Energy

		Competition among electric generators and the creation of an Independant System Operator will make some state functions obsolete, while the State will need to take on new roles to nurture healthy markets.
		Energy-related public goods programs will continue in competitive energy markets, but the State will need more efficient and adaptable management of those programs.
		As economic regulation diminishes and performance-based rate-making is refined, the State can consolidate oversight duties and end years of inter-agency turf wars.
		A stronger state energy policy will be forged if involved agencies routinely seek legislative approval for changes and are held accountable annually for progress toward established goals.

For Competition's Sake

Finding 1: As presently constituted, neither the Public Utilities Commission nor the California Energy Commission is well-designed to perform the State functions needed by competitive energy markets.

The need and political consensus to reform the State's energy regulatory structure is increasing as energy markets undergo fundamental change. The sentiment is well-represented by the testimony of Southern California Edison Company:

Restructuring the industry without reforming the regulatory process is a recipe for failure, and would represent a decision only half completed. Without regulatory reform, Californians simply will not reap the benefits of restructuring they deserve and have come to expect. In essence, electric restructuring will produce 'stranded regulators' if the State does not reform both the CPUC and the Energy Commission.⁽²¹⁾

Because of the physical nature of electricity and natural gas and because of their importance to the economy and public welfare, state oversight of a competitive energy industry will be essential. The nature of the oversight agency is framed by two key characteristics -- function and culture. What will the agency do? And how will it respond to inevitable conflicts and unforeseeable issues?

Reforming the State's oversight role requires separating existing functions that will not be needed from functions that will be needed and assessing the competencies and cultures of existing agencies to determine which is best suited to perform the needed tasks.

Obsolete Functions

The physical network that provides electricity is composed of three sectors: Generation facilities that generate electricity using nuclear, fossil-fuel, solar, geothermal, wind and other sources; transmission lines that transmit electricity from where it is generated to where it is needed; and distribution substations and wires that distribute the electricity to consumers.

The PUC has regulated closely the capital and operational expenses of investor-owned monopolies in all three sectors. The PUC has strived for reliable and safe service to be delivered to customers at fair and reasonable rates and with minimal environmental harm.

The Energy Commission's expertise and responsibilities have focused on generation: calculating the need for additional generation, reducing the need for generation through efficiency gains, encouraging generation technologies that are less polluting and renewable, and reviewing applications for thermal generating plants larger than 50 megawatts.

The plan for restructuring the electrical services industry calls for increasing competition among generators -- some of which are now owned by the investor-owned utilities, some by municipal utilities and some by independent power producers.

The transmission system, which is largely owned by the investor-owned utilities and is regulated primarily by the Federal Energy Regulatory Commission, would become a common carrier of the electricity and be managed by a new Independent System Operator (ISO).

The local distribution system is expected to remain a monopoly in the near term and be provided by the traditional utilities, although there may be competition to provide some distribution-related services.

The emergence of a competitive generation market and the break-up of the investor-owned utilities will render some State regulatory functions obsolete immediately. Other functions will become obsolete over time.

In testimony and other evidence provided to the Little Hoover Commission, six general State functions were identified as unnecessary once competitive forces begin to control the price of electricity supplied by generators:

1. PUC Generation Responsibilities. The PUC's detailed economic regulation of the generation sector can be eliminated because the expenses and revenues associated with those facilities will be governed by market forces. Any new facilities proposed by investor-owned utilities would be subjected to market pricing and will not be added to the rate base of the utility distribution companies. As a result, the PUC will not have to issue "Certificates of Public Convenience and Necessity" or conduct environmental reviews for new generation plants. The PUC will not have to determine the need for new generation through its Biennial Resource Planning Update or repeat its controversial bidding process for independent generators. Rate cases will not have to include the costs of operating and maintaining generation facilities, or ongoing energy cost reviews. One PUC Commissioner testified that this type of generation-related planning by the State is best referred to in the "past tense" -- leaving it to market signals to determine timing and dimension of generating stations.⁽²²⁾

2. PUC Transmission Responsibilities. While the precise responsibilities associated with the transmission system have not been resolved, the investor-owned utilities are not expected to propose and construct new transmission facilities as in the past. The economic aspects of operating, maintaining or expanding the transmission network are most likely to fall within the realm of the Independent System Operator, with continuing authority of the Federal Energy Regulatory Commission.⁽²³⁾

3. PUC Electricity Safety and Reliability Responsibilities. The PUC's safety and reliability oversight of investor-owned utility generation and transmission facilities can be scaled back and ultimately eliminated as the ISO assumes its duties and as more generation is provided by plants not within PUC control. It will be important for the State to consolidate and coordinate safety and reliability responsibilities, particularly for generation and transmission facilities, to reduce duplication and treat similar market players alike.⁽²⁴⁾

4. Energy Commission's "Load Management" Responsibilities. The Commission reviews the generation and transmission operations of investor-owned utilities to ensure they are efficiently making use of the electricity grid. This efficiency will be achieved without this oversight as the ISO takes control over transmission operations and competitive pressures push market players to seek every opportunity to lower costs.

5. Energy Commission's Informational Reports. The Commission's electricity, energy efficiency, energy technology, fuels and biennial reports, as currently defined by law, will be of little use in a competitive market. These reports were intended to guide government determinations of how much electricity was needed and to explore the alternatives to constructing new generating facilities. That analysis was to provide a basis for the PUC to consider facilities proposed by the investor-owned utilities and for the Energy Commission to perform a "needs analysis" as projects came to it for siting review. Some of the information in those reports will be needed by market players and policy makers. But the types of analysis and the forms for distribution should be geared to the needs of the market and policy venues rather than to the central planning function that the reports previously served.⁽²⁵⁾

6. The Energy Commission's Public Adviser. The Commission envisions the public adviser becoming a consumer advocate and complaint resolver, functions more appropriately housed elsewhere. The traditional function of helping the public in the process duplicates the Energy Commission's public information efforts and are unneeded if the procedures themselves are streamlined and understandable.

Needs of a Competitive Market

The promise of competitive markets is to deliver lower prices than those produced by government-regulated monopolies. Competitive markets, however, are complex by nature. Oversight agencies will need real time knowledge of market events and be able to explain trends in response to public and industry concerns. They will need to act quickly, confidently and with a sense of neutrality.

The challenges are large. Today, the major utilities make 200 electricity trades a day. In a competitive market, 1.5 million transactions a day will take place.

In addition to the constant flurry of transactions, the energy market will still be subject to long-term trends of supply and demand. Between 1990 and 2011 the State is expected to gain 4 million new households, increasing energy needs by 29 percent. The demand for peaking electricity -- the power needed for those brief periods of high energy use -- is expected to grow even faster -- by 40 percent over the next 18 years. Accommodating this growth, and replacing older inefficient generators with new efficient ones, will require more generation and transmission facilities to be sited.

The blackouts of the summer of 1996 raised significant concerns about system reliability even before the strains of competition are applied. The costs of blackouts can be enormous and the potential for more in a competitive market has policy makers and consumer groups concerned. The electricity restructuring legislation enacted in 1996 recognized the need to ensure reliability and provided for the creation of standards and better interstate protocols to improve reliability.

From testimony and other evidence gathered by the Little Hoover Commission, six State functions were identified as needed for competitive energy markets to function well.

1. Consolidated Generation and Transmission Facility Siting. Energy officials have predicted that because of population growth, the early retirement of nuclear plants, the advent of electric cars and a market-demand for cheaper power, California may experience in the near future the first real surge in new generation facilities in two decades.⁽²⁶⁾ A consolidated and streamlined siting authority is essential to encouraging the investment in new generation that is expected to produce lower-priced power.

While the Energy Commission has an established siting program, the approval process for new transmission lines has been fractured and confused.

Transmission facilities are now reviewed by the PUC if they are proposed by investor-owned utilities. Municipal utility districts can approve their own transmission additions, even if the lines are outside of their service territory. The Energy Commission reviews transmission lines associated with new power plants within its jurisdiction. And there is no clear process for licensing non-utility transmission facilities should any be proposed.

Recognizing the potential problem nationwide, the Keystone Center, a non-profit policy institute, recently completed a model state transmission siting law that closely resembles the Energy Commission's CEQA-like process for siting power plants. The model law was created because of concerns that transmission projects were bogged down in review procedures, adding to costs and creating uncertainty for project planners. If this process was not improved before the advent of competition, the group concluded, customers may not be able to capture the benefits of the market.⁽²⁷⁾

The Little Hoover Commission found significant agreement that the advent of competition provided the State an opportunity to consolidate the siting approval processes for generation and transmission. The sentiment is well represented by the Energy Commission's testimony:

Consolidation of licensing authority for generation and transmission facilities in California is one of the most important steps the Legislature should take to provide evenhanded, fair and effective land use and environmental regulation of a competitive generation industry, thereby enhancing regulatory certainty and process streamlining for all competitors.⁽²⁸⁾

One PUC Commissioner testified that the siting of generation and transmission facilities should be done by the same agency. But another Commissioner testified that the PUC saw itself doing environmental reviews of new transmission facilities as part of its oversight of distribution monopolies.⁽²⁹⁾

In addition to efficiency in process, consolidating these authorities would provide a consistent mechanism for the State to apply eminent domain authority, particularly when it is needed to acquire routes for new transmission facilities. Historically, transmission facilities were planned and constructed by investor-owned utilities, which have eminent domain power granted in the Public Utilities Code. Utilities are not expected to play that same role in the future. And if utilities were to initiate transmission additions, eminent domain authority would give them an unfair advantage over competitors lacking that authority.

The siting of transmission and generation facilities will not require the same economic thresholds of past government reviews. But proposals will need to be analyzed to ensure that new facilities are enhancing competition and not discouraging it, and that new facilities are not diminishing the physical reliability of the grid.⁽³⁰⁾ For those reasons, consolidating the State's siting review with the agency responsible for market power monitoring and system reliability would provide additional efficiency.

The restructuring prompted by deregulation provides the Legislature the chance to achieve a policy goal first set in the Warren-Alquist Act: to consolidate responsibility for regulating electrical generating and related transmission facilities.⁽³¹⁾ The siting authority also will continue to be the best place for the State to coordinate the goals of environmental protection and economic development, as was envisioned by the act.

Similarly, the Governor's 1995 energy reorganization plan envisioned consolidating the PUC's and Energy Commission's siting authority into a single agency, which also would have effectively consolidated the authority to site most generation and transmission facilities. That plan, however, was designed without consideration of the other oversight functions that a competitive generation market would need. As a result, it proposed creating a new facility siting board with no other responsibilities to perform that function.

2. Consolidated Safety and Reliability Oversight of Generation. In a competitive market, the State will need to consolidate the safety and environmental compliance oversight of generating plants to assure that market players receive equal treatment and that public health and safety goals are met. The Little Hoover Commission was told that federal, state and local agencies now competently perform these tasks, and even appear to coordinate their efforts to reduce overlap and conflicts. The PUC, for instance, establishes safety standards for investor-owned facilities and conducts reviews to ensure that utilities are in compliance. The Energy Commission places conditions on the approval of plants, and then makes sure those requirements are met. Smaller facilities are inspected by county authorities and all facilities must comply with federal and state worker safety laws. While this system may work well now, the agencies and the utilities will change significantly in the future, providing the need and the opportunity to realign these functions. In addition, federal authorities may take on a larger role in this area, preventing the State from performing this function.

In a competitive market, the costs associated with facilities dropping off line will be borne more directly by the investors, creating an incentive for generators to increase their reliability. But there also is increasing concern that the desire to reduce costs will diminish the overall reliability of the system. The Energy Commission already has a Transmission System Evaluation Program and a Generation System Efficiency Program. Where possible the State will want to consolidate this authority, and where the function cannot be consolidated it must be coordinated.

3. Market Power Monitoring. The PUC's electricity restructuring plan attempts to minimize the market power of existing monopoly utilities by turning transmission facilities over to an ISO and encouraging the utilities to divest some generating plants. But experts also believe continuous and detailed monitoring for potential market power abuses will be required for competitive forces to take and keep control of prices. The problem, defined by a Harvard researcher, has been detected in a number of industries where competition has slowly found its way into markets previously controlled by a limited number of suppliers:

As a basic matter, market power signifies an ability to affect the terms of trade in the market. More importantly , however, for the economists' case regarding the damage to society caused by the absence of competition, market power translates into an ability to earn supracompetitive returns, to maintain excess productive capacity, to invest in superfluous advertising and/or to engage in other forms of waste. ⁽³²⁾

A study of Britain's competitive markets found that the current duopoly is not delivering the prices that would be expected in a more competitive market. However, the existence of a market power watchdog was by itself enough to reduce potential market power abuses.⁽³³⁾ Economists have had a similar experience in telecommunications -- where the constant eye of federal regulators has appeared to reduce market power abuse even when competition is not vigorous enough to sustain downward pressure on prices.

Monitoring for market power in the electricity services industry will require detailed and constant analysis of transactions, and will require a knowledge of the economic and physical properties that determine the flow of electrons and the flow of dollars. The appropriate response to market power abuse will be varied. In some cases, the solution may be for the Energy Commission to accelerate the applications for new generators or new transmission facilities in order to encourage competition. In other cases, antitrust action may be the best solution. As in other competitive markets, the responsibility for responding to these problems will be shared among different entities, such as the U.S. Department of Justice and the State Attorney General, which both have authority to bring antitrust and related actions against market players

4. Gathering and Analyzing Market Information. Investors and consumers agree that gathering, analyzing and distributing technical market data by a government agency is critical to market players raising capital and developing competitive strategies and to consumers seeking to make informed consumer decisions. Antitrust laws prevent market players from sharing some critical information, and market data released by individual competitors is always suspect. The testimony from the National Conference of State Legislatures summarized the argument made by many others:

Companies grow and survive on good information in a competitive market. This role will be even more important if the generation sector operates in a less regulated market. The ability to acquire information about the demand, supply and the ability to distribute or transmit electricity will determine how successful the new competitors to today's utilities can be.⁽³⁴⁾

5. Representing California in Out-of-State Forums. A competitive market will increase the role of the State in government and industry venues outside of the State's borders -- advocating policy reforms in Congress, before the Federal Energy Regulatory Commission and in the courts. Since California is the largest consumer in the nation, its effectiveness in those venues will be critical to creating and protecting competitive conditions. Historically, the Energy Commission and the PUC have both tried to fill this role, occasionally taking different positions on the same issue. The State's effectiveness in these venues will require a consistent and unified voice, best provided by a single source.

6. Registering New Entrants. Competitive markets are likely to create a number of new distribution-related players, such as marketers and aggregators. A simple and straightforward registration process is needed to discourage fraud and police unfair business practices. The State's electricity restructuring act of 1996 established this function at the PUC.

Core Competencies and Cultures

The Little Hoover Commission, as it explored the State functions needed in competitive energy markets, was advised by a number of experts to consider how closely the needed functions relate to an agency's historic competencies, as well as an agency's cultural attributes for determining and defending the public interest.

Public Utilities Commission. The PUC's core competencies center on the detailed economic regulation of monopolies and the protection of consumers through the design of nondiscriminatory rates. It also establishes and enforces safety and reliability standards to protect workers and citizens in the production and delivery of inherently dangerous commodities. As new issues have arisen, it has developed new regulatory schemes to meet the needs of monopoly investors and ratepayers. For instance, the PUC has infused conservation alternatives into plans for meeting growing energy demands, included research and development programs in the rate base, and established subsidy programs for low-income residents.

While this evolution has required the PUC to develop new skills, it also has created a culture of intense intervention at the PUC. The intervention was done in the name of both the ratepayers and the shareholders, and carried out through a complex and detailed court-like process that built a factual record for Commission decision-making.

Inherent in the Commission's push for competitive markets is a strongly held belief on the part of the PUC's leadership that well-functioning markets will deliver products more cost-effectively than tightly regulated markets.

Specifically, the PUC's culture raises three concerns with potential market competitors: The first is that the PUC will be biased toward intervention into the market. Second, that the PUC will be biased in favor of the former monopolies that it has protected from financial risks. And third, that because of the PUC's large workload and the inability of Commissioners to be involved in the fact-gathering stages of a case, the PUC cannot quickly assess issues and make decisions.

Energy Commission. Like the PUC, the Energy Commission was created in response to market failure -- an under-investment in alternative and cleaner energy sources and in efficiency technology. It also was created to clarify State energy policies and consolidate approval of electricity generating plants.

Over the last decade, the Energy Commission has displayed a maturing ability to use market forces to increase energy choices and lower prices, while advancing publicly held environmental goals.

In the mid-1980s, the Energy Commission pushed -- over the PUC's objections -- for new natural gas pipelines into the State that are expected to save consumers $5.8 billion over 25 years. More recently -- during the gasoline price spike in the spring of 1996 -- the Energy Commission correctly and quickly identified the causes of the price hikes, reducing political pressure for the State to intervene in the market or ease air pollution requirements that the gasoline industry incorrectly blamed as the reason for the increase.

The Energy Commission has advocated that the decision of whether to intervene in markets be left to the Legislature and the Governor. To counter potential market power abuses the Energy Commission believes the first response should be traditional antitrust laws, with other priority remedies including a lowering of market barriers or State support of transmission additions to increase competition.⁽³⁵⁾

The Energy Commission in its 1995 Electricity Report transformed the "needs" analysis it conducts when new generation facilities are proposed to conclude that if a plant is financed completely at the investors' risk and complies with environmental laws it is automatically needed to promote competition.

The Energy Commission's fuels technology branch helped to develop alternatives to gasoline that prompted gas suppliers to develop cleaner burning fuels. The Commission participated in programs that spurred private sector research in home appliance efficiency. And anticipating a competitive electricity market, the Commission is looking for ways to nurture an "energy services" industry as a substitute for government conservation programs.

Like the PUC, the Commission relies on public hearings and plural body decision-making to set policy. But because of a smaller and more focused workload, Commissioners are directly involved in the hearings as well as the deliberations and decision-making.

Competitive Market Oversight

Virtually every state energy reorganization effort of the last 20 years has struggled with the central problem of how to align the regulatory authorities associated with the energy monopolies with those associated with the broader energy markets. The move to competitive markets completely reframes this debate. The issue before policy makers now is how to efficiently oversee energy markets that will become increasingly competitive.

Industry, environmental and consumer groups believe a commission rather than a department should provide oversight of competitive energy markets -- to avoid the capriciousness of a department director, to capture the wisdom of a multi-disciplined decision-making body and to create the political stability that markets favor.

The core function of that commission will be gathering the detailed market-related information that is needed for investors and generators to compete, for consumers to make wise decisions, and for law enforcement authorities and policy makers to be confident that competition and not market power abuse or collusion is controlling prices. Most of the regulatory functions will relate to the environmental and technical issues involved in siting and operating generation facilities.

Culturally, the oversight commission will be required to be a neutral decision-maker, treating all market players fairly. Culturally, the oversight commission will be needed to make quick decisions and be focused on the industry. And culturally, the oversight commission will have to be biased against intervention, relying whenever possible on market players to respond to fluctuations in supply and price.

Of the State's two energy agencies, the Energy Commission has more of the core competencies needed to facilitate competition: the ability to gather data on markets trends, its one-stop siting process and its technical energy expertise. The Energy Commission also understands the relationships among energy sources that are becoming more important as electric cars come to market and more electricity is produced from natural gas. And the Commission has demonstrated an understanding of how policies can influence market forces to increase consumer choice and lower prices.

The various interests are as concerned about how the state reorganizes itself as they are about the ultimate shape the state government takes. Some are concerned about distracting the agencies with reorganizing the government when they should remain focused on a restructuring industry. Others are concerned about the government losing expertise or prematurely ending needed regulation.

The PUC's former director of strategic planning, among many others, warned that merging the PUC and the Energy Commission in their present form would perpetuate the cultural problems of the two agencies. Rather, she urged that the functions of the existing agencies be realigned to reflect the needs of a restructured industry and the core competencies of the existing agencies, and suggested a new structure would emerge from that analysis.⁽³⁶⁾

In other words, both commissions need to do what they can do best during the transition to competitive energy markets. After adapting to the new economic landscape, additional consolidation could take place.

Recommendations

Recommendation 1-A: During the transition, the Governor and the Legislature should divest the PUC of the obsolete regulatory functions governing generation and transmission facilities.

The PUC's economic regulation of generation and transmission facilities will not be needed when competition begins and the transmission system is managed by the Independent System Operator, which is now slated for January 1988. The PUC will no longer need to conduct environmental reviews of new generation and transmission facilities, and will not be in a position to monitor safety and reliability of generation and transmission facilities.

Recommendation 1-B: During the transition to competitive electricity markets, the Governor and the Legislature should divest the Energy Commission of obsolete regulatory and planning functions.

The obsolete functions known at this time are economic forecasting and needs analysis associated with approving most generating facilities, its load management responsibilities and the periodic informational reports. As competitive markets develop, additional functions may prove to be unneeded, as well. While it is important for the public to have knowledge and access concerning decision-making procedures, there is no need to continue or expand the role of the public adviser to take on additional duties.

Recommendation 1-C: During the transition to competition, the Governor and the Legislature should assign to the California Energy Commission the new functions needed to make competitive energy markets operate.

In a competitive electricity generation market, the State will need a consolidated siting, environmental review and safety compliance authority for generation and transmission facilities. The market also will need refined variations of functions already performed by the Energy Commission -- in particular, the gathering and disseminating of detailed market information, monitoring for possible market power abuses and representing the State in regional, national and international regulatory venues. The Energy Commission also should be given the ability to grant facility applicants the power of eminent domain on a case-by-case basis.

Recommendation 1-D: The Governor and Legislature should amend the electricity restructuring act of 1996 to assign to the Energy Commission responsibility for enforcing safety and reliability standards concerning the transmission grid.

The Legislature correctly realized the important role in a competitive market of making sure that a reliable system is maintained. It is unclear at this time how much of that responsibility will rest with federal authorities. To the extent that the State can play a significant role in system reliability, that function should be consolidated with other market-oriented oversight responsibilities. One potential model would rely on the Independent System Operator to make recommendations to the Energy Commission regarding standards, have the ISO notify theEnergy Commission of potential violations and have the ISO investigate system failures. The legal authority for setting and enforcing standards, however, would be vested in the Energy Commission.