7 Drawing upon our experience with the implementation of PURPA, we next discuss

several of PURPA's difficult policy issues. The discussion is divided into

11

12

three parts: fundamental industry structural issues, pricing issues, and QF

1222222

1. System Operability and Reliability

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

The system of qualification restrictions and avoided, cost.payment
obligations under PURPA was not designed as a comprehensive framework
to deregulate the electric power industry. It had the much more
limited objective of encouraging the development of a small but
significant industry of private generation to increase overall energy
efficiency, conserve energy, and reduce national dependence on
insecure foreign sources of energy.

38

39

40

41

42

43

44

45

46

47

48

49

50

51

52

53

54

55

56

57

The PURPA model, especially as implemented by the FERC, is a system
designed to integrate with reasonable efficiency the planning and
operation of third-party resources into a power system whose

fundamental backbone consists of resources owned and operated by a
vertically integrated utility. PURPA was not intended to, nor is the
resulting structure particularly conducive to, supplant the

fundamental coordination and integration achieved in this backbone of
the system by a franchised utility entrusted with a legal obligation
to serve all demand in its territory.

What most distinguishes the supply of electric power from other

commodities is the need to balance supply with demand within narrow
tolerances on a continuous basis in order to maintain service
quality, reliability, and system integrity. In performing this
function, the many components on an electric power grid are highly
interdependent and must respond with a high degree of integration and
coordination if electricity is to be supplied reliably at minimum
cost. Among the many important coordinated functions which must be
achieved are:

a. Preservation of electrical frequency standards and system
stability by having a significant portion of generation able to
follow load subject to central dispatch;

Planning and coordinating unit commitment and maintenance
schedules;

Provision of adequate spinning reserve to assure system
reliability;

Operating and planning to provide for adequate response to
emergencies and subsequent system recovery; and

44555555

53

f. Scheduling of generation to achieve scheduled transfers of power
across electrical systems.

12345678

9

10

11

12

13

14

15

16

17

18

19

Because electrical systems are complex and their efficient planning and operation involves thousands of interrelated reactions and decisions, responsibility for these decisions has been entrusted traditionally to a single vertically integrated utility charged with a public utility obligation within its franchised service territory. It is extremely doubtful that all of these planning and operating decisions could be made as efficiently and reliably through a system of arm's-length contracts rather than through integration under one organization.

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

41

42

This is not to say that there is not room to accommodate

significant QF community within the current industry structure. However, for a healthy third-party generation community to prósper, a vertically integrated host utility is needed. As the size of the QF community grows relative to the franchised utility, the integrity of the utility backbone becomes increasingly threatened, and the reliability of the system deteriorates. The ability of a system to accommodate a larger QF industry without suffering significant deterioration in system operability and reliability depends on many things, including suitable and extensive QF contract provisions. However, the dividing line will probably only be understood through practice. The bottom line is that ratepayers will bear the risks of this experiment.

Policy-making in some jurisdictions, especially California, has tended to view the QF integration problem as essentially a pricing problem. That is, to state the approach in its barest essentials,

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

all that is necessary to solve the planning problem is to find the avoided cost level at which QF supply is sufficient when added to utility supply to balance total supply and demand. Solution to the operating problem, in turn, is pursued by time differentiating these

Such a policy model takes a few simplistic insights of economic theory and attempts to elevate them to a solution to highly complex technical and economic problems. Rather than providing a final and workable solution, it is really only a useful starting point.

Encouragement to view the problem as purely a matter of pricing is to a large extent conveyed by the FERC rules themselves. By mandating full avoided cost payments and then allowing adjustments to be made for certain specified QF operating characteristics, the rules, give the impression that virtually all performance dimensions can and should be "priced out", and that such a system should be sufficient to assure efficient system integration. But utility planning and operating problems are complex and multidimensional.

unrealistically optimistic to believe that these processes can be rationally guided by a system of multidimensional prices, even if applied on a real-time basis.

The deficiencies of a pure pricing system are also felt in the resource planning process. The current system of standard offer contracts in California, based on offering the same avoided costs to all QFs on a first-come, first-served basis, has resulted in a technological mix of QFs which many have questioned. Concern exists. that the QF resource mix, composed of considerable quantities of natural-gas-powered cogenerators, is not consistent with overall

12345678

state fuel use policies. This criticism simply highlights the fact
that the relevant dimensions of resource value (e.g.,

dispatchability, fuel diversification, etc.) are not, and possibly
cannot be, adequately incorporated into a standard pricing system and
should be supplemented with additional contractual controls of
various kinds.

The Utility Obligation to Serve

A final fundamental structural change resulting from PURPA is that
the meaning of the utility's traditional obligation to serve becomes
progressively vague as the size of the QF industry grows larger.
This results in greater financial and service reliability risks for
ratepayers. No longer can the utility by itself, using its own
assets, provide reasonable assurance of continued service. The
fundamental purpose of PURPA to allow utilities to defer construction
of power plants essentially undercuts the utility's ability to -
self-sufficiently satisfy its service obligation. Instead, it must
rely on QFs, plus higher reserve margins, if necessary, to meet its
service obligation.

The bottom line is that both the utility and its ratepayers are
subjected to greater risks. The performance and persistence of QFs,
especially across a wide range of general economic conditions, is not
the same as a utility's, nor is it well understood. A QF's
obligations to the public are contractual and relatively limited.
the other hand, a utility's obligations are more extensive and
established by a totally different body of laws and regulations. If
a QF's economics turn sour, the QF can simply stop supplying power