usage around a number of regional hubs that will be the focus of commercial transactions. We invite the suggestion of alternative strategies that achieve these policy objectives.

Many market participants have a legitimate need to achieve some certainty about their future costs for transmission use, in order to arrange for long-term power transactions. Ideally, a system of physical property rights defining use of the transmission grid would exist and be able to support our objectives for a competitive market. However, the same conditions which require the coordination role of the ISO preclude any practical system of independent physical property rights which could govern use of the transmission grid. The alternative is to create a system of contracts that provide the equivalent certainty for long-term transmission costs without compromising short-term operations coordinated through the ISO. Therefore, in addition to coordinating the daily and hourly dispatch, the ISO will administer a system of transmission congestion contracts. We believe this system of tradeable contracts provides the best method of meeting the legitimate needs of the market while respecting the special conditions of the interconnected transmission grid.

We recognize fully that these various functions of the ISO constitute an important innovation that, while fully consistent, goes well beyond the minimum requirements currently being considered in proposed rulemakings at the Federal Energy Regulatory Commission. We have adopted this consistent set of proposals based on the comments of many parties and a careful study of the relevant features of other reforms in transmission systems elsewhere in the United States and in other countries. We are confident that California can capture and improve upon the best practice, and that Californians are fully capable of implementing here incremental improvements on what has been embraced elsewhere. Hence we direct the participating utilities to formulate a detailed proposal that adheres to the minimum requirements we have specified and to present such a proposal to FERC for its approval. We are confident that this system will meet and advance well beyond the FERC minimum standards by providing a package which is both a "conforming, open access" and an "innovative pricing" proposal.

1. This Rulemaking and its companion Investigation have attracted an extraordinary degree of formal participation. At last count four hundred ninety-seven persons and entities have become formal parties. The views and opinions of our fellow Californians were sought in a series of public participation hearings held across the state; our full panel hearings were broadcast on public access channels and carried by many of California's cable television operators. As a result of heightened public awareness, we have received hundreds of letters from individuals and benefitted from the organized views of many of California's vital communities such as the Latino Issues Forum, California/Nevada Community Action Association (Cal/Neva), the Greenlining Institute, Senior Utility Ratepayers of California, Inc., and the American Association of Retired Persons. Realizing that we could benefit from an even more broadly cast effort to receive views and opinions we dispensed with the need for formal party status in the first Ruling by the Coordinating Commissioner.

2. Throughout our discussion a convention has arisen in which references are made to "electrons" or "electricity" as the commodity that it generated, transmitted, distributed and consumed. Those who are concerned that we acknowledge the basic teachings of physics or electrical engineering will point out that the electrons oscillate and it is power that moves and is consumed.

3. The Independent System Operator is a fourth party with a financial stake in the bilateral transaction. As is the case with generation nomination from the spot market, a dispatch nomination originating from a bilateral contract must obtain transmission services and thereby incur a liability for these service costs. Transmission liabilities must be settled with the operator of the transmission grid irrespective of their origin. In the case of nominations from the spot market settlement will be made by the utilities which then distribute the electricity to their customers. Bilateral contract nominations may be settled by the generator, the end use customer, the broker or aggregator, or the distribution utility acting as an agent for any of the parties. Again, we note the obligation to be resolved without the felt need that the Commission dictate the resolution. By the same token we leave the issue of compensating the broker for aggregator to the contracting parties who have elected to utilize such an intermediary.


Last Modified: 10/17/2007

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