BEFORE THE
PUBLIC SERVICE COMMISSION
OF MARYLAND
IN THE MATTER OF THE INQUIRY
INTO THE PROVISION OF STANDARD
OFFER SERVICE BY SOUTHERN
MARYLAND ELECTRIC
COOPERATIVE, INC.
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*
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CASE NO. 8985
INITIAL BRIEF OF THE MARYLAND OFFICE OF PEOPLE’S COUNSEL
I.
Introduction
The Commission instituted this proceeding on November 14, 2003 by issuing a
Notice of Inquiry and directing “SMECO to present argument on whether the key policy
elements of the framework established in Case No. 8908 for competitive supply for SOS
[Standard Offer Service] offered by the investor-owned electric utilities are applicable to
SMECO’s provision of SOS for the years 2005 through 2008. The key elements include:
(1) grouping of existing customer classes into services and customer segments
(Residential and Type 1-3) with varying supply portfolios and pricing structure; (2) retail
generation prices that represent the full cost of retail service including an administrative
charge and the cost of transmission service as a function of load characteristics; (3) a
competitive procurement process for all services and portfolios; and (4) shifting some
exposure for volume or regulatory risk from wholesale suppliers to customers.” SMECO
filed Initial Comments on January 30, 2004. OPC and Staff filed their Initial Comments
on March 5, 2004. OPC’s comments argued that SMECO had not provided sufficient
information to evaluate the risk exposure to its customers that results from its proposed
procurement process.
SMECO filed comments in response to Staff’s and OPC’s Comments on March
26, 2004. OPC and Staff filed Reply Comments on April 23, 2004. Again, OPC
concluded that SMECO had not filed sufficient information to allow the Commission to
make an informed judgment on its procurement process.
On May 3, 2004, the Commission issued a Notice that it delegated consideration
of the issues in this case to the Hearing Examiner Division on an expedited basis. On
June 1, 2004, the Commission set a hearing in the case for June 7, 2004. The
Commission issued an Order in this case on June 17, 2004 (hereinafter, the “Order”) that,
as discussed in more detail below, discusses certain issues of the case and directs that the
Hearing Examiner address certain issues through evidentiary proceedings, which are
described as Phase II of the case.
SMECO prefiled direct testimony on June 17, 2004 and June 28, 2004. OPC and
Staff prefiled testimony on July 2, 2004. The Hearing Examiner conducted evidentiary
hearings on July 6, 2004 and July 8, 2004.
II.
Scope Of This Proceeding
In its January 30 and March 26 Filings, SMECO provided only general
descriptions of its procurement strategy.1 SMECO states that it proposes to use a “self-
Report of Southern Maryland Electric Cooperative, Inc., January 30, 2004, Case No. 8985 (“January 30
Filing”), p. 13, [BEGIN CONFIDENTIAL MATERIAL]
1
[END CONFIDENTIAL MATERIAL] The Response of Southern Maryland
Electric Cooperative, Inc., March 26, 2004, Case No. 8985 (“March 26 Filing”) does not provide additional
details on the hedging strategy.
2
managed portfolio” approach that will have the Cooperative [BEGIN CONFIDENTIAL
MATERIAL]2
3[END
CONFIDENTIAL MATERIAL] The make-up of these purchases defines the
hedging strategy, which determines the level of risk that is borne by SMECO’s customers
during the service year. While SMECO’s January 30 Filing and March 26 Filing
provided some information on the mechanics of how purchasing would be done on its
behalf, they did not provide any specifics on the hedging strategy.
SMECO’s proposed procurement method varies significantly from the approach
adopted by the Commission for the investor-owned utilities in Case No. 8908.4 Under
the Case No. 8908 approach there is an established schedule for the utility to solicit bids
to take on the obligation for a certain percentage of the utility’s entire SOS obligation.
The result of the RFP process is that the utility has in place, prior to the service year,
contracts with suppliers for its entire SOS obligation, whatever that obligation turns out
to be, at a fixed and known price. The Commission explicitly directed the Hearing
Examiner to consider the issue of whether SMECO’s proposed procurement
methodology, as opposed to the methodology approved for the investor-owned utilities, is
in the public interest.
Moreover, SMECO has indicated that it intends to procure
supply for its SOS load through the use, in part, of short
terms contracts and spot market purchases. Commission
takes no position on this strategy at this time because the
Commission has not explored the significance or impact of
this difference between SMECO’s procurement proposal
2
3
4
See Order No. 78400, Case No. 8908, April 29, 2003 and Order No. 78710, Case No. 8908, Phase II,
September 30, 2004.
3
and the procurement methodology already approved for
investor-owned utilities. The Commission directs the
Hearing Examiner to consider these issues in Phase II of
this proceeding…” (Order, p. 2)
As discussed in detail below, the information SMECO has provided during
discovery in this proceeding indicates that there are certain guidelines for the
procurement process but no definite parameters. SMECO has reserved the right to alter
the strategy at any time without notifying the Commission. The Commission recognized
this deficiency in the Order.
Under Case No. 8908, the procurement methodology has a
specific blended portfolio of multi-year contracts. By
contrast, the SMECO Phase I proposal contained no policy
guidance for the management of a SOS portfolio for risk,
price volatility, etc. (Order, p.2)
The Commission explicitly stated that Phase II of this proceeding would consider
whether a proscribed procurement strategy, as opposed to the complete discretion sought
by SMECO, is in the best interests of SMECO’s customers.
Phase II should explore whether a power portfolio should
be defined or if there should be certain parameters for
procuring a blended portfolio for full requirements service.
(Order, p. 2).
Additionally, SMECO had no made proposals on how it would design retail rates
to recover the constantly changing cost to procure wholesale power for its SOS load. The
Commission also set these issues for an evidentiary hearing in Phase II. Id.
III.
Issues
1. Whether SMECO’s proposed strategy of using short term contracts and spot
market purchases to satisfy its SOS load obligation is in the public interest.
4
2. “[W]hether a power portfolio should be defined or if there should be certain
parameters for procuring a blended portfolio for full requirements service.”
(Order, p. 2)
3. Whether SMECO’s retail rate proposal is reasonable.
IV.
Argument
A.
SMECO Has Not Demonstrated That Its Proposal To Use Short Term
Contracts And Spot Market Purchases Of Power Is Reasonable And
In The Public Interest
The record in this case provides a comparison of the procurement approach
proposed by SMECO and the full requirements contract approach approved in Case No.
8908 that reveals a series of difficulties created by the SMECO proposal that do not exist
with the full requirements contracts approach. These difficulties, which will be detailed
below, led both the OPC’s witness, Jonathan Wallach, and the Staff’s witness, Calvin
Timmerman, to conclude that it would be in the best interest of SMECO’s customers for
the Cooperative to pursue the full requirements contracts approach approved in Case No.
8908 as opposed to the self-managed portfolio approach it has proposed.5
1.
Under SMECO’s Proposed Methodology, Its Customers Bear
Price Risks That Do No Exist Under The Full Requirements
Contracts Approach
In contrast to the Case No. 8908 approach, SMECO’s proposal will expose its
customers to price volatility risk. The goal of the Case No. 8908 approach is that an
investor-owned utility will go into the service year with fixed price contracts that exactly
OPC Exhibit 1A, D. Testimony of J. Wallach, p. 15 (“My primary recommendation is for SMECO to
provide stable and certain prices to residential consumers through procurement of full requirement supply
with a mix of varying-duration contracts consistent with the approach adopted in Case No. 8908. The
approach proposed by SMECO appears to expose residential customers to undue price risk; such risk can
be eliminated by contracting for full-requirements supply at a fixed price”); and T. 408, l. 20-22, testimony
of C. Timmerman (“…[BEGIN CONFIDENTIAL MATERIAL] [END CONFIDENTIAL
MATERIAL]
5
5
cover its SOS obligation.6 This provides their customers with the benefits of price
certainty and stability.7 As a result, those utilities can calculate retail rates based on the
results of the RFP process that will be set for the service year. There is very little chance
that the utility’s costs of wholesale power will increase over the year, necessitating an
increase in retail rates.8 This eliminates the risk that small retail consumers will face
extraordinarily high bills resulting from unexpected market conditions that those
customers are not likely to understand, or even be aware of, and are ill-equipped to
handle. In its order in the first phase of Case No. 8908, the Commission noted that “the
procurement and pricing structure is designed to protect customers from sudden sharp
changes in wholesale prices.”9
The SMECO approach does not provide that protection.10 [BEGIN
CONFIDENTIAL MATERIAL]
[END CONFIDENTIAL MATERIAL] These increases in costs will be directly
passed on to customers through the PPCA.11 Therefore, high prices in the short-term and
spot markets will result in unexpectedly high bills for SMECO’s customers.
The full-requirements contracts approach used in Case No. 8908 puts the risk of
high spot market prices during the service year entirely on the suppliers with winning
6
OPC Exhibit 1A, D. Testimony of J. Wallach, p. 6; Staff Exhibit 1A, D. Testimony of C. Timmerman, p.
3.
7
OPC Exhibit 1A, D. Testimony of J. Wallach, p. 6.
8
Staff Exhibit 1A, D. Testimony of C. Timmerman, p. 3 (“Retail customer price risk is limited to the
default of a wholesale supplier or the activation of the renewable, transmission and volumetric risk pricing
provisions”). The volumetric risk pricing provisions are applicable only to non-residential services. Id.
9
Order No. 78400, Case No. 8908, slip. op., p. 84.
10
OPC Exhibit 1A, D. Testimony of J. Wallach, p. 6.
11
SMECO Exhibit 6, D. Testimony of T. Berge, p. 2, l. 5-17.
6
bids.12 It is logical to assume that bidders in that approach would include some premium
in their bid based on their analysis of the chance of increased prices during the service
year. Such a premium is in the nature of an insurance premium that is set in advance and
can be included in set retail rates in a manner that is reasonable for residential customers.
Bidders will base the risk premium included in their bid on their own price forecast for
the service year and the risk they see of deviations from that forecast. A competitive RFP
process will protect customers against paying an unreasonably high risk premium.
SMECO’s approach puts the risk of price forecast error of one group, APM, on its
customers. Under the Case No. 8908 approach, bidding suppliers make their price
forecasts and make their bids accordingly.13 The one with the forecast most
advantageous to consumers wins the bid and the winning supplier bears the risk of its
forecast being incorrect.14
As explained below, SMECO experienced difficulties that prevented it from
implementing its procurement strategy as originally adopted. The difficulties that
SMECO has experienced in getting its managed portfolio approach in place demonstrate
one aspect of the risk imposed on its customers as a result of SMECO attempting a selfmanaged portfolio approach. [BEGIN CONFIDENTIAL MATERIAL]15 16 17 18 19
Staff Exhibit 1A, D. Testimony of C. Timmerman, p. 3, l. 23 (“Wholesale suppliers bear all other input
price and volume risk”).
13
T. 423, l. 19-424, l. 2, testimony of Staff witness C. Timmerman.
14
T. 425, l. 1-12, testimony of Staff witness C. Timmerman.
15
OPC Exhibit 1A, Attachment 2, [BEGIN CONFIDENTIAL MATERIAL]
12
[END CONFIDENTIAL MATERIAL]
16
17
18
19
7
8
20 21 22
[END CONFIDENTIAL MATERIAL]
SMECO has not produced any policy or supporting analysis with respect to
supplier diversity in their portfolio that would allow the Commission to judge whether
the decision to forgo purchasing certain forward energy products because of supplier
diversity concerns was a reasonable decision. These difficulties show the complications
that can arise, and the resulting risk to consumers, in the Cooperative taking on the
burden of managing its portfolio on its own. [BEGIN CONFIDENTIAL MATERIAL]
[END CONFIDENTIAL MATIERAIL] its approach exposes
its customers to the risk that some new difficulty could arise in this complicated
undertaking that could adversely affect SMECO’s ability to buy hedging products, to the
detriment of its customers.
2.
Under SMECO’s Self-Managed Portfolio Proposal, Its
Customers Bear The Risks Of Differences Between Projected
Load And Actual Load
[BEGIN CONFIDENTIAL MATERIAL] [END CONFIDENTIAL
MATERIAL] Actual load can vary from projected load due to abnormal weather, an
incorrect forecast of economic conditions, and unanticipated switching of customers from
SOS to third-party retail suppliers. If the projected load is greater than the actual load,
[BEGIN CONFIDENTIAL MATIERAL] 23
20
21
22
23
9
[END CONFIDENTIAL MATERIAL]
Under a full requirements contracting approach, the risks associated with
variances between the projected loads and the actual load are borne entirely by the
wholesale suppliers.24 The wholesale suppliers are responsible for the entire SOS load,
no matter whether the actual load ends up being more or less than projected load.
3.
SMECO’s Proposed Approach Requires Allocation Of
Procurement Costs Between Rate Classes
SMECO proposes to compile a single portfolio of power to serve all of its SOS
customers. As a result, there must be an allocation procedure to assign costs between rate
classes.25 Whenever a cost allocation is performed, there is a risk that the allocation
method will not accurately reflect the true relative responsibility for causing the costs.26
While there are no pending issues among the parties over the allocation method described
so far by SMECO, the inherent inexactness of cost allocation remains. A full
requirements contracts approach can be implemented such that suppliers bid to supply the
Staff Exhibit 1A, D. Testimony of C. Timmerman, p. 3, l. 3 (“Wholesale suppliers bare all other input
price and volume risk”).
25
Staff Exhibit 1A, D. Testimony of C. Timmerman, p. 7.
26
Staff Exhibit 1A, D. Testimony of C. Timmerman, p. 9 (“Q. WITNESS BRADFORD STATES ON
PAGE 12 OF HIS TESTIMONY THAT THERE WILL BE NO CROSS-SUBSIDIES BETWEEN RATE
CLASSES. DO YOU AGREE? A. I disagree. Because SMECO’s cost allocations are based on prior year
rather than current or projected year load analysis and because the cost allocation model cannot account for
the varying cost of volumetric risk that different customer classes impose on the single portfolio, it is very
likely that some cross-subsidy will exist between customer classes.”).
24
10
rate classes separately. This method provides the transparency of direct market pricing
for each rate class and obviates the need for cost allocation.27
4.
SMECO’s Proposal Makes Prudence Evaluation Difficult
The prudence review that would result from SMECO’s procurement proposal
would occur sometime after the service year. The prudence review would look at the
many separate purchases and sales, both forward and spot, used by SMECO to serve its
SOS load. The prudence review required under SMECO’s proposal approach will be
difficult to effectively implement.28 This after-the-fact review could possibly identify
egregious procurement decisions by SMECO or its agent. However, the costs would
have already been incurred, and there would be no corrective action the Commission
could take for the service year in question. In addition, there is no baseline strategy to
use to compare against their actual activity unless the Commission approves the strategy
before it is implemented. In contrast, the prudence evaluation required under Case No.
8908 is simply determining whether the utility followed the procurement process
prescribed by the Commission.
27
T. 408, l. 3-10, testimony of C. Timmerman. [BEGIN CONFIDENTIAL MATERIAL
[END CONFIDENTIAL MATERIAL]
Staff Exhibit 1A, D. Testimony of C. Timmerman, p. 4 (“…it will be very difficult to evaluate the
imprudence of SMECO’s purchase of any particular component of SMECO’s SOS portfolio. Short of the
identification of gross errors on part of SMECO or its agent, it is possible prudence review will become
driven by the results of SMECO’s procurement rather than the process.”)
28
11
5.
SMECO’s Proposed Method Creates A Mismatch Between Its
Costs To Procure Power For SOS And The Retail Rate For
SOS
Because SMECO will be making sales and purchases of power for its SOS load
[BEGIN/END CONFIDENTIAL MATERIAL] there is no way to establish an accurate
retail rate ahead of time. SMECO has proposed a PPCA that is calculated using six
months of historical data and six months of projected data in order to smooth out the
PPCA as much as possible.29 However, the operation of the PPCA will mean that if
SMECO’s procurement costs vary from its retail rate for a particular month, the
collection of that difference will be spread out over six months. Thus, the retail rate will
be incorrect for the month when the difference first occurred as well as the subsequent
months.
The mismatch between actual SOS costs and SOS retail rates means that rates
SMECO’s customers face do not necessarily reflect the actual costs of supplying them
SOS. 30 As a result, these customers may be led to make inefficient decisions. The full
requirements contracts approach results in retail prices that accurately reflects the actual
procurement costs of the utility. Thus, the consumer can make efficient decisions on his
retail supply based on the prices he pays for the utility SOS.
29
T. 403, l. 20-404, l. 1. [BEGIN CONFIDENTIAL MATERIAL]
[END CONFIDENTIAL
MATERIAL] OPC Exhibit 1A, D. Testimony of J. Wallach, p. 15 (“Moreover, adopting the 8908
approach will restore transparency to the procurement process and eliminate the discretion inherent in the
proposed process that frustrates the Commission’s ability to assure its reasonableness. Under the proposed
approach, with purchases over time depending on prevailing market conditions, the Commission will not be
able to take actions in the event that the total cost of the portfolio is unreasonable. Under the 8908
approach, in contrast, the Commission has an opportunity to reject the selection of winning bidders prior to
transactions and execution.”)
30
Staff Ex. 1A, D. Testimony of C. Timmerman, p. 11, l. 8-20.
12
6.
SMECO’s Proposed Procurement Methodology Is Not In The
Public Interest
The record reveals that SMECO’s proposed procurement methodology produces a
litany of problems not presented by the full requirements contracts approach as discussed
above. The most serious of the difficulties is the risk imposed on SMECO’s customers
under the self-managed portfolio that is instead placed on suppliers in the full
requirements contracts approach. SMECO has not shown that there is a corresponding
benefit to its approach that overcomes these deficiencies. This litany of problems
presented by SMECO’s proposed procurement methodology has led both OPC’s witness,
Mr. Wallach, and Staff’s witness, Mr. Timmerman, to conclude that the interest of
SMECO’s customers would be better served by adopting a full-requirements contract
approach similar to that adopted by the Commission in Case No. 8908. Mr. Wallach
stated his conclusion as follows:
My primary recommendation is for SMECO to provide
stable and certain prices to residential customers through
procurement of full-requirements supply with a mix of
varying duration contracts consistent with the approach
adopted in Case No. 8908. The approach proposed by
SMECO appears to expose residential customers to undue
price risk; such risk can be eliminated by contracting for
full-requirements supply at a fixed price.31
Similarly, Mr. Timmerman testified as follows:
[BEGIN CONFIDENTIAL MATERIAL] 32
31
OPC Exhibit 1A, Testimony of J. Wallach, p. 15.
32
13
[END CONFIDENTIAL MATERIAL]
There is no dispute that SMECO is planning to use short term and spot energy
purchases for a portion of its load. [BEGIN CONFIDENTIAL MATERIAL] 33
[END CONFIDENTIAL MATERIAL] Also, SMECO has not provided a risk profile
analysis that corresponds to this vague strategy. In fact, without the details on exactly
how much will purchased ahead of time and how the forward purchases will be made, it
is not possible to perform such an analysis. Thus, the Commission cannot make an
informed decision on the difference in risk exposure for SMECO’s customers under the
SMECO approach and the 8908 approach. Therefore, there is no basis for the
Commission to find that the deviation from the full requirements contract approach
proposed by SMECO is in the public interest.
It is OPC’s position that SMECO’s customers should not be exposed to risk in
any greater degree than the customers of the investor-owned utilities under Case 8908.
Price volatility risk is harmful to customers whether their utility is investor-owned or a
cooperative.34 SMECO’s proposed procurement strategy exposes its customers to annual
price volatility risk that does not exist in the Case No. 8908 approach. In addition,
SMECO has not produced the necessary information to evaluate the magnitude of that
increased exposure. Therefore, OPC recommends that the Commission should direct
33
34
T. 385, l. 17-386, l. 2, testimony of OPC witness J. Wallach
14
SMECO to adopt a full requirements RFP approach similar to that adopted in Case No.
8908.
The fact that SMECO has embarked on its self-managed portfolio already creates
some practical challenges to implementing a full requirement contract approach at this
time. There are, however, solutions to these problems. For example, SMECO could
structure its RFP such that the bidders take on a SMECO’s current contract obligations
and factor the cost of the contracts, which may be above or below current market prices,
into their bids. Another alternative is for SMECO to do a full-requirements bid for a
portion of its load. Mr. Wallach suggests one-third.35 The self-managed portfolio
approach would supply the remainder of the portfolio. This would give the Commission
a valid reference as to the cost efficiency of the two approaches. In any event, if the
Commission permits SMECO to pursue its current approach for 2005, the Commission
should state its intention to conduct a thorough review of SMECO’s purchasing to decide
whether SMECO should continue this approach or adopt a full requirements RFP
approach in line with the other utilities in the state for 2006.36 Such a review of
SMECO’s approach should take place in early 2005 to allow changes to be made in
SMECO’s procurement for 2006.
B.
If The Commission Allows SMECO To Continue With Its SelfManaged Portfolio Approach, The Commission Should Require
SMECO To File A Detailed Procurement Strategy, And Any Changes
To That Strategy, For Commission Approval
In addition to seeking a proposed decision on whether SMECO’s proposed
purchasing strategy is in the public interest, the Commission directed that “Phase II
35
36
OPC Exhibit 1A, Testimony of J. Wallach, p. 15.
Id., p. 15-16.
15
should explore whether a power portfolio should be defined or if there should be certain
parameters for procuring a blended portfolio for full requirements service.”37 Without a
detailed and defined procurement strategy, the Commission cannot judge the level of risk
to which SMECO’s customers would be exposed under SMECO’s self-managed portfolio
proposal. Therefore, the Commission should require that SMECO file for Commission
approval a defined procurement strategy for its portfolio, with sufficient supporting
analysis, so that the Commission can ensure that the risks being borne by SMECO’s
customers are in the public interest and that the resulting SOS prices are reasonable. The
Commission has the authority to make this requirement by its statutory obligation to
ensure that SMECO’s operations in procuring SOS are in the public interest.38 Further,
SOS remains a regulated service and the Commission has an obligation to ensure that the
resulting SOS prices are just and reasonable.39
The following hypothetical example demonstrates the Commission’s obligation to
require such a filing If SMECO’s procurement strategy was to purchase all of the energy
it needs for SOS in the hourly spot markets, it is certainly possible that the Commission
might find that the resulting risks to its customers would not be in the public interest.
On the other hand, OPC would have no objection to SMECO adopting a full
requirements contracts approach in keeping with the Case No. 8908 approach. It appears
that SMECO plans to do something in the middle. In order to judge whether the SMECO
proposal would result in an acceptable level of risk for SMECO’s customers, the
Commission must have before it a definite procurement strategy that will not change in
midstream without Commission approval. The Commission has the obligation to be
37
Order, p. 2.
Md. Public Utility Companies Code Ann. (“PUC Article”) §2-113 (2003).
39
PUC Article, §§7-509(a)(1)(i) and 4-102.
38
16
informed of SMECO’s procurement strategy and take action to prevent harm to
consumers from unreasonable risks.
SMECO does not believe that the Commission should make a ruling on a detailed
procurement strategy. As succinctly stated by its counsel during hearings in this case, it
believes that SMECO40 [BEGIN CONFIDENTIAL MATERIAL] [END
CONFIDENTIAL MATERIAL] Thus, under SMECO’s formulation, the Commission
would have no ability to review where SMECO’s customers would be in the range
between unhedged (all spot purchases)and fully hedged (full requirements contracts).
The Commission has statutory obligations that prevent it from giving SMECO that level
of discretion. In light of those obligations, OPC recommends that if the Commission
allows SMECO to continue with its self-managed that the Commission should require
that SMECO make a compliance filing that provides a detailed procurement strategy for
Commission approval. The SOS prices for 2005 will largely result from the procurement
strategy. Thus, the filing and Commission approval must occur prior to the start of 2005
to ensure that the 2005 SOS prices will be just and reasonable.
1.
SMECO Has Not Filed A Comprehensive And Detailed
Procurement Strategy
SMECO has consistently refused throughout this proceeding to provide the
Commission with a concrete description of its procurement strategy. Such a description
would specify the amount of energy that would be purchased in advance of the service
year, the type of contracts used to make those forward purchases, the time frame for the
purchases, and the pricing parameters for the purchases. SMECO continues to stand on
40
T. 118, l. 7-9.
17
its description of its procurement strategy as41 [BEGIN CONFIDENTIAL
MATERIAL] [END CONFIDENTIAL MATERIAL] This information is insufficient
for the Commission to judge the risk being placed on SMECO’s consumers. SMECO’s
brief description does not indicate how it intends to satisfy its capacity and ancillary
service obligations. It does not indicate the type of products that will be purchased, the
terms or quantity for each type of product, the timing of the purchases, or the pricing
parameters for each product. These pieces of information are necessary to analyze the
risk to customers resulting from the strategy.
The minimal parameters proposed by SMECO are in stark contrast to the
approach approved by the Commission in Case No. 8908. Under Case No 8098, the
Commission approved strict parameters for the products that the utilities will purchase to
provide SOS. This relieved the utilities of the discretion to alter that strategy.
Once a procurement strategy is defined, the risk inherent to customers as a result
of that strategy can be analyzed. The analysis uses market prices for advanced purchases
that are planned and a price forecast for the portions of energy that will not be purchased
ahead of time. Using that risk profile, an informed decision can be made that the strategy
is reasonable and in the public interest. However, the risk profile analysis in only valid if
the strategy is actually followed. If the strategy is changed in mid-stream, customers are
exposed to new risk.
SMECO filed a Report with the Commission on June 30, 2004 that provides some
information on its purchases to date.42 However, its report does not provide any
41
SMECO Exhibit 1A, D. Testimony of A. Slater, p. 11; T. 199, testimony of SMECO witness J. Walker
[BEGIN CONFIDENTIAL MATERIAL]
[END CONFIDENTIAL MATERIAL]; see also
T. 244, l. 17-245, l. 15, testimony of SMECO witness J. Brannan.
42
OPC Exhibit 4.
18
description of its overall hedging and purchasing strategy. The Report also does not
provide a projection of the expected total cost of the portfolio or the risk profile, referred
to as an “S-curve” during the hearing. SMECO’s witness Walker admitted during the
hearing that [BEGIN CONFIDENTIAL MATERIAL] [END CONFIDENTIAL
MATERIAL]43 Yet, SMECO’s President, Mr. Slater, testified that [BEGIN
CONFIDENTIAL MATERIAL]
[END CONFIDENTIAL
MATERIAL]44 This information is necessary for the Commission to evaluate
SMECO’s proposed approach.
2.
The Record Contains Pieces Of Information On SMECO’s
Procurement Strategy But Is Insufficient
Through discovery, OPC has received documents from SMECO that provide
some insight into SMECO’s proposed strategy and the associated risk analysis. [BEGIN
CONFIDENTIAL MATERIAL] 45 46 47 48 49 50 51 52
43
44
T. 505, l. 13-19, testimony of SMECO witness J. Walker.
T. 155, l. 12-156, l. 14, testimony of SMECO witness A. Slater.
45
46
47
48
49
50
51
52
19
20
21
22
23
53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69
[END CONFIDENTIAL MATERIAL]
The cat and mouse game of revealing SMECO’s procurement strategy through
discovery and cross-examination does not produce a sufficient record for the Commission
to judge whether the risks to which SMECO’s customers are being exposed are
reasonable. The Commission has a statutory obligation to endure that SMECO’s
procurement policy is in the public interest. SMECO has not met its burden of showing
that its proposed procurement method sufficiently limits the risks to its customers.
3.
SMECO’s Desire For Total Flexibility Exposes Its Customers
To Risk
SMECO and APM’s desire to be able to deviate from a procurement strategy is
problematic for its customers because it exposes them to risk. [BEGIN
CONFIDENTIAL MATERIAL] 70 71 72 73 74
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
24
70
71
72
73
74
[BEGIN CONFIDENTIAL MATERIAL]
[END CONFIDENTIAL MATERIAL] OPC Exhibit 1A, Testimony of J. Wallach, p. 11, l. 1-2.
[BEGIN CONFIDENTIAL MATERIAL]
[END CONFIDENTIAL MATERIAL] Id. at p. 13, l. 13-17.
25
4.
The Commission Should Direct SMECO To File A
Comprehensive Procurement Strategy For Commission
Approval
In order to make a reasoned decision on SMECO’s procurement strategy, the
Commission should require it to make a compliance filing that details its entire
procurement strategy, including the information in the Power Execution Strategy for each
and every energy, capacity, ancillary services, and transmission hedge product that is part
of SMECO strategy for 2005 and beyond. Additionally, the Commission should require
that SMECO demonstrate that its strategy is reasonable and in the public interest by filing
an up-to-date risk analysis of the strategy and the expected total average cost of the
portfolio based on purchases made to date, market prices for planned forward purchases,
market price projections for short-term purchases, and their analysis of the risk of price
variations in short term and spot markets. There should also be periodic updates on the
progress of assembling the portfolio that include all purchases made to date, an updated
risk portfolio and expected value. Based on this information and whatever other record is
developed, the Commission should make a determination of whether SMECO’s strategy
is reasonable and in the public interest. To ensure that SMECO’s SOS prices for 2005
26
are reasonable, the Commission must make a determination of the reasonableness of the
risk associated with the procurement strategy for 2005.
A Commission decision on the merits of SMECO’s procurement strategy is only
meaningful prior to the execution of the strategy. An after-the-fact review of the
purchasing decisions made during a particular time period would have no bearing on the
risk to which customers had been exposed during that time period and there would be no
remedy if the Commission determined that SMECO’s procurement decisions had been
imprudent.
C.
It Is In The Best Interest Of SMECO’s Customers For The
Cooperative To Hedge Its Load To The Greatest Extent Possible
During the hearings in this matter, SMECO clarified that [BEGIN
CONFIDENTIAL MATERIAL]
[END CONFIDENTIAL MATERIAL]
While there will always be greater risk for customers whose
utility is pursuing a managed portfolio approach than for customers whose utility is
purchasing with full requirements contracts, [BEGIN CONFIDENTIAL MATERIAL]
[END CONFIDENTIAL MATERIAL]
Therefore, the Commission should state
in its order that it expects the strategy that SMECO files in compliance with the
Commission’s order should set forth a procurement strategy that hedges the load
obligation to the maximum feasible extent.
27
As stated above, the SMECO Board has already taken the position that it is in the
best interest of its customers to [BEGIN CONFIDENTIAL MATERIAL]75
[END CONFIDENTIAL MATERIAL]
The maximum feasible level of hedging
provides more protection for SMECO’s customers from price volatility risk and is in line
with the goals of the Case No. 8908 Settlement.
D.
Rate Issues
In prefiled testimony and during the hearing, OPC raised issues concerning the
elements of the Administrative Charge and allocation of costs among rate classes in the
Base SOS Rate and the Purchased Power Cost Adjustment (“PPCA”). The Stipulation
and Settlement Agreement (“Stipulation”) filed in this case resolves those issues in the
context of the conditions precedent of that Stipulation. Specifically, the Stipulation is
conditioned on the Commission allowing SMECO to continue to acquire power for its
SOS load using a self-managed portfolio. OPC maintains that the Commission should
require SMECO pursue a full-requirements contracts approach as argued in this brief.
The Stipulation resolves the retail rate issues OPC raised with the rate methodology
proposed by SMECO to be used in conjunction with SMECO’s proposed self-managed
portfolio approach.76 If the Commission agrees with OPC and requires SMECO to utilize
a full-requirement contract approach, SMECO’s retail rates would be set using a
methodology along the lines of that used for Case No. 8908.
75
T. 255, l. 12-20, testimony of SMECO witness J. Brannan.
Stipulation 1, p. 2 (“NOW, THEREFORE, in the event that the Commission authorizes SMECO to
proceed procuring SOS supplies using a self-managed portfolio, the Settling Parties agree to the following
settlement and compromise:…”).
76
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V.
Conclusion
WHEREFORE, for the reasons state above, OPC respectfully recommends that
the Commission direct SMECO to utilize a full-requirements contracts approval to
acquisition of power for its SOS load. If the Commission allows SMECO to continue
with its self-managed portfolio approach, OPC respectfully recommends that the
Commission require SMECO file a comprehensive and detailed procurement strategy for
Commission approval prior to the 2005 service year.
Respectfully submitted,
______________________
Theresa V. Czarski
Deputy People’s Counsel
______________________
William F. Fields
Assistant People’s Counsel
August 3, 2004
Maryland Office of People’s Counsel
6 St. Paul Street, Suite 2102
Baltimore, Maryland 21202
(410) 767-8150
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CERTIFICATE OF SERVICE
I HEREBY CERTIFY that on this _____ day of August 2004, a copy of the
foregoing Initial Brief of the Maryland Office of People’s Counsel was mailed via firstclass, postage prepaid to all parties of record.
_______________________
William F. Fields
Assistant People’s Counsel
Maryland Office of People’s Counsel
6 St. Paul Street, Suite 2102
Baltimore, MD 21202
410-767-8150
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