UNITED STATES OF AMERICA
BEFORE THE 
FEDERAL ENERGY REGULATORY COMMISSION

California Independent System Operator   )		               Docket No. ER98- ____-000
Corporation                                                 )			             

Prepared Direct Testimony of
Charles A. Smart
for the California Independent System Operator Corporation

I.	INTRODUCTION

Q.	WHAT IS YOUR NAME AND BUSINESS ADDRESS?
A.	My name is Charles A. Smart.  I am the Chief Financial Officer for the California Independent System Operator Corporation (ISO).  My business address is 151 Blue Ravine, Folsom, CA  95630

Q.	PLEASE DESCRIBE YOUR PRESENT RESPONSIBILITIES AT THE ISO.
A.	As Chief Financial Officer of the California ISO, I am responsible for preparing fiscal records and financial reports, formulating and administering the overall financial and accounting plans, policies and practices, and forming relationships with lending institutions, financial stakeholders and the financial community.  Specifically, I am responsible for the following functions: accounts payable, accounts receivable, capital markets, cash accounting, cash management, commercial bank relations, corporate finance, custody responsibilities, electronic data interchange, foreign exchange, insurance risk management, international cash management, investment banking relations, investor relations, long term debt, payments risk management, pension funds, short-term debt, short-term investing, tax administration and treasury operations.

Q.	DESCRIBE YOUR EDUCATIONAL BACKGROUND AND PROFESSIONAL EXPERIENCE.

A.	I received a Bachelor of Arts degree in Psychology in 1968, a Master of Arts degree in Education in 1969 and a Masters of Business Administration in 1972 from Stanford University.  From 1974 to 1980, I was employed by International Business Machines, Inc., as a Systems Engineer and Marketing Representative.  From 1980 to 1991, I was employed by First Interstate Bank, N.A., as the Vice President & Manager of Corporate Treasury Services.  From 1991 to 1997, I was employed by Consolidated Freightways, Inc., as the Assistant Treasurer and Manager of Treasury Services.

Q.	WHAT IS THE PURPOSE OF YOUR TESTIMONY?
A.	The purpose of my testimony is to sponsor the ISO’s cost of service analysis and rate schedules.  Specifically, I will describe the ISO’s budget process, present the ISO’s 1998 and 1999 Operating Budgets, and explain how the ISO’s Grid Management Charge will recover the ISO’s projected costs of service from transmission customers.

Q.	WHAT EXHIBITS HAVE YOU ATTACHED TO YOUR TESTIMONY?
A.	I have attached copies of the ISO’s forecasted Operating Budgets for 1998 and 1999 as Exhibit CAS-2.  A description of the ISO’s budget process is attached as Exhibit CAS-3.  The ISO’s Cost of Service Statements are attached as Exhibit CAS-4.  The ISO’s Rate Schedules are attached as Exhibit CAS-5.  Workpapers for the ISO’s Operating Budget and the Cost of Service Statements are included in Exhibit CAS-6.

Q.	DESCRIBE THE ISO’S CORPORATE STATUS.
A.	In accordance with Assembly Bill 1890, State of California 1995-96, Regular Session, September 24, 1996 (AB 1890) and the California Public Utility Commission Order Nos. R.94-04-031 and I.94-04-032 (April 20, 1994), the ISO is responsible for creating a new independent legal entity to take over the operation and control of transmission facilities in the State of California.  The ISO has set up a new and complete transmission control center containing the necessary computer and communication equipment and has hired experienced staff to safely and reliably operate the transmission facilities under its control.                                                                                     
Also in accordance with AB 1890, the ISO was incorporated, in May 1997, as a non-profit public benefit corporation under section 5110 et seq. of the California Corporation Code.  As such, the ISO will have no shareholders and no equity.  The ISO’s operating costs (including coverage on debt financing) will be recovered through operating revenues each year. 
	
Q.	WHAT IS THE STATUS OF THE ISO’S OPERATIONS?
A.	During the third quarter of 1997, most of the systems development work for the ISO
was completed.  Each of the IOUs – Pacific Gas & Electric Company (PG&E), Southern California Edison Company (SCE), and San Diego Gas & Electric Company (SDG&E), will transfer their Area Control Center (ACC) operations to the ISO by the end of the year.  Final preparation of protocols and procedures is expected to be completed by November 1, 1997.  Testing of the systems will begin in the fourth quarter.  The ISO is scheduled to begin operations on January 1, 1998.  
When this testimony is filed, the ISO will have approximately 170 of its projected staff of 273 full-time equivalent employees (FTE) in place.   

Q.	WHY IS THE ISO MAKING THIS SECTION 35 RATE FILING AT THIS TIME?

A.	The ISO was incorporated in May 1997.  In May and June the stakeholders were refining the tariff and delineating the scope of the ISO’s activities and responsibilities.  In June and July, the ISO’s interim staff began the budget process, while the ISO started hiring permanent employees.  In August, enough executive level, decision-making positions were filled to begin refining and finalizing the Operating Budgets for 1998 and 1999.  Department budgets were developed initially.  The department budgets were then compiled into ISO-wide budgets, which were submitted to the ISO Finance Committee and Board of Governors for approval.    The ISO received Board of Governor’ approval of the 1998 Operating Budget on September 10, 1997. 
Once the 1998 Operating Budget was approved, the ISO developed a financing plan, prepared the Section 35 cost of service statements, and presented a preliminary rate proposal to stakeholders in an effort to resolve the rate issues before the filing.  As a result of the stakeholder meeting, the ISO has had the opportunity to address many of the stakeholders’ concerns in this filing.
The ISO is cognizant of the need for parties to review and comment on the ISO’s proposed rates so they can make appropriate business decisions.  The ISO is also aware of the tremendous burden the ISO has put on the Commission’s resources.  Based on the timeline and available resources, the ISO has made every effort to complete this filing as soon as possible.   
 
II.	ISO ORGANIZATIONAL STRUCTURE

Q.	HOW IS THE ISO ORGAINZED?
A.	The ISO is organized into the following seven departments:	    
•	Executive Offices  (Staff of 2) 
•	Operations (Staff of 142) 
•	Planning
•	Operations Engineering
•	Power Management System/Scheduling Infrastructure/Scheduling Applications 

•	Customer Service (Staff of 56)
•	Business Systems 
•	Client Relations

•	Finance and Administration (Staff of 14)
•	Controller
•	Treasury
•	Internal Audits
•	Financial Planning

•	Human Resources (Staff of 12)
•	Recruiting 
•	Training 
•	Office Management

•	Computing and Communications (Staff of 36) 
•	Systems Integration
•	Computing Infrastructure
•	Telecommunications 
 
•	Legal and Regulatory (Staff of 11) 
•	Regulatory Affairs 
•	Market Surveillance 
•	Communications 

	The Operations Department will handle the main operations of the ISO, including planning, dispatching, scheduling, transmission management and security.  This department will have a staff of approximately 142, approximately 40% of which will be involved in the real-time dispatching function of the ISO.  Approximately 32% of the employees in this department will be working with the Power Management System, Scheduling Infrastructure and Scheduling Application support systems, which will manage the ISO’s scheduling and congestion management functions.  The remaining 28% of the operations staff will consist of planning and operational engineers who will be responsible for, among other things, determining the need for system upgrades and transmission expansion.  
	The Customer Service Department will consist of 56 employees who will be responsible for implementing the ISO’s settlements and billings for all of the administrative charges and market transactions managed by the ISO.  This department will handle all customer credit matters, meter data collection and analysis, and client relations issues.  This department will also organize the training for Scheduling Coordinators on the procedures for using the ISO’s scheduling and communications systems.   
	The Finance and Administration Department will control all financial planning matters, and coordinate the ISO’s banking affairs to keep the ISO’s operating funds separate from market transaction funds.  The Finance Department will also be responsible for the preparation of fiscal records and financial reports, the formulation and administration of the overall financial and accounting plans, policies and practices, and the establishment of relationships with lending institutions, financial stakeholders and the financial community.
	The Human Resources Department will coordinate all of the ISO’s hiring, training and overall office management, including procurement, mail services and facilities security.
	The Computing and Communications Department will be responsible for supporting and maintaining the ISO’s computing and communications infrastructure.  This department primarily will consist of system analysts and computer technicians, who will ensure that the ISO’s computing infrastructure and communications network run smoothly.  
	The Legal and Regulatory Department will oversee the ISO’s regulatory affairs, market surveillance responsibilities and communications matters.  The ISO’s market surveillance activities include the market monitoring and mitigation responsibilities that the Commission has entrusted to the ISO.  The Communications Director will be the public relations person for the ISO.

Q.	HOW WAS THE ISO’S ORGANIZATIONAL DESIGN DEVELOPED?
A.	The first step in designing the organizational structure of the ISO was to assess the ISO’s staffing requirements.  With the assistance of Coopers & Lybrand, the ISO conducted interviews with trustee staff, loaned staff, representatives from PG&E, SCE, SDG&E and LADWP, and vendor staff including Duke Engineering, Coopers & Lybrand and the ISO Alliance (Perot Systems, Ernst & Young and ABB Systems Control) to evaluate the organization’s personnel requirements.  In addition, the ISO reviewed the tariff, regulatory filings and orders, and its articles of incorporation to develop detailed statements of work required to fulfill the ISO’s responsibilities.  Drafts of the organizational structure and head count requirements were circulated to stakeholders from the Technical Advisory Committee (TAC) and modified to incorporate their comments.  Once a final organizational structure was prepared, it was approved by the TAC, with the caveat that the structure could be adjusted based on operational requirements as staff came on board.  For the most part, the organizational structure of the ISO has remained consistent with the original design approved by the TAC.  Some departments have been modified and some positions redefined, but the overall headcount is within the structure approved by the TAC.  The TAC and Board of Governors were kept informed of all changes to the organizational structure.     

III.	THE ISO’S OPERATING BUDGET

Q.	DESCRIBE THE ISO’S BUDGETING PROCESS.
A.	The ISO’s Operating Budget consists of two basic elements: 1) the Start-up and Development Costs, which are the expenses incurred prior to January 1, 1998 to establish the ISO’s basic infrastructure and operating systems; and 2) the ongoing Operating Budget for the ISO after operations begin on January 1, 1998.
The goal of the ISO’s budgeting process was to project as close as possible the ISO’s operating and financing costs for both 1998 and 1999.  The process also included projecting capital expenditures for 1998 and 1999.  The ISO’s projected 1998 and 1999 Operating Budgets were developed by the senior employee of each department in conjunction with myself, as Chief Financial Officer, and with the assistance of the ISO’s financial consultant, Coopers & Lybrand.  The budgeting process involved a “top-down” and “bottom-up” approach as described in Exhibit CAS-3.  The ISO staff and consultant were careful to ensure that all projected costs were included in the budget and that no costs were double counted.  Copies of the ISO’s forecasted Operating Budget for 1998 and 1999 are attached as Exhibit CAS-2, and include the ISO’s projected capital expenditures through 1999. 

Q.	HOW WILL THE ISO ENSURE THAT IT IS PROVIDING SERVICES IN THE LEAST COSTLY MANNER WHILE AT THE SAME TIME OPERATING THE SYSTEM RELIABLY?

A.	The ISO’s Board of Governors is comprised of a broad cross-section of California electricity users and providers.  AB 1890 provides that the members of the ISO Board of Governors shall be composed of representatives of investor-owned utility transmission owners, publicly-owned utility transmission owners, non-utility electricity sellers, public buyers and sellers, private buyers and sellers, industrial end-users, commercial end-users, residential end-users, agricultural end-users, public interest groups, and nonmarket participant representatives.  The Board of Governors sets the ISO’s goals and objectives and approves all major actions. It also reviews and approves the ISO’s capital and operating budgets on a yearly basis.  The ISO cannot exceed its approved budget without Board of Governors’ authorization.  It is in the best interest of all members of the Board of Governors for the ISO to maintain a reliable transmission system at the least cost.  To achieve that goal, the ISO’s CEO executive compensation bonus structure depends on the CEO’s successful implementation of the Board of Governors’ goals and objectives.
In addition, the ISO is organized as a nonprofit corporation.  It does not have shareholders for whom it is expected to provide a return on equity capital.  From a cost perspective, the ISO’s operational goals are limited to ensuring that its revenues meet its costs and carrying out the Board of Governors’ financial goals and objectives.
The ISO’s employee bonus structure is designed to reward individuals that contribute to meeting the goals and objectives established by the CEO and approved by the Board of Governors.  In addition, the ISO’s managers have instructions to manage their departments in a cost efficient manner.  Employees will thus have every incentive to operate efficiently and reduce costs. 

1.	Start-Up and Development Costs

Q.	WHAT ARE THE START-UP AND DEVELOPMENT COSTS?

A. 	As required by AB 1890, the ISO is responsible for creating an independent legal entity to take over the operation and control of transmission facilities in the State of California.  To meet this responsibility, the ISO was required to establish a complete transmission control center with the necessary equipment and staff to safely and reliably operate the transmission facilities under its control.  Many of the initial Start-Up and Development cost estimates were developed by PG&E, SCE and SDG&E, based on their own equipment and staffing needs to control transmission facilities. The Start-Up and Development costs consist of costs related to all of the ISO’s activities up through December 31, 1997, and those completion costs that are expected to be incurred in 1998 and 1999, including equipment purchases, trust administration expenses, consultant and legal fees, salaries, and facility construction. 

Q.	WHAT IS THE AMOUNT OF THE ISO’S START-UP AND DEVELOPMENT COSTS?  

A.	The amount of Start-Up and Development costs is estimated to be $155,163,000 as of December 31, 1997.  This amount reflects the cost of the hardware and software for the Power Management System, the Scheduling Infrastructure, the Scheduling Application and the Balance of Business Systems.  This amount also includes the meter and data acquisition and communications and computing infrastructure.  In addition, start-up costs include the cost of the leasehold improvements for the primary and satellite centers.  The ISO facilities also required considerable construction to accommodate the computer and communication infrastructure necessary for the ISO’s operations.  In addition to the $155,163,000 of Start-Up and Development costs that will be incurred by December 31, 1997, additional start-up capital expenditures of $23,303,000 will be incurred in 1998 and 1999, bringing the total estimated Start-Up and Development costs to approximately $178,466,000. 

2.	Operating Budget 

Q.	WHAT ARE THE MAJOR EXPENSE ITEMS CONTAINED IN THE ISO’S 1998 OPERATING BUDGET?

A.	As shown below, the ISO’s Operating Budget is comprised principally of two major expense categories: 1) Salaries and Benefits and 2) Third Party Vendor contracts primarily supporting the communications and computer infrastructure.  Salaries and benefits and Third Party Vendor contracts amount to 33% and 44%, respectively, of the ISO’s operating expenses for 1998.  Smaller operating expense budget items include the building lease and facilities costs (2%), professional and consulting services (technical) (5%), legal and regulatory consulting services (5%), employee training, travel and professional dues (3%), other expenses (3%) and a 5% budget contingency amount for yet to be identified items and unforeseen events.  As discussed below, this contingency is reasonable given the ISO’s start-up nature and the lack of operating history. 

The 1998 Operating Budget includes costs relating to getting the ISO up and running.  Such costs are expected to diminish over time and thus, the 1999 Operating Budget is projected to be lower than 1998.  The 1999 Operating Budget is preliminary and will not be approved by the Board of Governors until 1998.

California Independent System Operator Corporation
Estimated Operating Budget
(in 000’s)

								1998			1999

Salary and Benefits				           $36,376	           $35,851
Building, Leases & Facility Costs 			   2,261	  	   2,464
Insurance						      620		      625
Third Party Vendor Contracts			 	 47,799		 46,603
	Professional and Consulting Services		   	   5,615		   5,525
	Legal, Regulatory and Consulting			   5,500		   5,200
	Training, Travel and Professional Dues 		   3,348		   3,315
	Other							   2,124		   1,773
	Contingency						   5,486		   5,420
		
Total Operating Expenses		         $109,129	         $106,775

Salaries and Benefits
Q.	DESCRIBE THE PROCESS FOR SETTING THE COMPENSATION STRUCTURE FOR ISO EMPLOYEES.

A.	The compensation plan for ISO employees was designed to reflect the need for flexibility in a start-up organization, to be cost-efficient and to be sufficiently competitive to attract knowledgeable and experienced individuals to get the ISO up and running in a safe and reliable manner.  The process to achieve these objectives was first to benchmark the projected 

salary for a particular position with the comparable position in the market place.  The market prices were defined using compensation survey information from various industries such as the utility industry, power trading, financial services, and west coast industrials.  Using this market data, the ISO created a series of base salary guidelines for each position.  Incentive compensation targets (i.e., bonuses) were also based on this market data.  The base salary and incentive compensation criteria were set using the 50th percentile of the market data as the midpoint.  The actual salaries offered to ISO employees varied only slightly from the 50th percentile benchmark. 
The ISO’s employee benefits programs were designed to be competitive with the market place, but not excessive.  The benefits load factor, as a percentage of base salary costs, is 42%, which includes the cost of FICA, Medicare, Federal and State Unemployment Compensation, Employee Training Tax, retirement and savings plan contribution, group insurance, and short-term and long-term disability.  The utility industry has, on average, a benefits package worth approximately 46% of the base salary, with the financial services industry at 38% of base salary.
 	
Building/Facilities
Q.	DESCRIBE THE ISO FACILITIES EXPENSES.
A.	The ISO has established primary and backup ISO operation centers at two geographically separate locations to house the ISO’s equipment and personnel.  The primary facility is in Folsom (in the Sacramento area) and consists of 79,000 square feet of space under a 10-year lease.  This space also houses the Power Exchange’s backup operations, which use approximately 3,232 square feet.  The initial arrangements for this facility were made by PG&E in October 1996, acting on behalf of the WEPEX Steering Committee.  The annual cost of the lease is $759,000 with additional estimated operating and maintenance costs of $836,000 per year.  (CAS-2 at 5).  The necessary costs to render the lease space sufficiently secure and to accommodate its specialized operations are included in 1997 start-up costs. 
The ISO’s backup facility is located near the PX’s headquarters in Alhambra (in the Los Angeles area).  The functions of the backup facility include resource control, real-time scheduling, transmission management, outage coordination, operation of the southern part of the non-EHV system under the direction of the primary facility, and provision of operational verification (QA/QC) to complement the primary facility’s development activities.  The backup facilities have been leased for ten years with an annual cost of $456,000 and estimated yearly operating and maintenance costs of $210,000 (See CAS-2 at 5).     

Insurance
Q.	WHAT ARE THE INSURANCE COSTS?
A.	The ISO’s insurance costs consist of insurance premiums for workers’ compensation, property, pollution, general liability, automobile coverage and director and officer liability.  See CAS-2, at 6.

Third Party Vendor Contracts 

Q.	WHAT ARE THE ISO’S THIRD PARTY VENDOR CONTRACTS.
A.	The ISO’s third party vendor contracts include the MCI Communications and Services Contract; the IBM Computing and Services Contract; the ISO Alliance Maintenance Services Contract; the UTS Meter Data Acquisition Contract; the ABB Maintenance Contract; and other miscellaneous third party vendor contracts: 
Third Party Vendor Contracts
 (000’s)
										  1998
MCI Communications and Services Contract		           $28,433	
		IBM Computing and Services Contract			   8,735 	
		ISO Alliance Maintenance Contract				   1,271
		UTS Meter Data Acquisition Contract			   3,750
		ABB Maintenance Contract					      293
		Other								   5,317								Total			$47,799  

Q.	DESCRIBE THE MCI COMMUNICATIONS AND SERVICES CONTRACT.
A.	The ISO’s communications infrastructure will be supported by the MCI Communications Contract.  The communication infrastructure consists of a private, state-wide network for voice and data communications that allows the ISO to communicate with market participants to control and monitor the power grid and to provide the facilities for transporting metering data. The fixed communications services provided under the MCI Contract are estimated to cost $28.433 million in 1998.  The MCI Contract runs through the year 2003, with an option to extend for either one or five years.  It will provide the ISO with data, voice, and other communication services and related equipment as described in Schedules A and B of the contract:
Schedule A Customer Services include:
•	A wide area network to allow data communication between the ISO and two thousand connected entities over defined facilities with redundant capacity, local area networks at two ISO sites, connection to eight area control centers, internet access and security, and other security management services;

•	Voice communication services including a voice network between the ISO, PX, Area Control Centers (PG&E, SCE and SDG&E), and LADWP locations, tariff telephone services, and premise equipment of PBX, voice mail, multiple-line communication consoles, multiple-channel voice logging recorder, paging systems, and dial up satellite systems for emergency voice communication;

•	Building wiring and site planning; and

•	System administration and system support.

Schedule B Customer Services include:

•	Analog dial-up service or dedicated analog line (19.2 kbps)

•	Dedicated digital lease line service (from 56 kbps to 1.544 mbps)  

•	High Speed digital packet data transmission service

•	ISDN service
 
•	Customer premise equipment  (routers, Channel Service Units/Data Service Units, modems)

Q.	DESCRIBE THE IBM COMPUTING AND SERVICES CONTRACT.
A.	The ISO’s computing and services contract with IBM runs until December 31, 2000 and is estimated to cost $8.735 million for 1998.  Under the contract, the ISO will not own any of the computers provided by IBM.  Instead, IBM will own, service and maintain all computing and office equipment for the life of the contract.  The contract provides four main areas of service:
1.	Cost Center/Help Desk – This service is the first level of contact for internal ISO staff and external users of the ISO’s communication facilities.  Under this service, IBM will provide an 800 number for external users to call with technical scheduling problems.  
2.	Office Automation Services – This service will provide the internal ISO staff with desktop computers and other office equipment.  Under this provision, IBM will provide desktop and laptop personal computers, support systems such as e-mail, directory systems, printers, copiers, fax machines, and other office equipment. The contract provides that IBM will supply all the necessary office equipment as part of a service, but the ISO will not purchase any of the office equipment.  IBM will be responsible for servicing and replacing equipment as needed for the length of the contract.
3.	System Management Support Center – Under this provision, IBM will provide supplies and personnel to support, monitor and manage the ISO office automation network and attached subsystem equipment.  The subsystems included in the equipment monitoring are the Power Management System (PMS), Scheduling Application (SA), Scheduling Infrastructure (SI), Meter Data Acquisition System (MDAS), and the Balance of Business System (BBS).  The system will alert operators if any subsystem equipment fails.
4.	Security Services – Under this service, IBM will provide a security risk assessment to the ISO regarding the security of the ISO network and data.  IBM will also provide a centralized server security system for the ISO office automation network.      
The contract provides for ongoing annual costs through the year 2000 at declining annual rates of $8.7 million to $5.9 million, with allowances for inflation.

Q.	DESCRIBE THE ISO ALLIANCE MAINTENANCE CONTRACT.
A.	The ISO Alliance Maintenance Contract includes the support for the Scheduling Infrastructure (SI), Congestion/Transmission Management Software and the Balance of Business Systems (BBS).  This maintenance contract will cost $1.271 million in 1998.  The ISO Alliance is made up of ABB Control Systems, Perot Systems and Ernst & Young.  The SI System (from ABB) provides the information management services needed by the scheduling system.  It will support the hardware, software and data bases that will allow the ISO to collect, validate, store, transfer, archive and audit the energy and ancillary services schedules nominated or accepted by the ISO from the PX and Scheduling Coordinators.  Also part of this system is the Scheduling Applications (SA), which will be used by ISO personnel to assess the state of the transmission system, to evaluate Preferred Schedules submitted by the SCs and to establish committed operating schedules.  
The Congestion/Transmission Management Software (provided by Perot) will assist the ISO in congestion management and in determining the transmission price associated with the use of congested inter-zonal transmission paths.  
The Balance of Business Systems (BBS) provided by Ernst & Young consists of the computer and support for the following business processes: 1) settlements to calculate payments owed between the ISO and SCs for imbalances, congestion and ancillary services; 2) billing and credit to support accounting, invoicing, payment and collection of payments; 3) administration to provide general accounting systems and administrative functions associated with the ISO’s daily operations.

Q.	DESCRIBE THE UTS METER DATA ACQUISITION CONTRACT AND THE ABB MAINTENANCE CONTRACT.

A.	The UTS Meter Data Acquisition Contract will enable the ISO to collect metering data from all generators and others connected directly to the transmission lines, tie points and possibly zonal interface points.  Services provided by UTS will cost $3.750 million in 1998.  The UTS Meter Data Acquisition Contract will support the ISO’s metering infrastructure, which includes metering standards, data servers, interface equipment, databases and software to allow the ISO to collect the metering data.   The ABB Maintenance Contract provides the support for the ISO’s Power Management System.   

Q.	WHAT IS THE $5.317 MILLION FOR “OTHER” LISTED UNDER THIRD PARTY VENDOR CONTRACTS.

A.	The $5.317 million related to “other” in the budget consists of the following equipment and services: new telecommunications equipment, pagers, calling cards, long distance service, cellular service, 800 numbers, conferencing, Web administration, remote access services and equipment (modems and modem pools), data and voice drops, and security services.  This budget item also provides funds for enhancements to local and wide-area networks, variable usage above baseline quantities in MCI and IBM Contracts, and pass-through amounts not included in baseline contract (e.g., taxes).   The variable usage amount is primarily to account for the uncertainty in determining how the third party contracts will actually be used by the ISO.  Depending on how they are used, the costs may vary significantly.  In addition, the need for future enhancements to these systems is likely because the ISO has made several modifications to the infrastructure underlying those contracts in 1997.  

Professional, and Consulting Services
Legal, Regulatory and Consulting

Q.	WHAT COSTS ARE INCLUDED IN THE PROFESSIONAL, LEGAL, REGULATORY AND CONSULTING EXPENSES?

A.	The Professional and Consulting Services line item ($5.615 million) consists of costs related to professional and technical consulting services, including, but not limited to, financial advisory and audit services, information, technology and management consulting services to assist the ISO in operating its information technology resources; employee compensation and benefits consultants; and consultants to assist the ISO in carrying out its responsibilities under the tariff, such as preparing planning studies, conducting maintenance tests and operations audits, and preparing the emergency preparedness manual.  CAS-2 at 8.  These costs also include expenses related to the ISO’s market surveillance responsibilities such as the development of a market surveillance plan and an electronic database to analyze scheduling data to mitigate market power.
	The Legal, Regulatory and Consulting line item ($5.5 million) consists of the projected legal and regulatory expenses to carry out the ISO’s responsibilities in 1998.  These expenses include, but are not limited to legal and consulting expenses related to a possible section 35 rate hearing in this proceeding; obtaining approvals for debt financing; making a compliance filing on Phase II matters; dispute resolution activities; exploring new access charge and congestion pricing methodologies; revising protocols; preparing the June 1998 filing regarding firm transmission rights; preparing any required CPUC filings; and travel and other related expenses.  See CAS-2 at 9.

Other
Q.	WHAT EXPENSES ARE INCLUDED IN THE “OTHER” BUDGET ITEM?
A.	 This line item in the Operating Budget ($2.124 million) includes, among other things, the following costs: board member compensation; materials and supplies; printing; publications; field personnel vehicles; advertising; miscellaneous hardware and software; off site storage; and bank operating expenses.

Contingency
Q.	WHY IS THERE A CONTINGENCY IN THE OPERATING BUDGET?
A.	The ISO added a contingency of $5.486 million (5%) to the Operating Budget for several reasons.  First, the ISO is a new entity with no operating history on which to base forecasts of future expenses.  Accordingly, the contingency amount is intended to account for costs yet to be identified because of the ISO’s lack of operating history.  Second, the ISO, like any project under construction, has encountered, and will continue to encounter, unforeseen problems and glitches that will need to be addressed to ensure the ISO’s ability to reliably manage the transmission grid.  Third, because of the start-up nature and not-for-profit character (i.e., no equity) of the ISO, the contingency in the budget will help to mitigate potential liquidity problems that may arise.  As the ISO acquires operating history and establishes an Operating and Capital Reserve Account balance, the ISO would expect the contingency budget amount to be reduced or disappear. 

Q.	DOES FERC ALLOW PROJECTED BUDGETS TO INCLUDE CONTINGENCIES? 

A.	It is my understanding that FERC generally does not allow utilities to add contingency percentages to their Period II costs of service.  However, the ISO is in a much different situation.  First, the ISO, unlike other utilities, does not have an operating history on which to base it future costs.  Thus, all operating cost projections are inherently more unreliable than other utilities’ Period II costs of service, which simply escalate current costs to project future costs.  Second, unlike other utilities, the ISO is a non-profit organization.  If, for any reason, the ISO has unforeseen expenses, it will not have equity funds to cover those expenses.  If it turns out that the ISO has excess revenues, the excess will simply be treated as a reduction to the next year’s revenue requirement.

3.	Tax Status

Q.	WHAT IS THE ISO’S CURRENT TAX STATUS?
A.	The ISO was incorporated as a California non-profit public benefit corporation under section 5110 et seq. of the California Corporation Code.  In the near future, the ISO will file an application for tax-exempt status under section 501(c)(3) of the Internal Revenue Code. 

Q.	IF THE ISO OBTAINS TAX-EXEMPT STATUS FROM THE IRS, WHAT WILL BE THE EFFECT ON THE ISO’S OPERATING BUDGET?

A.	If the ISO is successful in obtaining tax-exempt status under 501(c)(3), the ISO will not have to pay federal or state income taxes.  Accordingly, the ISO’s Operating Budget does not include a provision for income tax liability.  The ISO will, however, still be responsible for payroll taxes, sales, and property taxes, regardless of the IRS determination under 501(c)(3).
	Furthermore, according to Ms. McDonald, Exhibit SM-1 at 5-7, if the ISO is successful in obtaining tax-exempt status under section 501(c)(3), then the ISO may be able to issue tax-exempt bonds, which will reduce the ISO’s financing costs.  However, the ISO does not expect a ruling on its tax-exempt status until 1998.

IV.  COST OF SERVICE STATEMENTS AA THROUGH BM

Q.	PLEASE DESCRIBE THE COST OF SERVICE STATEMENTS CONTAINED IN EXHIBIT CAS-4.

A.	The ISO’s cost of service statements included in this Section 35.13 filing were prepared at my direction with the assistance of the ISO’s retained professionals.  These cost of service statements are attached to my testimony as Exhibit CAS-4.  Because the ISO will not begin operating until January 1, 1998, there are no Period I cost of service statements.  The cost of service statements in Exhibit CAS-4 contain projected costs and revenues for 1998 and thus are akin to the Period II or Test Period data under section 35.13(d)(3) and (4).  In developing this rate filing, the ISO encountered several difficulties in preparing the Commission’s cost statements because the ISO is not a typical public utility for which the statements were designed.  The ISO made every effort to be consistent with the intent of each statement.
  
Statement AA – Balance Sheets
	Statement AA contains the ISO’s Balance Sheet, which shows that the ISO has Total Assets of $155,163,000 (beg. year bal.) and $245,742,000 (end of year bal.).  The Cash Balance on line 6 contains revenues from the ISO’s operations that are in excess of operating and financing costs.  The ISO Board of Governors set the funding of this account at 15% of the Operating Budget.  If this fund is fully funded, excess funds will be used to reduce the next year’s revenue requirement.  These funds can be used for unexpected expenditures to meet expenses if the ISO’s revenues are lower than its costs.    

Statement AB – Income Statements
	Statement AB contains the ISO’s Income Statement.  Line 1 shows that at the end of 1998, the ISO expects to have $153,488,000 in operating revenues and Line 3-4 show that the ISO will have $109,129,000 in operating and maintenance expenses.  Line 12 indicates that the ISO will have interest income in the amount of $1,626,000.  This income is earned on the ISO’s Operating and Capital Reserve account, debt service accounts, and the unused portion of the bond issuance.  Subtracting out the interest charges the ISO will incur of $16,148,000 leaves a $12,106,000 net loss.    

Statement AC – Retained Earnings Statements
	The $12,106,000 in unappropriated retained earnings balance represents the ISO’s net loss from operations on an accrual basis. 

Statement AD – Cost of Plant
	Statement AD lists the ISO’s cost of plant in service.  The ISO does not have any transmission plant booked to accounts 350-359.  However, as discussed below, the ISO has transmission operating and maintenance expenses booked to accounts 560-574.  The ISO’s average plant balance for 1998 is $178,121,000, which is broken down into Intangible Plant $99,738,000 and General Plant $78,383,000.  Intangible Plant contains the ISO investment in software.  The General Plant accounts contain hardware, furniture, communication equipment and leasehold improvements.  

Statement AE – Accumulated Depreciation and Amortization
	Statement AE shows the ISO’s accumulated depreciation and amortization for year ending December 31, 1998 of $20,972,000.  Statement AE is submitted for illustrative purposes. The revenue requirement for the ISO’s proposed Grid Management Charge does not include depreciation as a cost item.  Instead, as discussed in more detail below, the Grid Management Charge revenue requirement is based on operating costs and debt service costs. 

Statement AF – Specified Deferred Credits
	The ISO will not have deferred credits in 1998. 

Statement AG – Specified Plant Accounts (Other than Plant in Service) and Deferred Debits

Statement AG contains Specified Plant Accounts and Deferred Debits.  This consists of the costs the ISO projects that it will pay for the debt issuance in 1998.   

Statement AH – Operation and Maintenance Expenses 
	Statement AH shows the ISO’s projected operating and maintenance expenses of $109.129 million for the year ending December 31, 1998.  The ISO projects transmission operating expenses of $34,640,000 (accounts 560, 561, 566) and transmission maintenance expenses of $2,421,000 (account 568).  The ISO has projected customer account expenses of $7,960,000 (accounts 901 - 905), customer service and informational expenses of $2,502,000 (accounts 907 - 913, 916).  The ISO’s administrative and general operation expenses are projected to be $60,757,000 (accounts 920, 921, 923, 924, 925, 928, 930, 931) and the administrative and general maintenance expenses to be $848,000 (account 935).  Statement AH also includes the estimated board member compensation and related expenses of $600,000 for 1998. 

Statement AI – Wages and Salaries
	Statement AI shows the total ISO projected wages and salaries of $33,900,000 for 1998.  The bulk of the wages and salaries are charged to transmission O&M expenses, $17,368,000, and administrative and general O&M expenses, $11,925,000.  The remaining $4,607,000 is booked to Customer Accounts and Customer Service and Information.  The development of the ISO’s salaries is discussed in more detail in section III(2), above. 

Statement AJ – Depreciation and Amortization Expenses
	The ISO’s total depreciation expense is projected to be $41,944,000 for the year ending December 31, 1998.  The depreciation rates, using the straight-line method, are based on the average useful life of the General and Intangible Plant.  The estimated useful lives were based on estimates of the technological useful lives of the assets.

Statement AK – Taxes Other than Income Taxes
	Statement AK shows the ISO’s projected property tax liability of $904,000 and its employer payroll tax liability of $1,489,000. 

Statement AL – Working Capital
	Statement AL contains the ISO’s projected working capital requirements for 1998.  The 13-month average working capital requirement is $5,825,000 per month. 

Statement AM – Construction Work in Progress
	This statement was not prepared because it is not applicable to the ISO’s operations.

Statement AN – Notes Payable 
	This statement was not prepared because the ISO has not projected expenses related to principal repayment within a time not exceeding one year from the date of issue.  As explained further below, the ISO will rely on the ISO Trust’s existing line of credit until it is able to obtain permanent financing by issuing bonds.  
 
Statement AO – Rate for Allowance for Funds Used During Construction
	This Statement was not prepared because the ISO does not intend to request a return on funds used during construction.

Statement AP – Federal Income Tax Deductions – Interest
Statement AQ – Federal Income Tax Deductions – Other than Interest

	These statements were not prepared because it is expected that the ISO will be granted tax-exempt status under either section 501(c)(3) or 501(c)(4) of the Internal Revenue Code.   

Statement AR – Federal Tax Adjustments
	Statement AR was not prepared because the ISO did not have operations in 1997 and does not expect to have Federal tax adjustments in 1998.   	

Statement AS – Additional State Income Tax Deduction
Statement AT – State Tax Adjustments

These statements were not prepared because the ISO expects to be granted tax-exempt status under section 501(c)(3) of the Internal Revenue Code.   
 
Statement AU – Revenue Credits
	Statement AU shows the total revenues projected from ISO operations of $153,488,000, including revenue credits of $7,000 from Application fees and $770,539 from MCI Communication Subscriber Charges.  	

Statement AV – Rate of Return
	This Statement contains the ISO’s cost of debt.  The ISO is organized as a non-profit public benefit corporation under California Law.  As such, the ISO will have no shareholders and no equity on which to provide a return.  The ISO will finance its operations solely through debt issuances.  The cost of the debt financing is projected to be 6.92% in 1998, as shown on Statement AV.  For a more detailed discussion of the ISO’s debt costs, see the testimony of Sandra McDonald.   

Statement AW – Cost of Short-term Debt
The ISO has not projected short-term debt costs for 1998.  

Statement AX – Other Recent and Pending Rate Changes
	There are no recent or pending rate changes.

Statement AY – Income and Revenue Tax Rate Data
	This statement was not prepared because the ISO expects to be granted tax-exempt status under section 501(c)(3) of the Internal Revenue Code.   

Statement BA – Wholesale Customer Rate Groups
	As indicated in Statement BA, the ISO will have only one customer group.  All of the ISO’s customers, whether wholesale or retail, will pay the same rate, which will be the Grid Management Charge.  The ISO’s costs will be allocated to all customers based on metered volumes transmitted on or through the ISO Grid.  As discussed below in more detail, a small portion of the ISO’s MCI Communications Contract will be directly assigned to Communication Subscribers who are connected to the ISO’s communication network.   

Statement BB – Allocation Demand and Capability Data
	As shown in Statement BB, in developing the Grid Management Charge, the ISO forecasted its annual volumes to be 208,000,000 MWh.  This forecast is based on the current demand of the investor-owned utilities (IOUs), PG&E, SCE and SG&E, plus the volumes wheeled by the IOUs under existing contracts, and an estimate of the amount of wheeling through transactions.  See Testimony of Seabron C. Adamson, London Econ., SCA-1 at 5.  

Statement BC – Reliability Data
Statement BD – Allocation Energy and Supporting Data

	These statements were not prepared because they are not applicable to the ISO’s operations.  The ISO will not own any generation facilities and does not have responsibilities relating to generation adequacy.  

Statement BE – Specific Assignment Data
Statement BF – Exclusive-use Commitments of Major Power Supply Facilities

	Statements BE and BF are not applicable because the transmission rates for using the ISO Grid, referred to as the Access Charges, were developed by the investor-owned utilities (IOUs), PG&E, SCE and SDG&E, based on the costs of operating their specific transmission facilities.  The ISO’s Grid Management Charge is based only on the administrative costs of operating the ISO.
Statement BG – Revenue Data to Reflect Changed Rates
Statement BH – Revenue Data to Reflect Present Rates
As stated in Statements BG and BH, the ISO will have only one customer group.  The ISO’s forecasted revenue requirement for 1998 is $152,710,000.  See Testimony of Sandra McDonald, Exhibit SM-1 at 14.  For 1998, this amount equals the forecasted volumes, 208,000,000 MWh, times the Grid Management charge of 0.7342 $/MWh.  The annual revenue requirement for the ISO will be established under the Grid Management Charge formula rate, which will account for differences between actual and forecasted costs.

Statement BI – Fuel Cost Adjustment Factors

	Statement BI was not prepared because it is not applicable to the ISO’s operations.

Statement BJ – Summary Data Tables
	Statement BJ contains a summary of the ISO’s plant in service and operating expenses. 

Statement BK – Electric Utility Department Cost of Service, Total and as Allocated
	Statement BK shows the ISO’s 1998 revenue requirement to be $152,710,000.	

Statement BL – Rate Design Information
As discussed in more detail below, the ISO will charge each Scheduling Coordinator using the ISO Grid a Grid Management Charge (GMC) based on the metered load of that Scheduling Coordinator.  The GMC is a formula rate designed to recover the cost of operating the ISO.  The GMC will be based on the projected annual costs and volumes with an annual adjustment that will account for the difference between actual and projected costs and volumes.  The formula will also contain a mechanism whereby the GMC will be reviewed periodically and recalculated, effective as of the beginning of the following quarter, if the projected volume estimate, on an annualized basis, changes by 5% or more.  The GMC will be billed to Scheduling Coordinators on a monthly basis, in arrears, based on metered load.  This formula rate methodology will provide Market Participants with the financial security of a predictable GMC and will ensure that the ISO will be able to recover its actual costs on a timely basis.
In addition, a portion of the ISO’s costs associated with the MCI Communications Contract will be directly assigned and billed on a monthly basis to “Communication Subscribers (CS)” -- entities that are connected to the ISO’s communications network.  Projected revenues from this charge (CS Charge) will be credited to the ISO’s forecasted revenue requirement and reflected in the calculation of the GMC for the same year.  See Statement BA.

Statement BM – Construction Program Statement
	This Statement was not prepared because the ISO does not intend to file for construction work in progress in rate base.

V.  ISO RATE STRUCTURE

Q.	DESCRIBE THE ISO’S PROPOSED RATE STRUCTURE.
A.	The ISO has proposed a rate structure to ensure that the ISO will collect only those revenues it requires to meet its costs and to maintain a satisfactory amount of reserves. 
The GMC is designed to recover the ISO’s costs of doing business, including operating costs, financing costs, projected cash-funded capital expenditures, start-up costs and a small amount to fund a reserve account to smooth seasonal cash flows and any differences between the ISO’s projected and actual costs.  In arriving at the total costs to be recovered, a certain portion of the MCI Contract costs will be directly assigned to users of the ISO’s communications network.  
The revenues the ISO expects to receive from the direct assignment portion of the GMC will be subtracted from the costs used to calculate the volume-based charge.  The GMC is explained in more detail below.  
For the most part, the ISO will pass through to customers charges for ancillary services in accordance with ISO Tariff Sections 2.5.27 through 2.5.27.4 and 2.5.28 through 2.5.28.4.  For Voltage Support and Black Start Capability, the ISO proposes to charge the ISO’s cost, based on market bids for the short-term and long-term contracts that it procures for those services, in accordance with ISO Tariff Sections 2.5.27.5, 2.5.27.6, 2.5.28.5, and 2.5.28.6. 
	In addition, the ISO will charge customers Usage Charges for inter-zonal congestion and a Grid Operations Charge for intra-zonal congestion.  These charges will be a pass-through of the bids and/or adjustment bids the ISO receives in the bidding process under ISO Tariff Section 7.3.1 and 7.3.2.  
	Finally, the ISO will pass-through charges for customers engaging in Wheeling Out and Wheeling Through transactions, in accordance with ISO Tariff Section 7.1.4.  These pass-through charges will be based on the Participating Transmission Owner (PTO) Access Charge at the point the power exits the ISO Controlled Grid.    

1.	Grid Management Charge (GMC) 

Q.	WHAT IS THE GRID MANAGEMENT CHARGE?
A.	The Grid Management Charge (GMC) will apply to all Scheduling Coordinators using the ISO Controlled Grid and is designed to enable the ISO to recover its costs of operating.  The GMC will consist of two types of charges: 1) the Communications Subscriber (CS) Charge applies to all entities that are connected to the ISO’s data communication network; and 2) the volume-based charge that applies to all scheduling coordinators based on their metered demand.  As discussed in more detail below, the GMC will be adjusted annually to account for any differences in projected versus actual costs and volumes. 

Q.	WHAT COSTS WILL BE RECOVERED IN THE COMMUNICATIONS SUBSCRIBER (CS) CHARGE PORTION OF THE GMC?

A.	The CS Charge portion of the GMC will recover a portion of the MCI Communication costs and assign those costs to entities that are connected to the ISO’s data communication network.  The MCI Communications infrastructure is currently capable of handling up to 2000 Communications Subscribers.  Approximately $7.7 million will be assigned for collection through this charge.  The $7.7 million represents the portion of the ISO’s MCI Contract expenses related to the cost of the 2000 communication subscriber capability.  The various types of connections available to subscribers are as follows:

MCI COMMUNICATIONS CHARGE BREAKDOWN

				Allocated 		Allocated 		Allocated
Percent		Annually  		Annually 	            Monthly 
Service Class		By Class	By Class		By CE			By CE     .                     

Analog Dial-up (160)	   2.7%		$   210,786		$1,317			$ 109.78

ISDN Dial-up	 (480)	 12.2%	     	     936,826		  1,952			   162.64

Frame Relay  	 (880)	   6.1%	     	     468,413		     532			     44.36

768 Leased   	 (192)	  72.9%	  5,620,955		29,276			2,439.65

64 Leased  	 (288)	   6.1%	     	     468,413		  1,626			   135.54   .  
	 2000			$7,705,393		

The type of connections ranges from analog and digital dial-up connections to dedicated leased line connections of various speeds.  Frame relay connections require digital leased line connections.  Communication Subscribers will pay the CS Charge on a monthly basis.  These various options were selected as contract options to meet the anticipated differences in the speed and quantity of information services that will be needed by Communication Subscribers.  The need for these particular options was identified by user groups that consulted in the development of the design of the communications services to be provided under the MCI Contract.  The actual service option selected by particular Communications Subscribers will be at their election.  
At the start of operations on January 1, 1998, the ISO expects to have approximately 200 communications subscribers.  However, at the time of this filing, the ISO will not know how many subscribers will be in each service class.  The expected revenues from this charge cannot be calculated with any certainty.  Thus, for purposes of the GMC, the ISO has roughly estimated the CS Charge revenues to be 1/10 (200/2000) of the total potential revenues ($7.7 million x 1/10 = $770,000).  The $770,000 in CS Charge revenues has been credited to the revenue requirement used to calculate the GMC for 1998.  If more entities become Communications Subscribers during 1998, those revenues will be credited to the 1999 GMC revenue requirement.  

Q.	WHAT COSTS WILL BE RECOVERED IN THE VOLUME-BASED PORTION OF THE GMC?

A.	The components of the volume-based portion of the GMC, as set forth in ISO Tariff Section 8.2, are:
•	Start-Up and Development Costs (Section 8.2.1) (discussed below in the context of financing costs)

•	Operating Costs (Section 8.2.2)

•	Financing Costs (Section 8.2.3)

•	Operating and Capital Reserve Costs (Section 8.2.4)

Each one of these components is discussed below.  

Operating Costs
Q.	WHAT ARE THE OPERATING COSTS?
A.	This includes all of the ISO’s operating costs for carrying out its responsibilities under the ISO Tariff.  These costs include all staffing costs, including salaries, benefits and incentive programs for employees, costs of operating, replacing and maintaining ISO systems, lease payments on ISO facilities, and reasonable contingencies. 

Financing Costs
Q.	WHAT ARE THE FINANCING COSTS?
A.	The ISO’s financing costs consist of the principal and interest expense associated with the debt issued to finance the Start-Up and Development costs and future capital expenditures.  In her testimony, SM-1 at 3-5, Ms. McDonald discusses the amount of financing costs the ISO will incur when it issues bonds early in 1998.
 
Q.	DESCRIBE THE ISO’S EXISTING CREDIT LINE AND ITS ROLE IN THE FINANCIAL STRUCTURE OF THE ISO.

A.	The Credit Agreement is a $191,000,000 Line of Credit issued to the ISO Restructuring Trust (ISO Trust) for financing the development and start-up costs of the ISO.  The main banking agent for the Credit Agreement is the Bank of America, N.T. & S.A., and the guarantors are PG&E (45% of Credit Commitment), SDG&E (10% of Credit Commitment), and SCE (45% of Credit Commitment).  The existing Credit Line enables the ISO, through the ISO Trust, to borrow funds. 

Operating and Capital Reserve Costs
Q.	WHAT ARE THE OPERATING AND CAPITAL RESERVE COSTS?
A.	The Operating and Capital Reserve cost item (ISO Tariff Section 8.2.4) is necessary to provide satisfactory coverage of debt obligations and to provide funds for pay-as-you-go capital expenditures.  Since capital expenditures can be made from the coverage component, the greater of the amounts will be included in the GMC.  Coverage not used for capital expenditures will be maintained in a reserve account (ISO Tariff Section 8.5) to smooth the variance between the ISO’s forecast costs and its actual costs.  The ISO Board of Governors has initially established the Operating and Capital Reserve Account at 15% of the prior year’s operating budget.  As Ms. McDonald discusses in her testimony, Exhibit SM-1 at 16, when the account is fully funded, any excess funds from that account will be swept out and used to reduce the following year’s GMC.  

Q.	WHY IS THE OPERATING AND CAPITAL RESERVE ACCOUNT NECESSARY?

A.	First, as discussed in the testimony of Sandra McDonald, the investors who purchase the ISO’s bonds will require a reserve balance to ensure that the ISO will be able to meet its obligations without relying on external credit facilities.  Exhibit SM-1 at 13-15.  Second, the reserve balance will help mitigate potential liquidity problems arising from intra-period cash flow and the seasonality of the ISO revenue stream.  Third, because the ISO has no operating budget history with which to compare its projected budget, this account will smooth the difference between projected and actual expenses and volumes at least during the initial years of operation.  Once this account is fully funded, any excess revenues will be used to offset the ISO’s revenue requirement in the next year.  Fourth, the account will allow the ISO to make cash-funded capital expenditures.

Q.	DO THE OPERATING EXPENSES INCLUDE ANNUAL CHARGES ASSESSED BY THE FEDERAL ENERGY REGULATORY COMMISSION PURSUANT TO 18 C.F.R. § 382.201?

A.	No.  A projection for an Annual Charge assessment was not included in the cost of service for the ISO because the Access Charges for the individual Participating Transmission Owners – PG&E, SDG&E and SCE – include such Annual Charges.  If the ISO were to include a projection for Annual Charges in its cost of service, customers would be charged twice for Annual Charges on the same transmission.  However, in the event the IOU Access Charge methodology is revised to exclude Annual Charges or if the Commission orders the ISO to pay Annual Charges in lieu of the IOUs, the ISO has included a component (Account 928) in the operating cost portion of the GMC formula that would capture the cost of Annual Charges.  The Annual Charge component in the GMC formula in the ISO’s current filing is zero.

Q.	ON WHAT PRINCIPLE HAS THE ISO RELIED IN DECIDING TO WHOM THE GRID MANAGEMENT CHARGE SHOULD BE CHARGED?

A.	The policy of the ISO is that all load within the ISO Control Area should be assessed the Grid Management Charge, as all load within the ISO Control Area benefits from the services provided by the ISO.  There is a policy question of whether load served under existing operating arrangements should be exempted from the Grid Management Charge.  Under these existing operating arrangements, load serving entities use resources within their service area to serve part of their load without scheduling the resources with the existing control area operator.  The ISO Board of Governors agreed that this is an issue on which it will not take a position, but will instead implement the decision the Commission makes based on the Commission’s evaluation of the parties’ pleadings.  
The ISO strongly urges the Commission, should it decide that this exemption should be granted to services under existing operating agreements, to limit the exemption to such agreements.  Any decision that bases an exemption on the nature of the arrangement, rather than the fact that the arrangement is preexisting, would have serious adverse consequences on the ISO.  A decision that certain types of arrangements may be exempt would invite Market Participants to structure transactions with the intent of avoiding the Grid Management Charge.

Q.	WHY IS THIS RESULT UNDESIRABLE?
A.	It would encourage inefficient behavior by Market Participants and potentially lead to smaller and smaller amounts of load supporting the GMC.  

Q.	WHAT IS THE INEFFICIENT BEHAVIOR THAT WOULD BE ENCOURAGED?

A.	Market Participants would be incented to accept higher cost energy options, rather than the lowest cost energy options, if the higher cost options could be delivered at lower total prices without a GMC charge.  For instance, an aggregator might decide to purchase from a higher priced generator if that generator is located within the boundaries of a new metered sub-system.  This decision would position it to argue that it should be exempted from the GMC even though it would benefit from the services offered by the ISO.  

Q.	WHY IS THE BEHAVIOR YOU DESCRIBED INEFFICIENT?
A.	It is inefficient because it optimizes one Market Participant’s result and sub-optimizes the result for the market as a whole.
 
Q.	HAS THE PRINCIPLE BEEN FULLY APPLIED IN CALCULATING THE ESTIMATED VOLUMES USED IN THE GMC?

A.	No.  Due to the open question of whether existing operating agreements will be exempt from the GMC charge, the volumes figure excludes service to load which could qualify for the exemption should it be granted.  This action is necessary to ensure that the ISO will have sufficient revenues to cover its cost of operations. 

Q.	WHAT VOLUME ESTIMATE IS USED TO CALCULATE THE GMC?

A.	The GMC rate is calculated by dividing the yearly projected ISO’s operating and finance costs (numerator), as discussed above, by the projected annual volumes (denominator) transmitted on the grid.  As Mr. Seabron Adamson of London Economics discusses, the projected volumes that will be transmitted on the ISO Grid in 1998 will be approximately 208,000,000 MWh in 1998.  SCA-1 at 5.  Using these volumes as the denominator, and the ISO’s revenue requirement as the numerator, the GMC rate is calculated as follows:
Development of Grid Management Charge

				    		   	1998		
		
Total Revenue Requirement    	         $152,710,000	

Transmission Volume (MWh)	           208,000,000	

Grid Management Charge ($/MWh)		 $ 0.7342	

Q.	HOW SENSITIVE IS THE GRID MANAGEMENT CHARGE TO CHANGES IN VOLUMES AND COSTS?
 	
A.	Based on the current Grid Management Charge of $0.7342/MWh, the rule of thumb is that a +/- 30,000,000 MWh change in the volume will have an approximate effect of +/- $0.1 on the Grid Management Charge.  Likewise, a +/- $20,000,000 change in costs will affect the Grid Management Charge by approximately +/- $0.1.

Q.	HOW WILL THE ANNUAL RATE ADJUSTMENT MECHANISM WORK?
A.	The annual rate adjustment mechanism will ensure that the GMC is recovering the ISO’s actual operating and capital costs and will prevent the ISO from overrecovering or underrecovering its costs over time.  After sufficient revenues are collected, the annual adjustment will correct for a surplus or deficit in total revenues during the previous year.  This adjustment will thus correct for the variance between projected and actual costs and volumes.  Any unpaid GMC charges from Scheduling Coordinators will also be included in the adjustment.  In accordance with ISO Tariff Section 8.5, any excess funds will be retained until the Operating and Reserve Account is fully funded and then will be used to reduce the following year’s revenue requirement.  The formula will also contain a mechanism whereby the GMC will be reviewed periodically and recalculated at the beginning of the following quarter if the projected volume estimate, on an annualized basis, changes by 5% or more. 

Q.	WHAT IS THE GRID MANAGEMENT CHARGE FORMULA?
A.	The GMC formula, as developed in Sandra McDonald’s testimony, SM-1 at 17-18, is contained in the rate schedules attached to my testimony as Exhibit CAS-5.  The GMC rate schedule, which is Schedule 1, lists the specific FERC accounts that are included in the GMC formula rate.  The GMC rate schedule along with the other rate schedules will constitute Appendix L of the ISO Tariff.
  
2.	Ancillary Services

Q.	HOW WILL THE ISO CHARGE FOR ANCILLARY SERVICES?
A.	Transmission customers using the ISO Grid must either self-provide or purchase the following ancillary services: Regulation Service, Spinning Reserve Service, Non-spinning Reserve Service, and Replacement Reserve Service.  Additionally, transmission customers must purchase from the ISO Voltage Support Service and Black Start Capability.  These two services cannot be self-provided.  The ISO will settle charges for all ancillary services not self-provided based on the cost of the service to the ISO.  Charges for Regulation, Spinning and Non-spinning Reserve Services will be determined through the ancillary services auction as provided in ISO Tariff Sections 2.5.27 through 2.5.27.4 and 2.5.28 through 2.5.28.4, and passed directly to customers who do not self-provide these services.  See Schedules 4, 5, and 6 in Exhibit CAS-5.
Charges for Voltage Support and Black Start Capability will be based on the contracts the ISO enters into with service providers.  The ISO’s costs will be passed directly to transmission customers.  The Voltage Support charge will be based on the ISO’s long-term and short-term contracts for Voltage Support service in accordance with ISO Tariff Section 2.5.27.5.  See Schedule 3 in Exhibit CAS-5.  The ISO is currently negotiating contracts for Voltage Support and Black Start service.  
Scheduling, System Control and Dispatch Service is one of the six services required in Order No. 888, but is not included as a separate ancillary service in the ISO tariff.  The ISO’s function is to provide scheduling, system control and dispatch services for the entire ISO Grid.  The costs associated with this service are included in the ISO’s operating costs and will thus be recovered by the ISO through the Grid Management Charge and not as a separate scheduling charge.  

3.	Congestion Charges

Q.	WHAT ARE CONGESTON CHARGES?
A.	Section 7.3.1 of the ISO Tariff provides that the ISO will impose a Usage Charge on transmission customers using a congested inter-zonal transmission path.  This charge will be determined by the ISO’s inter-zonal congestion management process set forth in ISO Tariff Section 7.2.5.  See Schedule 11 in Exhibit CAS-5.  The Grid Operations Charge (ISO Tariff Section 7.3.2) will be imposed by the ISO on transmission customers using a congested intra-zonal transmission path.  The Grid Operations charge will be determined by the ISO’s intra-zonal congestion management process in Section 7.2.6.  See Schedule 12 in Exhibit CAS-5.  Because these congestion charges are merely passed through by the ISO to the highest bidder for the service, there are no specific rates in the rate schedules for these charges.

4.	Imbalance Energy Charges

Q.	WHAT ARE IMBALANCE ENERGY CHARGES?
A.	Imbalance Energy Charges consist of charges for Imbalance Energy, dispatched Replacement Reserves charge, and Unaccounted for Energy.  Imbalance Energy is the real time change in generation or demand that is instructed by the ISO to maintain the ISO Controlled Grid in accordance with the applicable reliability criteria.  The charge for dispatched Replacement Reserves applies when Scheduling Coordinators’ generation falls below their load or loads exceed schedules (see ISO Tariff Sections 11.2.4.2 and 2.5.28.4).  Unaccounted for Energy is the difference between energy delivered into a service area and the total metered demand in the service area (adjusted for losses) attributable to meter measurement errors, power flow modeling errors, energy theft, statistical load profile errors and distribution loss deviations.  In addition, Scheduling Coordinators may either self-provide or settle obligations to provide for Transmission Losses with the ISO at the Hourly Ex Post Price for Imbalance Energy, in accordance with ISO Tariff Section 7.4.1.2. 
The charges for these services fall under the ISO’s Energy Imbalance Charge rate schedule, Schedule 9, Exhibit CAS-5.  Energy Imbalance Charges are calculated in accordance with ISO Tariff Section 11.2.4.1 and are based on the Hourly Ex Post Price for energy during the settlement period.  See also ISO Tariff Section 2.5.23.        

5.	Access Charges/Wheeling Access Charges 

Q.	WHAT IS AN ACCESS CHARGE?
A.	An Access Charge is basically a transmission rate.  The Access Charges for transmission on the ISO Controlled Grid have been developed by each Participating Transmission Owner (PTO) based on each PTO’s transmission service revenue requirement.  PG&E Docket No. ER97-2358, SCE Docket No. ER97-2355, and SDG&E Docket No. ER97-2364.  Each non-PTO customer will be charged the Access Charge for the PTO where the power exits the ISO Grid.  See Schedule 10, Exhibit CAS-5.  The Wheeling Access Charges will likewise be based on the Access Charge for the utility where the power exits the ISO Grid for wheeling out or wheeling through transactions.  Access Charges will be charged to transmission customers directly by the PTOs.  Wheeling Access Charges will be passed through by the ISO in accordance with ISO Tariff Section 7.1.4.  See Schedule 13, Exhibit CAS-5.  Because the ISO is merely passing through the Wheeling Access charges developed by the PTOs, there are no rates for this service in the ISO’s rate schedules.  Access Charges will be charged to customers directly by the PTOs.   

6.	Reliability Must-Run Charge

Q.	WHAT IS THE RELIABILITY MUST-RUN CHARGE?
A.	The Reliability Must-Run Charge is based on the cost for generation that the ISO determines is required to be on line to meet the applicable reliability criteria requirements. The ISO will enter into contracts with generators giving the ISO the right to call on the generator to generate energy and/or provide ancillary services when necessary to ensure the reliability of the ISO Controlled Grid.  The ISO will recover the costs of Reliability Must-Run Generation from the utility that is a party to the TCA in whose service area the Reliability Must-Run Generation is located.  The charge will be determined in accordance with ISO Tariff Section 5.2.7.  See Rate Schedule 15.  

7.	Application Fee

Q.	WHAT IS THE NON-REFUNDABLE APPLICATION FEE?
A.	The ISO will charge a nonrefundable application fee to scheduling coordinators submitting a completed Scheduling Coordinator application form under ISO Tariff Section 2.2.4.1.  The application fee is $500 and is based on the ISO’s average cost of processing the application forms.  The costs of processing the Scheduling Coordinator application include:
•	Making available application documentation to Scheduling Coordinator, including instructions, application, tariff and protocols;

•	Receiving completed application, logging and distributing to responsible client relations director;

•	Completing initial review in 21 days, including review of size and form of security deposit, reviewing file for accuracy and completeness;

•	Visiting Scheduling Coordinator site to inspect required facilities (communications link-up, computer hardware, telephone facilities, billing system, 24 hr/day staffing).  

Q.	WHAT OTHER CHARGES WILL THE ISO IMPOSE?	
A.	Finally, if a Generating Unit, Load or System Resource fails to respond to an ISO dispatch instruction, the ISO can charge the Generating Unit, Load or System Resource for the difference between the Generating Unit’s, Load’s or System Resource’s instructed and actual output or demand at the Hourly Ex Post Price.  This charge will be calculated in accordance with ISO Tariff Section 2.5.22.11.  See Schedule 14, Exhibit CAS-5.

Q.	DOES THIS CONCLUDE YOUR TESTIMONY?
A.	Yes.