"This legislation represents a piecemeal approach to a problem which requires deliberate and thoughtful consideration .... [It] could lead to 'cream-skimming,' which would result in increased...
Rate Unbundling: Are We There Yet?
RATE UNBUNDLING: ARE WE THERE YET?
FEBRUARY 15, 1996
THE ELECTRIC INDUSTRY CONTINUES to evolve in different forms across the country. Some proposed changes are radical, others are more evolutionary, but few utilities remain unaffected. Competition in the generation sector sharpens the focus on cost-effectiveness, market share, and new lines of business. Investor-owned utilities (IOUs) are reorganizing their current business structures and regulators are struggling either to lead the charge or to keep up.
One of the biggest challenges facing regulators is to encourage the benefits of competition while protecting electric consumers from excessive rates that produce windfall profits for shareholders. For example, over the past few years, California's IOUs have asked for a higher allowed return on common equity (ROE) to compensate shareholders for the additional risk associated with competition in the electric generation sector. In 1994, following the landmark "Blue Book" restructuring proposal from the California Public Utilities Commission (CPUC), the IOUs cried even more loudly for higher returns in their annual rate proceeding on cost of capital.
In that docket, the Independent Energy Producers Association (IEP) asked the CPUC to consider a new approach to regulating the cost of capital for California's electric utilities. In parallel with the unbundling of electric services and associated rates, the IEP asked the CPUC to unbundle the cost of capital.1 The premise of IEP's argument was that unless utilities disaggregate the risks of providing unbundled services, along with rates and the allowed shareholder returns, IOU customers would end up overpaying for certain services, such as transmission and distribution (T&D) activities, while underpaying for others, such as generation. In addition, utility generation services would gain an unfair advantage over other
generation-only competitors. In a decision issued in November 1994, the CPUC agreed with the argument presented by IEP and charged that any future unbundling of services should include an unbundling of the ROE and rates associated with those services.2
Since the CPUC's 1994 order, California's IOUs have made significant progress towards disaggregating and unbundling their electric services. For example, Pacific Gas & Electric (PG&E) and San Diego Gas & Electric (SDG&E) have filed applications with the CPUC to reorganize utility assets and form holding companies. Once restructured, those companies will operate separate business entities for the production, marketing, and delivery of electric services. In addition, these two utilities and Southern California Edison (SCE) have each filed open-access transmission tariffs with the Federal Energy Regulatory Commission (FERC) to provide transmission-only services to customers. Consistent with the CPUC's decision, it would appear that now is the time for unbundled electric tariffs to include ROE components that reflect the risk of providing unbundled services.
THE CHALLENGE AT HAND
The challenge in unbundling the cost of capital comes not in proving the theory to be fair and equitable, but in determining how and when to do it. As concerns how, the traditional methods of determining cost of capital require identifying and collecting data for comparable groups. Since most electric services have been vertically integrated for a considerable time, truly