Theoria v. Praxis: Why California?s Hybrid Market Structure Falls Short

By Published On: April 30, 2005

<i>By Steven Kelly, Independent Energy Producers policy director</i> When the California Public Utilities Commission endorsed an open, transparent, competitive procurement process last December, the Independent Energy Producers Association was encouraged because it meant that the ?winners? would be consumers benefiting from project developers that foster innovation and generation efficiencies. Unfortunately, we are unclear as to how this procurement process will be implemented in practice. As we watch it unfold, it isn?t too transparent and, hence, we don?t feel that it?s very open or will be fully competitive. Recently, we asked the commission to clarify how it proposes to implement standards announced in its long-term procurement decision adopted in December 2004. We wanted to know how the independent evaluator (IE)?who will assess bids from merchant generators and utility-owned and/or -operated facilities?is to be selected and what role it would perform in the evaluation process. Similarly, we inquired as to how the utilities and/or the independent evaluator were planning to compare projects, what selection criteria they were using, and which criteria were more or less important than the others. As we stated in our motion to the commission, ?The issue is how PG&E, the IE, and the PRG [Procurement Review Group] will go about comparing?fairly and without bias?these two types of proposals??those pitched by utilities and those by independent generators. This seemed like a fair question. We are thus puzzled by the vociferous reaction to the motion by the utilities. One would think the sky was falling. What?s really at issue? We are at an important juncture in California. The governor?s office, the CPUC, and the California Energy Commission have each endorsed an ?open, transparent, competitive procurement? mechanism. Nice theory. But what does it mean practically? First and foremost, we must determine whether this goal can be accomplished when the utilities have a business interest on both sides of the deal as buyer and seller. I believe this is an untenable relationship from a competitive perspective. However, if the utilities are allowed to continue to participate as both buyer and seller, then the commission must address how to ensure a truly level playing field. What is the role of the independent evaluator? What are the bid evaluation criteria? These are examples of the practical questions raised by IEP that must be addressed by the commission. The turmoil surrounding utility procurements arises necessarily from the ?hybrid market structure? endorsed by the commission?s long-term procurement decision. In endorsing this structure, the commission removed the ban on utility-affiliate transactions (i.e., they allowed utility-owned, utility-turnkey, and utility merchant affiliates to ?compete??to sell to themselves). To counter the potential for abuse, they required the utilities to compete to sell generation resources in an open, transparent, competitive procurement environment. In theory, this is a reasonable attempt to create a balance in procurement. However, inherent problems arise in practice. The inherent problem of the hybrid market structure is that the utility has not one but two business interests. On the one hand, the utility is a buyer on behalf of its load. On the other hand, the utility is a seller of wholesale generation products. As buyers, the utilities have sought to redact from public review information regarding what they need, when they need it, and how they select the products they buy. They say they need to redact this information because of the potential for market power. Yet while seeing market power at every opportunity, they fail to take steps to mitigate its presence. For example, by redacting the what, when, where, and how of procurement, they create barriers to new market entrants, ironically increasing the probability of market power being exercised. This does not seem terribly prudent from a seller?s perspective. So why might it be occurring? The answer lies in the other role of the utility, that of a seller of wholesale generation products. The utilities have an interest in minimizing if not eliminating competitors. Normally, a utility would accomplish this by building its own resources, rolling the costs into rates, and ignoring potential lower-cost competitors. However, utilities in California are directed to procure resources through open, transparent, and competitive means. Because the characteristics of this environment have yet to be defined at the commission, the utilities have had free rein in defining the terrain in which they procure products and services. In defining this terrain so far, they attempt, not surprisingly, to limit competitors? access to key planning and procurement data that would provide insights into what the utilities might want, when, and where. One would expect them to do this because the utilities? business interest as sellers of wholesale products obviously conflicts with the goal of openness and transparency in the procurement process. A ?level playing field? is an important standard that shouldn?t be taken lightly. However, it can be achieved only if all competitors have equal access to the same information. As long as the utilities have access to critical planning data describing where new generation is most needed, yet no one else enjoys this access, the utilities have inherent advantages as sellers in the market. As long as the utilities have access to the criteria for picking winners and losers, yet no other bidders have this information, you can guess who will fall into the ?winner?s bin.? The theory of an open, transparent, and competitive procurement process, as articulated clearly in the commission?s long-term procurement decision, is all well and good; but it is simply words on paper if not implemented in practice.

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