UNITED STATES OF AMERICA BEFORE THE FEDERAL ENERGY REGULATORY COMMISSION

Transcription

1 UNITED STATES OF AMERICA BEFORE THE FEDERAL ENERGY REGULATORY COMMISSION Credit and Capital Issues Affecting the ) Docket No. AD Electric Power Industry ) COMMENTS OF SOUTHERN CALIFORNIA EDISON COMPANY Gary Y. Chen Southern California Edison Company 2244 Walnut Grove Avenue Post Office Box 800 Rosemead, CA (626) gary.chen@sce.com Attorney for SOUTHERN CALIFORNIA EDISON COMPANY January 30, 2009

2 TABLE OF CONTENTS I. INTRODUCTION AND SUMMARY...1 II. USE OF ADDITIONAL COST OF CAPITAL MODELS...2 III. METHODS FOR SELECTING PROXY GROUP COMPANIES...3 IV. USE OF MEDIAN ESTIMATES...4 V. CREDIT RATINGS...5 VI. DEBT EQUIVALENCE...5 VII. CAPACITY MARKETS ARE A SUPERIOR SOLUTION...6 VIII. CONCLUSION...7 i

3 UNITED STATES OF AMERICA BEFORE THE FEDERAL ENERGY REGULATORY COMMISSION Credit and Capital Issues Affecting the ) Docket No. AD Electric Power Industry ) COMMENTS OF SOUTHERN CALIFORNIA EDISON COMPANY Southern California Edison Company ( SCE ) hereby submits the following comments in the above-captioned proceeding in response to the Federal Energy Regulatory Commission s ( Commission or FERC ) Supplemental Notice of Technical Conference issued on December 18, SCE is submitting these comments to provide its views on certain topics discussed in the Technical Conference ( Conference ) held in this docket on January 13, SCE appreciates this opportunity to present its perspective on cost of capital issues and other matters that are the subject of this docket. I. INTRODUCTION AND SUMMARY At the Conference, Chairman Kelliher specifically requested that the conference panelists address the extent to which there is a need for change in existing FERC policy with respect to credit and capital issues, or the extent to which it's important that current policy continue in place. 1 SCE believes that there are three aspects of the Commission s current preferred methodology for determining electric utility return on equity that should re-examined: (1) reliance only on the Discounted Cash Flow ( DCF ) 1 Conference transcript, p. 2, ll (Acc. No ; Transcript ). 1

4 model, (2) methods for selecting proxy group companies, and (3) use of median estimates from the proxy group results. In addition to commenting on the Commission s methodology for determining return on equity, SCE also addresses credit ratings and two issues related to power procurement: (1) debt equivalence, and (2) the merits of capacity markets and long-term power purchase agreements. II. USE OF ADDITIONAL COST OF CAPITAL MODELS In general, the Commission relies exclusively on estimates from the DCF model to determine return on equity ( ROE ) for electric utilities. Although reliance on only one model reduces the analytical burden of determining ROE and can promote model consistency among litigated ROE outcomes, no one financial model can be expected to estimate ROE accurately in all circumstances. And as the Commission is aware, the paramount test of reasonableness for ROE is the end result of the estimation process, not the means by which it is achieved. 2 In Order No. 679, the Commission recognized that there is a benefit to introducing more information into the analysis process, and we will consider on a caseby-case basis whether the application of the traditional DCF analysis should be modified 3 The Commission has previously recognized that it may be appropriate to consider 2 Under the statutory standard of just and reasonable it is the result reached not the method employed which is controlling. It is not theory but the impact of the rate order which counts. Federal Power Commission et al. v. Hope Natural Gas Co., 320 U.S. 591, 602; 64 S.Ct. 281, (1944). 3 Promoting Transmission Investment through Pricing Reform, Order No. 679, FERC Stats. & Regs. 31,222, order on reh g, Order No. 679-A, FERC Stats. & Regs. 31,236 (2006), order on reh g, 119 FERC 61,062 (2007) at P

5 methods in addition to the DCF method. For example, in Distrigas of Massachusetts Corp, the Commission stated that no one methodology is preferred to the exclusion of all others. The DCF methodology, which we endorse, is but one analytical tool. 41 FERC 61,205 at 61,550 (1987). The Commission added in a later case that [i]n some instances, the DCF methodology alone may be inappropriate. Williston Basin Interstate Pipeline Co., 50 FERC 61,284 at 61,913 n. 90 (1990). SCE urges the Commission to carefully reassess the use of additional financial models to determine the ROE for electric utilities, and to employ them in appropriate circumstances. This is especially important now because financial market conditions can change rapidly, reducing the likelihood that the Commission s preferred DCF methodology will give the correct result in all cases. III. METHODS FOR SELECTING PROXY GROUP COMPANIES In several recent electric utility ROE decisions, the Commission has selected a regional proxy group of companies for its DCF analysis. This approach does not comport with the structure of financial markets today. Electric utilities finance their activities in national and in some cases, international financial markets. The Commission s regional proxy group approach can result in ROE estimates for utilities of the same risk category, but in different geographic areas, that vary by nearly two percent. This is not a reasonable result. With respect to comments by presenters at the Conference, it is noteworthy that none of the presenters referred to regional financial markets in any way. This fact by itself should demonstrate that there are not regional differences in the cost of capital for 3

6 electric utilities of similar risk. 4 Excluding otherwise comparable utilities from the proxy group solely based on geographical location makes the proxy group less representative and therefore renders the DCF analysis less robust. For this reason, the regional proxy group approach produces flawed results and the Commission should return to a national proxy group approach. 5 IV. USE OF MEDIAN ESTIMATES In several recent cases, the Commission has adopted the use of a median estimate to determine ROE for a single company, while retaining its previous method of using a midpoint estimate to determine ROE for the members of a Regional Transmission Organization (RTO). The defect of the median approach is that it only considers the middle of the distribution of estimates and does not account for the full range of company estimates produced by the selected proxy group. 6 In this way, the median estimate is inferior to the midpoint estimate, or an arithmetic mean estimate, which takes account of 4 While the geographic location of an electric utility, particularly as it determines the state or states which regulate its retail rates, may affect its level of risk, the electric utility must compete for capital in national financial markets. 5 Petitions for rehearing addressing the use of a regional as opposed to national proxy group are currently pending in three dockets before the Commission. See Atlantic Path 15, LLC, Docket No. ER , Petition for Rehearing and Motion for Clarification of Southern California Edison Company, filed March 20, 2008; The Nevada Hydro Company, Inc., Docket No. ER , Petition for Rehearing of Pacific Gas and Electric Company, San Diego Gas & Electric Company, and Southern California Edison Company, filed April 23, 2008; and Startrans IO, L.L.C., Docket No. ER , Petition for Rehearing of Pacific Gas and Electric Company, San Diego Gas & Electric Company, and Southern California Edison Company, filed April 30, If the proxy group produces an odd number of estimates, then the median equals the middle estimate. If the proxy group produces an even number of estimates, then the median equals the average of the two middle estimates. 4

7 the full range of estimates produced by the chosen proxy group. In addition, the use of the median to estimate the ROE for a single company and the use of the midpoint to estimate the ROE for a group of companies has the potential to result in ROE differences between otherwise risk-comparable companies that are not reasonable. 7 V. CREDIT RATINGS At least two presenters, W. Paul Bowers and Garry Brown, discussed the significant differences that exist at the present time between the cost of financing for A- rated electric utilities and the cost for BBB-rated utilities. 8 Not only is there a substantial cost difference between the two rating classes at this time, but the experience of the past few months emphasizes the importance of enabling electric utilities to maintain A-class ratings so that they can access capital under all market conditions. 9 VI. DEBT EQUIVALENCE Several presenters at the Conference called for the use of 15-year power purchase agreements (PPAs) between utilities and independent power producers to ensure that new baseload generation will be built. 10 Although this may turn out to be the case in 7 A petition for rehearing addressing the use of the median, rather than the midpoint, of the zone of reasonableness is currently pending before FERC. See Golden Spread Electric Cooperative, Inc., et al. v. Southwestern Public Service Company, Docket Nos. EL , Docket No. ER , Motion to Intervene and Petition for Rehearing of Edison Electric Institute, filed May 21, Transcript, p. 17, l. 16 through p. 19, l. 14 and p. 42, l. 1 through p. 43, l Traditional analyses of optimal credit ratings do not generally contemplate situations where capital is not available at any price. At times during the past two years, and especially during the past five months, SCE has encountered situations where it had no access to the commercial paper market at any reasonable cost, even though its short-term credit ratings were investment grade. 10 See, for example, Transcript, p. 32, ll

8 some situations, regulators also need to recognize that PPAs create debt equivalence or imputed debt for the host utility. To offset the increased risk of this imputed debt, the host utility is required to carry more equity on its balance sheet to maintain its credit rating. 11 That in turn increases the overall cost of capital for the host utility, which must be taken into account when evaluating the benefit of PPAs. VII. CAPACITY MARKETS ARE A SUPERIOR SOLUTION Presenters at the conference discussed the relative merits of capacity markets and power purchase agreements as means to ensure that new generation capacity is constructed in a timely manner. 12 SCE notes it is actively working as a member of the California Forward Capacity Markets Advocates ( CFCMA ) 13 to promote a centralized capacity market at the California ISO. CFCMA has filed proposals at the California ISO and the California Public Utilities Commission for a centralized capacity market similar to forward capacity market designs used in PJM and ISO New England. A key and unique feature of the CFCMA design is it allows new generation that clears in the centralized capacity auction the option of obtaining up to a 10-year fixed capacity payment at the auction clearing price (indexed to inflation). The certainty of a 10-year capacity payment presents a path that allows the construction of new generation without the need for a long-term PPA. 11 Transcript, p. 64, ll See, for example, Transcript, p. 31, l. 4 through p. 32, l The other members of CFCMA are San Diego Gas & Electric, Reliant Energy, NRG Energy, and NextEra Energy Resources (formerly FPL Energy). 6

9 VIII. CONCLUSION The recent upheavals in the financial markets have highlighted the importance of maintaining electric utilities that are financially strong, so that they can obtain the credit necessary to fund their ongoing operations and system expansion. Allowed rates of return and the structure of power procurement have important effects on utility credit quality and deserve careful attention. Respectfully submitted, /s/ Gary Y. Chen Gary Y. Chen Southern California Edison Company 2244 Walnut Grove Avenue Post Office Box 800 Rosemead, CA Telephone: (626) Attorney for Southern California Edison Company January 30,

10 CERTIFICATE OF SERVICE I hereby certify that I have this day served the foregoing COMMENTS OF SOUTHERN CALIFORNIA EDISON COMPANY upon each person designated on the official service list compiled by the Secretary in this proceeding. Dated at Rosemead, California, this 30th day of January, /s/ Vicki Carr-Donerson Vicki Carr-Donerson Southern California Edison Company 2244 Walnut Grove Avenue Post Office Box 800 Rosemead, CA (626)