Regulated Rate Option – Energy Price Setting Plan
Energy Alberta GP Inc. (“EEA”) is required to file monthly energy rates with the AUC. These monthly energy rates are determined under the Electric Utilities Act (“EUA”), in accordance with the Regulated Rate Option Regulation (the “RRO Regulation”), and the applicable AUC approved energy price setting plan (“EPSP”).
In this decision, the AUC considered EEA’s application requesting approval of a proposed EPSP for the term of May 1, 2018, to April 30, 2021.
Decision Summary
The AUC approved EEA’s request to procure full-load products and fixed block products using a descending clock auction format.
EEA’s Current EPSP
The AUC explained that the monthly energy charges under EEA’s current EPSP are composed of the following elements:
• base energy charge;
• reasonable return compensation;
• Alberta Electric System Operator (“AESO”) trading charges;
• Natural Gas Exchange (“NGX”) trading charges and transaction fees;
• AESO collateral costs;
• backstop collateral costs;
• NGX collateral costs;
• external EPSP development and regulatory costs;
• other credit costs;
• retail adjustment to market (RAM) costs;
• uplift charges (UC);
• commodity risk compensation; and
• other risk compensation.
The AUC noted that, typically, the base energy charge, reasonable return, commodity risk compensation and other risk compensation are the most contentious components of the EPSP, as was the case in this proceeding.
Regarding the base energy charge under EEA’s current EPSP, the AUC explained that:
(a) The base energy charge reflects the value of the forward market energy products acquired by EEA;
(b) under its current EPSP, EEA procures 7X24 flat volume blocks in 10 megawatt (MW) block sizes, and it procures 7X16 peak volume blocks in 5 MW block sizes;
(c) the 7X24 flat volume product means the volumes in MW for an energy product for all hours in a day, Monday through Sunday inclusive; and
(d) the 7X16 peak volume product means the volumes in MW for an energy product for hours eight through 23 in a day Monday through Sunday inclusive.
Concerning EEA’s procurement of energy products under its current EPSP, the AUC explained that:
(a) EEA procures its energy products for each month through six auction sessions, plus one contingency auction session, if required;
(b) the auctions sessions are spread out, approximately equally across the 120-day allowable price implementation period related to procurement of energy for a given month; and
(c) EEA designed its current auction to follow a random close format, where the initial price input is confidentially determined for each auction session, referred to as the seed price.
To determine monthly charges under EEA’s current EPSP:
• The volume-weighted average price of the forward market energy products acquired during the 120-day procurement period is used as the starting point to set the base energy charges for a given month.
• The total energy portfolio cost for the month is determined using the cost and associated volumes of all the forward market energy products acquired for a given month, which is then separated into an on-peak energy portfolio cost and an off-peak energy portfolio cost.
• From this information, a weighted average on-peak price per MWh and a weighted average off-peak price per MWh is determined.
• For each rate class, the weighted average on-peak price per MWh is multiplied by the ratio of a rate class’s on-peak forecast load to its total forecast load.
• The resulting figure is added to the product of the weighted average off-peak price per MWh and the ratio of the rate class’s off-peak forecast load to its total forecast load.
• The resulting figures are the base energy charges in $/MWh for each rate class in the service area.
The AUC explained that this methodology results in the rate classes with a higher ratio of on-peak forecast load to total forecast load having a higher base energy charge since the cost of on-peak forward market energy products is greater than the cost of off-peak forward market energy products.
Regarding risk compensation under the current EPSP, the AUC explained that section 6(1) of the RRO Regulation requires that:
(a) the AUC approve a risk margin that provides the owner with just and reasonable financial compensation for the risks described in section 5 of the RRO Regulation; and
(b) this risk compensation components to be distinguished from and separate to the reasonable return compensation component.
The need for risk compensation arises from:
(a) Price Risk: Differences between the cost of the forward market energy products acquired by EEA to meet its forecast load, and the actual cost of electricity used by EEA’s customers; and
(b) Volume Risk: Differences between the volume of electricity EEA acquires in advance of the month and the actual volume of electricity used by EEA’s customers during the month.
These risks result from price and volume differences on an expected versus actual basis, and correspondingly, net systematic losses or gains for EEA. The AUC explained that the systematic losses, can be significant, and EEA receives commodity risk compensation for these losses.
In addition to commodity risk compensation, EEA also receives other risk compensation. The AUC explained that EEA receives other risk compensation for being exposed to two types of cost recovery risk, namely:
(a) the risk caused by the differences between actual and forecast electricity sales, given that EEA charges monthly RRO rates based on forecast electricity sales; and
(b) the risk that EEA’s actual operating costs will be different from its forecast operating costs. The amount approved for other risk compensation in its current EPSP is $0.07/MWh.
EEA’s proposed 2018-2021 EPSP
EEA proposed several changes to the 2018-2021 EPSP from its current EPSP, largely related to the forward market energy products procured, the auction format, the number of auction sessions, the calculation of the base energy charge and the calculation of the commodity risk compensation.
For the 2018-2021 EPSP, EEA proposed acquiring the following blocks of forward market energy products:
• 7X24 flat volume blocks in 5 MW block sizes;
• 7X16 peak volume blocks in 5 MW block sizes;
• a full-load product; and
• changes from the current EPSP including a reduction in the block size of the 7X24 peak volume blocks, from 10 MW to 5 MW, and the addition of the full-load product.
EEA explained that the full-load product would be procured in strips (full-load strips or full-load strip products). EEA expected that the full-load strips would average about 4 MW in size. The actual size of each full-load strip would not be known until the month concluded and the actual hourly load, including losses, was determined.
EEA proposed that approximately 50 percent of the forward market energy products would be full-load strips and the remaining 50 percent would be fixed block products. EEA would simultaneously procure three forward market energy products for each month through a series of four scheduled auction sessions, plus up to two contingency auction sessions (a change from the current six auction sessions, plus one contingency session).
EEA proposed using a descending clock auction format (discussed below). Two components of the descending clock auction would be completed on a confidential basis: (1) the starting price methodology, and (2) the competitiveness assessment and volume reduction methodologies.
Currently, EPSP’s base energy charge is determined using the acquisition prices for the flat and peak block products. EEA proposed that under the 2018-2021 EPSP, only the volume-weighted average price of the full-load strip products acquired in all auction sessions during the 120-day allowable price implementation period would be used to determine the base energy charges for the month.
EEA also proposed to include a backstop charge. The backstop charge is a $/MWh charge related to costs of having a backstop supplier for electricity in case EEA cannot acquire all of its forward market energy products through its auction sessions. The backstop charge component to the proposed 2018-2021 EPSP includes a retainer fee, whereas, the backstop used in the current EPSP does not.
RRO Regulation
The AUC first considered whether the provisions of the RRO Regulation permitted EEA to acquire full-load strip products for approximately 50 percent of the forward market energy products it procures and to determine the value of its commodity risk compensation using the price of these full-load products.
The AUC specifically considered three sections of the RRO Regulation:
(a) Section 5(2): compensation may only cover risks to which the owner is directly exposed;
(b) Section 6(1)(f): risk of acquisition remains with the owner; and
(c) Section 6(1)(b): reasonable return must be allowed for, and it must not consider risk compensation.
The AUC concluded that EEA’s proposed commodity risk compensation methodology would not result in EEA receiving excess reasonable return over and above the amount explicitly awarded.
Section 5(2): Risk compensation may only cover risks to which the owner is directly exposed
Section 5(2) of the RRO Regulation states that “The risk margin may only cover risks to which the owner is directly exposed and may not include risks that are borne by a person other than the owner.”
The AUC concluded that EEA’s proposed commodity risk compensation methodology was not contrary to Section 5(2) because:
(a) the suppliers of that product would bear the commodity risk associated with the full-load product, and the price of the commodity risk associated with the full-load product would be paid to the suppliers of that product, not to EEA;
(b) EEA was not requesting risk compensation, i.e., a risk premium, over and above what suppliers were building into the price for the full-load product; and
(c) EEA would appropriately only receive compensation for the commodity risk to which it is exposed associated with the fixed block products.
Section 6(1)(f): Procurement risk of acquisition remains with the owner
The AUC found that even though EEA proposed to acquire full-load product for half its monthly load, it would remain responsible for the procurement of all the energy required to satisfy its monthly load obligations. The financial risk of satisfying all of its monthly load ultimately remained with EEA, should energy not be supplied through either full-load strip products, or fixed block products, or if the backstop mechanism was triggered.
The AUC concluded that EEA’s proposed commodity risk compensation methodology did not violate section 6(1)(f). The AUC rejected an intervener’s argument that by offering a different forward market energy product (the full-load product) the owner’s risk was transferred to someone other than the owner, contrary to the RRO Regulation.
In making these findings, the AUC noted:
(a) Owner is a defined term under RRO Regulation and includes an RRO provider, such as EEA; and
(b) Neither “procurement” nor “acquisition” is defined in the RRO Regulation or the EUA. Nor were there any specific provisions to inform the Commission on the approval of the EPSP “in a manner that ensures that procurement risk of acquisition remains with the owner.”
Section 6(1)(b): Reasonable return must be allowed for and it must not consider risk compensation
The AUC concluded that EEA would not receive excess reasonable return due to its proposed methodology for commodity risk compensation and therefore did not contravene section 6(1)(b)(ii). In making this finding, the AUC noted that:
(a) the only difference in the prices of full-load and fixed block products would be the cost of the additional volume risk associated with full-load products;
(b) to the extent that a supplier builds additional return into the amount it needs in order to be willing to provide the quantity of its full-load product bid, an amount that is above its forecast cost of the additional risks it will be facing, that supplier would be disadvantaged, all else being equal, versus another supplier with the same costs who does not price-in such additional returns;
(c) over time, this supplier would determine that its strategy of including additional return was suboptimal, because of a continued lack of success from offers into the full-load product auctions and an effect of competition. This concept supports the position that the cost of full-load products will not contain excess reasonable return in relation to fixed block products;
(d) arbitrage opportunities would be addressed by the competitive properties (including the competitiveness assessment step) of its proposed auction process; and
(e) the competitive nature of the auction process should lead to full-load product auction prices that differ from the fixed block product auction prices, only by the forecast value of the additional risk faced by the suppliers of the full-load product.
Energy Acquisition Process
Regarding the ESPS energy acquisition process, the AUC considered EEA’s proposed:
(a) descending clock auction format;
(b) contingency plan in case the descending clock auction format and the procurement of full-load product did not function as intended; and
(c) a backstop mechanism for supply of forward market energy products if it cannot acquire all of its required volumes through the descending clock auction format.
Descending Clock Auction Format
The AUC approved EEA’s proposed use of a descending clock auction format for its 2018-2021 EPSP.
In approving the change in an auction format (from a random close to a descending clock auction), the AUC found that:
(a) on balance, the descending clock auction design format was not expected to discourage participation in such auctions for the 2018-2021 EPSP due to its complexity; and
(b) the descending clock auction design format had a reasonable chance of being implemented successfully by EEA in Alberta, based on successful experiences in other jurisdictions using the descending clock auction format for the procurement of multiple products.
The AUC agreed with EEA that the descending clock format better ensured that competitive forces inherent in the determination of forward hedge prices for the full-load product would capture the proper value for commodity risk compensation. As a result, instead of having an administratively-determined value for commodity risk compensation, market participants engaged in a competitive, descending clock auction would determine this value.
Requested Flexibility
The AUC granted EEA’s requested flexibility to make limited adjustments to certain auction parameters to ensure the ongoing competitiveness of its auctions, with one modification for the auction round lengths as discussed below.
EEA stated that parameters might require adjustment based on EEA’s experience with the descending clock auction in the context of the Alberta electricity market, as this would be the first time that such a procurement would be used in Alberta. Such adjustments were necessary to improve the ability of the descending clock auction process to attract participation that would produce competitive results, or if changes in the Alberta electricity market necessitated adjustments.
Backstop Mechanism
The AUC approved EEA’s proposed backstop mechanism except for including an amount of $2.50/MWh for fixed risk compensation as part of the backstop commodity risk compensation mechanism.
Considering the possible changes in the Alberta wholesale electricity market over the EPSP term, the structure of the proposed EPSP and the new descending auction design, the AUC preferred EEA’s proposal in which a backstop supply arrangement would be established at the outset of the EPSP’s term. The AUC found that such a plan reduces the uncertainty associated with procuring electricity for the RRO if the regular and contingency auction sessions were unable to obtain sufficient supply.
Risk Compensation
The AUC, by extension, also approved EEA’s proposal for pricing commodity risk compensation as set out in its 2018-2021 EPSP. The AUC found EEA’s proposed market-based commodity risk compensation methodology to be a logical extension of its proposal for procuring full-load products and fixed block products simultaneously through the use of a descending clock auction.
The AUC found that the winning prices for the full-load product and the fixed block products would incorporate each suppliers’ cost for bearing the risk associated with each product. The AUC agreed with EEA’s proposal to derive the commodity risk compensation by providing the market the opportunity to both incur and price the risk and use its appropriate tools to manage that risk.
With market-determined prices, the AUC considered that the difference between the price for the full-load product and the fixed block products would compensate EEA for both price and volume risk.
On this basis, the AUC found that EEA’s proposed commodity risk compensation methodology would result in a commodity risk compensation that is market base and would reflect the risk differential associated with full-load products.
Reasonable Return
The AUC found that under EEA’s proposed methodology, the reasonable return percentage for a subsequent year would be more than the 1.50 percent that EEA has requested, even if none of the parameters between years changed. However, using the same assumptions and the AUC’s methodology, the resulting after-tax reasonable return percentage for the subsequent year would be exactly 1.50 percent. This exercise supported the AUC’s finding that the methodology in Decision 2941-D01-2015 was the proper manner to determine the reasonable return.
The AUC denied the methodology proposed by EEA for the annual calculation of the reasonable return.
EEA receives a reasonable return for its obligation to provide service. The reasonable return compensation is a legislated requirement under section 6(1)(b) of the RRO Regulation.
EEA’s current ESPS reasonable return compensation was $2.51/MWh (after-tax), determined as part of the generic RRO proceeding held during 2014/2015. The $2.51/MWh was calculated as 1.50 percent of EEA’s energy revenues, non-energy revenues and distribution and transmission revenues, less local access fees and municipal franchise fees, for the year 2013. This after-tax amount was approved for the entire term of the current EPSP and, therefore, has remained static at $2.51/MWh.
EEA based its proposed reasonable return for 2018-2021 on the methodology approved in its current EPSP but with the opportunity to update the reasonable return each July to reflect the energy revenues, non-energy revenues and distribution and transmission revenues, less local access fees and municipal franchise fees, for the previous year.
The AUC directed EEA, as part is compliance filing, to revise its reasonable return calculation methodology to be the same as the methodology in Decision 2941-D01-2015.
Order
The AUC approved EEA’s EPSP, subject to the findings and directions set out the decision.
The AUC directed EEA to submit a compliance filing, to reflect certain changes required to the 2018-2021 EPSP.
