SJR 259

Joint Subcommittee Studying Electric Utility Restructuring

November 7, 1997, Richmond

SCC Restructuring Plan

The SCC's plan is a two-phase restructuring process beginning in 1998. In Phase 1 (1998-2001), the rates of all electric utilities would be thoroughly examined, retail pilots would be conducted, and the SCC would pursue such key ingredients as independent system operator (ISO) formation. Phase 2 would mark the beginning of actual retail competition—if the SCC and General Assembly agreed that retail competition was in the public interest—and Virginia's electric utilities would be required to file retail competition plans. (The SCC's plan can be viewed at the SCC's Internet web site: http://dit1.state.va.us/scc).

According to SCC staff, the Phase 1 rate examination is essential, because these rates could be in effect for an extended period of time during a transition to competition. Virginia Power and AEP Virginia have rate/alternative regulatory plan cases currently pending before the commission (Virginia Power's case is set for hearing in early 1998), and Allegheny Power is expected file a rate case as early as 1998. Thus, in some respects, Phase 1 has already begun.

The rate reviews proposed by the SCC would (i) determine whether current rates reflect costs and (ii) undertake preparatory work for a competitive model. The review would include examination of such issues as inter-class subsidies, unbundled rates and bills, stranded costs and margins, transition and transaction costs, and consumer services.

SCC staff believes that the formation of a regional independent system operator (ISO) is critical to the success of any significant level of retail access. In concept, ISOs would establish order and efficiency in a competitive market by providing centralized generation dispatch coordination. Consequently, the report proposes ISO formation (coordinated with other states and the federal government) during Phase 1, as well as the concurrent formation of a regional power exchange (RPX) to develop a spot market for electricity.

Pilot Programs

Phase 1 of the plan would also include retail access pilot programs and studies lasting up to two years. The SCC's plan anticipates SCC-coordinated retail pilots conducted by Virginia's investor-owned utilities (such as AEP Virginia and Virginia Power) and at least two electric cooperatives. SCC staff hopes that the pilot programs would produce useful information in several areas, including information technology requirements, generation supply and load matching, time-of-use metering, marketing and rate information, rules governing utility affiliates, and consumer protection.

The staff cautioned the subcommittee, however, that the pilots were unlikely to produce meaningful information about electricity prices or reliability in a competitive market. The joint subcommittee received a similar message from a New Hampshire Public Utility Commission representative, who commented earlier this year on that state's retail competition pilot. However, SCC staff emphasized the value of pilots in Virginia, underscoring the necessity of developing information about technology requirements and consumer protection in particular—information best developed in the test tube of a pilot project.

Stranded Costs

A key restructuring issue is utility compensation for anticipated capital losses resulting from generation asset devaluation in a competitive market. Put simply, some utilities anticipate that regulated rates are the only means of ensuring sufficient rates of return on some electricity generation plants. New coal-fired plants with the latest in federally required emissions control technology may fall into this category. Nuclear power plants and power purchased from nonutility generators (NUGs) may be in this category as well.

The SCC's report raises many questions about stranded cost recovery, while providing no proposed formula for its calculation. Included are questions about mitigation, equitable cost sharing between shareholders and ratepayers, recovery periods, and allocation among customer classes—to name just a few. The staff told the joint subcommittee that its plan included no recovery formula, to avoid prejudicing ongoing discussions between Virginia Power and its NUGs, with whom Virginia Power has purchase power contracts (contracts said to be currently above market—and potentially the source of stranded costs). These discussions resulted from a November 1996 SCC order directing Virginia Power to conduct negotiations with its NUGs to determine whether the contracts could be renegotiated to reduce this utility's potential stranded cost exposure.

Phase 2

In Phase 2 (denominated as the "decisional phase"), the SCC and General Assembly would jointly review the pilot program results, ISO/RPX formation progress, and retail competition in other states. They would also review reliability issues and the transaction and transition costs associated with restructuring. A cost-benefit analysis would be undertaken as part of this review to determine whether the benefits of retail competition outweigh its costs. If the review supports the development of retail competition, all electric utilities would be required to file retail competition plans.

The electric utilities' retail competition filings would be required to detail the following:

• Generation reliability,
• ISO/RPX development,
• Likely rate impact on customer classes,
• Necessary information and metering technology,
• Market power issues,
• Necessary consumer protection measures and their implementation,
• Proposed implementation period,
• Stranded costs and margins, and
• Environmental impact.

The SCC would conduct public hearings on these submissions, ensuring that each approved plan meets the above standards and that net benefits would accrue from its adoption. If transition proceeds smoothly, the SCC could choose to accelerate the phase-in pace; if it does not, the phase-in period could be extended.

Options for Competition

The SCC staff believes there are several models for competition in Virginia, including a wholesale competition model and a retail competition model that encompasses (i) an expanded wholesale model, (ii) an ISO/RPX model, and (iii) straight bilateral contracts. Essentially, the SCC's wholesale model would encourage market pricing by basing electric utilities' return on new capacity (where they choose to build rather than buy) on wholesale market prices and not on traditional rate base pricing. An expanded, or modified wholesale model would permit large retail power purchases by a limited number of industrial customers. The logic: these purchases are indistinguishable in size from the direct, wholesale purchases (from the supplier of their choice) currently made by municipal power suppliers and electric cooperatives.

The ISO/RPX model is key to the SCC's view of a functional competitive retail market. An RPX (regional power exchange) would provide dispatch logic for generation and a competitive spot market for electricity based on generation owners' bids for generation at specified times of the day. An ISO (independent system operator) would then direct generation dispatch using RPX-developed information concerning anticipated loads at different times of the day (load curves).

The electricity customer fits into this model by having the equivalent of retail access. This is accomplished—assuming the local distribution companies have appropriate information technology—by customers exercising "contracts for differences." Straight, bilateral contracts could be accommodated within this model for a limited number of large customers. However, the SCC staff believes that the ISO/RPX model diminishes the logic or need for such transactions. Moreover, the straight bilateral contract model (one between a retail supplier and purchaser) does not, in the SCC staff's estimation, provide for effective access to competitive suppliers for many classes of customers.

Need for Legislation

The SCC plan identified two narrow areas where legislation may be needed to support retail competition's evolution: first, legislation authorizing construction of "merchant plants" (essentially NUGs) in incumbent utilities' service territories to counterbalance the utilities' potential market power and, second, legislation to address issues associated with eminent domain and merchant plants' construction and siting. SCC staff strongly recommended that this and all other legislation associated with restructuring be done without an attempt to anticipate federal legislative activity in this area. While some federal bills under consideration offer "grandfathering" to states with restructuring plans enacted prior to the federal bills' effective dates, the staff noted that such grandfathering ultimately requires conformity with the federal enactment.

Taxation Task Force

The state and local taxation task force furnished an update concerning its continuing examination of restructuring's likely impact on state gross receipts and local property taxes. A potential constitutional barrier to gross receipts tax collection from out-of-state electricity providers spurred the formation of this task force. The task force has also addressed localities' concerns about potential property tax revenue reductions that could result from retail competition—reductions tied to generating units that may be uneconomic (and consequently reassessed at lower values) in a retail market.

The task force chairman made several recommendations to the joint subcommittee. First, he recommended that the joint subcommittee communicate with Virginia's congressional delegation, urging them to support legislation authorizing states to tax every person or entity supplying electricity within its borders (thereby eliminating the taxation nexus issue discussed above). He also recommended that any retail competition pilot program undertaken in the Commonwealth ensure taxation parity among all electricity providers. The partial deregulation of the natural gas industry has resulted, he noted, in gross receipts tax disparity, because certain natural gas transactions purchased from out-of-state suppliers are now exempt from that tax, while others are not. In that vein, he also suggested a 1998 study of all energy-related taxation.

Utility Entry into Unregulated Markets

Virginia Power and the Coalition for Fair Competition, comprised of heating, ventilation, air conditioning and refrigeration (HVACR) contractors, together with fuel oil and propane distributors, told the subcommittee that their year-long negotiations have produced a compromise. At stake was the range of permitted activities by Virginia Power subsidiaries in unregulated markets served by coalition members.

The parties negotiated guidelines (termed "standards of conduct") applicable to any Virginia Power subsidiary activity involving the sale of fuel oil or propane, general contracting, consulting engineering, or HVACR appliances during the transition to competition. The agreement mandates structural, operational and personnel separation between Virginia Power and any such subsidiary. Furthermore, it establishes billing and marketing restrictions, including restrictions on such a subsidiary's use of the Virginia Power logo in subsidiary promotional material. These standards would be implemented in the SCC's review of any application by Virginia Power for SCC approval of a subsidiary's entry into these markets.

Future Activities

The joint subcommittee will convene its next meeting on December 17 to receive stakeholder responses to the SCC's proposed restructuring plan and to receive and discuss proposals for restructuring-related legislation in the 1998 Session.