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Impact of Act 129 on Pennsylvania Default Electricity Service

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On Oct. 15, 2008, Pennsylvania Governor Ed Rendell signed into law House Bill 2200 as Act 129 of 2008 (“Act 129”),1 which effects significant changes to the Commonwealth's electricity market policy relating to, among other things, default service by local utilities. Default service is the backstop electricity service that utilities must provide customers who are not being served by a competitive supplier.

Act 129 amends the Public Utility Code and changes the landscape for electricity default service by imposing a new legal standard – least cost procurement over time – which utilities must meet in the procurement of generation supply for default customers.

Act 129 may create regulatory uncertainty for default service in the near future. As a result, we will likely see contested proceedings before the Pennsylvania Public Utility Commission (the “Commission”) as it implements the new legal standard.

Furthermore, default service plans of two major utilities – PECO Energy Company (“PECO”) and PPL Electric Utilities Corporation (“PPL”) – are in the early stages of proceedings before the Commission, and though the utilities will be filing supplemental testimony in support of their plans, it is unclear how the Commission will apply Act 129’s requirements.

What Is Default Service?

Pennsylvania restructured its electricity market with the passage in 1996 of the Electric Generation Customer Choice and Competition Act (the “Competition Act”).2 The Competition Act provided customers the ability to freely choose their electricity supplier to meet their electricity supply needs.3

It opened generation supply service to competition among suppliers and shifted the risk of generation investment from customers onto shareholders. It did not, however, eliminate the utilities’ obligation to serve electricity customers.4

Although the concept seems diametrically opposed to a competitive market, the utilities’ continued “obligation to serve” customers in a restructured market stems from the fact that, for a variety of reasons, some electricity customers have chosen not to select an alternative electricity supplier or, in the reverse, some electricity suppliers have chosen not to serve certain customers.5

The utilities’ continued obligation to serve customers in the restructured electricity market has been termed “default service.”6

Default Service Before Act 129

The Competition Act was implemented by a series of utility restructuring settlements, which capped the utilities’ rates for supply, distribution and transmission services while permitting utilities to fully recover stranded costs (the “restructuring transition period”).7

The expiration of the utilities’ restructuring transition periods triggers their obligation to provide customers default generation supply,8 which must be acquired by utilities at “prevailing market prices.”9

Utilities are guaranteed the right to recover fully all reasonable costs associated with providing default service.10

The Competition Act required the Commission to promulgate regulations defining the utilities’ obligation to serve customers at the end of the restructuring transition periods.11

After three years of a series of roundtables and public comment periods, the Commission adopted a Final Rulemaking Order12 promulgating Default Service Regulations and a Final Policy Statement13 in May 2007.

The Default Service Regulations provided utilities flexibility and discretion in certain areas, for which the Final Rulemaking Order and Final Policy Statement provided guidance on the Commission’s preferred general framework for default service.14

The Default Service Regulations required the utilities to develop a procurement plan to acquire electric generation supply at prevailing market prices.15

The regulations defined “prevailing market prices” as “[t]he price that is available in the wholesale market at particular points in time for electric generation supply.”16

For a default service procurement plan to successfully meet the legal standard of “prevailing market prices,” the Commission’s Final Rulemaking Order recommended a portfolio of spot market purchases and short-term fixed contracts (i.e., one year or less).17

In this regard, the Commission stated that it had a policy preference for short-term contracts over long-term contracts, concluding that customers will save more money over time with the gradual increase of utilizing short-term fixed price contracts and spot market prices.18

In fact, the Commission stated it was “generally skeptical of the [utility’s] ability to beat the market over periods of time greater than one year.”19

This is not to say that the Commission fully opposed the use of long-term contracts in meeting the “prevailing market prices” standard.

However, it limited its support for the use of long-term contracts to two narrow circumstances:

  1. to meet the supply requirements of the Alternative Energy Portfolio Standards Act of 200420 (the “AEPS Act”), which requires utilities and electric generation suppliers to gradually increase their utilization of renewable energy sources to 18% of their total sales by 2021; and
  2. to meet the supply needs of residential and small business customers in the early years of the post-transition period in order to minimize price volatility in the early years of posttransition.21

However, the Commission emphasized that the use of long-term contracts should “only be used when necessary and required for [utility] compliance with [the AEPS Act], and should be restricted to covering a relatively small portion of the default service load.”22

It further emphasized that “an over-reliance on long-term contracts would mute demand response, create the potential for future default service customers to bear future above market costs, and limit operational flexibility for [utilities] to manage their default service supply.”23

As for the method of procuring generation supply, the Commission disfavored bilateral contracting, concluding that the optimal method of acquiring electricity includes a direct exposure to market forces, either through a competitive procurement process (such as an auction or request for proposal (“RFP”)) or a purchase in a spot market.24

The Commission stated that it was “very skeptical of a [utility’s] ability to obtain the best prices for customers with bilateral, long-term contracts.”25

The Commission indicated that it preferred competitive bid processes and spot market energy purchases in order to carry out the objectives of the Competition Act – that is, such procurement methods ensure that default service rates more closely track prevailing wholesale market prices and encourage customer choice of generation suppliers through direct access to retail competitors.26

Additionally, the purpose of these procurement methods is to mitigate rate volatility as terms of default service plans expire, the idea being that customers will not experience large changes in rates as default service plans expire if rates more closely track wholesale energy prices throughout the default service plan.27

How Act 129 Changes The Landscape For Default Service

Act 129 amends the Competition Act28 and changes the requirements for electricity default service in a few significant ways. First, Act 129 imposes a new legal standard for default service procurement plans.

While keeping the requirement that utilities must procure generation supply at “prevailing market prices,” such procurement must now also be at the “least cost to customers over time.”29

Next, Act 129 requires utilities to achieve least cost procurement through a “prudent mix” of spot market purchases, short-term contracts and long-term contracts of four to twenty years in length.30

The prudent mix entered into by utilities applies to any type of energy purchased to provide default service, including energy or alternative energy credits required to be purchased under the AEPS Act.31

While it is clear that long-term contracts are contemplated as a resource that should be part of the prudent mix under Act 129, it is not certain that such contracts must be included for each customer class.

Nor is it clear that a “prudent mix” would include a long-term contract for each type of energy purchased to provide default service, including energy or alternative energy credits required to be purchased under the AEPS Act.

It is equally unclear how utilities will meet their burden of proof in showing that their procurement method of choice meets the new “least cost” standard.

Perhaps out of a recognition of there being no clear consensus on the benefits of using longterm contracts, Act 129 limits the use of long-term contracts to a maximum of 25 percent of the default service projected load, but it does not set a floor.32

However, the 25 percent limit may be exceeded if the Commission, after a hearing, determines for good cause that a greater portion of load is necessary to be served by longterm contracts in order to achieve least cost procurement.33

Finally, Act 129 requires utilities to acquire a prudent mix of generation supply through a competitive procurement process, including auctions, RFPs or bilateral agreements entered into in the “sole discretion” of the utilities.34

Bilateral agreements under Act 129 must be at prices which are no greater than the cost of obtaining generation under comparable terms in the wholesale market;35 however, concern over the use of bilateral contracting stems from potential below-the-market contracts with affiliates that would harm the development of wholesale and retail competition over time.

In an apparent attempt to assuage concern over affiliated transactions, bilateral agreements are subject to Commission review and approval under Chapter 21 of the Public Utility Code–relating to relations with affiliated interests.36

Time will reveal the efficacy of such a safeguard.

Conclusion

Several utilities already have default service plans approved pursuant to the Commission’s regulations on default service. Under Act 129, such plans may remain in effect through their approved term.

Those utilities that only recently commenced proceedings to obtain approval of proposed default service plans – PECO and PPL – will need to modify their plans to ensure compliance with the new legal standard of least cost over time. On a procedural level, Act 129 changes the time frame for such proceedings from seven months to nine months.37

In sum, Act 129’s treatment of default service is a departure from the Commission's regulations in that it provides a new legal standard of least cost to consumers over time, contemplates the utilization of long-term contracts, including contracts up to twenty years in length, and allows bilateral agreements as a method of competitive procurement.

  1. Press Release, Governor Rendell Signs Energy Conservation Bill to Save Consumers Millions on Electricity; Urges Legislature to Pass Rate Mitigation Bill (Oct. 15, 2008) (on file with the Governor’s Office).
  2. 66 Pa.C.S. §§ 2801-2812.
  3. 66 Pa.C.S. § 2801.
  4. 66 Pa.C.S. § 2807(e)(3) (“If a customer contracts for electric energy and it is not delivered or if a customer does not choose an alternative electric generation supplier, the…[utility]…shall acquire electric energy at prevailing market prices to serve that customer and shall recover fully all reasonable costs.”).
  5. For example, electricity suppliers may be reluctant to serve particular customers because of customer location, customer load patterns or a customer’s credit history.
  6. It was once termed “provider of last resort” service in keeping with the concept of it being backstop service for customers who do not receive power from competitive electricity suppliers.
  7. See Joint Petition for Full Settlement of PECO Energy Company’s Restructuring Plan and Related Appeals, Docket Nos. R-00973953 and P-00971265 (Apr. 30, 1998); see also Joint Petition for Full Settlement of PP&L, Inc.’s Restructuring Plan and
    Related Court Proceedings, Docket No. R-0097395 (Aug. 12, 1998); Joint Petition for Full Settlement of Pennsylvania Power Company’s Restructuring Plan and Related Court Proceedings, Docket No. R-00974149 (Apr. 1, 1999); Joint Petition for Full Settlement of Restructuring Plans of Metropolitan Edison Company and Pennsylvania Electric Company and Related Dockets and Related Court Proceedings, Docket Nos. R-00974008 and R-00974009 (Sept. 23, 1998); Joint Petition for Full Settlement of West Penn Power Company’s Restructuring Plan and Related Court Proceedings, Docket No. R-00973981 (Nov. 3, 1998).
  8. 66 Pa.C.S. § 2807(e)(3).
  9. Id.
  10. Id.
  11. 66 Pa.C.S. § 2807(e)(2).
  12. Rulemaking Re Electric Distribution Companies’ Obligation to Serve Retail Customers at the Conclusion of the Transition Period Pursuant To 66 Pa.C.S. § 2807(e)(2), Final Rulemaking Order, Docket No. L-00040169 (May 10, 2007) (“Final Rulemaking Order”).
  13. Default Service and Retails Electric Markets, Final Policy Statement, Docket No. M-00072009 (May 10, 2007) (“Final Policy Statement”).
  14. 52 Pa. Code § 69.1802(c).
  15. 52 Pa. Code § 54.186(a),(b)(1).
  16. 54 Pa. Code § 54.182.
  17. Final Rulemaking Order at 16, 24-25.
  18. Id. at 24-25.
  19. Id. at 25.
  20. 73 P.S. § 1648.1, et seq.
  21. Final Rulemaking Order at 24-25; 52 Pa. Code § 69.1805.
  22. 52 Pa. Code § 69.1805.
  23. Id.
  24. Final Rulemaking Order at 20.
  25. Id. at 20 n. 9, 25.
  26. Id. at 5, 22.
  27. Id. at 5.
  28. 66 Pa.C.S. §§ 2807(3.1)-(3.9).
  29. 66 Pa.C.S. § 2807(e)(3.4).
  30. 66 Pa.C.S. § 2807(e)(3.2).
  31. 66 Pa.C.S. § 2807(e)(3.5).
  32. 66 Pa.C.S. § 2807(e)(3.2).
  33. 66 Pa.C.S. § 2807(e)(3.2).
  34. 66 Pa.C.S. § 2807(e)(3.1).
  35. Id.
  36. Id.
  37. 66 Pa.C.S. § 2807(e)(3.6).

"Impact of Act 129 on Pa. Default Electricity Service" was originally published in Law360, and has been reprinted with Law360's permission.