20010207jh.doc

DECISION MEMORANDUM

TO: COMMISSIONER HANSEN
COMMISSIONER SMITH
COMMISSIONER KJELLANDER
JEAN JEWELL
RON LAW
LOU ANN WESTERFIELD
DON HOWELL
RANDY LOBB
DAVE SCHUNKE
TERRI CARLOCK
ALDEN HOLM
BEVERLY BARKER
TONYA CLARK
WORKING FILE

FROM: JOHN R. HAMMOND

DATE: FEBRUARY 1, 2001

RE: IN THE MATTER OF THE APPLICATION OF AVISTA CORPORATION FOR A DEFERRED ACCOUNTING ORDER. CASE NO. AVU-G-00-7.

On December 21, 2000, Avista Corporation filed its Application for a Deferred Accounting Order. On January 9, 2001, the Commission issued Notice of Application and Notice of Modified Procedure which amongst other things required the parties to file written comments on or before January 30, 2001. Order No. 28608. The Commission Staff was the only party to file comments.
BACKGROUND
Avista states that as a part of its operations it provides natural gas distribution service in certain portions of Eastern Washington, Northern Idaho, California and Oregon. The Company alleges that because of the recent price volatility of the cost of gas it believes that a proportion of future natural gas costs should be hedged through fixed price transactions rather than through the approved benchmark mechanism. However, Avista states that currently the cost of natural gas for its customers is determined exclusively by the Company’s Natural Gas Benchmark Mechanism in Tariff Schedule 163 which does not provide accounting treatment for additional transactions relating to gas supplies included in the Company’s purchased gas adjustment (“PGA”). Accordingly, Avista seeks a Commission order authorizing the deferral of revenues and expenses resulting from fixed-price financial transactions (financial instruments, instruments) it enters to serve the Company’s retail, natural gas customers. Avista states that Commission authorization of this type of order would allow it to supplement its existing accounting practices to include the costs of these transactions into the Company’s PGA mechanism. Finally, Avista states that its request, if approved by the Commission, does not in any way relieve the Company of its obligation to demonstrate the prudency of these fixed price transactions or any other gas supply transaction when it later seeks recovery of these amounts through its PGA mechanism.
Accordingly, Avista requests approval of deferred accounting treatment for the revenues and expenses associated with fixed price transactions for the period of January 1, 2001 to March 31, 2002.
STAFF ANALYSIS AND RECOMMENDATION
The Company currently purchases all its gas from an affiliate under the benchmark mechanism set up in Order No. 27908. Staff recognizes that this mechanism does not provide an accounting device to pass revenues and expenses for fixed-price transactions on to customers. The Staff also believes that these types of transactions can provide price stability and reductions in the cost of gas purchased if the price in the market is higher. Like the Company, Staff is concerned with the volatility of gas prices, thus it is reasonable to use fixed price transactions in order to combat this situation. However, these transactions do contain an element of risk. For example, if the market price drops below the instrument price, there will be a premium over market price that the customers will have to pay. Likewise, if the market price goes above the instrument price, customers will enjoy prices that are below market prices as well as the benefits of stable prices. With the current benchmark mechanism, there is no incentive for the Company to use fixed price transactions for customers because it cannot pass the benefits and risks to them. Accordingly, Staff recommends amending the benchmark mechanism to allow the Company to defer the revenues and expenses associated with fixed price transactions for the period of January 1, 2001 to March 31, 2002.
The Company currently has three instruments in place to fix the price of gas for customers from January through March 2001. It has requested that it be able to pass the costs of these instruments on to customers. Staff performed an analysis on these three fixed-price transactions and the results as summarized below are typical of the risks and benefits that can happen with financial instruments.
Sumas Instrument
In early December 2000, there was a tremendous increase in prices for gas at the Sumas Citygate. Suppliers and LDCs began a rush to purchase less expensive gas from the Rockies area. Then, Northwest Pipeline implemented an Operational Flow Order that required customers to purchase and flow gas through Sumas. The Citygate prices tripled and then they went even higher. By December 8, 2000, the daily price was over $42.00/MMBtu. Avista decided to act on the high prices by purchasing a financial instrument to fix the price of gas for 10,000 MMBtu/day for January through March 2001 at $12.65/MMBtu.
By the end of the month, the prices at Sumas had softened significantly. The benchmark price, which is based on the first-of-the month price, lowered to $14.20/MMBtu. However, that price is still higher than the instrument price. If this accounting order is approved, Idaho customers will save over $115,600 for the month of January by fixing the price of gas at $12.65/MMBtu. However, based on futures prices as of January 8, 2001, the fixed prices will cost Idaho customers over $477,000 in premiums for Sumas gas for the months of February and March 2001. That is the danger of fixed price transactions. The Company proposes to pass both the savings and the cost of premiums on to customers.
AECO Instrument
The Company also purchased an instrument for AECO gas. The purchase price at $7.20/MMBtu for 896 MMBtu per day is lower than current prices and Staff projects a savings of $153,000 for Idaho customers based on January 8, 2001 futures prices.
Rockies Instrument
The Company has a hedge for gas from the Rockies area. The purchase price at $7.40/MMBtu for 2,407 MMBtu per day is also lower than current prices. Using futures prices as of January 8, 2001, Staff projects a saving of $125,000 for customers because of this hedge.
Overall, based on futures prices, these three financial transactions will cost Idaho customers about $83,400 to have a portion of their gas prices fixed. The fact that the market is extremely volatile makes the purchase of financial instruments a risky matter. One of the parties in the contract will win and the other will lose. There will always be a premium required to buy gas at a fixed price. Because of the inherent risk, Staff believes it is important for the Company to share the risks and the benefits of these instruments with customers. This request does not address any sharing provisions. When Staff reviews the Avista’s Benchmark Mechanism along with our review of the PGA mechanism for Intermountain Gas Company, Staff will investigate the possibilities of a sharing mechanism. Staff will continue to monitor the prudency of gas-related costs based on the following criteria:
1. Current market conditions
2. Current and future prices
3. Information available to the affiliate marketer
4. Any other information useful in establishing purchase strategies

Staff proposes to conduct further review of the benchmark mechanism and hedging practices to determine whether the Company and its customers are receiving adequate services for the fees paid to Avista Energy for its expertise in gas acquisition and transport rather than receiving full exposure to a high-cost market. Staff believes its continued review should evaluate whether services that include risk assessment and development of a gas purchase strategy are a function for the distribution company or a service that should be included in the current contract with Avista Energy. The current PGA and benchmark mechanism simply track market prices to demonstrate customer costs and benefits. Sufficient information has not been provided on risk assessment/planning services provided by Avista Energy or that there are sufficient incentives to undertake such services to secure gas at the lowest possible cost for customers. The results of this review may require further changes to the benchmark mechanism.
Staff recommends approval of the Application as filed to allow the accounting entries to be recorded beginning January 1, 2001. The gas purchased under these instruments is currently only about 5% of the total load. Staff intends to review this accounting policy along with a review of the PGA benchmark mechanism prior to the end of the trial period on March 31, 2002. Staff believes there should be accountability and sharing of the risks and rewards of financial instruments for the Company. Staff agrees with and reiterates the Company’s statement that “the proposed changes to the PGA process does not relieve the Company of its obligation to demonstrate the prudency of its decisions.” Dukich letter dated December 20, 2000, attached to Application. Staff will continue to monitor the use of financial instruments by the Company and evaluate prudency for cost recovery when it is requested by the Company.
Commission Decision:
Does the Commission wish to approve Avista Corporation’s Application for a Deferred Accounting Order?

John R. Hammond

Staff: Alden Holm
Terri Carlock

M:avug007_jh

DECISION MEMORANDUM 5