Staff Brief.pdf

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SCOTT D. WOODBURY
DEPUTY ATTORNEY GENERAL
IDAHO PUBLIC UTILITIES COMMISSION
PO BOX 83720
BOISE, IDAHO 83720-0074
[phone]
Idaho Bar No. 1895
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UTILITIES C0i1MISSIC)N
Street Address for Express Mail:
472 W. WASHINGTON
BOISE, IDAHO 83702-5983
Attorney for the Commission Staff
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF PACIFICORP DBA UTAH POWER &
LIGHT COMPANY FOR APPROVAL OF
INTERIM PROVISIONS FOR THE SUPPLY
OF ELECTRIC SERVICE TO MONSANTO
COMPANY.
POST-HEARING BRIEF OF
COMMISSION STAFF
CASE NO. PAC-Ol-
COMES NOW the Commission Staff by and through its attorney of record, Scott
Woodbury, Deputy Attorney General and submits the following post-hearing brief in Case
No. PAC-01-16 addressing the pricing model used by PacifiCorp to value Monsanto
interruptible load.
Following hearing in Case No. PAC-01-, the Commission in writing extended its
cross-examination ofPacifiCorp s witness Mark Kline. The Commission did so in order to gain
a better understanding of the Black-Scholes pricing model used by the Company to establish the
valuation of the credit for Monsanto s interruptible load.
The concern that prompted further questioning from the Commission was why the
Company s pricing model assigned less value to a contract offer of 1 000 hours of economic
interruption than it did to 500 interruptible hours. Tr. pp. 840, 841. This result seemed to
demonstrate that the additional 500 hours had negative value, a result that was counter-intuitive
to the expectation that additional hours would provide additional value. At first Staff was told
by the Company, that the volatility in the forward prices caused this result. The Company
POST-HEARING BRIEF
OF COMMISSION STAFF
speculated that because the valuations of 500 hours and 1 000 hours of interruption were
estimated at different points in time and because the forward prices used in the model are always
changing, erratic valuation could occur. A number of Commission follow-up questions for Mr.
Kline addressed the timing of the two analyses. From his responses it seems clear that forward
price volatility does not explain the lower interruptible value.
Mr. Kline s initial analysis, using 1 000 hours of interruptibility, extended into the
shoulder months. It was speculated that including these shoulder months rather than using only
peak periods, contributed to the loss of interruptible value. The Commission required Mr. Kline
to value the hours of interruptibility over different months to include only peak periods, in the
summer and winter. Mr. Kline noted in his response that the model was based on the electric
prices at Palo Verde and that "forward prices for power at Palo Verde during the shoulder
months of April, May, June and October were generally higher than winter forward prices." Tr.
p. 815. It thus appears that the Company s use of shoulder months was not the reason for the
lower value.
Through another round of informal questions the Company explained to Staff that the
apparent loss of interruptible value was the result of an error in the way the model adjusts net
present value (NPV) of increased interruptibility. As Staff understands it, the Company used the
model to calculate the NPV of a hypothetical product designed to deliver the services offered by
Monsanto. The services included 95 MW of operating reserve for 300 hours per year, 67 MW of
economic curtailment for 500 hours per year and a system integrity benefit. The Company then
calculated the NPV of a hypothetical product that provided the same services with the exception
that 1 000 hours rather than 500 hours of economic interruption was provided. PacifiCorp
determined that the model overvalued operating reserves in the first run and adjusted the value of
economic curtailment to make up for the error. Apparently, the same adjustment on a unit basis
was made to the second model run that valued additional economic interruption. The result was
that at some point additional hours of interruption had negative value with the adjustment. The
Company s explanation was provided over the phone and Staff does not claim to have a
complete accounting or thorough understanding of this issue. Additional information provided
by the Company does not appear to fully explain the error correction or the model results.
Moreover, it is unclear how lost revenue should be factored into the value of increased
POST-HEARING BRIEF
OF COMMISSION STAFF
interruptibility. Without additional time and investigation, Staff cannot confirm all input and
logic flow of the model.
It is important to also note that in the Company s model the product used to value
interruptibility is not actually available in the market. Tr. pp. 815 , 816. Numerous assumptions
were necessary to devise a product to replicate Monsanto s interruptible load.
While the model is deterministic (non-random), it is, nonetheless, dependent on a
number of key assumptions including the selected market hubs for natural gas and electric power
along with the forward price estimates of electric power and natural gas. Mr. Kline testified
given the same input variables, the model will produce the same result if run independently by
different sources." Tr. p. 810. The key is "given the same input variables." In fact, numerous
combinations of reasonable assumptions could be made producing a host of outputs.
One important thing that the Company s pricing model illustrates from the market
pricing approach is that there is a diminishing return on increased economic interruptibility. This
point was made by a number of witnesses. Interruption during the super peak hours would have
the greatest value to the Company and additional hours of interruption would have less value.
Staff concurs with this position and believes it is consistent with Staff s recommendation that
there should be some floor for the minimum appropriate interruptible rate. The model also
demonstrates that the amount of interruptibility is optimized at 300 hours of 95 MW operating
reserve and 1 000 hours of67 MW economic interruption.
While PacifiCorp s model has been found to include errors, it is Staffs opinion that
the Company s pricing model does provide one method of evaluating the interruptible portion of
the Monsanto contract. Based on the assumptions selected in this case (strike price $16.31; date
of market price 9/03; package of services provided) and additional information provided, we note
that the Company s model ultimately produces a corrected net price to Monsanto of 2.6 to
7~/kWh. (Compare Exh. 36
, p.
5 2.516~/kWh.Staffs more traditional analysis produces
results that range from 2.3 to 2.7~/kWh. Tr. at 729.
Staff believes that the issues of contract length and single contract seems to be
resolved in that the Company has pretty much agreed to a single contract for five years.
Although it is Staffs contention that the situs/system allocation issue can appropriately be
deferred to the Multi-State Process case (Case No. P AC-02-3), Staff believes that it is
POST-HEARING BRIEF
OF COMMISSION STAFF
acceptable to use a cost of service analysis based on situs allocation in this case as the starting
point to determine the appropriate Monsanto rate.
CONCLUSION
WHEREFORE, Staff recommends that the Commission not determine the value of
Monsanto s interruptibility based solely on the modeled results presented by PacifiCorp. Rather
the net price paid by Monsanto should be established based upon a firm rate at cost of service
discounted to reflect a more reasonable credit for interruptibility. Staff believes that both the
record establishing a firm rate and the record establishing an interruptible credit support a net
price in the range of 2.3 to 2.7 cents per kWh. Given the uncertainty in the modeling results
presented by the Company, its estimate of appropriate net cost to Monsanto does no more than
verify that the net cost range proposed by Staff is reasonable.
DATED this I?'day of October 2002.
RESPECTFULLY submitted
~~.
Scott D. Woodbury
Vld/B:PACEOl16 sw
POST-HEARING BRIEF
OF COMMISSION STAFF
CERTIFICATE OF SERVICE
HEREBY CERTIFY THAT I HAVE THIS 15TH DAY OF OCTOBER 2002
SERVED THE FOREGOING POST-HEARING BRIEF OF COMMISSION STAFF, IN
CASE NO. PAC-01-, BY MAILING A COpy THEREOF, POSTAGE PREPAID
TO THE FOLLOWING:
DOUG LARSON
ACIFICORP
201 S MAIN, SUITE 2300
SALT LAKE CITY UT 84140
JOHN ERIKSSON
STOEL RIVES LLP
201 S MAIN ST STE 1100
SALT LAKE CITY UT 84111
RANDALL C BUDGE
RACINE OLSON NYE BUDGE & BAILEY
PO BOX 1391
POCATELLO ID 83204-1391
JAMES R SMITH
MONSANTO COMPANY
PO BOX 816
SODA SPRINGS ID 83276
JAMES F. FELL
STOEL RIVES LLP
900 SW FIFTH AVENUE, SUITE 2600
PORTLAND, OR 97204
SECRETARY
CERTIFICATE OF SERVICE