California Humming With Debate Over Deregulation of Electricity : Utilities: Key issues are likely to be resolved this week when the PUC issues its formal recommendations.

The details may be enough to make a person’s eyes glaze over, but few issues affect more people in the state than electricity deregulation, a subject that has been the focus of debate among utility companies, regulators and ratepayers for the better part of two years.

At issue is the future shape of the $20-billion industry that produces, distributes and transmits electricity throughout California as it moves from a regulated monopoly of vertically integrated utilities to a market-driven economy of big and small players.

The upheavals that are in store are comparable on a regional level to the changes that rocked the nation when long-distance telephone service was deregulated, or when American Telephone & Telegraph was broken up.

The issue is being watched well beyond California. Regulators around the country are waiting to see how deregulation takes place here as they consider moving their own industries toward market systems.

Key issues remain unresolved, particularly the ultimate form a competitive market will take, who will pay for the changes and how much they will cost.

But those matters are likely to edge closer to resolution in a few days, when the California Public Utilities Commission issues its formal recommendations at a meeting in San Francisco on Wednesday. The final recommendation is likely to require legislative action and federal approval as well.

Driving the entire process is the desire by consumers and businesses to lower the state’s electricity rates, now among the highest in the nation.

On average, Californians pay 10.28 cents per kilowatt-hour of electricity, or nearly 50% more than the national average, according to the PUC.

“You have some major businesses where utility rates are an important part of doing business, and if you lower them, it makes them more attractive for businesses to stay here and to expand here,” said Ray Remy, president of the Los Angeles Area Chamber of Commerce.

For consumers, the key issues will be the continuing widespread availability of service, potential shifting of costs from big to small customers and how much it will cost to make the transition.

For utilities, the key issues will be maintaining a fair profit margin and market share, coverage of their sunk or stranded costs and protection of shareholder interests, particularly in the face of potential competition from out-of-state generators. (Sunk or stranded costs are those that have already been incurred, such as investments in nuclear power plants, but have not yet been recovered through the current rate structure.)

The utilities have already begun preparing for the sea change. Southern California Edison Co., for example, recently announced a major streamlining of its operations to make it quicker on its feet. In the Bay Area, Pacific Gas & Electric Co. similarly announced it would separate its power plant and power line businesses into discrete units.

Four proposals are now on the table:

* The pool proposal, which was put forward in May by PUC President Daniel Fessler and Commissioner Gregory Conlon. Modeled on British systems, it would create a wholesale pool into which power generators would sell electricity and from which wholesale customers would buy power for distribution to retail customers. Rates would be set by the market in real time.

Initially, this was the front-running proposal, but it was vigorously attacked by businesses, consumer groups and environmentalists and now looks unlikely to be adopted without significant modifications.

* Also in May, PUC Commissioner Jessie Knight Jr. offered the main competing proposal, which would provide for so-called direct access by consumers to power through individual agreements forged with the producers themselves. That proposal had little backing on the commission when first introduced, but elements of it may end up in the final recommendation.

* A compromise proposal, negotiated by Gov. Pete Wilson and sponsored by Southern California Edison and its larger customers, would combine elements of the two other proposals and provide for full recovery of utilities’ transition costs.

* A framework for restructuring, sponsored by major consumer and environmental groups, would likewise be a compromise. Key to this proposal is opposition to full recovery by utilities of their sunk costs.

At the heart of each proposal is the intention to replace the regulatory process now used to set rates with market- and performance-based rates, in much the same way the natural gas and telecommunications industries have been freed of regulatory constraints.

The Real Costs

Hanging over all the discussion of the form a market system would take is how the utilities--Edison especially--will handle the costs of transition.

Those would consist primarily of the past costs of building nuclear power plants, as well as the costs of honoring government-mandated contracts to buy power from alternative power generators, such as solar and wind, at above-market rates.

The costs of these uneconomical contracts are now built into electricity rates. Under a market system, they would have to be calculated separately and added to customer bills as an extra charge.

Estimates of these transition costs are all over the map. They may be so high that some observers think they could end up raising overall rates.

One study, by the state Office of Energy Assessments, predicted that under either Fessler’s pool proposal or Knight’s direct-access proposal, the added costs of compensating Edison for the cost of its nuclear power plants and other transition costs would more than offset any market reduction in rates.

Under restructuring, Edison would be guaranteed higher revenues for at least 10 years, which would not be offset by customers’ savings for 10 years after that, wrote Douglas M. Grandy, chief of the Office of Energy Assessments, in an August letter to the PUC.

Consumer groups have argued that the utilities are already being compensated for their sunk costs through the current rate structure. In the case of Edison, they argue, ratepayers could be left holding the bag for as much as $5 billion in extra charges for the sunk costs in the San Onofre nuclear plant alone.

For its part, Edison worries that it may end up the big loser if its costs are underestimated or if it can’t recover the full measure of its past investments in nuclear power plants or alternative power contracts. The utility also acknowledges that ratepayers could end up losers if such costs are overestimated.

“The inevitable result of an upfront, one-time estimate of transition costs is that the forecast will prove to be wrong, perhaps grossly wrong,” Edison said in some of its written testimony. “If grossly wrong, the result will be either a financial meltdown of the utility or windfall profits for shareholders and unfair cost burdens for customers.”

The effect on utilities could be catastrophic. Moody’s Investors Service this summer estimated that the total amount of stranded costs for 114 U.S. investor-owned utilities is about $135 billion, with 34 of those utilities facing exposure equal to or greater than their total equity.

Edison’s own stranded costs are among the highest: $12.4 billion, 2 1/2 times its estimated $4.9 billion in equity, Moody’s calculated. Pacific Gas & Electric’s stranded costs are $9.5 billion, more than its $8.5 billion in equity.

“If stranded costs are not fully recoverable, they will have an impact on a significant portion of the industry,” Moody’s said.

The Case of San Onofre

An example of the dilemma confronting regulators on the issue of stranded costs is the case of the San Onofre Nuclear Generating Station, 95% owned by Edison and San Diego Gas & Electric.

The question is whether and how much to reimburse the utilities for the costs of building and operating the plant.

The matter is likely to be settled in the next week, and will undoubtedly be figured into the restructuring recommendation.

The utilities argue that they are entitled to some form of reimbursement because they built the plant at great expense and in good faith in response to regulatory requests to boost production capacity in the 1960s.

The investments were made with the assumption that the plant would operate cheaply compared to plants powered by fossil-fuels, whose prices were expected to skyrocket.

The problem is that fossil fuel prices plummeted in the 1980s. The utilities fear that under the market system being proposed by the commission, San Onofre would find itself producing power that was too costly to sell.

A settlement in November, 1994, between the utilities and the PUC’s Division of Ratepayer Advocates would have allowed the utilities to continue operating the plant and selling power at above-market rates over the next three years.

That would have meant about $400 million a year to Edison and less than $100 million for SDG&E.;

The settlement also would have allowed the utilities to earn an 8% annual return on the utilities’ investments in the plant, which are estimated to be about $2 billion on the part of Edison and $700 million on the part of SDG&E;, and allow recovery of those costs over eight years.

That would modify the existing terms of a 10% return over 13 years.

That settlement required approval by the full commission. But a judge this year recommended that the commission reject the settlement, and Fessler himself has put forward an alternative that is less generous to the utilities, allowing them a 3.8-cent-per-kilowatt-hour rate and a 6% return.

Edison opposes the alternative proposal, which it says would reduce its operating revenue by about $120 million in 1996.

For their part, opponents of the continued operation of San Onofre argue that the non-competitive plant should simply be mothballed and written off. They argue that ratepayers would be forced to pay more than $5 billion in above-market electricity prices over the next eight years under the terms of the original settlement.

“If Edison gets what it wants in the deregulation plan and the proposed San Onofre settlement, consumers will continue to pay high prices and utilities will reap windfall profits,” said Mike Florio, an attorney with the consumer group Toward Utility Rate Normalization.

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The Proposals

Here are the four proposals on electric deregulation currently before the California Public Utilities Commission:

POOL

* Power producers would sell electricity to a pool, from which wholesale customers would buy power for distribution to retail customers.

* Cost of generation would be determined hourly or half-hourly by an auction at the wholesale level conducted by an independent pool system operator.

* Wholesale consumers would provide so-called “bundled” service to retail customers, transmitting and distributing electricity for a single price.

* Switch-over to this system would begin no later than Jan. 1, 1997. After two years, retail customers would be able to buy electricity directly from power producers, subject to certain conditions.

* Utilities would be permitted to recover 100% of “stranded” costs.

DIRECT ACCESS

* Consumers would be allowed to buy power directly through individual agreements with power producers.

* Consumers would also have the option of buying power from a regulated utility or participated in voluntary pools.

* Service could be “unbundled,” meaning generation, distribution and transmission would be provided by different entities at separate rates.

* Higher rates or cost-shifting among consumer groups would be prohibited.

* Utilities would be allowed to recover 90% of the non-economic portion of their power plants, but 100% of the cost of maintaining non-economic power contracts.

MEMORANDUM OF UNDERSTANDING

* Negotiated by Gov. Pete Wilson and sponsored by Southern California Edison Co. and its larger customers, it would combine elements of the pool and direct access proposals.

* Like the pool proposal, would set up a wholesale pool and an independent system operator, but like the direct access proposal, it would also allow for retail competition for certain customers.

* Utilities would be allowed to recover 100% of transition costs.

* Direct access would be phased in over five years.

FRAMEWORK

* Sponsored by major consumer and environmental groups, it would combine elements of the pool and direct-access proposals.

* It would oppose the full recovery by utilities of stranded costs.

* Rate cuts for customers would be explicitly ordered.

* It argues that power producers should be denied incentives for keeping uneconomical plants in operation, and that groups of small customers should be allowed to compete with large customers for the best electric rates.

--PATRICK LEE