BILL ANALYSIS                                                                                                                                                                                                           1
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                 SENATE ENERGY, UTILITIES AND COMMUNICATIONS COMMITTEE
                                DEBRA BOWEN, CHAIRWOMAN
         

         SB 173 -  Dunn                Hearing Date:  April 8, 2003       S
         As Amended:         April 3, 2003            FISCAL       B
                                                                       
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                                       DESCRIPTION
          
          Existing federal law  , the Public Utility Regulatory Policies Act  
         (PURPA), requires electric utilities to offer to buy power from  
         certain non-utility co-generation and small power production  
         facilities, known as qualifying facilities (QFs), at rates that are  
         "just and reasonable?and in the public interest" and that do not  
         "discriminate against (QFs)."

         PURPA provides these rates shall not exceed the utility's "avoided  
         cost" - the cost the utility would otherwise pay to generate or buy  
         power from another source.

         PURPA leaves determination of avoided cost to state regulatory  
         commissions.  

         Existing state law  (Public Utilities Code Section 390) establishes  
         procedures for determining "avoided cost."  Section 390 contains two  
         alternative formulas for determining avoided cost - one of which  
         relies on gas price indices at the California border  and one of  
         which relies on Power Exchange (PX) energy prices.  QFs have a  
         one-time option to switch from the gas index formula to the PX  
         formula.

          This bill  requires the California Public Utilities Commission  
         (CPUC), when determining prices to be paid to QFs, as well as  
         certain natural gas benchmarks applicable to CPUC-regulated gas  
         corporations, to use only the gas price indices it finds reliable  
         and verified according to criteria specified in the bill.

          This bill  requires the CPUC, if it determines no reliable and  
         verifiable gas price index exists, to determine QF prices in a  
         manner that's equitable and consistent with PURPA.











        Existing state law  prohibits acts of unfair competition under  
       Business and Professions Code Section 17200 et. seq.  Remedies and  
       penalties for a violation of Section 17200 include injunctive relief  
       and damages or restitution and/or civil penalties of up to $2,500  
       per violation.
        
       This bill  clarifies that "making a false statement or report for use  
       in an energy price index" is unfair competition and establishes a  
       higher maximum civil penalty of $25,000 per violation for making  
       such a false statement.

                                     BACKGROUND
        
       PURPA was enacted in 1978 to encourage competition in the power  
       generation market through the creation of a class of non-utility  
       co-generation and small power production facilities known as QFs.   
       Implementation of PURPA required California's investor-owned  
       utilities (IOUs) to buy power from QFs under long-term contracts at  
       the IOUs' avoided cost.  Approximately 25% of the electricity demand  
       of IOU customers is now met by QFs.  QF facilities include gas-fired  
       co-generators, small hydroelectric, and renewable resources  
       including wind, biomass, geothermal and solar.

       Avoided cost is intended to reflect the cost the IOU would otherwise  
       pay to generate or buy power, not the QF's actual cost.  The  
       standard is based on a hypothetical gas-fired power plant buying gas  
       on the margin.  Many QFs are not fueled by natural gas and the QFs  
       that do burn gas don't necessarily buy their fuel on the spot market  
       and may be more efficient than the hypothetical gas-fired power  
       plant.

       Prior to electric restructuring, avoided cost was set by the CPUC  
       according to the estimated cost to the IOU of running an additional  
       gas-fired power plant.  AB 1890 (Brulte), Chapter 854, Statutes of  
       1996, codified an interim avoided cost standard in Section 390 which  
       relies on California border gas price indices.  Under Section 390,  
       once specified conditions were met, avoided cost was to be based on  
       "competitive" prices established through the PX.  

       Since the PX is now defunct, the PX formula intended by Section 390  
       is irrelevant.  Wildly high and volatile border gas prices during in  
       2001, combined with the financial insolvency of the IOUs and  
       potential for dramatic rate increases, made paying QFs according to  
       border gas price indices unaffordable and undesirable.  This led to  
       negotiations in 2001 that resulted in the majority of QFs entering  









         five-year contracts at a fixed energy payment of 5.37 cents/kwh.   
         However, around 25% of QFs still have contracts tied to gas price  
         indices.

         Recent investigations indicate border gas price indices have been  
         subject to manipulation and false reporting, which suggests these  
         indices are not a reliable indicator of either just and reasonable  
         wholesale gas prices or legitimate gas transactions.

         The criteria in this bill the CPUC must use to determine whether a  
         given gas price index is "reliable and verified" track  
         recommendations made in a recent Federal Energy Regulatory  
         Commission (FERC) report "Price Manipulation in Western Markets."   
         According to the FERC report, "the process for reporting natural gas  
         price indices was fundamentally flawed and must be fixed.  Traders  
         had the ability and incentive to manipulate the published indices  
         and they did so."  The fixes recommended by FERC staff are based on  
         practices employed by the New York Mercantile Exchange (NYMEX).

         Retail electricity prices can be directly (through contract prices  
         or reasonableness benchmarks based on indices) or indirectly  
         (through generation costs of electricity suppliers) influenced by  
         natural gas price indices.  In addition, retail natural gas prices  
         are affected by natural gas price indices to the extent contract  
         pricing terms are tied to indices or indices serve as a benchmark  
         for the reasonableness of a gas utility's procurement.

                                        COMMENTS
          
          1.Are California border gas indices are a good proxy?   Given the  
           demise of the PX and evidence of manipulation of gas indices, it  
           seems appropriate to reevaluate the formula mandated by Section  
           390.  It doesn't seem to be in the public interest to make  
           consumers pay electricity and natural gas rates based on indices  
           which are known to be subject to manipulation.

           If the avoided cost formula must be based on border gas indices,  
           it makes sense for those indices to be "reliable" according to  
           some accepted standards and "verified" by an authoritative third  
           party.  However,  the author and the committee may wish to consider   
           whether border gas indices, even if reliable and verified, are the  
           appropriate and exclusive indicator of avoided cost.  Is a  
           statutory formula for avoided cost necessary in the first place or  
           should the Section 390 formula be repealed entirely, and the CPUC  
           permitted to set avoided cost on its own, consistent with PURPA's  









         mandate?

        2.Is it possible to comply with this bill and Section 390 at once?    
         It appears the only exchange currently meeting the criteria laid  
         out in this bill is NYMEX.  However, NYMEX does not indicate  
         California border gas prices.  The existing Section 390 formula  
         requires the use of a California border gas index.

         Under this bill, if no "reliable and verified" index is available,  
         setting avoided cost defaults to the CPUC.  In this case, the CPUC  
         would be faced with an apparent conflict with the Section 390  
         formula.  To resolve this conflict,  the author and the committee  
         may wish to consider  adding "Notwithstanding Section 390" to the  
         beginning of subdivision (d) of Section 391.x.

        3.Double referral.   This bill has also been referred to the Senate  
         Judiciary Committee.

                                      POSITIONS
        
        Sponsor:
        
       Author

        Support:
        
       Southern California Edison

        Oppose:
        
       Berry Petroleum Company
       California Cogeneration Council
       Calpine Corporation
       Independent Energy Producers
       Pacific Gas and Electric
       Sempra Energy
       Sithe Energies
       Smurfit-Stone Container Corporation
       Western States Petroleum Association

       
















         Lawrence Lingbloom 
         SB 173 Analysis
         Hearing Date:  April 8, 2003