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Pennsylvania ALJ: Market Conditions Warrant Greater Hedging of Default Service Supplies

February 15, 2012

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Copyright 2010-12 Energy Choice Matters

Default service plans should reflect currently depressed market prices, and should hedge to protect against a "major increase in energy prices" -- those are the conclusions contained within a recommended decision from a Pennsylvania ALJ concerning Pike County Light & Power's default service plan for the two-year period starting June 1, 2012.

The recommended decision essentially repudiates the current spot-based default service procurement, ordering the use of greater hedging, in part because of favorable market conditions.

While the recommended decision grows out of the facts specific to Pike County Light & Power, much of the ALJ's decision is based not on case-specific facts, but on an interpretation of the PUC's "new" rules implementing Act 129, governing default service, and thus could have major implications in all other default service plans soon to be adjudicated by the PUC.

Pike County had proposed continuing to rely exclusively on the spot market for default service (see 7/18).

However, the ALJ cited the PUC's recent default service rulemaking, in which the PUC removed from its default service policy statement a preference for shorter term, full requirements contracts and spot purchases.

Citing the final rules issued last fall, the ALJ quoted the PUC as finding that, "it should be noted that the 'least cost over time' standard [required by Act 129] should not be confused with the notion that default prices will always equal the lowest cost price for power at any particular point in time."

"In implementing default service standards, Act 129 requires that the Commission be concerned about rate stability as well as other considerations such as ensuring a 'prudent mix' of supply and ensuring safe and reliable service," the rulemaking said.

The spot-only approach, "does not include the 'prudent mix' of contracts that are designed to yield a default service product that is the 'least cost to customers over time' consistent with Act 129, as recently interpreted by the Commission," the ALJ concluded.

The ALJ further concluded that, for residential customers, the reliance on spot pricing has introduced "substantial volatility" into the default service price at Pike County.

Quarter to quarter volatility has averaged 21% since June 2009, and customers on Pike County's spot-only generation service have seen quarterly increases of 29.9%, 34.5%, and 45.8%, and decreases as large as 34.5% and 19.5%, during a two-year span.

"I recommend the Commission require Pike County at this time to adopt a plan that increases rate stability for its default service customers," the ALJ said.

"[I]t is reasonable to require the Company to move forward with a default service plan that provides a more reasonable mix of resources and reduces the price instability of Pike County's current default service so as to achieve the goals of Act 129 for Pike County's residential customers," the ALJ added.

Although the ALJ only recommended a one-year block hedge as sought by the Office of Consumer Advocate, the ALJ noted that, per Act 129, "long-term purchase contracts of between 4 – 20 years in length ... could have been requested."

Specifically, the ALJ recommended that Pike County be required to procure on behalf of residential default service customers a 1 MW (or less) on-peak fixed price block for a one-year term for each delivery year during the default service period. The residential peak default service load is about 1.7 MW.

The procurement, a financial hedge in the form of a fixed for variable swap, is be accomplished in the March/April 2012 and 2013 time frames covering the June 1 - May 31 plan years

Pike County may cancel the hedge procurement if its default service load decreases by more than 25 percent.

Aside from complying with Act 129, the ALJ said that the hedge is prudent given current market conditions.

"[The OCA's] testimony supports a finding that current market conditions are depressed relative to the wholesale market pre-2009. The addition of a hedge will provide a degree of protection against a major increase in energy prices over the course of its two year plan," the ALJ said.

"While it is not possible to predict market prices over the course of the plan, it is reasonable to take prudent steps to reduce exposure and increase rate stability. Market conditions, as well as Pike County's residential default service load, now warrant taking this step," the ALJ added.

The case is P-2011-2252042.

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