Retail Energy in 2002: A Regulatory About-face
State regulators redouble their deregulation efforts-or abandon them altogether.
The past year was a phenomenal one for state public utility regulators.
A historical confluence of events, including the catastrophic failure of the move to deregulate California electric markets and a nationwide epidemic of corporate financial scandals, led in large part by energy trading firms, helps to explain the developments.
The cry for help by consumers faced with uncertain supply and prices was directed primarily at state public utility commissions (PUCs), which have a legal duty to ensure reliability and fair prices for essential services like electricity.
The PUC responses ranged from full retreat back to traditional regulation in the West, to a dogged attempt to find a way to make the market work in states where the crisis was not as severe, such as Pennsylvania.
Nevertheless, a review of the most important decisions issued by state regulators leaves one with the impression that there now exists a general consensus, albeit a begrudging one in some cases, that electricity may not be the type of product best delivered in an unregulated environment. Further, traditional topics not often mentioned during the heyday of deregulation, such as return on equity, cost of service, and allocation of affiliate debt costs, are once again of the utmost importance to consumers and the public welfare.
California Returns to Regulation
Perhaps the defining moment for the return of the regulator in the wake of the Western power crisis was the decision by the California Public Utilities Commission (CPUC) in the fall of 2001 to cancel, at the direction of the state legislature, its electric direct access program. At that time, the CPUC noted that the state was issuing bonds to cover the cost of power purchases required as a result of the financial failure of the states two largest electric utilities, Southern California Edison Co. and Pacific Gas and Electric Co. Since that time, the PUC has made a number of decisions indicating that any hopes it may have had of relying on the market to replace the traditional role of regulators are far gone.
A recent decision stands as a perfect example of this trend. The CPUC adopted procedures for the state's investor-owned utilities to resume full energy procurement responsibilities on Jan. 1, 2003, removing the state from power-buying responsibilities. The rule marks a return to state-supervised, long-term integrated resource planning and also includes a ratemaking balancing account mechanism to track utility power purchase costs. The CPUC said that it is now developing a long-term planning process to ensure that sufficient new resources are developed to provide a low-cost, reliable electric system for California consumers. The rule calls for the "upfront" approval of the utilities' procurement processes and plans, which should minimize the need for any after-the-fact review of the resulting purchases, the CPUC said.
[Re Policies and Cost Recovery Mechanisms for Generation Procurement and Renewable Resource Development, 220 PUR4th 377 (Cal.P.U.C. 2002).]
Two Flavors for the Grid
In an earlier decision, the CPUC also permitted Southern California Edison to update its current performance-based rate plan, in large part to account for declining sales associated with the recent energy crisis. But the state legislature recently had passed a law requiring the CPUC to ensure that errors in estimates of demand elasticity or sales do not result in a material over or undercollection of revenues by the state's regulated electric utilities-a signal that state energy policy had shifted a focus on regulation. The CPUC noted that the adoption of a balancing account tied to an approved revenue requirement essentially restores the Energy Revenue Adjustment Mechanism (ERAM) that was in place before the move to performance-based ratemaking.
Nevada Takes Strong Action to Protect Consumers
The Western power market crisis also brought out the strongest of weapons available to a utility regulator-the prudence disallowance. A prime example of this is actions taken by the Nevada Public Utilities Commission (NPUC) when faced with large rate hike requests by Sierra Pacific Resources operating utilities Nevada Power Co. and Sierra Pacific Power Co. The NPUC denied Nevada Power recovery of $437 million of the $922 million in purchased power costs it had incurred during the height of the regional power crisis in 2001. Similarly, it disallowed $55.8 million of the $205 million in power costs deferred by Sierra Pacific power during the period.
In both cases the NPUC found that the utilities' managers had made inexcusable mistakes in planning for and executing their purchase of power to meet peak needs. For example, it said that the decision by Nevada Power to purchase power in April of 2001 for delivery in the third and fourth quarter of the year at an average price of $513 per megawatt hour, when it knew as early as November of 2000 that it would have excess supplies, was beyond explanation.
In both cases the NPUC asked the question traditionally reviewed in prudence cases: What would a reasonable and prudent manager have done given the information available at the time? Similar findings were made in the Sierra Pacific case, where the NPUC found that nearly every party to the proceeding had agreed that there was some level of imprudence on the part of the utility in obtaining purchased power.
The unique aspect of these disallowances was their timing. The cases coincided with a period of great regulatory instability in the region, as policy-makers began reevaluation of ongoing efforts to deregulate the power industry. In fact, one of the major arguments posed by the utilities in support of its purchasing practices was that state regulators had not given clear signals as to the future service obligations of incumbent utilities under restructuring. That being the case, managers could not reasonably plan for the long term, and they were forced to buy blocks of short-term high-priced power instead.
Kansas Shocked by Failed Utility Diversification
Aside from problems directly related to electric restructuring efforts, regulators recently have been called to review the effect on ratepayers of the cyclical trend of diversification of utility companies into unregulated lines of business. Many companies with utility assets made major efforts to enter the energy trading business when a fully restructured industry may have seemed inevitable. Major losses in unregulated businesses leave companies weakened and throw risk on consumers who purchase what are still monopoly utility products. Again, the state PUC is often seen as the last and best hope for such consumers.
Last year's prizewinner in this category is Westar Industries and the Kansas State Corporation Commission's (KCC) review of that company's failures in diversification. The KCC ruled that financial and corporate restructuring of Western Resources Inc. (WRI) is necessary to achieve a balanced capital structure within the company's public utility business. WRI is a holding company that provides electric service in parts of Kansas as KPL and in a separate service territory through its wholly owned affiliate, Kansas Gas and Electric Co. WRI also owns 100 percent of Westar Industries Inc., a holding company that owns several nonutility businesses, most prominently ONEOK, an energy services company with gas pipeline and production assets, and Protection One, a company specializing in monitored security services for residential and commercial consumers.
The KCC found that Westar's Protection One venture had experienced losses totaling over $291 million between 1997 and 2001. If Westar were permitted to shift debt and assets to its own advantage, the company's regulated utility business, if viewed as a stand-alone, would be left with a capital structure consisting of 117 percent debt and a negative 17 percent equity. To protect consumers of regulated services from paying higher prices as a result of the company's financial difficulties, the KCC ordered Westar to make a series of accounting entries to reverse the allocation of debt made to the regulated side of the business. It also directed WRI to transfer its KPL utility business to a utility-only subsidiary. The KCC also opened an investigation into further transactions between utility operations and unregulated business activities to remove opportunities for WRI to use the utility business to build nonutility ventures and to cover losses.
Pennsylvania Finds Market Manipulation
Even in Pennsylvania, a state sometimes identified as a place where deregulation of the electric market might one day work, the state PUC has found evidence of anticompetitive behavior in its regional wholesale market and has moved to assist ratepayers as competitors leave the retail market.
On June 13, 2002, the PUC issued a report finding clear evidence that PPL Electric Utilities Corp. had engaged in an unlawful exercise of market power and gaming of market rules to force up prices for regional power pool capacity during the first half of 2001. The PUC forwarded the report to the Federal Energy Regulatory Commission (FERC) and the U.S. Department of Energy.
The PUC asked FERC to consider taking further action against the company. It said that PPL unilaterally had raised the price of capacity credits to unprecedented levels. Under wholesale power pool rules, marketers and aggregators are required to own or have a right to sufficient generating capacity to cover daily energy transactions. Failure to maintain sufficient rights results in the imposition of a capacity deficiency charge.
According to the PUC, the electric utility found itself in a unique position on Jan. 1, 2001, when it was the only entity in the market with uncommitted capacity resources. The utility wasted no time taking advantage of the situation by demanding capacity auction prices equal to the full penalty rate, the PUC said. It found that PPL had gained its advantage by increasing exports of power at a time when the total capacity obligation of the system was rising.
The PUC complained that PPL's gaming of the wholesale market system at a time that it possessed monopoly power had damaged its competitors and undermined the public's confidence in the competitive market, as evinced by a significant decline in the retail shopping and new supplier market participation in Pennsylvania.
In a case related to these events, the PUC later in the year issued an emergency order directing New Power Co., a bankrupt power supplier and former Enron affiliate, to rescind previously issued "make-up bills" for charges purportedly owed by customers after the supplier left the state retail choice market. The PUC said that all of the bills covered the same July 1, 2002, through Aug. 1, 2002, billing period but inexplicably contained the same usage figure of 603 kWh, and contained no meter reading information.
The PUC said that the competitive supplier had failed to respond to its inquiries. It concluded, "We are left with the appearances and must conclude that bills issued for a period during which the company was not in business, which are not based on actual meter readings, and which list the same usage for disparate customers, points to a probability of fraud on the public which this Commission cannot disregard."
Faced with a situation where many customers might respond to the billing with its upcoming payment due date of September 2002, the commission on Aug. 28 issued an emergency directive requiring New Power to issue a notice to the 13,000 affected customers, and to issue refunds to those who had already made payment. [Re New Power Co., Docket No. M-00021632, Aug. 28, 2002 (Pa.P.U.C.).]
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