Academic journal article Energy Law Journal

Benchmarking the Price Reasonableness of a Long-Term Electricity Contract*

Academic journal article Energy Law Journal

Benchmarking the Price Reasonableness of a Long-Term Electricity Contract*

Article excerpt


A. Background

Electric utilities in the United States have engaged in wholesale electricity trading since well before the 1978 passage of the Public Utility Regulatory Policies Act (PURPA).1 The PURPA encouraged the development of qualifying cogeneration and small power production facilities and engendered the emergence of independent power producers.2 Pre-PURPA trading was dominated by bilateral transactions largely comprised of: (1) seasonal exchanges, where a winter-peaking utility supplied energy to a summer-peaking utility that subsequently returned the energy in the winter at a preset exchange ratio; (2) sales of economy energy by a utility with surplus generation and relatively low fuel cost to a utility with relatively high fuel cost, with the transacting utilities sharing the resultant fuel cost savings; (3) reserve sharing, whereby two or more utilities, likely with differing demand patterns and plant mixes, pooled their reserves for reliability planning purposes; and (4) emergency support, where two or more utilities agreed to supply each other when one experienced a real-time operation shortage.3

These transactions were often the result of power pooling agreements among utilities.4 For example, the California Power Pool (CPP) was formed in 1961, with participation by Pacific Gas and Electric Company (PG&E), Southern California Edison Company (SCE), and San Diego Gas and Electric Company (SDG&E). The CPP agreement aimed to provide for the selling, pooling, and sharing of energy sources for both reserve margins and emergency situations.

The key driver for transactions under (1) and (2) above was fuel cost savings. Reliability and operational benefits rationalized transactions under (3) and (4). Because these transactions delivered obvious benefits to both parties, regulatory approval at the federal and state levels was routine without the fanfare of contentious evidentiary hearings.

B. Price Benchmarking Based on Avoided Costs

The 1978 PURPA required a utility to purchase power output from a qualifying facility (QF).5 section 210 of the PURPA requires that the rates paid to QFs be "just and reasonable" and "not discriminate against qualifying cogenerators."6 However, the rates should not "exceedf] the incremental cost to the electric utility of alternative electric energy" (i.e., the costs the utility avoided by purchasing from the QF).7 In general, the PURPA delegated the responsibilities of determining the utility's avoided cost and enforcing the utility's purchase obligation to the states.

Armed with this PURPA authority, a state regulator decides the rate a regulated utility pays to a QF, provided that the rate does not exceed the per-unit cost the utility can avoid as a result of the QF purchase.8 For example, in July 1985, the California Public Utilities Commission (CPUC) issued Decision 8507-022 stating that the total avoided cost was the difference between the utility's total cost without the QF production and the utility's total cost with the QF purchase.9 Hence, implementation of the PURPA necessitates the use of a price benchmark-the buying utility's per kilowatt hour (kWh) of avoided cost due to a QF purchase. If the QF price is set at or below a utility's ex post per kWh avoided cost, which can vary continuously with actual operations, the utility's customers are a priori not disadvantaged by the QF purchases.10

However, a QF contract may have a fixed price term that lasts for a period of up to ten years in California and longer elsewhere. When a long-term QF contract price is capped at a utility's unbiased projection of avoided cost, the QF purchase should ex ante not increase the utility's expected rates.11 To be sure, as the Federal Energy Regulatory Commission (FERC) observed in the preamble to its rules implementing the PURPA,12 the QF price may result in a price higher or lower than the utility's actual avoided cost. …

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