We begin the new year with a recap of the major rulings issued last year by state public utility commissions (PUCs).

Electricity took center stage as state commissioners began in earnest to examine rising competition in the power generation market. The seemingly endless number of privately sponsored seminars, conferences, and reports on the issue might suggest that regulators are following rather than leading on policy. But consensus remains far off. State PUCs are cautious (em carefully investigating retail wheeling and scrutinizing cost and service issues. This same caution shows up in the slowdown of ratepayer-subsidized conservation plans in several states in the face of excess capacity and rising energy costs.

Competition remained a focal point in telecommunications, with PUCs approving tentative openings in the local exchange market. While both natural gas and telephone utilities are farther along in reform, the level of regulatory activity has not diminished. If the past year is any guide, utilities can expect for some time to operate under prudence reviews, service standards, and least-cost planning rules. Regulators are still bound by legislation that requires rate protection for monopoly customers, while utilities continue to function under a duty to serve on demand.

Price-cap or incentive-based regulation methods are gaining converts in both energy and telecommunications markets to promote cost-cutting and other market efficiencies. Pricing flexibility is also now common in energy and telecommunications, where utilities can show competitive pressure. Nevertheless, where cost- of-service regulation has eased somewhat, regulators pick up the slack by policing the marketplace to ensure fair play among market participants.

Electricity (em Reforms Amid Hysteria

Regulatory reforms (em prompted by high power costs in some parts of the country (em range from retail wheeling programs to incentive ratemaking. Even so, new developments at the state level have turned up several roadblocks: 1) what to do about the utility obligation to serve; 2) how to maintain current subsidies for conservation and other social goals; and 3) how to allocate the costs of stranded investment?

State regulators and electric utilities have also struggled with the high-cost power contracts mandated under the Public Utility Regulatory Policies Act (PURPA) and state industrial planning policies. Cogeneration and renewable-resource power contracts that looked acceptable a few years back now place utilities at a disadvantage in meeting new sources of competition. Here, again, California exemplifies the battle (em electric utilities complained that renewable-resource contracts bid under the PUC's Biennial

Resource Plan Update (BRPU) would saddle ratepayers with millions of dollars in additional purchased-power costs, just when the state could least afford it. The battle continues, but Southern California Edison announced late last year that it had negotiated an agreement to replace 495 megawatts (MW) of mandated purchases with a contract for 375 MW of wind-generated power at a substantially lower price than the mandated BRPU energy auction.

s Retail Wheeling. On April 20, 1994, the California PUC issued a sweeping proposal to restructure the state's electric power industry. The plan makes "direct access" to power supplies (retail wheeling) for all consumers the centerpiece of reforms aimed at tapping the price-leveling powers of the growing competitive market for electric generation services. Michigan has inaugurated a limited experiment for the state's two largest utilities. Connecticut has rejected the idea because of the state's excess capacity, and state regulators worry openly about the effect such a radical change might have on their ability to promote conservation and other social goals.

State legislatures have also played a part, passing a limited retail wheeling law in Nevada and considering the same in Ohio. A number of other states have opened investigations on the wheeling and stranded investment issues.

A major uncertainty in the debate is the utility obligation to serve, which requires a utility to provide service on demand under rates, terms, and conditions approved by the PUC. The Michigan wheeling case directly addressed the issue; customers participating in Michigan's wheeling experiment may return to bundled utility service after the experiment ends on the same terms as nonparticipants. However, if a participant chooses to return before the end of the program, that customer's load would be served from incremental generation or power-supply resources beyond those required to serve other retail customers. The most expensive source of fuel or purchased power, as well as other tariffed charges, would be assigned to the prematurely returned customer. Such a customer would also be exposed to interruption to maintain system integrity.

s Stranded Investment. Who pays for the cost of power facilities built by utilities under the current regulatory framework but rendered uneconomic in the restructured marketplace? Regulators cannot wait for a magic answer to this question. Plant writedowns and "equalization fees" are two solutions that have threatened utility power sales in the past year.

Even as it works to perfect retail wheeling, the California PUC continues to seek more traditional solutions to the problem of high utility rates. Southern California Edison Co. has asked to accelerate rate recovery of its embedded investment in nuclear generating

facilities, claiming that the move was necessary to prepare for the emerging competitive market. Edison plans to accelerate depreciation of current investment in its San Onofre and Palo Verde plants by a total additional capital recovery of $75 million per year. Conversely, it would slow depreciation on transmission assets, which are expected to appreciate in a more competitive environment. The PUC found that consumers would see a near-term rate reduction of $5 million, and a $39 million net-present-value

reduction in revenue requirement over 40 years. It acknowledged that the plan would only modestly improve the competitiveness of the nuclear plants, but called it a "move in the right direction." It noted, however, that future capital additions in the nuclear area would outpace the rate base reductions under the plan, and that performance-based pricing of the incremental costs was needed to address the cost-control problem. Re So. Calif. Ed. Co., 152 PUR4th 263 (Cal.P.U.C.1994).

Perhaps the most notorious case in which a utility claimed a serious threat from competition in the retail sale market is the dispute between Niagara Mohawk Power Corp. and Sithe/Independence Power Partners L.P., developers of a 1,040-MW gas-fired qualifying cogeneration facility (QF). Sithe had announced plans to sell electricity at retail to its would-be steam hosts, Alcan Rolled Products Co. and Liberty Paperboard L.P. Alcan is currently a Niagara customer; Liberty plans to locate a new paperboard recycling plant on the Sithe/Independence site, with a substantial capital contribution from the QF's parent. Niagara complained that the sale would lead to higher rates for its other customers, and that the QF would earn significant profits without the retail sales because both Niagara and Consolidated Edison Co. were required to purchase its output. The New York Public Service Commission (PSC) ruled that the retail sale made the QF a public utility. Re Niagara Mohawk Pwr. Corp., 150 PUR4th 113 (N.Y.P.S.C.1994). In a subsequent ruling, however, the PSC applied "something less than full utility-type" regulation to the sale, saying that extensive oversight of the QF's prices was not required because the sale was competitive. Re Niagara Mohawk Pwr. Corp., 150 PUR4th 438 (N.Y.P.S.C.1994).

While granting a certificate for the sale, the PSC addressed the stranded investment issue by requiring the QF to pay Niagara an "equalization fee" to mitigate the extent to which investment undertaken to serve Alcan and other local growth now falls on Niagara's other customers. It rejected the QF's arguments that payments to the utility under gas transmission and wheeling arrangements should offset the equalization charge. Re Sithe/Independence Pwr. Partners L.P., 155 PUR4th 149 (N.Y.P.S.C.1994). Later, the PSC set the equalization payment at $19.6 million over a 10-year period. Re Sithe/Independence Pwr. Partners L.P., Case 94-E-0136, - PUR4th - Sept. 29, 1994 (N.Y.P.S.C.).

The Rhode Island Public Utility Commission (PUC) has announced that it will consider on a case-by-case basis whether to regulate sales by nonutility power producers to a single customer within the service territory of a certificated electric utility. Narragansett Electric Co. had asked the PUC to issue a declaratory ruling that as a matter of law furnishing electricity to a single customer should trigger regulatory jurisdiction. The PUC found the suggested rule too broad, but added that the rate impact of the utility's losing its fifth-largest customer and the attendant load loss and stranded investment "must play a role" in its consideration. Re Narragansett Elec. Co., 154 PUR4th 304 (R.I.P.U.C.1994).

Telecommunications (em

Slowly but Surely

State regulators moved slowly but surely toward a more open market structure for telecommunications in 1994. Although the U.S. Court of Appeals for the District of Columbia remanded to the Federal Communications Commission (FCC) its decision to require local exchange carriers (LECs) to permit competing enhanced service providers to "physically collocate" equipment in LEC switching facilities, regulators in several states have acted to open the local network. A well-publicized example occurred in New York where Rochester Telephone Corp. won approval for its plan to split into three separate companies and open its local service market to full competition. The company will separate into a holding company, a regulated provider of wholesale basic-exchange access services, and a competitive provider of retail local services. The plan includes a shift to incentive ratemaking, with a $21-million reduction in rates. Re Rochester Tel. Corp., - PUR4th-, Dkt. Nos. 94071 et al., Oct. 13, 1994 (N.Y.P.S.C.).

Competition in the local telephone market was uniquely acknowledged by the Maine Public Utilities Commission (PUC) in a recent rate case involving New England Telephone Co. The PUC found that current rate structures did not cause toll service to subsidize basic local service (em that is, the actual cost of local service closely matched revenues re-ceived by the carrier. Thus, it rejected the local carrier's proposals to raise local rates by 25 percent and further reduce toll rates by 8.5 percent. It described the carrier's rate plan as "a

short-sighted reaction to the growing competition in the telecommunications industry." Re New Eng. Tel. Co., 152 PUR4th 1 (Me.P.U.C.1994).

In a case that should soothe those alarmed at the prospect of a regulated company using

its monopoly revenues to support competitive activities, the West Virginia Public Service Commission premised its cost allocation for the Chesapeake and Potomac Telephone Co. on new plant being installed primarily to provide market-based services. The LEC must assign any in-creased depreciation costs (em such as a reduction in the remaining life of an asset (em to the competitive category, unless it can show that monopoly service was the direct cause of the added expense. Re Chesapeake & Pot. Tel. Co. of W.Va., 150 PUR4th 286 (W.Va.P.S.C.1994).

In another landmark case, the Michigan Public Service Com-mission (PSC) granted its first competitive certificate in the local exchange telephone market. City Signal Inc. was granted a license to provide local telephone service in the Grand Rapids District Ex-change in competition with the existing local carrier, Ameritech Michigan. As the PSC found, "the time has come for competition in the local exchange market." It cautioned that new players in the local exchange market cannot create exchange configurations or pricing mechanisms that serve only business or high-volume users. On the other hand, as new competitors, they will not be required to serve every customer in the local access and transport area or the state. Re City Signal, Inc., Case No. U-10555, Oct. 12, 1994 (Mich.P.S.C.).

Telecommunications common carriers in Massachusetts, except pay-telephone service providers, will no longer require a certificate from state regulators before offering new intrastate services. But the commission rejected calls to streamline its rate tariff regulations for non-dominant carriers, because that would involve altering a state law that prohibits rate changes until 30 days after the filing date. Re Regulatory Treat. of Telecom. Common Carriers, 152 PUR4th 483 (Mass.D.P.U.1994).

Traditional Regulation (em

Alive and Well

Traditional prudence reviews and least-cost planning may not survive intact if competitive

energy markets develop further. Nevertheless, both tools appear alive and well at the state PUCs.

In a telling decision, the Washington Utilities and Transportation Commission (UTC) conducted a traditional prudence review of purchased-power planning by Puget Sound Power & Light Co. and ordered $16.8 million in rate disallowances associated with two large "above-market" cogeneration contracts. The case offers a glimpse of the continuing role of state regulators. Increasing competition means that both "build" and "buy" options must be held to the same high standards to adequately protect ratepayers, the UTC said. It intends to investigate the "interaction" of least-cost planning with competitive bidding and prudence reviews, as well as whether performance-based ratemaking is appropriate under the new market conditions. Washington Utils. & Transp. Comm'n v. Puget Sound P&L Co., 156 PUR4th 297, Dkt. No. UE-920433, et al., Sept. 27, 1994 (Wash.U.T.C.).

Central Maine Power Co. agreed to a one-time write-off of $5 million in fuel costs to settle a long-running dispute over its management of two purchased-power contracts. The Maine PUC found the utility imprudent and ordered a 50-basis-point equity-return penalty, which it implemented in a subsequent rate case. The company won a stay before the state supreme court by challenging the penalty. To settle the dispute, the PUC allowed the utility to write off the $5 million in fuel costs. In return, the utility agreed to a cap on future purchased-power disallowances to prevent its 1995 return on equity from falling below 6.8 percent. Re Cent. Maine Pwr. Co., 152 PUR4th 316 (Me.P.U.C.1994).

The Florida Public Service Commission (PSC) directed Tampa Electric Co. to cease constructing transmission facilities to serve two municipalities that were formerly full-requirements wholesale customers of Florida Power Corp. The PSC set aside claims that it lacked jurisdiction to disturb the terms and conditions of a wholesale power agreement. Citing section 366.04(5) of the Florida statutes, commonly known as "The Grid Bill," the PSC claimed authority to assure efficient operation of the state's energy grid and prevent further duplication of transmission and distribution facilities. The PSC found the transmission line uneconomic and duplicative of existing facilities because revenues for the power sales did not outweigh the project cost. It also found that subsidy of the construction by Tampa Electric ratepayers and the loss of wholesale and wheeling revenues to Florida Power would offset any savings to ratepayers in the two cities. Re Florida Pwr. Corp., 152 PUR4th 398 (Fla.P.S.C.1994).

Though technically farther along in its transformation to a competitive marketplace, the gas industry also faces continued regulation. The Massachusetts Department of Public Utilities (DPU) changed its review standard for gas purchasing decisions from the current "net benefit to ratepayers test" to a broader cost-benefit analysis of market offerings available to a local distribution company (LDC) when it makes new supply arrangements. The DPU cautioned that, unlike electric utility power-purchase contracts, gas-supply contracts require detailed management by the LDC. It said that approval of a contract would not guarantee rate recovery in the face of imprudent management. Re Berkshire Gas Co. et al., D.P.U. 93-187 et al., Jan. 19, 1994 (Mass.D.P.U.).

The Washington UTC has directed Northwest Natural Gas Co. to upgrade its least-cost plan to incorporate several developments, including: 1) new gas-fired electric generation, 2) the effect of industrial and transportation-only load on future demand,

3) the possibility of acquiring and selling released pipeline capacity, 4) storage alternatives as a supply-side option, and 5) demand-side management for firm industrial customers. The UTC said it would address the prudence of the utility's resource acquisitions only during ratemaking proceedings. Re NW Nat. Gas Co., 153 PUR4th 174 (Wash.U.T.C.1994).

Water Utilities (em

Paying for Federal Mandates

They say new regulations are like hidden taxes; politicians get away with something for nothing. The cost is not felt until the affected industry invests the capital necessary to make the mandated improvements and then recoups from ratepayers. In a rate-regulated industry like water, where competition cannot force shareholders to absorb costs, regulators seek to avoid the sometimes exorbitant rate increases needed to fund water-system improvements mandated by the Safe Drinking Water Act (SDWA). Such increases had regulators looking at new rate designs such as systemwide rate averaging, long-range planning, and rate base valuation rules.

s Averaged Rates. The Florida PSC has allowed Southern States Utilities Inc. to charge statewide uniform rates for water services, finding the averaged rate structure superior to stand-alone charges for individual service districts. The PSC also rejected alternative rate structures, including: 1) uniform rates with subsidy cap; 2) stand-alone rates adjusted by a uniform companywide amount; 3) uniform rate, excluding return on investment;

4) stand-alone rate with residential rate cap; 5) countywide rates. The PSC found that while the uniform rates involved the greatest level of subsidies between service districts, they produced charges that even the utility's poverty-level ratepayers could afford. It added that spreading costs among all ratepayers was important because of the industry's need to replace aging infrastructure while also upgrading treatment facilities to meet increasingly stringent environmental standards. Furthermore, the PSC said that statistical analyses showed no correlation between significant cost factors and revenues that might support individual system rate adjustments. Re So. States Utils., Inc., 155 PUR4th 454 (Fla.P.S.C.1994).

s Strategic Planning. The New York PSC has directed all large water utilities (annual revenues in excess of $1 million) to file long-range strategic plans on a yearly basis. It found formal planning requirements necessary to ensure that utilities and ratepayers are adequately prepared to finance construction to meet SDWA and surface water treatment rules as well as other corrective actions to maintain high-quality service. Re Policy to Require Large Water Utils. to Initiate Long-Term Strat. Plan. Process, 155 PUR4th 361 (N.Y.P.S.C.1994).

s Rate Base Issues. Citing a need for new water treatment facilities required under the SDWA, the Maine PUC has approved a rate increase of 24.5 percent for Consumers Maine Water Co., a new water utility formed by the recent merger of three smaller companies. The PUC also set new policy for the treatment of post-test-period additions to rate base for water companies. It rejected a proposal to require utilities to show that: 1) the plant is required by government mandate; 2) the addition is known and measurable and the "matching principle" is not violated; and 3) the financial health of the utility is threatened if the investment is not included. Re Camden & Rockland Water Co., et al., 154 PUR4th 89 (Me.P.U.C.1994). t

Phillip S. Cross is an associate legal editor of PUBLIC UTILITIES FORTNIGHTLY

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