QPLEASE STATE YOUR NAME, OCCUPATION AND BUSINESS ADDRESS.
AMy name is Richard McCann, PH.D. I am a partner of M.Cubed, a utility rate and economic consulting firm. My business address is 2655 Portage Bay, Suite 3, Davis, California, 95616. A statement of my qualifications is presented as Appendix A to this testimony.
QON WHOSE BEHALF ARE YOU TESTIFYING IN THIS PROCEEDING?
AThe California Independent Petroleum Association (CIPA) is a non-profit trade association dedicated to representing the interests of independent oil and natural gas producers operating in California. The association currently represents more than 400 companies including producers, royalty owners, and service and supply companies involved with the production of oil and natural gas throughout the state. For the most part, CIPA members are large energy consumers—for some producers, particularly in Southern California, electricity can represent any where from 33 - 60 %of the cost of each barrel of oil. As a result of these substantial electricity expenditures, California=s petroleum production costs tend to be higher than other producing states.[1] Reducing these expenditures is critical for California=s independent producers to remain viable, and to continue to contribute to the state=s energy needs.[2]
QWHAT IS THE PURPOSE OF THIS TESTIMONY?
AIn this proceeding CIPA is most concerned with two issues: attempts to impose excess charges on Adeparting loadsand ensuring that exit fees imposed on direct access customers are reasonable and based on the actual costs incurred by the California Department of Water Resources (DWR). CIPA encourages the Commission not to allow Aexit fees@ to be used as a back door way of making distributed generation (DG) uneconomical.[3] Rather, and as expressed in a number of public policies, we believe the state should encourage businesses to self-generate.
In developing its policies, the Commission should analytically segregate those measures that are implemented on the customer side of the meter from those on the utility side. Conservation, demand-side management and distributed generation all fall on the customer side; utility-retained generation, the DWR contracts and direct access agreements are on the utility side. Impeding the development of DG and self-generation by imposing an inappropriate exit fee, we believe, is in direct contradiction of current state policy. Given the fact that California still faces the potential for yet another physical energy crisis, CIPA believes that discouraging new self-generation would be extremely shortsighted.
QSHOULD THE COMMISSION CONTINUE TO FOLLOW ITS EFFICIENCY/EQUITY GOALS IN THIS PROCEEDING?
AYes. The California Public Utility Commission (CPUC) has generally followed the dual goals of making sure that its policies maximize efficiency (i.e., setting prices to most accurately reflect costs) while balancing equity concerns (i.e., treating similarly situated customers similarly while considering wealth disparities). In cases in which these twin goals are at odds—for example, improved pricing signals may disproportionately harm low-income ratepayers and small businesses—the Commission has typically based its policies on efficiency concerns, but provided mitigating interventions to ensure equitable outcomes. In some instances, the Commission has both increased system-wide rates, and provided special rate protection to low income residential customers (e.g., CARE), farmers (e.g., equal percentage of marginal cost caps), and other ratepayers (e.g., providing renewable generation incentives so that a wide variety of ratepayers can reduce their energy expenditures over the long-term).
CIPA encourages the Commission to continue to follow its same efficiency-based, equity-mitigation approach in this case. As will be discussed in the remainder of this testimony, this approach would result in reasonable, cost-based, exit fees for direct access customers only, for efficiency reasons. Energy users who self-generate now or in the future should not be assessed any exit fee, for both efficiency and equity reasons. Though principally nested in efficiency rationale, this approach would represent a form of equitable treatment for those reducing or eliminating their reliance on the DWR contract power, while existing programs B coupled with improved revenue requirement calculations B would protect the most vulnerable ratepayers from any harm.
QDO BASIC PRINCIPLES REQUIRE THAT MEASURES ON THE CUSTOMER SIDE OF THE METER BE TREATED EQUITABLY AS DEPARTING LOADS?
AYes. People do not eat or drink electricity. They cannot ride on electricity, nor does it provide shelter. Electricity allows people to cool or heat their food or their house, to clean or move objects, or to see in the dark. Electricity is a motive force for providing services to individuals—it is not a final consumable good.
This fundamental characteristic of electricity suggests that in developing its policies the Commission should focus on the final services that electricity helps engender, not the commodity itself. People can and should be allowed to choose different ways of receiving those same services. For example, utility customers can choose to reduce their electricity consumption and cooling their houses by either running their air conditioners or installing window shades and insulation. They can even install their own generation independent of what is delivered by the local electric utility. All of these actions are options available on the customer side of the meter. It is important to note that the utility can help deliver these services in different ways as well. Large central generation stations obviously provide the lion’s share of generation, but distribution and transmission system management can improve the efficiency, quality and reliability of power. These are all actions available on the utility side of the meter. In short, generating electricity is but one option for meeting the service requirements for individual customers.
This insight indicates that it is a false dichotomy to distinguish generation from conservation. As technology advances, the distinction between the two blurs even further. To a customer, the distinction is meaningless—he or she simply wants to cook food, stay warm or read a book. The only true distinction for the Commission is an economic one—what measures are implemented on the utility side of the meter versus the customer side. The Commission has regulatory authority over most of those on the utility side, but it has little or no authority, certainly in terms of cost recovery, on the customer side. Customers need not justify their investment or consumption choices to the Commission. Customers generally assume all of the risks of their investments, and gain all of the benefits. Those investments do not end up in the utility rate base, and are not recoverable as “stranded assets” if they become uneconomic. For these reasons, the Commission should treat all customer side measures equally and equitably. To do otherwise leads to discrimination among customers who are otherwise similarly situated.
Although it was not specified in the Commission’s definition of “departing load”, CIPA does not believe it is the intent of the Commission to consider imposing an exit fee on customers who install conservation and load management measures. To do so, the Commission would have had to stop the recent awards of statewide and local energy efficiency program funding (R.01-08-028). Likewise, it is clear that the Commission cannot impose an exit fee on firms that go out of business, individuals who pass away or agricultural customers who switch to diesel or natural gas engine water pumping. The fact is that all of these are examples of departing loads. Singling out customer-owned generation requires that the Commission make an explicit technological choice to discourage distributed generation. This would be a direct contradiction of numerous state policies encouraging distributed generation, such as the waiver of standby charges that was enacted by the legislature last year, the creation of a statewide financing authority with a focus on distributed generation, and substantial research expenditures on different DG technologies. In short, consistency with state policies requires equitable treatment for all customer side measures – including self-generation.
QDOES DG SERVE THE COMMISSION'S EFFICIENCY GOALS?
AYes. The Commission, as well as the State Legislature (e.g., passage of Senate Bill 28X exempting natural gas turbines and renewables from standby charges), has made it amply clear that increased penetration of DG is a highly preferred means of addressing a number of policy goals, including increasing overall system efficiency, reducing costs, and increasing reliability. What=s more, DG enables customers to adopt the energy generation technology and measures that best suits their needs. For example, some customers might be willing to pay a premium for DG installation as a way of ensuring generation reliability, while others may only be concerned about bottom-line costs. In this respect, DG represents one of the sole market-based forces left standing post-restructuring for individual customers, and should be protected as such.
Well-developed DG can have substantial efficiency benefits at the system level. For example, DG can reduce the need for economically- and environmentally costly Apeaker plants,@ and can reduce transmission and distribution (T&D) costs by lowering the demand on the T&D system. Finally, by spreading outage risks across a greater number of generators, DG can improve overall system reliability.[4]
The CPUC, California Energy Commission, and State Legislature has recognized DG=s important potential contributions by providing significant funding, as well as technical assistance, for its development.[5] For example, public funds have been available for several years now to support the development and purchase of photovoltaics, solar thermal heating units, wind, and fuel cell systems. In this respect, it would not only be ironic for the Commission to raise the price of DG development through significant exit fees, but also at cross-purposes with its other important initiatives. Under such a scenario, the exit fees associated with any DG that was developed would essentially be paid for by the available public subsidies.
QWILL DWR’S ESTIMATES STYMIE FUTURE DG DEVELOPMENT?
AYes. As indicated by testimony co-sponsored by CIPA, independent analyses of DWR=s revenue estimates indicate that the department’s estimates may be as much as one-third too high.[6] Obviously, as the Commission moves forward in its deliberations, it is important that accurate revenue requirements are used as the basis to develop an exit fee policy. CIPA encourages the Commission to pay careful attention to different intervenors= testimony related to properly determined revenue requirements.
Despite these questions over the DWR’s estimates, exit fees at any level, would severely retard DG development. In its current estimates, DWR is proposing an exit fee of about 2.2 to 2.5 cents per kWh. The difference in the capital costs between a distributed generation unit and a merchant power plant selling into the wholesale market amounts to about 2 cents per kilowatt-hour (kWh).[7] In addition, a DG user relying on gas takes on the direct gas purchasing risk for generation. On the other hand, customers using DG gain direct control over their generation, can hedge market risks on their own, and can displace other energy use investments. Added on top of any interconnection fees, which are substantial, DG would cost as much at 5 cents per kWh more than a merchant power plant selling into the wholesale market. This price differential will give the merchant plant operators an extra margin against direct customer-controlled competition, and could leave the state under a greater threat from these entities in the future, especially as the contracts expire in 2011.
Navigant Consulting's assertion that estimating mistakes can be periodically corrected through Atrue-ups@ are not relevant to those customers who invest in and rely on DG to serve their loads. Despite Navigant’s claims that “true-ups” would mitigate the harm done to DG development by exit fees, the realities of the business world suggests otherwise.[8] DG investors plan on a multi-year time horizon—from one to three decades typically. A substantial portion of their investment is fixed up front, unlike other direct access customers who are more likely to be paying for power on a variable cost basis. A direct access customer in most cases can change its provider, but a DG owner makes a long-term commitment, unlike that of most other customers. They will not make investments based on the possibility that over-inflated exit fees might be reduced in the future. Such uncertainty will significantly depress investment, even if the expected costs are the same.[9]
When the DWR acquired its contract portfolio, its load forecast was not etched in stone. That forecast had inherent uncertainty about how customers would respond to higher electricity rates, changes in the state’s business climate, and even changes in technology. It is important to emphasize that utility customers are not required to make DWR’s forecast come true. DWR and the Commission must determine how they are going to address the risk that forecast will be wrong. The Commission and DWR must look at other risk management strategies rather than simply arbitrarily assigning customers who happened to be taking service in 2001 the burden of these contracts for the next 10 to 20 years. “Truing up” may work for some customers, but it will not work for those who have to make large irreversible investment decisions today.
QSHOULD EXIT FEES BE PLACED ON SELF-GENERATING CUSTOMERS?
ANo. As referenced above, the definition of Adeparting load@ has not yet been established in this proceeding.[10] In developing a definition, CIPA would encourage the Commission to be particularly sensitive to self-generators. DG developers are in no way reliant on the overall energy market from which the DWR contracts stem. Even if by some stretch of the imagination DWR=s excess power purchases could be seen as rendering a benefit to their clients, self-generators do not represent a ratepayer class in and of themselves.
Increasingly, observers are concerned that California is headed for yet another physical power shortage within the next several years. It has been suspected—and Sempra Resources appears to be contending—that the DWR contracts are largely financial instruments for paying off the potential costs of the summer of 2001 over a 10-year period rather than assuring delivery of actual physical power. The State Auditor came to the conclusion recently that the contracts had poor enforceability provisions for the state.[11] The state may be forced to look for a range of options in anticipation of this potential crisis. As previously discussed, self-generators help reduce pressure on this market by lowering demand through alternative supplies. This is particularly the case for self-generators who do not rely on grid power at all. For this reason, CIPA recommends that no exit fees be applied to self-generators.
QAS EQUITY GOALS CAN CLASH, SHOULD THE COMMISSION ERR TOWARD CHARGING THOSE WHO WILL TRULY BENEFIT FROM THE DWR PURCHASES IN THE FUTURE?
AYes. This case poses substantially complex equity issues. From an equity perspective the first critical question is who should pay Aunnecessary@ costs that were created either by (1) government mistake; or (2) as a result of illegal or unfair manipulation of the energy market. The answer in the second situation is clear B the parties who acted illegal or unfairly should pay the resulting costs. In this respect, CIPA fully supports every and all government efforts to re-capture electricity revenues that were, are, or will be unduly collected. If the government=s efforts at cost recovery are not successful, from a fairness perspective CIPA believes it would be more appropriate for the parties that actually intentionally manipulated the system to pay for the unnecessary costs. The state is pursuing many routes, both through the Federal Energy Regulatory Commission and the courts, to try to recover these funds. But this proceeding cannot and does not address this issue.
To the extent that the excess costs are the result of a government mistake – the first situation – a case could be made from an equity perspective that these costs should be recovered through general fund monies. From an economic perspective, the “take or pay” nature of the DWR contracts make these costs sunk, which means that the costs should not enter into the price of electricity. Those costs should be paid off in a lump sum fashion to the greatest extent possible. The allocation of those lump sum, sunk costs becomes an equity, not efficiency, question. Equity is often best served by assigning responsibility. The government that made the mistake represents the people, and, as is well experienced, the people must thereby suffer the consequences of government ineptitude or the benefit of government excellence. Theoretically, legislators have already fully weighed the efficiency and equity implications of general fund taxes, and as a result the current tax system can be relied upon to ensure equitable outcomes.