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Memo to Federal Power Marketing
Work Group

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DATE: May 9, 1996

TO: Federal Power Marketing Work Group via Wally Gibson, Northwest Power Planning Council

FROM: Marc Hellman, Staff, Oregon Public Utility Commission Footnote 1

SUBJECT: Having BPA Serve All PNW Residential and Irrigation Customers Post 2001

PROPOSAL

I propose that beginning in the year 2001, the new statutory mission of Bonneville Power Administration (BPA) entail serving all Pacific Northwest (PNW) residential and small-farm irrigation loads. I recommend that PNW residential and small-farm irrigation customers be required to purchase their generation needs from BPA. Publicly-owned utilities which currently purchase power from BPA would need to replace the "lost" federal power (BPA power associated with serving commercial and industrial customers) with alternative supplies. Investor-owned utilities would likely become surplus under this proposal because they would no longer be the generation services supplier of the residential and irrigation customers located in their service territories. The investor-owned utilities would be able to market their power to the direct service industries and also to the publicly-owned utilities that need alternative generation supplies. Even with these new markets for investor-owned utilities, some of the investor-owned utilities will likely face stranded costs. In that event, remedies for stranded plant will need to be developed. This proposal could take place under either a retail wheeling framework, or under the current environment which has limited retail wheeling opportunities. However, I believe this proposal is more compelling under a direct access environment. Implementation of this proposal would require new federal legislation.

This proposal and accompanying analysis focus only on the generation system of BPA. The transmission system is assumed to be divested, or at a minimum, have the control and operation of the transmission system transferred to an independent grid operator. While not specifically related to this paper, I recommend, if feasible, that BPA's transmission system be divested. The benefit of divestment is that it removes any self-dealing concerns that may currently exist where BPA is both a power supplier and the largest owner of transmission facilities in the Pacific Northwest.

ANALYSIS

BPA has sufficient resources to serve both PNW residential and irrigation loads through the early 2000s. Footnote 2 Around the year 2004, BPA will need to begin purchasing power in order to supply all PNW residential and small-farm irrigation loads on a firm basis. Absent any additional cost cutting measures, the cost of BPA power to residential and irrigation customers roughly equals 2.4 cents/kWh in 2001, and stays somewhat close to this value through the study period which ends in the year 2020. Footnote 3

The table below summarizes the findings of this project to date.

Year	BPA Res aMW	Res Loads aMW	Irrig Loads aMW	Firm Surplus (Res & Irrig) aMW	BPA Rev Req ($000)	BPA Firm& Nonfirm Sales Rev ($000)	Net BPA Rev Req ($000)	Net BPA Power Cost to PNW Res & Irrig (cents/KWh)
2001	8,000	6,917	734	349	1,824,471	207,559	1,616,912	2.4
2005	8,000	7,341	779	(120)	1,847,751	135,825	1,711,926	2.4
2010	8,000	7,908	840	(748)	2,076,813	30,133	2,046,680	2.7
2015	7,200	8,519	905	(2,224)	1,903,653	(246,730)	2,150,383	2.6
2020	7,200	9,178	974	(2,952)	1,702,655	(403,691)	2,106,346	2.4

These findings should be viewed with caution because the underlying data has not been rigorously reviewed and simplifying assumptions have been made for ease of analysis.

I have attached materials that provide information on BPA's revenue requirements and electric usage by state, by customer type, and by type of utility.

DISCUSSION

The Regional Forum is focusing on various alternatives for the electrical industry structure for the PNW. Many of these alternatives will focus on BPA given its current difficulties in both meeting its public policy objectives and being price competitive. One idea I believe we should explore is to dedicate BPA and its federal resources to serving the PNW's (as defined in the Regional Power Act) residential and small-farm irrigation electric loads. Footnote 4 The remaining types of customer classes, such as industrial and commercial customers, could have direct access (i.e., retail wheeling). The direct access option is not a requirement for this proposal, but seems to be an option supported by some parties. Whether or not there is direct access, residential and irrigation classes of customers would have the generation portion of their electricity service served by BPA. BPA would not be obligated to serve the commercial or industrial loads of publicly-owned utilities, but would only be required to serve residential and small-farm irrigation loads. (For purposes of this paper, I have provided an attachment which displays analysis for the option that BPA exclusively is required to serve residential customers only.)

All utilities in the PNW, including investor-owned utilities (IOUs) and publicly-owned utilities, (POUs) would no longer provide generation-related services to residential and small-farm irrigation customers located in their service territories. The IOUs and POUs would still provide distribution and transmission services to these customers. However, for the IOUs at least, this reduction in loads would be offset by the opportunity to serve the commercial and industrial loads of the POUs and the direct service industries (DSIs). For the POUs, BPA would continue to serve their small-farm irrigation and residential loads. Most or all POUs would need to find alternative energy supplies to meet their commercial and industrial loads. And correspondingly, the POUs would be under no obligation to purchase power from BPA to meet their commercial and industrial loads. Footnote 5 Additionally, under a direct access scenario, the IOUs and generating publics would have the opportunity to sell power directly to the commercial and industrial loads of all other utilities including the DSIs. Correspondingly, industrial and commercial customers of all utilities would have a choice of who provides their generation services.

The proposal that BPA should be reserved for, and serve, PNW residential and small-farm irrigation customers seems equitable for a number of reasons. First, it eliminates the longstanding public versus private battle for federal-based resources. At least in the mid 1970s to the early 1980s, almost all electricity consumers wanted to purchase power from BPA. This was a major consideration and focus of the Regional Power Act which created the residential and small-farm power exchange. Since the early 1990s, most wholesale customers do not want to be served, at least not entirely, by BPA. This proposal would end the public/private debate at least for residential and small-farm irrigation customers, and would provide, at a minimum, open access to all utilities to purchase power from the supplier of their choice to meet their non-residential loads. This proposal can be thought of as changing from a public preference of federal resources to a residential and small-farm irrigation preference framework.

If the PNW moves to retail wheeling, large industrial customers are likely to benefit relative to other classes of customers, due to their size. To ensure that residential customers have the potential to benefit from the transition to retail wheeling, it seems reasonable to group all

residential customers as a class in order to create purchasing power. Footnote 6 Equity considerations may also warrant treating all residential customers equivalently at least with respect to generation.

Furthermore, requiring BPA to serve PNW residential and irrigation customers ensures that the benefits of the PNW hydroelectric system are retained by the residents of the PNW.

Finally, according to my analysis, BPA's federal resources may be economic in the long term. Residential customers may be willing to accept higher near-term prices for generation services in exchange for lower prices in the long term. In addition, residential customers can use BPA as the vehicle to promote the region's public policies regarding energy and environmental issues.

ISSUES

This proposal raises a number of significant issues. These issues include:

Should residential and small-farm irrigation customers be required to purchase their power from BPA?
Will BPA's rates be competitive?
Will BPA be responsible for acquiring resources to meet residential and irrigation loads?
Will utilities experience stranded cost under this option? If so, to what extent, and by whom, will the stranded costs be recovered?
How will BPA's rates be determined?

Each of these topics will be discussed in turn.

Should residential and small-farm irrigation customers be required to purchase their power from BPA?

I believe it is preferable to require residential and small-farm irrigation customers to purchase their electric power needs from BPA. An alternative to this concept, offered for discussion, is to allow residential and small-farm irrigation customers, either individually or through a brokering arrangement that includes some aggregation of customers (like those in a utility's service area or state), first rights of refusal to BPA power. In this latter alternative, BPA power would be offered to differing classes of customers in order of their "rights" to federal power. For example, residential and small-farm irrigation customers would be offered BPA power first. To the extent that BPA has surplus power after this offering, BPA power could then be offered to all public schools, and then government agencies, hospitals, and so on. I have no recommendations on what the priority of differing classes of customers should be except that residential and small-farm customers should be given first rights of refusal to BPA power.

I believe alternatives which essentially provide certain types of customers first rights of refusal to BPA power have several drawbacks. One drawback is that BPA would not have a reasonably firm customer base and resulting revenues. Without such a sales base to depend on, BPA would lack certainty in meeting its repayment obligations. It seems to me that any solution we propose, which includes the continued existence of BPA, should have BPA on solid financial footing. I note that BPA's current actions in attempting to lock in customers for a five-year period through rate discounts and stranded cost protections is evidence that BPA will undertake significant efforts to ensure that it meets its financial obligations. Another drawback to the concept of giving residential and irrigation "first rights of refusal" to BPA power is that it effectively results in BPA competing in the generation market to a greater degree with private industry. If BPA was unable to sell its power to most of the PNW residential and irrigation customers, then BPA would need to market its surplus power elsewhere. This necessarily requires BPA to compete with private industry. The benefit of requiring residential and irrigation customers to purchase power from BPA essentially prevents BPA from competing to any large degree with private industry. This result occurs because BPA's average generating capability is close to the load demands of PNW residential and irrigation customers. The table on page two of this correspondence has BPA in load/resource balance around the year 2004. Requiring residential and small-farm irrigation customers to purchase all of their power needs from BPA may address the concerns of some parties to the regional forum who do not support the concept of a federal agency in competition with private industry.

Finally, a first-rights-of-refusal approach to BPA power, under a direct access environment, could be administratively complex and cumbersome. BPA would have to contact the top priority customers, see how much power was sold, how much power was left, then contact the second set of customers and repeat the same process. I believe such a process has a significant drawback if many customer contacts need to be made, or if there are many levels of preference ranking. In addition, customers on lower levels of preference ranking could not be sure they would receive BPA power. This supply risk feature may prove unattractive to these customer classes.

Will BPA's rates be competitive?

This is, of course, a critical question. The table on page two provides estimates of BPA's average cost between the years 2001 and 2020. BPA's projected cost is 2.4 cents/kWh in the year 2001, rises to about 2.7 cents/kWh during the middle of the study period, and then falls back to 2.4 cents/kWh in the year 2020 as the WNP-related debt is paid off. These average cost estimates for generation services may appear to some as perhaps too high to be competitive. If BPA supplies the residential and small-farm loads, as is proposed in this paper, then this paper's average cost estimates probably underestimate BPA's average cost due to the need to shape BPA's resources to fit the residential and small-farm load patterns.

Clearly some actions are needed in order for BPA to remain price competitive. There are proposals being discussed that essentially entail shedding the WNP debt obligations onto the transmission system. One could argue that it is inherently unfair that residential and small-farm customers take full responsibility for WNP-related debt while all other classes of customers have the freedom to choose their energy supplier. I agree with this viewpoint. Some type of stranded-plant charge should be implemented as we move to a fully-competitive generation market. In addition, BPA's cost cutting activities need to continue. Residential and small-irrigation customers would likely only agree to commit to purchasing BPA's power only if BPA appeared to be the low-cost provider in the PNW. Therefore, we should look for additional opportunities to reduce BPA's costs.

Will BPA be responsible for acquiring resources to meet residential and irrigation loads?

I believe BPA should be responsible for acquiring, but not building, resources to meet its firm obligations. Again, under my proposal that does not include a first-rights-of-refusal option, firm obligations would entail meeting forecasted residential and small-farm irrigation loads. Assuming residential and small-farm customers are required to purchase from BPA, then those customers should have a major voice in BPA's decisions to purchase power. This feature is consistent with the objective that BPA become more accountable to this region and its priorities. The benefit of having BPA acquire but not build resources is that this option removes BPA from the business of constructing generation resources. We should attempt to limit the amount by which a governmental agency competes for services that could be provided by private industry. Clearly, private industry is capable of building new generation resources.

Will utilities experience stranded cost under this option? If so, to what extent, and by whom, will the stranded costs be recovered?

Under any direct access proposal (i.e., retail wheeling), the issue of stranded cost needs to be addressed. My proposal calls for BPA to serve PNW residential and small-farm irrigation loads whether or not direct access is implemented. Assuming that direct access is not implemented, then my proposal will have some consequences to customers and utilities. High-cost generation utilities will likely experience stranded cost because the generation that is "freed-up," through the loss of providing generation services to their residential and small-farm customers, would likely not be able to be sold at the same price to the DSIs or publicly-owned utilities. Therefore, these high-cost utilities would argue for some charge to compensate them for stranded costs. Residential and small-farm irrigation customers of low-cost utilities, where the average generation cost is lower than BPA's, would face rate increases. The low-cost utilities themselves might benefit from this proposal because their "freed-up" energy that would have been sold to residential and small-farm customers can now be marketed to the DSIs and other utilities. Perhaps some of these benefits could be captured and returned to the residential and irrigation customers of the low-cost utilities to transition those customers in a way that removes rate shock.

It should be clear, however, that in a direct access environment, high-cost utilities will face stranded costs and low-cost utilities could potentially reap capital gains. I believe that customers of high-cost utilities will eventually benefit from direct access even if they face stranded cost charges.

Under a direct access scenario, customers of low-cost utilities will face rate increases because the utility will no longer be obligated to sell to its customers on an embedded-cost basis. Therefore some of the troublesome potential outcomes I have identified regarding stranded cost will also arise under direct access frameworks. Perhaps some of the ideas that are developed for the direct access proposals could also be used for this proposal.

How will BPA's rates be determined?

I propose that BPA's rates to residential and small-farm customers be set on an embedded-cost basis. The BPA rates for surplus firm, to the extent BPA is firm surplus, and nonfirm sales to other types of customers should be market based. BPA's rates for residential and irrigation customers would be developed through an administrative hearings process and reviewed and approved by the agency or board to which BPA is accountable. There should be changes such that BPA is more accountable to its customers. I do not have any specific recommendations in that regard; however, continuation of the 7(i) processes for changing BPA's rates has the drawback of being administratively cumbersome. Lawyers and public policy leaders should be asked to help work out details for developing the process by which BPA rates for residential and small-farm customers would be established. However, the controversy and adversarial nature of BPA's current proceedings should be lessened to a large degree because of the removal of the exchange and DSIs. BPA's rates for residential and small-farm irrigation customers would be differentiated on the basis of cost of service. The non-statutory based price discrimination that is now found in BPA's rates would hopefully end.

CLOSING COMMENTS

The Regional Forum provides us an opportunity to shape the structure of the PNW energy industry including the future role of BPA. There will be many proposals offered, each with their own strengths and drawbacks. I hope the proposal contained in this paper will be considered. I acknowledge that requiring residential and small-farm customers to purchase their energy needs from BPA has its drawbacks, including lack of customer choice, and decreased incentives for BPA to be economic. Perhaps these drawbacks can be overcome if BPA is clearly shown to be the low-cost provider of generation services. Analysis in this paper shows that BPA can be economic. The strengths of the proposal are retention of the benefits of the PNW hydroelectric system for PNW citizens, retaining a vehicle by which widely-supported public purposes can be pursued, elimination of the public versus private debate on the sharing of these benefits, and largely removing BPA as a competitive threat to privately-owned generation services providers.

Footnote 1

The views expressed in this paper are my own and do not necessarily reflect the policy positions of the Oregon Public Utility Commission.

Footnote 2

The analysis is preliminary and will be revised as more information is obtained. For example, WNP #2 is assumed to be retired at the end of 2013, and firm "transfers out" have not been included. Because of the load profile of residential and farm loads, BPA would likely need to enter into power sales contracts with other power suppliers to effectively shape federal resources by both time-of-day and season. These power sales transactions may result in a slight increase in BPA's average rate to the residential and small-farm customers.

Footnote 3

Again, the per kWh rates relate solely to generation services. The rates do not include transmission- related costs.

Footnote 4

Residential and small-farm irrigation customers were chosen to be the customer types to purchase BPA power because they were the types chosen in the Regional Power Act to qualify for the Exchange under section 5 (c).

Footnote 5

Again BPA would serve PNW residential and small-farm irrigation customers. To the extent BPA has surplus firm or nonfirm power, this additional power could be sold to utilities, or under a direct access environment, to other end users.

Footnote 6

An alternative to this proposal that creates purchasing power for residential and small-farm customers is to allow for the use of aggregators that act as agents on behalf of many residential or small-farm customers. I believe this option is allowed for in the California plan to implement direct access.