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Arizona Commissioner: "Simple Deregulation" A "Nonstarter," But Says "Regulated Competition" Consistent With Constitutional Charge

Memo Outlines Use Of Range Of Prices, Ability To Challenge "Excessive" Rates As Meeting Constitutional Standard

December 12, 2018

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Copyright 2010-17
Reporting by Paul Ring •

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Arizona Corporation Commissioner Justin Olson has filed a memo in an ACC proceeding reviewing electric choice, stating that, "simple deregulation is a nonstarter," due to the ACC's duty under the state's constitution, but that a framework of, "regulated competition," would be within the ACC's authority

Discussing a recent workshop on electric choice, Olson in the memo wrote that, "[o]ne of the reoccurring concerns that is raised is whether restructuring is compatible with the Arizona Constitution."

Olson attached to his letter a memo drafted by his policy advisor addressing the background and analysis of the Phelps Dodge decision further addressing this question (discussed further below)

Among other things, the policy advisor memo concludes that competition relying on a range of prices (tighter than used under the old rules) with the ability to challenge "excessive" prices would be consistent with the ACC's constitutional responsibilities.

Olson further said in his memo that, "Another threshold issue that was raised at the workshop and discussed in the attached memo is how this initiative should be described in our state. I believe that we should refer to the effort as restructuring to a framework of 'regulated competition.' Our constitution requires the Commission to regulate PSCs [public service corporations]. A framework of simple deregulation is a nonstarter. The constitution does, however, leave the method of regulation to the Commission. If the rules are properly amended to comply with Phelps Dodge the Commission has the constitutional authority to implement regulated competition."

The memo from Olson's policy advisor concludes that the Arizona Constitution does not preclude regulatory competition

The policy advisor memo recites the history of electric choice in Arizona, noting that, at a September 2013 meeting, Janice Alward, Director of the ACC's Legal Division, counseled Commissioners that categorically, "market rates is a threshold problem with moving toward a competitive rate setting market." Alward told Commissioners "Phelps Dodge says market rates are not constitutional, that the Commission must use fair value."

As a result, in 2013, the commissioners ultimately voted to close the electric choice docket with several Commissioners commenting that the constitution precluded retail competition.

The policy advisor memo states, "Alward's interpretation rests on a strict dichotomy between establishing rates using fair value and setting the rates through the market."

The policy advisor memo states, "The Arizona Constitution requires regulation of public service corporations, but it does not mandate the method or structure of regulation to be used. The constitution requires the Commission to 'prescribe... just and reasonable rates and charges to be made and collected, by public service corporations.' A 'public service corporation' is defined as any corporation furnishing gas, oil, electricity, water, wastewater, telecommunications, and common carriers. The Commission's authority is triggered by a company offering a regulated service. The Commission's authority does not depend upon whether a PSC is granted a Certificate of Convenience and Necessity (CC&N) that grants the company a monopoly. The Commission's authority does not materialize by extending the privilege of a monopoly in exchange for regulation. The Commission retains its ability and mandate to regulate regardless of whether competition has been allowed among PSCs."

Citing precedent from a 1982 state supreme court case, the policy advisor memo states, "The constitution does not dictate whether PSCs will compete for customers or be granted an exclusive right to serve customers in a particular area."

"Not only is the system of regulated monopolies not required by the constitution, it is not explicitly required by the statutes governing the issuance of CC&Ns. Certainly, the Commission has the authority to decide that the public would be better served by granting monopolies. There are many valid public policy reasons to justify this practice. Although that has been Commission practice, it does not prevent a change in regulation. Our governing constitutional and statutory provisions do not prescribe a particular theory of regulation. A proposal to allow for regulated competition among PSCs is not inconsistent with the constitution," the policy advisor memo states

The policy advisor memo notes that, "Arizona courts have confirmed that this type of regulated competition can be implemented in telecommunications consistent with the constitution."

Citing precedent from several telecomm cases before the state supreme court, including one involving competitive local exchange carriers (CLECs), the policy advisor memo said that, "As long as the Commission makes fair value determinations within a framework to prescribe just and reasonable rates it can do so within the structure of regulated competition."

The policy advisor memo then turns to the Phelps Dodge decision.

"In summary, the court ruled the Commission could not set rates exclusively with the market and invalidated portions of the Rules as written. The decision did not find that the constitution prohibited the Commission from using a method of regulated competition," the policy advisor memo stated

The policy advisor memo noted that, "The heart of the Phelps Dodge decision concerns the constitutional mandate to establish just and reasonable rates. The court took specific issue with Rule 1611A which provides that 'market rates are deemed just and reasonable.' The court held that although the Commission 'may be influenced by markets forces in determining what is just and reasonable, the Commission may not abdicate its constitutional responsibility to set just and reasonable rates by allowing competitive market forces alone to do so.' (emphasis added). While the court found the rule unconstitutional, it held that this rule could be severed, leaving the remaining framework intact."

The policy advisor memo stated that, "Despite taking issue with Rule 1611A, the court took pains not to limit the Commission's options for regulating PSCs. The court recognized the Commission can fulfill its duties 'as long as the method complies with the constitutional mandate and is not arbitrary and unreasonable.' The court affirmed the regulatory competition framework implemented in telecommunications. The court said, 'assuming the Commission establishes a range of rates that is just and reasonable, the Commission does not violate Article 15, Section 3 by permitting competitive market forces to set specific rates within that approved range.' These are the touchstones of regulatory competition: a) a range of rates set by the Commission and b) competitive market forces to set rates within the range."

The policy advisor memo stated that, "The Phelps Dodge Court explains how the Rules could be modified to ensure the regulatory framework passes constitutional muster. The court insists that oversight should include a meaningful range of rates. In compliance with the Rules, the Commission had authorized PG & E to charge customers a rate that was not less than the company's marginal cost nor greater than $25 per kilowatt hour. The court noted that the Commission did not actually determine the company's marginal cost. On the other side of the range, the cap was set at approximately 500 to 830 times the average price of electricity. The court reasoned that if the range was virtually unrestricted the Commission was allowing the market alone to determine the rates. The Commission should make actual marginal cost findings and endeavor to set a tighter cap based on actual market conditions. The court also expressed concern that the Commission retain its responsibility to discover and adjudicate claims of excessive rates. The Commission should consider requiring a more regular and standard review of price ranges to ensure there is a continual adherence to market conditions. The Commission should ensure there is an adequate process for challenging prices that are charged even within the allowed price range. If the Commission establishes a regulatory process to set a meaningful range of rates, it does not violate the constitution to allow competitive market forces to set rates within the approved range."

The state constitution requires the ACC to, "ascertain the fair value of the property within the State of every public service corporation doing business therein." Various court cases have struck the ACC's prior position that a fair value determination was not required when setting rates in a competitive market

However, Phelps Dodge held that while, "the Commission should consider fair value when setting rates within a competitive market," the Commission still, "has broad discretion in determining the weight to be given that factor in any particular case."

"The fair value requirement does not tie the hands of the Commission to establish rates based on the traditional rate of return formulas," the policy advisor memo concluded

"Fair value must be taken into consideration but it does not preclude the Commission from using other factors. The fair value requirement is not a barrier to regulated competition," the policy advisor memo concluded

The policy advisor memo concludes that, "Retail competition in the supply of energy is not incompatible with the Arizona Constitution. The constitution requires the Commission to regulate PSCs, but it does not mandate a structure of regulated monopolies. A structure of regulated competition has long been implemented and approved by Arizona courts in the telecommunications industry. Although the Phelps Dodge decision invalidated several Competitive Rules as written, the decision did not hold that retail competition in the supply of energy was unconstitutional."

The policy advisor memo concludes that, "The Commission can heed the concerns of the Phelps Dodge court by a) making an explicit fair value determination on every ESP [electric service provider], b) establishing a meaningful range of rates, c) requiring a consistent and continual review of the price ranges, and d) establishing a process for challenging rates charged by ESPs. The Commission can address these issues and enact a regulated competition structure that would be consistent with the Arizona Constitution."

Docket No. RU-00000A-18-0284

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