The Changing Face of Default Service Procurements in PA

When Pennsylvania embarked on the deregulation (or as some would say “re-regulation”) of its retail electric markets in 1997, it established the approach to providing “default service,” i.e., the electricity provided to those retail electricity customers that either cannot (usually for economic reasons) or chose (consciously or otherwise) not to shop for their electricity with what was then an emerging group of competitive electric generation suppliers.

The 1996 electric restructuring legislation, known as the “Electricity Generation Customer Choice and Competition Act,” 66 Pa.C.S. § 2801, et seq., required the incumbent electric utilities to provide such default service to customers, both during the period when retail rates were subject to statutorily mandated “caps” and thereafter when such rate caps terminated, unless their default service obligation was modified by the state Public Utility Commission.

While the original rate caps applicable to the Pennsylvania electric utilities have now expired and there is a robust competitive electric generation supply business in operation in the state, the default service obligation remains with the incumbent electric utilities.

While the default service supplier has remained unchanged in Pennsylvania since the late 1990s, how utilities actually procure electricity for their default service customers has been the subject of legislative changes, conceptual debates and, most recently, legal challenges.

The Competition Act originally required the provider of default electric service to retail customers to “acquire electric energy at prevailing market prices to serve that customer …” 66 Pa. C. S. § 2807(e)(3). There was considerable debate about exactly what constituted “prevailing market prices,” with many stakeholders raising concerns that this legislative standard placed too much emphasis on the then-emerging electricity market, with its uncertain and volatile pricing, to set the base line rates to be charged to default service customers.

The fear was that default service rates tied to short-term or “spot” market prices could fluctuate wildly from high to low and would be costly to these default customers, many of whom lack the economic resources to absorb and pay for such price volatility. At the same time, default service rates that provide long-term rate stability were viewed as not reflecting “prevailing” market price.

So, in response to the concerns about the “prevailing market price” standard, Pennsylvania’s General Assembly enacted in 2008 what is known as Act 129 which, among many other things, specifically modified Section 2807(e)(3) of the Competition Act by eliminating the prevailing market price standard for energy procured to serve default service customers.

Under Act 129, electric generation procured to satisfy default service customers “shall include a prudent mix” of the following: (1) spot market purchases, (2) short-term contracts (less than four years in length), and (3) long-term purchase contracts (generally between four and 20 years in length). 66 Pa. C. S. § 2807(e)(3.2).

Unfortunately for many stakeholders in the Pennsylvania electric generation market, the advent of the “prudent mix” approach has not mitigated the issues and debates about how to procure electric energy for default service customers.

A relatively recent case on point is the Commonwealth Court’s decision in Popowsky v. Pennsylvania Public Utility Commission,. 71 A.3rd 1112 (Pa. Cmwlth. 2013). Popowsky involved the PUC’s consideration of a default service procurement plan filed by Pike County Light & Power Co.

Under its default service plan, Pike proposed to obtain electric energy for its default service customers solely via purchases on the spot market, where prices vary daily based on market conditions. After the PUC approved Pike’s default service plan as filed, the state’s Office of Consumer Advocate — the state entity charged with representing the interests of residential ratepayers in PUC proceedings — filed an appeal with the Commonwealth Court arguing that the PUC’s approval of Pike’s default service plan violated the provisions of Section 2807(e)(3.2), which required that the default service plan consist of a “prudent mix” of spot purchases, short-term contracts and long-term contracts.

Pike argued before the commission initially and later in the Commonwealth Court that several factors supported its decision to procure power for default service customers solely via the sport market.

First, under Pike’s prior default service plan, it obtained all electric generation on the spot market.

Second, because of the very small size of Pike’s default service customer base, it was difficult for it to estimate its actual energy requirements for this service. And, if it overestimated those requirements and purchased too much electric generation, it would create potentially needless costs that would have to be recovered from the default service customer base, which is particularly unsuited to pay these additional amounts.

Third, because of its small size, Pike found it difficult to negotiate favorably priced long-term contracts.

Both at the PUC and later on appeal at the Commonwealth Court, the OCA claimed that Pike should be required to expand its default service supply portfolio to include “financial hedges,” a form of purchased financial contract that would protect the utility and its default service customers if the variable spot market price for electricity increased beyond certain prescribed parameters.

However, the PUC specifically found that the price of a fixed-price hedge might cost customers more than the fluctuation in the market price of electricity on the spot market. Accordingly, PUC rejected any requirement that Pike supplement its default service plan predicated on spot purchases with any financial hedges.

In Popowsky, the Commonwealth Court first rejected the OCA’s claim that the PUC’s finding regarding the cost of the financial hedge was not supported by substantial evidence. Second, the court rejected the OCA’s argument that the PUC erred by approving Pike’s default service plan even though it only contained one of the three sources comprising the “prudent mix” under Section 2807(e)(3.2) of the Competition Act, i.e. spot purchases.

The OCA argued that to have a “prudent mix” of resources, the PUC was obligated to have included at least two of the enumerated sources in Section 2807(e)(3.2). The PUC countered by arguing it was lawful for it to only approve one of the Section 2807(e)(3.2) components for Pike (i.e., spot purchases) when that was the most prudent course of action and likely to be the least costly over time.

The Commonwealth Court ruled that Section 2807(e)(3.2) of the Competition Act contained a “latent ambiguity” in circumstances where the PUC does not believe, after a review of the record evidence, that any more than a single source of supply should be used to support a “prudent mix” default service plan.

Contrary to the OCA’s claim, the Commonwealth Court found that the PUC did not read the word “mix” out of Section 2807(e)(3.2). Rather, the PUC’s conduct was lawful since it properly considered the possibility of including short-term contracts (including financial hedges) and determined it was not prudent to do.

In the Commonwealth Court’s view, the word “prudent” trumps the word “mix” in the Competition Act. The court also hinted that the OCA’s view of “mix” would require that some of each type of supply be included in the default service supply plan, and the OCA did not recommend inclusion of long-term purchase contracts.

As Pennsylvania’s utilities embark on their next round of default service filings, they must be aware of the PUC’s legal authority under Popowsky to eschew, under certain circumstances, some of the enumerated sources in Section 2807(e)(3.2) of the Competition Act when considering default service plans.

For now, the Commonwealth Court’s decision in Popowsky is the last word on this issue. The Pennsylvania Supreme Court denied the OCA’s petition for allowance of appeal at Docket No. 641 MAL 2013 in a per curiam order issued Dec. 31, 2013.

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