One need only reflect upon the primary sponsors of current efforts to repeal section 210 of the Public Utility Regulatory Policies Act of 1978 (PURPA) to begin to understand the folly of these efforts for the nation. The sponsors do not represent electricity ratepayers, who are claimed to be overpaying billions of dollars as a result of PURPA. Rather, the sponsors are electric utilities, privately owned monopolies that compete with the independent power companies that benefit most directly from PURPA.1

The sponsors of PURPA repeal claim that increasing competition in the electricity generation market has rendered PURPA unnecessary.2 They argue that PURPA is now a hindrance to full and fair competition. To reduce electric rates, the logic goes, we must repeal PURPA. But the real motive behind the attempts to repeal PURPA does not stem from a desire to reduce electric rates. The motive comes from the desire of utilities to improve their competitive position (and that of their affiliates) in the current generation market as well as in what promises to be the increasingly competitive market of the future.

That being said, PURPA repeal is nevertheless unlikely to promote competition and reduce electricity rates. Without underlying structural changes in the electric services market (e.g., unbundled and open-access transmission), repeal will stifle the very competition PURPA was instrumental in creating. Significantly, this competition forms the foundation for further competitive advancements throughout the country. PURPA repeal will retard the progress of competition and thwart related efforts to reduce electricity rates. Many of the other benefits of PURPA, such as increased fuel and resource diversity and increased reliability, will be threatened as well.

Of course, PURPA implementation has not been without its unintended side effects. No one can deny that certain PURPA-based contract payments were premised upon forecasts that proved inaccurate, and that these payments exceed current market values. However, many independent power companies receive prices that are unquestionably competitive in today's markets. The majority of independent generation in California, for example, receives between roughly 4 and 6 cents per kilowatt-hour, all-in (em well below the purchasing utilities' system average cost for power.3

Thus, in considering whether to repeal PURPA, it is essential to weigh its ongoing benefits against its unintended side effects, and to consider whether those side effects can be mitigated or prevented in the future. Analysis reveals that, while certain refinements to PURPA implementation may be warranted, PURPA should not be repealed.

Why PURPA?

Responding to the energy crisis of the mid-1970s, Congress enacted PURPA to break our nation's dependence on foreign oil and increase domestic energy conservation and efficiency.4 To achieve these ends, Congress sought to limit competition in the wholesale electric generation market by encouraging cogenerators and small power producers.5 It included measures in PURPA to suppress barriers that had prevented independent energy producers from entering the market and competing with the public utilities.6 PURPA removed those barriers to entry for a limited class of independent generators called "qualifying facilities" (QFs). The new law contained three key requirements:

s Duty to Buy. Utilities must purchase power from QFs at just, reasonable, and nondiscriminatory prices.

s Duty to Serve. Utilities must sell backup, standby, or maintenance power to QFs at nondiscriminatory rates.

s Deregulation. QFs are exempt from most federal and state regulations concerning public utilities.7

In implementing PURPA, the Federal Energy Regulatory Commission (FERC) mandates that QFs receive the purchasing utility's full "avoided costs" for power. In other words, under PURPA the utilities pay QFs what the utilities would otherwise spend to generate or procure the power in the absence of the QFs.8 Thus, electric ratepayers are indifferent, from a short-term price perspective, as to whether power is purchased from QFs or otherwise generated or procured by the utilities. From a broader perspective, ratepayers benefit significantly from QF purchases, because increased use of cogeneration and renewable technologies conserves energy, promotes resource diversity, enhances reliability, benefits the environment, and increases competition (em to name but a few of the benefits. The FERC left it to the states to determine the utilities' avoided costs.9

Has it Worked?

It is undisputed that PURPA has been a dramatic success in bringing competition to the electricity generation market and reducing electricity costs. More than half of all new generation resources are nonutility resources. The FERC has found that utilities no longer dominate the market for new generation capacity.10 QFs also comprise large amounts of existing generation capacity in certain markets; one-third of Southern California Edison Co.'s (SCE's) generation capacity in southern California, for example, is QF capacity.

As a result of this increased competition, utilities have been forced to become more efficient in their own generation practices, which has in turn led to lower avoided costs and lower rates to consumers. Short-run avoided-energy payments to QFs by SCE and Pacific Gas & Electric Co., for example, have declined by well over 50 percent since 1982.

In proposing to repeal PURPA in The Electric Utility Ratepayer Act, Sen. Don Nickles (R-OK) asserts that one-quarter of existing QF capacity is renewable, while three-quarters is cogeneration. The fact that cogeneration makes up three-quarters of the independent power developed under PURPA does not indicate a failure; rather, it is part of the PURPA success story. First, the stated goal of PURPA was to encourage both cogeneration and renewable technologies, not simply the latter. Second, cogeneration is extremely efficient, inexpensive, and environmentally benign generation. Cogeneration has been and should be encouraged. Further, that one-quarter of all existing QFs are renewable is in itself a resounding success, considering that renewable technologies only now are becoming competitive with fossil plants from a price perspective. Without PURPA, much of the renewable capacity in existence today would not exist. Similarly, it is likely that the further development of renewable capacity will be hampered significantly if PURPA is repealed.

It cannot be denied that mistakes have been made in implementing PURPA. A number of states established long-term forecasts of utility avoided costs in the early 1980s based upon overstated predictions of increasing fuel prices. States also failed to limit access to attractively priced contracts, resulting in overcapacity in certain markets. But the same forecasts that led to excessive avoided-cost projections also justified the ratebasing of above-market utility plants. As FERC Chair Elizabeth A. Moler stated when the FERC rejected a move by New York State Electric & Gas Corp. (NYSEG) to cut the wholesale rates it pays to two QFs under fixed-price contracts:

"It has become popular of late to blame the competitive ills of the investor-owned utilities on the QF industry...; what has been totally ignored is the high cost of [the utilities'] own resources."11

Indeed, the stranded costs associated with certain utility plants, especially nuclear units, looms large in comparison to the above-market costs associated with QF contracts.

If Repeal, What Then?

If Congress should repeal PURPA, utilities would be free to return to their pre-PURPA anticompetitive behavior. They could refuse to purchase power from, or sell power to, nonutility generators (NUGs) under reasonable terms, and could deny transmission access to NUGs that managed to find willing buyers. In addition, the loss of their exemption from existing federal and state regulation of public utilities would impose unacceptable burdens on NUGs. When utilities can no longer wield market power, and when wholesale generators no longer face burdensome regulations, then and only then will the PURPA debate be timely.

Proponents of repeal point to the Energy Policy Act of 1992 (EPAct) and argue that the above preconditions have been met.12 They are wrong. Through continued control of transmission services and the bundling of transmission, generation, and ancillary services, among others, utilities continue to wield undue market power. Indeed, the FERC's recent open-access Notice of Proposed Rulemaking (Mega-NOPR) is premised upon that fact:

"In today's electric industry, which is dominated by vertically integrated utilities, an owner or controller of transmission service can exclude generation competitors from the market, thereby favoring the transmission owner's own generation."13

While EPAct's wheeling provisions mark a step in the right direction, they are by no means sufficient to warrant repeal of PURPA. As the FERC states in the NOPR, by the time an individual competitor obtains a wheeling order from the FERC under EPAct, the market opportunity likely is lost.14 In addition, the FERC observes that the patchwork regulation of the nation's transmission grids under EPAct is inefficient and does not permit open and fair wholesale competition.15 The FERC considers 137 electric utilities to be owners of transmission facilities used in interstate commerce, and notes that only 21 currently provide "any form of open access transmission."16

In addition, failure to unbundle transmission, generation, and ancillary services would allow the utilities to subsidize their competitive generation services from their regulated monopoly services. The result would be less competition, with no reduction in end-use rates.

Repealing PURPA would potentially subject all electricity generators (em existing and new (em to public utility regulation under the Federal Power Act and by the states. Many could be subject to the Public Utility Holding Company Act of 1935 as well.17 Such regulation was, and remains, antithetical to vibrant competition by independently owned generators.

Commenting recently upon PURPA repeal efforts, FERC Chair Moler recently put the matter succinctly: "We're not there yet."18

If Not, What Next?

While it is clear that the repeal of PURPA would represent a serious error, industry and regulators are not powerless to address some of the problems associated with PURPA implementation. In fact, many of the needed mechanisms for reform already exist or are currently being developed.

For example, regarding utility complaints that the PURPA "obligation to purchase"19 unduly burdens the utilities by forcing them to buy "high-priced" QF power, various jurisdictions have incorporated competitive bidding programs into their PURPA implementation strategy. In such contexts, long-term firm-power contracts are only made available if and to the extent there is an identified need for such power. The contracts also are allocated only to the most efficient providers of such power. In light of the FERC's recent ruling on California's competitive bidding program,20 there is a degree of uncertainty in connection with such programs. Principled and workable resolution of these controversies will be instrumental in reshaping PURPA implementation.

With respect to QF pricing, few dispute that the concept of avoided cost is sound; the controversies have arisen in connection with determining utility avoided costs in practice. As electricity markets continue to develop and become more competitive, however, the cumbersome administrative determinations and forecasts of utility avoided costs will naturally give way to market-based references for avoided cost. Price indices for electricity already exist and more are being developed. NYMEX is on the verge of launching a futures market for electricity. Performance-based ratemaking for utilities, which ties utility cost recovery to how well the utility performs compared to specified market references, is growing in use and sophistication. All of these factors will contribute to the development of more market-sensitive and less controversial avoided-cost determinations.

Utilities complain that states are setting avoided costs too high in order to encourage QFs, or particular kinds of QFs (e.g., renewable generators). But these complaints simply do not warrant PURPA repeal. Other, less draconian measures are available.

Little need be said about long-term forecasts and fixed-price contracts. As the Third Circuit Court of Appeals recently held in the Freehold case,21 and the FERC confirmed in both the NYSEG and West Penn Power Co. cases,22 existing contracts must be honored. A successful transition to a competitive market requires that contract terms be upheld. Above-market QF payments are properly considered transition costs; utilities expect no less with respect to their own assets. For new contracts, utilities and regulators can avoid the long-term forecast errors of the past by adopting more market-sensitive and competitive pricing mechanisms.

Most important, of course, is rapid progress toward a truly competitive generation market in which the entry barriers suppressed by PURPA are eliminated. The FERC's Mega-NOPR and the various state restructuring efforts currently underway hold considerable promise in this respect.

Several preconditions must be satisfied before revisiting PURPA is warranted: 1) All generators must enjoy equal access to competitive markets; 2) The market must properly value the unique characteristics of services offered by different generators, particularly renewable generators; and 3) Regulation must not hamper the development or operation of NUGs. PURPA repeal today would only destabilize existing QF contracts and increase the competitive advantage of investor-owned utilities in the future. t

Jerry R. Bloom is a partner at the law firm of Morrison & Foerster, resident in the firm's Los Angeles office, and chairman of the firm's international energy practice group. Joseph M. Karp is an associate at Morrison & Foerster and a member of the firm's energy practice group. Messrs. Bloom and Karp specialize in the development and operation of cogeneration and other alternative energy projects. Both authors have handled contract disputes between utilities and independent power suppliers.

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