‘Bypassing’ Affects Rate Rulings : PUC Trying to adapt to New Environment

May Co. used its clout as a major telephone customer of Pacific Bell to obtain a special rate to transmit data between its department stores--a rate that, uniquely, will not increase for seven years, regardless of what happens to rates paid by the utility’s other customers.

The California Public Utilities Commission granted the phone company’s request out of concern that, if May Co. and other major users were to leave the regulated network, remaining customers would wind up paying more for basic telephone service.

Nor is the capability of large utility users to bypass regulated systems limited to telecommunications. “Among all the utilities, you now have a lot of entrepreneurs running around, combing the field,” observed William Aherne, director of the PUC’s public staff. “May Co. was in to cut a special deal on rates to keep it on Pacific Bell’s network.”

The May Co. ruling reflects a radically changing environment in utility regulation, one that challenges traditional practices and is testing the mettle of the five appointed PUC members, whose own membership will undergo a majority change by the end of next year.

Crucial Decisions

The commission faces a series of crucial multibillion-dollar decisions that will profoundly affect the futures of the major utilities it regulates and the bills paid by their customers.

“We are never again going to be a commission the people don’t pay attention to,” said Commissioner Priscilla C. Grew. “Now that utility costs have become a significant part of the family budget, people are going to stay permanently interested.”

As the economy moves “toward a greater reliance on the private market to resolve problems,” PUC President Don Vial said, the result will be to “segment” consumer interests by market clout. “The largest users will be able to shift costs to those with less market power,” he predicted.

In such a regulatory environment, Vial said, the PUC must weigh the “social cost” to society if high rates drive major users from the regulated networks in favor of new and less costly alternatives, taking with them revenue that formerly helped support the fixed cost of maintaining the utilities’ distribution system. These fixed costs then would have to be borne by a shrinking customer base composed of small businesses and residences.

“We’re trying to inject a level of balance on the social issues,” he said, “and that’s tough to do. Someone ‘s going to have to pay.”

Broader Issues

The ramifications of divesting AT&T; of its local telephone companies, which resulted in formation of Pacific Telesis Group as parent of Pacific Bell and successor to Pacific Telephone, have dominated PUC deliberations for several years. But broader issues of “network bypass” and the related question of how much utility customers should pay of the cost of building such huge projects as San Onofre Nuclear Power Station are now competing for center stage.

The pressure to keep large users from bypassing utility systems by increasing residential rates closer to the utilities’ costs of providing service will be “a major theme” in PUC deliberations in coming years, predicted commissioner Grew. Large customers can buy gas directly from utilities, bypassing the normal tariffs and network, she explained, while large electric customers can switch to gas if that becomes economical or even generate their own power. In addition, major telecommunications customers can build or lease private systems.

In each case, the effect on utilities is a loss of revenue without a corresponding cut in the cost of maintaining the gas, electricity or telephone system.

Adding to the pressure, Grew said, is the fact that the state is enjoying an energy surplus just as the big nuclear power generators at San Onofre in northern San Diego County and Diablo Canyon in San Luis Obispo County become fully operational. This raises questions about the role of conservation in setting rates, she said. For example, should rates rise with usage to discourage consumption? And if rates do rise with usage, will that force major customers to switch to cheaper alternatives? Should utilities exploit their new nuclear-power resources, or buy currently cheaper hydroelectric power from the Pacific Northwest?

Recognition of the PUC’s increased visibility led to a reorganization of the staff last August, said executive director Joseph Bodovitz.

A new public-staff division was created to “consider the interests of all customers of a utility over the long run ,” Bodovitz said. “This means present and future ratepayers, residential, commercial, industrial, etc.” The PUC then weighs all the evidence before attempting to strike a reasonable balance between the often-differing needs of consumers and the utilities.

In addition, he said, a new evaluation and compliance division audits utility claims and insures that utilities follow PUC policies.

Consumer Advocates

The new structure was designed to clarify staff roles, Bodovitz said. The public staff now acts strictly as a consumer advocate and theoretically has no more access to the commissioners than do representatives of the regulated utilities. In contrast, the evaluation and compliance division, said director Bruno A. Davis, “is an extension of the commission itself.”

“Everybody’s perception is more clear now about what the roles are,” agreed the PUC’s newest commissioner, Frederick R. Duda, a former corporate lawyer from Oakland appointed by Gov. George Deukmejian last Nov. 27.

The remainder of the 1980s will test the effectiveness of the reorganization and the wisdom of the five appointed commissioners. Commissioner William T. Bagley, Deukmejian’s first nominee, who says he accepted the appointment with the understanding that he would likely not finish a six-year term, said he plans to step down “in a matter of months, after I wind up a few things I’m working on.”

That will leave Duda and the three appointees of Deukmejian’s predecessor, Edmund G. Brown Jr.--Vial, Grew and Victor Calvo. While Vial’s term has four years to run, those of Grew and Calvo expire on Dec. 31, 1986.

So by 1987, four of the five commissioners will likely owe their jobs to Deukmejian.

By then, PUC may well have made some key regulatory decisions. With completion of the last big construction projects--San Onofre and Diablo Canyon nuclear plants and the Helms Pump Storage Facility--the commissioners must now decide how much of their cost was “prudent” and reimbursable through customers’ rates.

Could Bankrupt Utilities

“We could bankrupt the utilities,” said Commissioner Bagley. “However,” he added, “where someone put the roof on backwards, we’re going to disallow that!”

The stakes are as large as the projects’ enormous price tags. The differences of viewpoint between the utilities and the public staff serve to underline the controversy surrounding the commissioners’ eventual rulings:

- Pacific Gas & Electric seeks to recover from its customers the $5.6 billion it spent building nuclear generating units No. 1 ($3 billion) and No. 2 ($2.6 billion) at Diablo Canyon. While the PUC’s study of those expenditures is only preliminary, the public staff has indicated already that it questions $2.5 billion of Unit 1’s $3-billion cost.

- PG&E;’s Helms Pump Storage Facility in the Sierra Nevada east of Fresno, which resumed operation on May 1 after being closed for repairs shortly after opening last June, cost the company nearly $1 billion. While about $250 million of that is in litigation between PG&E; and a supplier over an 18-month delay and repair costs caused by a burst pipe, the commission staff has recommended that $44 million spent to replace problem generators be borne by PG&E;’s shareholders, not its customers.

- Construction of Units No. 2 and No. 3 at San Onofre Nuclear Generating Station, musically referred to as SONGS, cost Southern California Edison and its junior partners, including San Diego Gas & Electric, $4.5 billion. The staff has recommended granting just $3.7 billion in rates, leaving $762 million--roughly the company’s 1984 net income--on the shareholders’ shoulders.

In addition, the commission will try to strike a balance later this year in a highly controversial rate case filed by Pacific Bell. The telephone company originally requested a $1.3 billion rate increase for 1986, then scaled it down to $935 million in the light of lower inflation and interest rates and reduced overhead. But the PUC public staff has recommended that, far from a rate increase, Pacific Bell’s rates should be decreased by $480 million--leaving a $1.6-billion gap between for the commission to consider.

On ‘Watch List’

The awesome gap prompted the Chicago-based financial consulting firm of Duff & Phelps to list Pacific Bell debt on its “watch list” for possible downgrading as investment vehicles.

Disposition of the Pacific Bell rate case will provide the first clear evidence of how--and how forcefully--the five commissioners intend to restructure telephone rates to remove price incentives for large users to make private telecommunications arrangements. If the PUC is intent on making rates track costs, residential rates are sure to rise significantly; both Pacific Bell and General Telephone claim that the cost of providing a dial tone, the most basic service, averages more than twice current basic monthly charges.

And those monthly charges traditionally have been averaged throughout the network so that customers in less-dense areas pay about the same rate to obtain a dial tone, the basic hookup, as those in metropolitan areas, where economies of scale make the service considerably less costly. In other words, urban dwellers subsidize the telephone service of rural dwellers--all in the name of keeping service affordable for all who need it.

In addition, below-cost residential telephone service has been subsidized from toll and Yellow Pages revenues, both of which now are under competitive pressures and cannot safely be increased. Such “cross-subsidies” were feasible within the integrated Bell System operating as a regulated monopoly--not in a world of alternative suppliers, Pacific Bell argues.

Cheap Rates Ending

Even the customers’ newest advocate, the PUC public staff, agrees that the era of cheap utility rates is ending. “It’s time to adjust prices more closely to actual costs,” said director Aherne. Where utility rates are set too far above cost, they create opportunities for firms to bypass utilities and to use less costly alternatives, he said.

May Co.’s “tailored” data-transmitting phone rate may be the exception today, Vial said, but it could well become the rule tomorrow as the PUC struggles to adjust to a more market-oriented regulatory environment.

“The marketplace responds to those who have money,” he said. “For them it’s a marvelous, neutral system. But for those who don’t have money in their pockets, it’s a very negative, cruel system that doesn’t recognize needs.”