2004 Legal Seminar

1. 2004 Legal Seminar

2. When is a Contract Not a Contract? More lessons from California . . . . Meg Meiser, William Huang, and Larissa Shamraj

3. California and the Midwest: Pre-restructuring transmission arrangements and the transition to restructured electricity markets. Competing factors Sanctity of contract Pre-existing transmission contracts as obstacles to effective restructuring A Tale of Two ISOs

4. Overview • Recent California cases on Existing Contracts • Recent Midwest ISO cases on Grandfathered Agreements • Implications for the future

5. 40 Ways (Minus 36) to Leave Existing Contracts • Abrogation or reformation • Renegotiation by parties • Unilateral modification under FPA §205 or §206 • “New service”

6. The “New Service” Approach • Existing contract, which previously provided everything necessary for deliveries, no longer adequate • Additional services or products necessary • TO may charge for “new service” on top of existing contract rate • Mobile-Sierra; cost support requirements

7. Existing Contracts in the California ISO • 1996 – AB1890; 1998, the California ISO began operations • Existing Contracts would continue to be honored. • “To the extent that Transmission Losses or Ancillary Service requirements associated with Existing Rights are not the same as those under the ISO’s rules and protocols, the ISO will not charge or credit the Participating TO for any cost differences between the two.” CalISO Tariff §2.4.4.4.4.5

8. TO Tariff Initial Decision • Transmission Owner Tariff • Costs to be charged and windfalls credited to TO Tariff Customers • TO Tariff Initial Decision denied TOs recovery of these charges from TO Tariff Customers • Recovery, if at all, by amending the Existing Contracts • TOs to shoulder costs if they lack rights to amend the contracts

9. SCS Tariff Filing • PG&E proposed to recover costs from Existing Contract holders (mostly municipals) • New Service; in the alternative, amendment to Existing Contracts • Filed November 12, 1999; requested retroactive Effective Date: start of Cal ISO operations (March 31, 1998)

10. SCS Tariff - Abeyance • Rate conditionally effective March 31, 1998 • Abeyance until 2002 • Charges continued to accrue • No information provided by PG&E

11. Reliability Services Tariff Filing • Reliability Must-Run and Local Out-of-Market Calls • PG&E characterized these costs as “Reliability Services” • According to PG&E, the firm transmission service provided under Existing Contracts did not include Reliability Services • Therefore, PG&E should be allowed to charge for Reliability Services as a new service • Alternatively, amend Existing Contracts

12. RS Tariff Decision • The Initial Decision rejected the new service theory • According to ALJ, Reliability Services “were not a gleam in PG&E’s eyes when these contracts were executed.” • Nevertheless, so-called Reliability Services were inherently included in the pre-restructuring firm transmission service • PG&E could seek to amend the Existing Contracts if no Mobile-Sierra protection • FERC affirmed the Initial Decision

13. Grid Management Charge Pass-Through Tariff Filing • Sought to pass-through Cal ISO’s GMC • “New service” theory • Partial success at ALJ level: • Approximately half of GMC Pass-through charges treated as a “new service” • Approximately half of GMC Pass-through charges were for functions already covered by Existing Contracts

14. GMC Pass-Through Tariff • Commission overturns Initial Decision in part – all administrative costs of ISO new • Existing Contract customers “fail to come to grips with the fundamentally new and different roles that now exist under the California ISO regime.” • Existing Contract Holders not “immune from all change brought about by restructuring” • ISOs/RTOs benefit all

15. Edison is authorized to pass on whole passel of ISO costs to a group of municipals as a contract amendment Little detailed scrutiny of underlying contract, but Commission goes through the steps of a pro forma analysis Edison seeks to pass on whole passel of ISO costs as new service for an exchange agreement with LADWP Commission puts on hold pending “guidance” from GMC rehearing Other cases in California

16. GMC Rehearing Order (Opinion No. 463-A) • Retained status quo: GMC costs are costs a new service • Distinguished MISO: • Retention of historical control areas • Continued to chastise municipals for failing to come to grips with change

17. GMC Rehearing Guidance? • Ammunition for both sides of the argument • Kelliher dissent: policy goal of preventing trapped costs does not justify new service ruling • Case on hold pending guidance still on hold • Reading tea leaves all that was left

18. SCS Tariff revived: Initial Decision • Initial decision in SCS Tariff case Phase I • Among the issues: • is the SCS Tariff a new service? • Should the SCS Tariff have an effective date of Day 1 of ISO start-up, though it was filed almost 20 months later • Presiding Judge says: • Yes • Yes • No need to look at Mobile-Sierra protections

19. Opinion No. 477: The other shoe • October 28, 2004: the Commission affirms the ID in whole on the new service • PG&E’s function as SC for ETCs was not required in contracts and was a new service • Charges can be passed on to ETC holders as costs of a new service • Mobile-Sierra irrelevant • Overrules ID on retroactive application: still an obligation to have tariff on file

20. Different standards? “While it may be true that there has not been a change in the physical characteristics of the ancillary services provided under the Control Area Agreements, it is nonetheless a fact that an entity such as the CAISO will operate under different standards than did PG&E with regard to ancillary services requirements, since it is operating a grid which comprises what were previously three separate control areas.” Opinion No. 477

21. Benefits of Restructuring? “As a Commission staff witness observed, with the formation of the ISO in California, there have been “massive” and “fundamental changes” in the manner in which electricity is sold and distributed there, so that “the complexities of operating the transmission system have increased exponentially.” Opinion No. 477 (citing Opinion No. 463-A)

22. “Additionally, it is highly significant that the CAISO has established competitive markets for ancillary services and imbalance energy.Thus, the situation is fundamentally different from that in which PG&E procured ancillary services in a non-competitive environment.” Opinion No. 477 “PG&E hydro units play a key role in the ISO ancillary service markets supplying approximately 70% of the total ancillary services requirement in Northern California, and approximately 85% of the regulation services in Northern California.” Testimony of Anjali Sheffrin, CAISO Director of Market Analysis, in PG&E hydro divestiture proceedings before the CPUC in 2000. Competitive Markets?

23. Contract Amendment: Gleam “RMR and OOM dispatch calls were not a gleam in PG&E's eyes when these contracts were executed.” Initial Decision (finding that Reliability Services were nonetheless included in the firm transmission service provided under the ETCs) New Service: Twinkle “It is self-evident that PG&E did not obligate itself to perform as a CAISO Scheduling Coordinator under its existing contracts, as the role itself and the responsibilities and obligations that it entails did not exist at the time these contracts were entered into, when the CAISO was not yet a twinkle in the California legislature’s eye.” Opinion No. 477 What’s the real difference? Gleam vs. Twinkle

24. The bad news: All “CAISO-created” charges are up for grabs Complexity of running grid increased “exponentially” Ancillary service standards of CAISO may not be the same as PTOs’ pre-ISO standards; costs can be passed along Municipals still not coming to grips with restructuring The less bad news: Many municipals have left their ETCs behind Can PTO recover for anything but “incremental” amounts? Commission declines to make SCS Tariff retroactive: the filed rate doctrine remains binding Credits must be given for things that were provided under ETCs SCS Tariff: How bad is it?

25. In MISO: A different story? • Imposition of any MISO administrative costs must be done as a contract amendment • Commission: Transmission Owners retain historical control areas • Other possibilities: • Gradual process towards markets, not there yet • Designated Transition Period ending on 1/31/08 • Broader group of entities involved in MISO process, including non-jurisdictionals • California a lesson in what not to do • Most costs associated with GFAs don’t flow through Tariff

26. Between a rock and a hard place “A few months ago in the Spring, it looked like we had two star[k] choices, either abrogate 300 contracts o[r] cripple MISO’s energy and transmission markets, and they were pretty unpleasant choices.” Commissioner Kelliher September 16, 2004

27. MISO Expedited Hearing & Settlement Process • Carrots, sticks, and a “timeline from hell” • Carrots: • Settle if you want the option that comes close to holding you harmless • Sticks: • Extremely expedited timeline • Litigation risk • New service threat • Non-jurisdictionals optional, but what happens if you opt out?

28. GFA Resolution • Carve-out does not harm MISO: • Between settlements and hearings, amount of GFAs “carved out” of MISO Day 2 markets only 9.6 percent of peak load • Issues Resolved for GFAs in MISO • How does the GFA integrate into the market? • Who is the “Responsible entity”? • What is the standard of review? • How are Schedule 16 and 17 costs passed on? • But what does it really mean? How binding is the resolution on future activities? What happens after 1/31/08?

29. Pre-emptive Resolutions: Proactive Commission or Strong-Arm tactics? • GFA expedited proceedings • Sellers Choice Contract settlement negotiations: marketwide attempt to address LMP and conflicts with existing power purchase contracts • FERC-brokered resolutions in termination dockets

30. Conflicts between pre-existing (or even recently negotiated) contracts and changing market structure inevitable Can California’s quarantine hold? No major market blips Enough entities playing the game New service requires change, but change is easy to find Are your contracts worth the paper they’re written on?

31. Risks of opting out • Loss of control and diminished ability to: • Mitigate financial impacts • Understand market complexities • Participate in market redesign • Dispute what’s going on • Retention of all old obligations, potential to add costs of new markets • Hedge can become cost plus (cost under ETC plus various “ISO-created” charges) anyway • Commission losing patience with those who are stuck in the past

32. “Complainants became dissatisfied with their bargains and sought contract modification. The law is quite clear on that point. The fact that a contract becomes uneconomic over time does not render it contrary to the public interest.” Commission decision in Nevada Power upholding high-cost power purchase agreements from Western meltdown “Through these existing transmission contracts, PG&E is obligated to provide firm transmission service. The creation of the CAISO did not relieve PG&E of that obligation…. I would reverse the Initial Decision determination that PG&E is providing a new service and grant the exceptions on this issue.” Kelliher Dissent in Opinion No. 477 Sanctity of Contract: Yes or No?