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					 In re: Consideration of Incentive Regulatory Mechanisms Pertaining
      to the Fuel and Wholesale Energy Procurement Practices of
                     Jurisdictional Electric Utilities
                              Motion of Commissioner Field
                             November 8, 2007 Open Session
As we all know, the price of natural gas has risen dramatically in recent years.
Unfortunately, the spike in natural gas prices does not appear to be a temporary
phenomenon, as the trading range over the last several years instead suggests a new
reality. While an increase in the price of a critical commodity such as natural gas may
be good for producers of natural gas and owners of mineral rights, nearly everyone else
loses because power plants fueled with natural gas generate much of our electricity and
when a cost to produce electricity increases so do electricity prices.

Businesses and industrial companies lose because the rise in electricity prices cause an
increase in expenses, which often cannot be passed on to customers in the form of
higher prices for goods and services. In addition to perhaps paying more for goods and
services, consumers also lose because higher electricity prices result in reduced
disposable income and the potential for serious financial strain. On a macroeconomic
level, the higher production costs experienced by businesses and industrial firms, and
the lower disposable income available to consumers, can lead to lower economic
growth rates, higher unemployment, and the increased chance of business failures.
Because of these detrimental effects, the Commission must ensure that our electric
utilities are doing everything within their power to keep the cost of the fuel used to
produce electricity as low as possible.

Under the regulatory compact, electric utilities are entitled to recover their prudently
incurred costs, including the cost of fuel used to generate electricity. Although they are
entitled to recover their fuel expenditures, electric utilities are not entitled to earn a profit
on their fuel or wholesale energy purchases. The mechanism by which electric utilities
recover their fuel costs is known as the Fuel Adjustment Clause. Through the Fuel
Adjustment Clause, utilities bill their ratepayers for a pro rata portion of the utility’s fuel
and wholesale energy costs. Fuel Adjustment Clauses are used in nearly every other
jurisdiction because of their administrative efficiency.

Although the Fuel Adjustment Clause has worked well, like any regulatory mechanism,
it is not perfect. Because utilities can pass though the cost of fuel to their customers,
utilities may seek to conduct their fuel and wholesale energy procurement practices in a
manner geared primarily to avoiding an imprudency determination, rather than pursuant
to the overlapping but expanded goal of maximizing ratepayer savings.

The Commission continues to observe such seemingly paradoxical practices whereby
electric utilities obtain energy from rate base plants that possess poor fuel-efficiency
ratings despite the presence of cheaper and more fuel-efficient generation in the
wholesale market. While we continue to investigate these practices pursuant to our
Fuel Adjustment Clause audits, I would like to explore whether the Fuel Adjustment
Clause can be modified to better align consumer and utility interests and eliminate fuel
and wholesale energy procurement practices that lead to detrimental economic effects
and adverse environmental consequences.

The social sciences inform us that people and organizations tend to operate most
efficiently when they are pursuing a goal that is in their self-interest. In the regulatory
arena, this axiom has resulted in the increased use of incentive regulation. This
Commission has seen success with such incentive regulatory mechanisms as formula
rate plans for electric utilities, price caps for telecommunications companies, and rate
stabilization plans and gas hedging incentives for gas utilities. When designed properly,
these incentive mechanisms, which replace the “stick” only (i.e., prudency review)
approach with a combination “carrot and stick” approach, can result in lower prices for

Based upon our positive experience with these innovative regulatory mechanisms, I
believe that this Commission should explore the implementation of incentive regulation
mechanisms for the fuel and wholesale energy procurement practices of our electric
utilities. As such, I move that this Commission, which has long been known as one of
the most progressive in the nation, initiate a rulemaking to evaluate and consider
incentive regulatory mechanisms, including, but not limited to the following:

      1. Yardstick Competition: whereby the electric utility’s fuel and wholesale
         energy procurement performance is compared to the performance of a peer
         group. Rewards would be allowed for performing better than the peer group
         and penalties would be assessed for performing worse than the peer group.

      2. Benchmarking: whereby the amount of fuel and wholesale energy
         expenditures that the electric utility would be allowed to recover from
         ratepayers would be established by a formula that reflects efficient fuel and
         wholesale energy procurement practices and the unique characteristics of the
         electric utility. Electric utilities that are able to reduce their fuel and wholesale
         energy expenses below the amount allowed by the formula would be allowed
         to retain all – or, alternatively, a portion - of the savings. Conversely, electric
         utilities that procure fuel and wholesale energy in an inefficient manner would
         not be allowed to recover any – or, alternatively, some portion - of the
         expenditures in excess of the benchmark.

When evaluating potential new fuel and wholesale energy procurement mechanisms,
Staff must ensure that perverse incentives are not created which trade lower fuel and
wholesale energy costs for higher total costs. For instance, solid fuels are currently less
expensive than fossil fuels. However, the capital costs for building solid fuel plants are
much more than the capital costs for building a natural gas plant with equivalent
capacity. Obviously, we do not want utilities to shift their generation portfolio toward a
particular fuel for the sole purpose of sharing in fuel savings if the choice of the cheaper
fuel results in higher total costs for ratepayers due to the incurrence of higher capital
costs necessary to build or acquire solid fuel generation.

To prevent this type of cost shifting, Staff should consider separate incentive formulas
for each generation type. For instance, the rule might consider benchmarks or
yardsticks whereby natural gas plants are compared only to a natural gas benchmark or
yardstick and solid fuel plants are compared only to a solid fuel benchmark or yardstick.
Such separate benchmarks or yardsticks could still provide incentives for electric utilities
to purchase wholesale energy when that purchase results in savings, regardless of the
fuel used to generate the wholesale energy.

The first phase of this rulemaking will be to consider the establishment of one or more
generic incentive mechanisms. Because of the presence of unique factors among each
jurisdictional electric utility, the generic mechanism or mechanisms that are found to be
in the public interest will be tailored to each jurisdictional electric utility in subsequent
and separate proceedings.

Because this rulemaking will involve consideration of complicated issues with far-
reaching impacts, I also move that the Commission hire Dr. David Dismukes as a
consultant in this rulemaking. Dr. Dismukes has done extensive academic research in
the field of incentive regulation. In addition, through his position at the L.S.U. Center for
Energy Studies, he has tremendous first-hand knowledge of the economics of the
various electric generation fuels. Acadian Consulting Group can perform the work for
$46,500, plus expenses not to exceed 10%.

Finally, I move that this rulemaking be noticed in the next official bulletin and that Staff
move quickly on this issue and attempt to bring us a proposed rule no later than the
June 2008 Open Session.