According to the Natural Gas Vehicle Coalition (em a national organization of local natural gas distributors, pipelines, and equipment manufacturers promoting natural gas vehicles (NGVs) (em the U.S. government supports our country's continued reliance on petroleum-based fuels for transportation through billions in subsidies and tax incentives. A new study by the Domestic Fuels Alliance claims that the amount of total subsidies could reach $300 billion if one considers the Persian Gulf War a "hidden cost for petroleum." The Coalition's point, however, is that the petroleum industry is trying to hinder the development of NGVs to the detriment of U.S. air quality and energy independence.

A different version of this publicity battle over subsidies and unfair trade practices has been playing out before state regulatory commissions for some time now. Natural gas local distribution companies (LDCs) have been seeking ratepayer funding of vehicle refueling facilities and promotional rates for gas supplies. The California Public Utilities Commission (CPUC) has moved from unfettered promotion of low emission vehicles (LEVs), to a more restricted approach under a new law that prohibits use of ratepayer funds for activities not directly related to utility service. The CPUC's shift might reflect the direction regulators will be forced to take where energy prices are under pressure. The move toward a more competitive environment in both the gas and electric industries has reinforced the argument that utility rates can no longer carry the burden of broad social policy objectives.

Nevertheless, other state commissions have approved experimental NGV programs. Massachusetts has concluded a major generic investigation of NGV programs and approved some funding of incentives for market development. While not often faced with programs as ambitious as those initiated by California utilities, regulators across the country have generally kept programs experimental and designed measures to ensure that ratepayers are protected from most program costs (see box on p. 44).

California (em Smog Drives NGV Rate Debate

In 1991, the CPUC authorized Pacific Gas and Electric Co. (PG&E) to establish a ratepayer-funded program designed to achieve "substantial market penetration" of motor vehicles fueled by compressed natural gas. PG&E's program included both vehicle and refueling station incentives and subsidies. The utility claimed that the incentives should result in the market becoming self-supporting after 1995. Re Pacific Gas and Electric Co., 124 PUR4th 107 (Cal.P.U.C.1991).

In its decision, the CPUC cited growing concern over air quality and increasing energy imports. Given consumer indifference, the low cost of gasoline, the lack of oil company participation, and the lack of financial incentives, the CPUC found it unlikely ("practically nil") that an NGV industry could survive without some form of initial public assistance.

The CPUC noted that the state legislature had directed it to encourage gas and electric companies to develop and market the LEVs. As part of the mandate, the legislature authorized charging program costs to ratepayers under certain conditions. The state law permitted ratepayer funding for investment in infrastructure, such as refueling stations, but also asked the CPUC to determine whether the program was in the ratepayers' interest. Further, the legislation outlawed using low-cost fueling tariffs at the expense of residential gas or electric customers.

The CPUC rejected a proposal by the state Division of Ratepayer Advocates to allocate 50 percent of the program costs to PG&E shareholders. It said the cost-sharing was inequitable because the program was instituted for the general welfare of the public:

"[T]here is no significant mismatch between the population which both bears partial responsibility for existing pollution problems and which will enjoy the environmental benefits of PG&E's NGV program and the population of ratepayers who will be asked to fund the program."

This conclusion also led the CPUC to strike down calls to exempt residential ratepayers from fixed infrastructure costs associated with the NGV program. It noted, however, that state law required a program review to ensure that residential customers are not subsidizing variable program costs, such as the commodity cost of gas delivered to NGV customers under the utility's new tariffs.

Despite the CPUC's clear decision to use ratepayer funds to help cure California's smog problem, the PG&E case does not provide a final answer to the overall political question of using utility rates to promote broad social goals. A short time later, the CPUC concluded a broad investigation of utility efforts to enter the LEV market. The primary question was how to define whether such programs were in the interest of ratepayers and, thus, qualified for funding. The CPUC authorized use of ratepayer funds to develop a refueling infrastructure for both natural gas and electric vehicles, but required evidence that programs promote the interests of ratepayers beyond the general public's interest in a cleaner environment. A utility should demonstrate that the programs address one or more of the following traditional utility responsibilities: 1) reliable and efficient utility service, 2) safe utility service, 3) environmentally and socially responsible utility service, and 4) reasonable rates. In addition, the CPUC issued a set of five guidelines for developing LEV programs that qualify for ratepayer funding (see box below). Re Utility Involvement in the Market for Low-emission Vehicles, 145 PUR4th 243 (Cal.P.U.C.1993).

The CPUC has yet to conclude its review of existing LEV programs run by utilities in the state under the new guidelines. Although a program using ratepayer funds to pay for acquisition of a fleet of NGVs for utility use would pass muster, it is not clear whether a broad program aimed at selling subsidized vehicles to the public in competition with existing vehicle dealerships would qualify. The new guidelines seem to back away from the CPUC's earlier broad view of ratepayer interests. The CPUC now agrees with the Division of Ratepayer Advocates:

"[N]either the Commission nor the utilities possess the jurisdiction of the primary social responsibility to initiate, underwrite, or guarantee the success of a vehicular solution to the state's air quality problems."

Nevertheless, the CPUC currently allows balancing-account funding for ongoing LEV activities. Yet it also set a limit on NGV activities for Southern California Gas Co. (SoCalGas), rejecting the LDC's proposal to build refueling stations and administer incentives outside of its own service territory. Under the proposal, SoCalGas would have run the NGV program in the service territory of one of its wholesale customers, Southwest Gas Corp. The CPUC said the LDC had failed to demonstrate that the program fit within the new LEV guidelines. While not convinced that a regulated utility should pursue NGV activities outside of its service territory, the CPUC said, the decision did not preclude SoCalGas from building, operating, and owning the proposed refueling stations if it used no ratepayer funds. Re Southern California Gas Co., 154 PUR4th 477 (Cal.P.U.C.1994).

LEV Subsidies (em

Is the Public Interested?

The issue of ratepayer subsidies for LEVs is growing more complex by the minute, at least in California. Recently, the California legislature has passed a new law designed to clear up any remaining confusion. The law, A.B. 3239, signed by Governor Wilson in September 1994, speaks to the earlier laws allowing ratepayer funding of utility research and development, including LEV programs that "the commission finds in the interests of those ratepayers." The new law defines "interests" as "direct benefits that are specific to ratepayers in the form of safer, more reliable, or less costly gas or electric service." The law was purportedly introduced by Assembly member Mickey Conroy (R-Orange) specifically to ban rate hikes enacted to fund utility LEV programs. The bill was backed by Californians Against Utility Company Abuse, a diverse coalition that includes industrial customers and consumer advocates as well as oil companies and others with a stake in the gasoline vehicle market.

Shortly after passage of A.B. 3239, the CPUC authorized SoCalGas to reallocate $9.1 million of its capital budget to its NGV capital budget. Re Southern California Gas Co., Decision No. 94-10-035, Application No. 92-11-017, Oct. 12, 1994 (Cal.P.U.C.). The CPUC had denied the request earlier in the year when setting the utility's rates, on grounds that the plan would increase NGV spending before the CPUC completed its generic review of such spending for all utilities in the state. In reversing its earlier decision, the CPUC noted that the LDC would only move money allocated for utility investments to its NGV program, with no increase to its overall revenue requirement, and that other utilities had been authorized to continue funding their LEV programs pending completion of the review.

In a separate concurring opinion, then-Commissioner Patricia M. Eckert raised a new concern. In addition to the political problems associated with raising rates for existing users, the NGV subsidy issue reveals "dueling regulatory philosophies." Eckert pointed out the unfairness of promoting NGVs while creating a new regulatory environment in which utilities have no choice but to be competitive. She characterized her vote in favor of continued NGV funding as a vote to honor prior commitments, not "to add social costs to utilities."

In a dissenting opinion, commissioners Norman D. Shumway and Jessie J. Knight focused on competition in the vehicle market and as a tool to achieve a cleaner environment. They argued that competitive markets assign shareholders 100 percent of the burden of new product risk in return for the opportunity to reap 100 percent of any rewards; therefore, captive customers should not have to finance the utility's NGVs. In addition, they warned, the funding increase could compromise the CPUC's role in bringing competition to the NGV market. (When the CPUC initially rejected the SoCalGas funding request, it directed the utility to pay particular attention to the fifth NGV program guideline, which cautions against interfering with the development of a competitive market.) The dissenting commissioners concluded that approving the funding was a mistake because the CPUC had not shown why a competitive approach was inappropriate to solve the air-quality problems plaguing the SoCalGas service territory. t

Faced with increasing competition, electric utilities are asking state commissions to authorize price cap plans that will enable them to compete more effectively. The Maine Public Utilities Commission (PUC) has responded by modifying its regulation of two large electric utilities in the state to include flexible pricing. Regulators in Pennsylvania have also agreed to examine a flexible-pricing proposal for an electric utility.

Maine's alternative electric rate plan for Central Maine Power Co. contains the nation's first price-cap plan in the electric industry. The comprehensive regulatory plan also includes flexible pricing, earnings sharing, and service reliability components. The PUC found that the alternative rate plan should produce just and reasonable rates as well as other benefits, including: 1) continued comprehensible and predictable regulation of electricity prices, 2) stable rates, 3) reduced administrative costs, 4) incentives for cost minimization, and 5) competition with reduced ratepayer risks. The price-cap plan uses current rates as a starting point.

The price-cap formula includes a price index, a productivity offset, a profit-sharing mechanism, sharing of qualifying facility (QF) restructuring benefits, and a mechanism to pass through certain costs outside of the price index. It also virtually eliminates dollar-for-dollar adjustment clause recovery of fuel and purchased-power costs. The service reliability component establishes an earnings-reduction mechanism that allows the imposition of penalties ranging from $250,000 to $3 million if net service quality or customer satisfaction declines as measured against five benchmark indicators. The pricing flexibility component lets the utility choose between a number of pricing options without having to seek PUC approval, typically between a marginal-cost-based floor and the price cap, subject to safeguards designed to protect core customers, avoid undue discrimination, and preserve the rate design policy expressed in earlier rate orders.

To protect ratepayers from any revenue deficits associated with flexible pricing, a "revenue delta cap" requires the utility to stop offering discounts without PUC approval when the difference between revenues collected under the new pricing policy and those the utility would have collected under standard rates approaches 15 percent.

The profit-sharing component of the price cap incorporates a 350-basis-point bandwidth above and below a benchmark return on equity of 10.55 percent. Profits or losses outside the bandwidth will be shared equally between ratepayers and shareholders.

The alternative regulation plan also allows the utility to pass through to ratepayers a share of savings/costs associated with QF contract buyouts and restructurings. Generally, net savings from buyouts and restructurings consummated after October 1, 1994, will be shared 50/50 between shareholders and ratepayers. Parties may request prudence reviews, rate design reviews, and rate level reviews while the plan is in effect. Re Central Maine Power Company, Docket No. 92-345 (II), January 10, 1995 (Me.P.U.C.).

In a later decision, the PUC granted Bangor-Hydro Electric Co. pricing flexibility while eliminating its fuel adjustment clause. The PUC ruled, however, that a full-fledged price-cap and incentive rate plan submitted by the utility was not fully developed. It adopted a series of incentives to ensure Bangor-Hydro's efficient operation and pointed out that without the automatic rate adjustments shareholders must absorb any revenue loss associated with rate discounting until the utility's next rate case.

The Bangor-Hydro plan includes similar but somewhat broader pricing flexibility than allowed Central Maine, subject to a 10-percent revenue delta cap. To further protect existing customers, the PUC required the utility to use three separate cost-benefit tests to screen new permanent load attracted under the long-term discount offers. The tests are designed to make sure that: 1) the utility earns more net revenues with the discount than without (revenue test), 2) the discount benefits the individual customer in the long-run (participant test), and 3) the discount produces overall economic efficiency (total resource cost test). The PUC rejected, however, a proposal to include external environmental costs in the discount-program testing requirements, finding no reason to "saddle [the utility] with external environmental costs that its competitors do not shoulder as well."

The commission also approved the utility's proposal to cap existing rates for five years, subject to periodic review to ensure that the utility does not earn more than its 10.6-percent return on equity. Re Bangor-Hydro Electric Co., Docket Nos. 94-125, 94-273, Feb. 14, 1995 (Me.P.U.C.).

The Pennsylvania Public Utility Commission (PUC) has suspended for further review a proposal by Pennsylvania Electric Co. to modify its existing tariffs to allow greater pricing and service flexibility. In a separate statement, however, Commissioner John Hanger warned of the potential for cost-shifting among customer classes if shareholders are not placed at risk for part of the revenue lost under the proposed discounting measures. He also viewed the proposal as an indication that mere opposition to retail wheeling will not protect core customers from such cost-shifting and that it is time to consider a major structural change in the state's electric industry. Given some of the "preemptive noises recently emanating" from the Federal Energy Regulatory Commission, the opportunity to devise a "Pennsylvania way forward may be getting slimmer all the time," Hanger warned. Pennsylvania Public Utility Commission v. Pennsylvania Electric Co., Docket No. R-00943280, Feb. 24, 1995 (Pa.P.U.C.).

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