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Regulatory Uncertainty Over Energy Procurement
Impedes Development and Construction of California Power Plants
By Christopher
A. Hilen
[May 2004]
While the emergence of Pacific Gas and Electric
Company (PG&E) from bankruptcy last month portends a possible
return to “normalcy” for California’s energy
industry, lingering uncertainty about the regulatory structure
of the California energy market remains. This enduring regulatory
uncertainty continues to impede the development and construction
of needed new power plants in California. In a potentially positive
development, California Governor Arnold Schwarzenegger recently
encouraged the California Public Utilities Commission (CPUC)
to expedite its adoption of the policies that are needed to
resolve this regulatory uncertainty.
Broad agreement exists that the California Legislature and
the CPUC need to provide greater guidance as to the role of
California’s utilities in power generation and procurement.
Thus far, however, no clear policy consensus on this issue has
emerged from the state’s policy makers. In the wake of
the Enron, NRG, Mirant, National Energy and Gas Transmission
(the former PG&E National Energy Group), and PG&E bankruptcies
and the continued fluctuations in power prices and regulatory
changes of direction, financial markets have, in effect, stopped
funding the construction of large power plants, absent the developer
having obtained a long-term contract for the purchase of the
plant’s output with some pricing certainty. With the limitations
imposed on direct access, the utilities represent essentially
the only viable market for developers to sell their electricity
in California. However, absent regulatory assurances of rate
recovery the utilities have been generally unwilling to enter
into long-term power purchase agreements (PPAs). The net result
is that project developers and financing parties are hesitant
to construct and finance even fully permitted projects.
The CPUC has been grappling with utility procurement related
issues since late 2001 when it instituted Rulemaking 01-10-024.
Starting in late 2003, the CPUC has issued several decisions
regarding utility resource procurement, but none of those decisions
provide definitive policy guidance to utilities and project
developers on the execution of long-term PPAs by the utilities
or the certainty of cost-recovery.
In December 2003, the CPUC authorized Southern California Edison
Company (Edison) to acquire Mountainview Power Company, the
owner of the Moutainview Power Project. The CPUC also concurrently
allowed Edison enter into a long-term PPA with this new affiliate
for the purchase of electricity from the Mountainview Power
Project. In authorizing the acquisition and associated PPA,
the CPUC cautioned that its decision should not be viewed as
precedential. It explained that its approval of the Mountainview
transactions was based on a unique set of facts, namely the
short-term opportunity for Edison to acquire the company (and
its plant) at a “distressed” price.
In a separate decision in December 2003, the CPUC adopted short-term
procurement plans for PG&E, Edison and SDG&E. These
approvals, however, are limited to the utilities’ respective
2004 resource needs and defer adopting long-term procurement
policies.
In January 2004, the CPUC issued a decision stating that the
utilities should use a formal RFP process to secure future long-term
generating capacity resources and seek to obtain portfolios
of short-term transactions, new utility-owned power plants,
and long-term PPAs. However, the CPUC provided no definitive
guidance as to the combination of these resources each utility
should employ; how the utilities should evaluate the merits
of competing proposals; or what ratemaking treatment generation
capacity additions and PPAs would receive. The CPUC did impose
certain non-resource specific adequacy requirements on the utilities
including that they:
- Maintain operating reserve margins of 15-17 percent, to
be phased in between now and 2008;
- Contract 90 percent of their summer load a year in advance;
- Limit spot-market purchases to 5 percent of their energy
needs; and
- Resubmit long-term power procurement plans for CPUC review.
The CPUC is currently considering proposed decisions by an
Administrative Law Judge and by Commission President Michael
R. Peevey that would authorize San Diego Gas & Electric
Company (SDG&E) to execute five separate agreements for
the purpose of meeting SDG&E’s near-term and long-term
grid reliability needs. The proposals emanate from an RFP issued
by SDG&E in May 2003 and include one demand response program,
purchase by SDG&E of two turnkey power plants (one of which
is being developed by SDG&E affiliate Sempra Energy Resources),
and long-term PPAs with two independently owned power plants.
Notwithstanding the fact that in its January 2004 decision
advocating the use of RFPs the CPUC made “permanent”
its pre-existing ban on procurement transactions between the
utilities and their affiliates, both the approved Mountainview
transaction and the SDG&E RFP pending approval include transactions
with a utility affiliate.
Four factors highlight the urgent need for definitive and clear
policy decisions on utility reliance on long-term PPAs. Policy
direction is required to create a stable power market that will
enable power plant developers to obtain financing for the construction
of new power plants:
- Lack of New Power Plants: No new large
power plants have completed construction in California in
the last year, and none are scheduled to come on-line over
the next year. The absence of contracts and financing is causing
even plants that have been fully licensed to have construction
deferred.
- Advantages of Retirement of Older Units:
California power plants with 900 megawatts of capacity have
been retired over the last two years. Given the aged status
of the California power plant inventory (40 percent of California’s
thermal power plants are more than 40 years old) and the higher
operating costs and environmental emissions associated with
these plants, it should be expected, and would be desirable,
that a substantial number of additional plants cease operating
within the next several years.
- Increase in Power Usage: There has been
a surge in home-building in high energy consumption areas
of California and increased economic activity statewide, increasing
overall demand for electricity.
- Decrease in Energy Conservation: Californians
are conserving less energy than they did during the summers
of 2001 and 2002, when retail electricity rates were at their
highest and the state government actively promoted conservation
programs.
The issues on which policy direction is needed include:
- Will California’s load-serving utilities be permitted
to once-again build and own gas-fired generation or will they
be required to procure power in the marketplace, through long-term
contracts? Can the independent generation market be expected
to remain viable if utility affiliates are allowed to compete?
If regulators believe that the promotion of both utility-owned
generation and independent third-party generation represents
good policy, how do regulators insure that the process is
sufficiently transparent and fair so that independent generators
will commit the necessary resources to compete against the
utility affiliates?
- Notwithstanding its statement of support for a portfolio
of resources that includes long-term PPAs, will the often
3-2 divided CPUC actually allow utilities to enter into long-term
PPAs and thus be able to flow through to ratepayers the benefits
such longer-term commitments may offer; or will they restrict
utilities to less attractive shorter-term commitments on the
theory that shorter terms “preserve options” and
provide downside protection?
- What showing of “need” will regulators demand
as a precondition of authorizing utilities to commit to any
new generation sources? Will they restrict utilities to purchasing
incremental power supply on an inventory “just in time”
basis; or will they recognize the “insurance”
benefits of erring on the side of committing to power acquisition
levels slightly in excess of actual needs?
- Will regulators be able to develop a process that provides
for full public input on utilities’ proposed incremental
power supply, but does not, and at great expense, increase
the uncertainties in, and extend the timeframes for, power
development and thus increase development risk, deter entrants
and drive up prices?
- What rules for cost recovery will utilities operate under
for utility-owned generation and for purchased power? Will
and how will the CPUC address the debt-equivalence impact
of long-term PPAs on the utilities’ financial ratings
and provide appropriate relief?
- What role will utilities play in demand-side management,
energy efficiency, and distributed generation?
- What load-serving role remains for direct access and community
choice aggregation?
The CPUC has 10 different proceedings underway to develop policy
on related industry issues. It initiated a rulemaking in early
April in which it promises to adopt long-term procurement plans
for the electric utilities and coordinate the other nine proceedings.
Davis Wright Tremaine is participating in and monitoring these
proceedings. The subjects of those proceedings include:
- Adoption of long-term procurement plans for the utilities
- Demand response programs
- Energy efficiency programs
- Distributed generation
- Renewable portfolio standards
- Community choice aggregation
- Electric transmission assessment and planning
- Avoided cost and Qualifying Facility pricing
- Natural gas supply
In a positive development, Governor Arnold Schwarzenegger sent
a letter to Commission President Peevey on April 28 expressing
strong support for the CPUC to develop a transparent, competitive
power procurement process. In his first significant expression
of energy policy, the Governor reaffirmed the state’s
commitment to energy efficiency and renewable energy, but his
strongest message was for the CPUC to include in its power procurement
policy upfront rate recovery standards that will provide the
utilities the assurance they need to enter into long-term PPAs.
The Governor’s letter may provide the impetus needed to
advance the development of needed power procurement policies
by the CPUC. The presently pending proposed decisions which
would approve the results of SDG&E’s RFP offer the
CPUC an immediate platform to act on the Governor’s message.
For more information, please contact:
This Energy Advisory is a publication
of the Energy Department of Davis Wright Tremaine LLP. Our purpose
in publishing this Advisory is to inform our clients and friends
of recent developments in energy law. It is not intended, nor
should it be used, as a substitute for specific legal advice
as legal counsel may only be given in response to inquiries
regarding particular situations.
Copyright © 2004 | Davis
Wright Tremaine LLP
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