STATE OF NEW YORK PUBLIC SERVICE COMMISSION. At a session of the Public Service Commission held in the City of Albany on February 13, 2008

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1 STATE OF NEW YORK PUBLIC SERVICE COMMISSION At a session of the Public Service Commission held in the City of Albany on February 13, 2008 COMMISSIONERS PRESENT: Garry A. Brown, Chairman Patricia L. Acampora Maureen F. Harris Robert E. Curry, Jr. Cheryl A. Buley CASE 06-M Proceeding on Motion of the Commission As to the Policies, Practices and Procedures For Utility Commodity Supply Service to Residential and Small Commercial and Industrial Customers. PHASE I. ORDER ESTABLISHING ELECTRIC SUPPLY PORTFOLIO STANDARDS, GOALS, AND REPORTING REQUIREMENTS (Issued and Effective February 26, 2008) BY THE COMMISSION: BACKGROUND In the Supply Portfolio Order, 1 it was decided that electric utilities should engage in hedging practices intended to reduce the volatility of the commodity prices they charge customers electing to take commodity supply from them instead of from alternative providers. The Supply Portfolio Order also requires electric utilities to participate in collaborative discussions for the purpose of developing electric price volatility metrics; establishing goals for reducing volatility 1 Case 06-M-1017, supra, Order Requiring Development of Utility Specific Guidelines For Electric Commodity Supply Portfolios and Instituting a Phase II to Address Longer-Term Issues (issued April 19, 2007).

2 as measured by those metrics; and, recommending requirements for reporting electric utility supply price information. After the metrics, goals and reporting requirements were developed, electric utilities were to meet yearly with Staff of the Department of Public Service (Staff) on the performance of their hedging portfolios and the strategies for structuring those portfolios. The collaboratives were conducted following the utilities submittal, on July 27, 2007, of descriptions of their hedging practices and their methods for measuring their portfolios performances. 2 Notice of the utility filings was published in the State Register on August 29, 2007, in conformance with State Administrative Procedure Act (SAPA) 202(1). The SAPA 202(1)(a) comment period expired on October 15, Those utility filings, however, served as the basis for collaborative discussions conducted with each of the utilities and interested parties during September and October Parties were then invited to submit comments, by October 30, 2007, on the utility filings and the collaborative discussions. Six responses to that solicitation were received, and, on November 7, 2007, Con Edison replied to the responsive filings. 2 The utilities submitting filings were: Central Hudson Gas & Electric Corporation (Central Hudson), Consolidated Edison Company of New York, Inc. (Con Edison) and Orange and Rockland Utilities, Inc. (O&R)(collectively, Con Ed/O&R), National Grid d/b/a Niagara Mohawk Power Corporation (National Grid) and New York State Electric & Gas Corporation (NYSEG) and Rochester Gas and Electric Corporation (RG&E)(collectively, NYSEG/RG&E). -2-

3 POSITIONS OF THE PARTIES The Utility Initial Filings Each electric utility, in its July 27, 2007 filing, explained its approach to managing its electric supply portfolio. Con Ed/O&R uses a co-efficient of variation (CoV) to measure the volatility of the commodity prices they charge, and to assess the success of their efforts to dampen that volatility. Based on its past three years of experience, Con Edison suggests that constraining volatility to a 10% range measured by this metric should be considered a reasonable tolerance band that serves as an acceptable goal for constraining its electric commodity price volatility. O&R, in comparison, experienced greater volatility for the same threeyear period than Con Edison. It believes, however, that it successfully mitigated volatility to a 15% tolerance band measured by the CoV metric. Con Ed/O&R ask that the respective 10% and 15% measurements serve as their goals, respectively, for limiting volatility. The utilities claim that distinctions between their service territories justify the adoption the two different goals. Con Edison s portfolio contains legacy contracts for procuring supply entered into long before the three-year period it uses to measure volatility. Some of those contracts are fixed-price and some are indexed to fuel prices; the utility deploys financial instruments to moderate the potential volatility of the latter. Con Edison states that its general objective is to choose a strategy that minimizes expected portfolio volatility given an expected average portfolio cost. It then employs a Monte Carlo simulation methodology to assist in identifying the optimal hedging strategy, and the magnitude of the commodity that should be hedged. -3-

4 O&R, on the other hand, did not enter into legacy contracts that could now be included in its portfolio. The load it is obligated to serve is also much smaller than Con Edison s, and the wholesale electric market in its service territory is more competitive than in Con Edison s service territory. As a result, O&R conducts a declining price auction to obtain commodity for a slice of its system requirements. Con Ed/O&R report that they typically procure new supplies or enter into hedging arrangements of no more than three years in length. They propose to report on a quarterly basis aggregate portfolio price and volatility data. National Grid reports that it currently measures volatility through a value at risk metric, but it notes that use of a standard deviation and CoV method would be reasonable. Like Con Edison, National Grid designed its hedging portfolio strategy using Monte Carlo analyses. Again, like Con Edison, National Grid s portfolio contains legacy contracts, and its hedging strategy must accommodate the existence of those contracts. It also uses financial instruments to fix the variable gas price component of legacy contracts that are indexed to that fuel, and also to hedge purchases it makes from New York Independent System Operator (NYISO) short-term wholesale markets. National Grid would report quarterly market prices, portfolio prices and a rolling twelve-month CoV for these elements, for its East, West and Central regions. Central Hudson explains that it constrains volatility primarily through hedging a portion of the purchases it makes from the NYISO during summer and winter peak hours. The utility is amenable to adopting a CoV method, but asserts that more study and experience is necessary before it could adopt a goal for constraining volatility, as measured by CoV. The utility -4-

5 also expressed its willingness to discuss reporting requirements at its collaborative. NYSEG/RG&E point out that they offer a fixed-price service to customers desiring that form of protection from volatile prices. In addition, NYSEG proposes to continue its current practice of hedging about 60% of the value of the variable price service it offers to residential electric customers and about 35% of the variable commodity service it offers to smaller non-residential customers. For its part, RG&E s portfolio is currently over-hedged due to legacy contracts, which provide for the supply of about 110% of the needs of residential variable-priced commodity supply customers and about 80% of the non-residential variable supply customers. NYSEG/RG&E did not propose metrics for measuring volatility, and did not suggest reporting requirements. The Comments No party objected to the use of standard deviation and CoV as appropriate metrics to measure the volatility of electric utility commodity supply prices. The commentators primarily focus their attention on reporting requirements. Con Edison Solutions Company (CE Solutions) argues that price transparency would be enhanced if information on the effect hedges have on forward prices were available, after the hedges are executed. That information, CE Solutions claims, would enable customers to more readily compare the prices the utility will offer to prices competitors offer. CE Solutions maintains that reporting the forward aggregate impact of the hedges would not impair the utilities ability to effectively engage in hedging activity, because the information would not enable competitors to predict the future hedging actions the utilities might take. Asserting that utilities currently report physical purchase price, volume, term, and counter-party -5-

6 information to the Federal Energy Regulatory Commission (FERC), CE Solutions claims that much of the information it seeks is already public. The Retail Energy Supply Association (RESA) and Intelligent Energy Company (Intelligent) voice their support for the reporting requirements CE Solutions proposes. Constellation Energy Commodities Group, Inc. (Constellation) also lends its support to CE Solutions. Constellation adds a proposal to limit the length of the term of the hedges that utilities may obtain, arguing that longer-term contracts are not desirable for a variety of reasons. In its comment, National Grid supports use of the standard deviation and CoV metric, on a rolling twelve-month average basis. That metric, it asserts, enables it to compare the magnitude of the price variation that customers experience in purchasing commodity from the utility to un-hedged market prices for commodity. National Grid cautions, however, that goals for limiting volatility should not be considered strict standards that firmly establish constraints on volatility that must be achieved. National Grid believes factors other than satisfaction of statistical goals should be considered when evaluating whether a utility has properly shielded customers from volatility. As to reporting requirements, National Grid proposes to provide price information on specified residential small nonresidential customer rates consisting of the rolling twelvemonth CoV for market prices; the rolling twelve-month CoV for the S.C. 1 residential rate; and, the rolling twelve-month CoV for the non-residential small customer S.C. 2D rate. National Grid also agrees to provide the price information separately for its three geographic regions -- West, Central and East. Finally, the utility would limit its reporting to historic data. -6-

7 NYSEG/RG&E propose a structured hedging program, similar to their hedging practices for gas supply service. Hedges would be undertaken on a twelve-month rolling average basis, for one-twelfth of the resources expiring from previous annual hedges. NYSEG/RG&E would explore a range of strategies, including physical bilateral contracts, financial contracts, and physical supply. It would report the average price of the aggregate hedges on a quarterly basis. NYSEG/RG&E claim that CoV should not be the only metric used to measure volatility. They assert that NYSEG s portfolio costs are higher than market, but it has a low CoV when compared to market prices. On the other hand, RG&E s portfolio costs are lower than market, an outcome attributable to its legacy contracts, but it has a comparatively high CoV. NYSEG/RG&E concludes that CoV should be used only in combination with an analysis of the expected costs of constraining volatility when utility performance is evaluated. In a November 7, 2007 reply to the October 30, 2007 responses, Con Ed/O&R opposes CE Solutions proposal for reporting forward hedging data. According to Con Edison, the reporting proposal conflicts with the Supply Portfolio Order. That Order, Con Edison asserts, explicitly warned against excessive disclosure and limited disclosure to historic, not forward, data. DISCUSSION AND CONCLUSION As discussed in the Supply Portfolio Order, most mass market customers generally find beneficial the restraints on electric commodity price volatility that utilities are able to achieve, because those customers are generally risk-adverse. The Supply Portfolio Order therefore required utilities to set standards for measuring volatility, and to set goals for -7-

8 constraining price volatility to levels that are acceptable. Utilities in this phase of this proceeding have proposed such standards and goals. Before addressing those standards and goals, it should be noted that utilities already engage in activities that reduce the volatility seen in the NYISO s wholesale electric markets, where prices are set on an hourly basis. Utilities making purchases from the NYISO, however, do not bill those hourly prices directly; instead, they average them over a monthly or bi-monthly period into one price that applies to all consumption for that billing period. Many utilities also continue to purchase under legacy contracts, some of which provide for fixed prices, further dampening volatility. Where legacy contracts are indexed to fuel prices, utilities use financial instruments to mitigate that element of volatility. As a result, the commodity that utilities supply to electricity supply customers opting to purchase from them is less volatile than NYISO hourly wholesale prices even before utilities manage their portfolios. The utilities generally acknowledge that standard deviation and CoV metrics are widely-used tools for measuring historic volatility of prices. 3 Standard deviation, the most common measure of statistical volatility, captures the variation of prices around the average price. This measure reflects the fact that, the more the actual price of electricity varies around the average, the more volatile that price is. As a result, the standard deviation will be small if many data points 3 Among entities deploying CoV to measure volatility are: The Department of Energy, Derivatives and Risk Management in the Petroleum, Natural Gas and Electricity Industries (October 2002), the American Gas Association, Natural Gas Price Volatility and the Outlook For Natural Gas (October 2007), and the National Association of Regulatory Utility Commissioners, Energy Portfolio Management: Tools and Resources For State Public Utility Commissions (October 2006). -8-

9 fall close to the average value. Conversely, if many data points deviate substantially from the average, then the standard deviation will be large. CoV, also referred to as unitized risk, is the standard deviation value divided by the overall average value. Unlike the standard deviation measure, it allows comparisons of volatility among data where the average value of each data set may be significantly different. However, where an average value is extremely low, the CoV can appear large even when the variation measured in real dollars is relatively small. Therefore, the combination of standard deviation and CoV taken together yields better information than either metric would if used individually. Although, when used together, standard deviation and CoV are appropriate metrics for monitoring the volatility of utility electric supply portfolios, and they give valuable insight into the performance of an individual utility s hedging practices, setting specific goals, targets and tolerance bands for limiting volatility is not appropriate at this time. Experience with the volatility metrics is insufficient to justify adopting strict constraints limiting the degree of volatility utilities can tolerate. Indeed, sole reliance on the standard deviation and CoV metrics to set strict standards could create perverse incentives. The metrics should be used to establish goals instead of strict standards. Utilities should pursue those goals, but should be free to respond to changing and unanticipated circumstances. As a result, the goals will be considered an objective rather than a mandatory target. Attempting to achieve a mandatory target when the circumstances do not warrant would not benefit either utilities or ratepayers, and instead treating -9-

10 the objectives as goals best protects ratepayers from volatility at a reasonable cost. Turning to reporting requirements, nearly all parties support at least some reporting. There is a wide agreement that each utility should at least report quarterly the relevant wholesale electric market prices and the hedged portfolio electric supply prices for the previous twelve months. We require that the reports also include the twelve month rolling averages for standard deviation and CoV for both prices. Finally, the utilities shall differentiate their reports by service classification. National Grid s proposal to report separate prices and metrics for its East, West, and Central operating areas, instead of reporting an aggregate number for the entire utility, advances the public interest. The proposal reflects the differences in electric supply prices among the different NYISO load zones where the utility operates. Although Con Edison, in comparison, gears its hedging activities towards meeting its entire full service load, its Westchester and New York City regions are charged different monthly supply charges based on NYISO zonal wholesale electric market prices that vary between the different regions. As a result, Con Edison should report regional prices and volatility data for its two separate regions, just as National Grid does for its three regions. It does not appear that the utility objects to this requirement, which will be expected of it. A number of parties sought additional reporting requirements, beyond those described above. These parties, primarily competitive energy suppliers, sought to compel utilities to forecast the potential effect of existing hedges on future utility electric supply prices. The utilities, for their part, generally opposed additional reporting. -10-

11 This matter was resolved in the Supply Portfolio Order, where it was decided that utilities need only disclose historic prices and their performance in managing volatility through their portfolio management efforts. Since the competitive energy provider proposals go beyond the requirements of the Supply Portfolio Order, they will not be adopted in this phase of this proceeding. 4 The quarterly utility reports on electric commodity hedging portfolio performance shall be filed with the Director of the Office of Electric, Gas and Water no later than the second week following each quarter (mid-january, mid-april, mid- June and mid-september) covering the previous 12-month period. These reports shall include electric market prices and utility portfolio prices for each applicable customer service classification, including energy and capacity prices, as well as the standard deviation and CoV for each classification. Finally, the utilities should arrange for the posting of these reports on their websites for easy access by customers and other interested parties. The Commission orders: 1. The electric utilities listed in the body of this Order shall implement the methods for measuring, monitoring and constraining electric supply price volatility described in their respective filings and in the body of this Order. 4 Constellation s arguments concerning the use of long-term contracts were addressed in the Supply Portfolio Order and in another phase of this proceeding, decided in Cases 07-E-1507 and 06-M-1017, Long Range Electric Resource Planning, Order Initiating Electric Reliability and Infrastructure Planning (issued December 24, 2007); its arguments will not be considered further here. -11-

12 2. The electric utilities listed in the body of this Order shall file the quarterly reports on electric supply prices and price volatility described in the body of this Order. 3. To the extent not granted, any relief requested in this phase of this proceeding is denied. 4. This phase of this proceeding is continued, for the purpose of the filing and consideration of the reports required in Ordering Clause No. 1. By the Commission, (SIGNED) JACLYN A. BRILLING Secretary -12-