Did a local distribution company procure prudently during the California electricity crisis?

Abstract

To manage cost risk, prudent procurement of electric power requires that some portion of a buyer's energy demand be met through long-term contracting. Under cost-of-service regulation or performance-based regulation, a local distribution company (LDC) should be allowed to fully recover all prudently incurred power procurement costs. However, the regulatory test of prudence is an ex post review with the threat of disallowance. This paper presents an economic analysis of procurement prudence involving a small LDC, Bear Valley Electric Service (BVES), which serves a resort area in Southern California. The key findings are: (a) high and volatile prices and rolling blackouts characterized the market environment faced by the owner of BVES, Southern California Water Company (SCWC), at its signing of a 5-year fixed price contract; (b) SCWC was a price-taker with no incentive to act imprudently; (c) the contract was obtained via a competitive bidding process; (d) the contract price was comparable to the benchmark price of contemporaneous contracts; (e) the fixed price contract was economic when compared to available alternatives; and (f) despite (a)–(e), a negotiated settlement with the state regulator and a large user resulted in substantial disallowance. The policy implication is that a regulator should approve a prudent procurement plan proposed by an LDC to remove the unreasonable risk of an ex post review. If the LDC strictly adheres to the plan, the resulting electricity purchases are per se prudent and should entitle the LDC to full cost recovery.