UNITED STATES OF AMERICA
BEFORE THE
FEDERAL ENERGY REGULATORY COMMISSION

	California Independent System		)			Docket No.  ER00-703-000
	Operator Corporation		)	

ANSWER OF
THE CALIFORNIA INDEPENDENT SYSTEM OPERATOR CORPORATION
TO MOTIONS TO INTERVENE AND REPLY COMMENTS

On December 1, 1999, the California Independent System Operator Corporation ("ISO") submitted the “Report to the Federal Energy Regulatory Commission: Studies Conducted Pursuant to the October 30, 1997 Order” in the above-captioned docket.  Pursuant to Rule 213 of the Commission’s Rules of Practice and Procedure, 18 C.F.R. § 385.213, the ISO hereby submits its Answer to Motions to Intervene and Reply Comments to comments submitted in response to the December 1 filing.
	The ISO does not oppose any of the motions to intervene, but seeks to respond to some of the comments submitted in order to clarify the ISO’s position on certain matters and to note that some issues raised in those comments have either already been addressed in existing proceedings before the Commission or will more properly be addressed in response to issues raised in other proceedings.

I.	Introduction
	As explained in the ISO's December 1 transmittal letter in this proceeding, the Studies were prepared in compliance with the Commission’s  “Order Conditionally Authorizing Limited Operation of an Independent System Operator”, 
Pacific Gas and Electric Co., et al., 81 FERC ¶ 61,122 (1997) (“October 30 Order”).  The October 30 Order required the ISO to prepare the following studies:
1)	A study that evaluates the effectiveness of the ISO’s “5 percent criterion” for the creation or modification of Congestion Management Zones (“Congestion Zone Criteria Study”);

2)	A study that evaluates the ISO’s methodology for calculating and assigning Transmission Losses to individual Scheduling Coordinators, compared to a method that assigned to each Scheduling Coordinator the full marginal Transmission Losses associated with its actual scheduled transactions (“Transmission Loss Study”); and

3)	A study that evaluates the ISO’s one-part approach to Ancillary Services bid evaluation as compared to a two-part bid evaluation that takes into account both the capacity and energy components of an Ancillary Services bid (“Single Versus Two-Part Ancillary Services Bid Evaluation Study”).   

II.	Answer to Interventions
	On December 9, 1999, the Commission issued a Notice of Filing concerning the Studies, and on December 20, 1999, the Commission issued a Notice of Extension of Time until January 11, 2000 for filing interventions and protests in this matter.  The Public Utilities Commission of the State of California (“CPUC”) filed a notice of intervention and comments, and motions to intervene were filed by several parties. The ISO does not oppose any of the Motions to Intervene. In addition, a number of parties filed comments on the December 1 filing.
III.	Reply Comments

A.	The Congestion Zone Criteria Study

This Study produced the most substantial comment on the part of intervenors.   In the October 30 Order, the Commission had directed the ISO to evaluate the effectiveness of its 5 percent criterion in determining whether a new congestion zone were warranted in a given area; to calculate the congestion costs associated with currently inactive Inter-Zonal Interfaces; and to evaluate the effectiveness of adopted mechanisms for mitigating market power in the currently inactive congestion Zones.   As noted in the Study, the ISO determined that the 5% threshold is not unreasonable, but that annual evaluation of the criteria for creating and modifying Zones is justified due to the fact that congestion costs and transmission utilization are likely to vary.     
	1.	Comments
The most common comment on the Congestion Zone Study made by intervenors was that the ISO had failed to go into sufficient depth of analysis in evaluating the Congestion Zone criteria, or in comparing its existing methodology with potential alternatives.  For example, the Oversight Board and the City and County of San Francisco both commented that the criteria were not fully addressed and evaluated.   Oversight Board at 2; San Francisco at 4.  As well, Sempra stated that the ISO’s Study “provides neither an assessment of the effectiveness of current or alternative mechanisms for mitigating market power in inactive zones nor a valid rationale for relying on inter-zonal congestion management for inactive zones.” Sempra at 6.   Both the five-percent criterion and the “workable competition” concept were criticized as being in need of further elaboration and justification.  See, e.g., Cities at 13; Sempra at 6, 9.    EPMI, on the other hand, argued that the 5 percent criterion should be maintained.   EPMI at 3.
A number of parties raised issues in their comments that have already been addressed by the Commission in other dockets.  For example, two parties suggested that the ISO’s congestion management structure results in improper costs shifts, and result in charges to customers who had no part in structuring the electric transmission system resulting in the congestion.  One such party was San Francisco, which argued that customers in areas where there is inadequate competition “should not be held responsible for historic utility decisions to substitute generation for more expensive transmission.”  San Francisco at 3-4.   Cities, for their part, stated that basing payment of the Usage Charge in addition to the Access Charge on whether customers are located in a Congestion Zone, when such customers had no role in deciding whether to construct transmission facilities suitable to prevent the congestion, resulted payments which are unjust and unreasonable.  Cities at 15-6. 
Another comment made by intervenors regarding this Study was that the ISO failed to demonstrate that Reliability Must-Run (“RMR”) contracts effectively have mitigated market power (Sempra at 7), and failed to separate out RMR costs incurred for reliability from those incurred to counter congestion (Oversight Board at 3; PG&E at 3). San Francisco argued that a break-down of RMR costs would be more helpful in analyzing potential congestion zones than is the 5 percent criterion.  San Francisco at 5.   
The Oversight Board commented that since the ISO is using variable costs to resolve intra-zonal congestion, the five-percent criterion will be met less often than expected.  This makes it a higher threshold, according to the Oversight Board, than originally anticipated. Oversight Board at 3.  Both Cities and San Francisco stated that the Access Charge should not be used as an element of the five-percent threshold, as the amount of the charge does not bear a relationship to the level of congestion.  Cities at 20-21; San Francisco at 6.   The Cities also argued that it would be more appropriate for the Commission, rather than the ISO, to determine whether a new congestion zone would be suitable in a given situation.  Cities at 9, 30-32.  The DWR commented that the ISO should be required to submit annual reports for each congestion zone, containing data on whether such zones remain just and reasonable.  DWR at 5.  Sempra criticized the ISO’s current congestion management system as providing the wrong incentives and thus requiring non-market-based processes to correct for these incentives.  Sempra at 12.
	2.	ISO Response
On January 7, 2000, the Commission issued an order on Amendment No. 23 to the ISO Tariff that directed the ISO to review its mechanism for Intra-Zonal Congestion management.   The ISO is currently evaluating the ramifications of the January 7 Order and considering how best to respond to the FERC directive.  The ISO believes that the Amendment No. 23 proceeding is the proper forum for addressing the many issues raised by commenters. 	The ISO commits to file concurrently in the instant docket its proposal for responding to and addressing the matters raised by the Commission in the January 7 Order. 
The ISO opposes any effort by intervenors to introduce into this or any other proceeding matters that either already have been resolved by the Commission or that have no direct bearing on the matters at issue in this proceeding or in the Amendment No. 23 proceeding.  
The ISO disagrees with intervenors who believe that the Commission would be better suited to determine when new congestion zones are needed.   ISO Tariff Section 7.2.7.2 provides that the “ISO shall monitor usage of the ISO Controlled Grid to determine whether new Zones should be created…in accordance with the following procedures.”  The existing structure, including the establishment of threshold criteria, is the appropriate method to make these determinations.  This is borne out by the Commission’s approval, in its Order on Amendment No. 22, of the ISO’s most recently created Congestion Zone.  It is not practical, nor a good use of the Commission’s resources, to ask FERC to investigate every instance where a zone might be created.     
As noted above, several commenters criticized the ISO Study for failing to include a definition of “workable competition”.   The ISO continues to believe that the classical economic definition of a workably competitive market is appropriate.  That is to say, a workably competitive market is one in which a large number of firms compete to produce the same product and no firm is able to raise prices significantly above system marginal costs for a sustained period of time.  Conversely, the ISO believes that a market is not workably competitive if a small number of firms have the ability to raise prices significantly above system marginal costs unimpeded by competition from other suppliers, other substitute products, or demand elasticity.  The absence of workable competition can be measured in many ways, including calculation of HHI indices, determination that a firm has more than a 20% market share, the number of hours a firm can be pivotal, the Residual Supply Index, and, the most conclusive measure, bid mark-up.
One of the commenters raised fundamental concerns that the ISO’s zonal methodology enhances opportunities for the exercise of market power.   See Sempra at 4-5.  Attachment A to this pleading includes a response to that argument prepared by the ISO’s Department of Market Analysis (“DMA”).
Regarding the cost-shifting issue, the Commission has ruled on this matter previously.   For example, in its Order of July 30, 1997, the Commission ruled that the ISO’s congestion management methodology “does not discriminate among classes of customers.”  80 FERC at 61,429. The Commission also reiterated this view in the October 30 Order, ruling that the “congestion pricing proposal does not result in improper cost shifts among customer groups.”  81 FERC at 61,477.  While the ISO has acknowledged that cost shifting may occur, it explained in the Study that “there is a trade-off between the administrative conveniences of fewer Zones and the inefficiencies introduced by the cost shifting in Intra-Zonal Congestion Management.”  Study at 15.  As this issue has already been resolved, it is neither justified nor appropriate to revisit it in this proceeding.  
As indicated in the ISO Studies, the ISO will release a detailed study on cost and value of Intra-zonal congestion within and across active and inactive zones.  The ISO described the methodology which it will use assess RMR costs attributed to Intra-zonal costs within and across active and inactive zones, and has requested the Commission to provide an opinion on the methodology.   
B.	The Transmission Loss Study

The purpose of this Study was 1) to compare the effects of the currently used transmission allocation methodology with a methodology based on full 
(unscaled) Marginal Loss Rates (“MLRs”) that take into account the actual scheduled transactions of each Scheduling Coordinator, rather than using a pro rata allocation to all load; and 2) to compare transmission loss responsibilities and their monetary values at applicable energy prices for various conditions under the two methods.   The Study found that the ISO’s current transmission loss allocation methodology is appropriate for the California energy market, as it maintains the relative significance of the economic signals. 
	1.	Comments

Intervenors had different views on this Study.   Some felt that the ISO’s Study was inadequate for failing to address the effects of the changes in methodology as it relates to Unaccounted For Energy (“UFE”)  since Amendment 22 was filed.   These parties argued that the Commission should require the ISO to file an additional Study, comparing the loss allocation methodology pre- and post-Amendment 22.  PG&E at 2; Metropolitan Water District at 10. 
Sempra argued that the ISO should be required to implement full marginal cost pricing of losses.   To avoid difficulties such as over-generation, Sempra recommended allowing scheduling coordinators to provide losses in kind, as well as to purchase losses from the spot market.  Sempra at 14.  Sempra also considered the Study to lack an empirical assessment of 1) the impact of alternative loss pricing mechanisms on market efficiency, or on load location and consumption decisions; or 2) the impact of scaling of marginal losses.  Sempra at 13.    Finally, Sempra criticized the Study for failing to consider what Sempra viewed as the real impact of calculating losses relative to the locations of SC loads, rather than the system load center - - the fact that loads distant from generation will face a price signal that reflects the cost of serving that load.  Sempra at 14-15. 
EPMI stated that the ISO’s current transmission loss allocation methodology is appropriate.  EPMI at 3.
	2.	ISO Response

	As regards UFE, the Commission did not direct the ISO to analyze this feature of transmission losses in the October 30 Order.   The ISO agrees that if the alternative loss allocation methodology (i.e., applied to resources) were used in the UFE allocations, there would be some differences in the loss allocation to each UDC service territory.  Additional numerical analysis would be needed, however, to determine the impact of the alternative loss allocation methodology on each UDC territory.  In any event, PG&E’s comments are beyond the scope of the Study directed by the Commission.
	The ISO does not believe it is appropriate to implement a full marginal loss allocation methodology, as recommended by Sempra.  The ISO believes that implementation of a full marginal loss methodology would result in over-generation, artificial thinning of the Ancillary Services market, and artificial depression of the ex post price.  This is not a desirable outcome or an appropriate methodology for the California market.   Scheduling Coordinators currently have the ability to provide for their own losses.  Moreover, if the SC’s provide the losses they are allocated, they will not have any imbalance energy charges.  Sempra is incorrect to complain of a lack of empirical data, as the Study provides results for the weighted prices of losses per SC under both the current method and the alternative method for pricing losses.  
As for the impact of scaling of marginal losses, the ISO believes that without applying a scaling of MIR to the estimated system loss, the actual system losses will be inaccurate (i.e., the value in the case study was 1.8 times the actual system loss.  See Section 3.3.2 of the ISO Study).  	
Finally, contrary to Sempra’s opinion, the ISO’s methodology does consider the relative location of loads with respect to associated generation.  For example, for a SC with load distant from generation, the ISO’s current methodology produces a reasonable estimate of the transmission losses associated with serving that load with load from the remote generation.  That is, the ISO’s current loss allocation methodology will allocate more losses to a generator remote from load than it would to a generator located close to load. 
C.	Single- Versus Two-Part Ancillary Services Bid Evaluation Study

The purpose of this Study was to explore the issue of ancillary services bid evaluation to determine whether a two-part bid evaluation approach, using the sum of the capacity bid price and an energy price component  would yield superior results to those achieved under the single bid methodology.  The Study found that the single bid approach is both more efficient and less complex than the two-part approach, and thus should be retained. 
This study did not elicit much comment on the part of intervenors.  EPMI voiced support for the ISO’s opinion that the single stage ancillary services bid process, adopted in the ISO’s August 1997 tariff filing, is superior to a two-part process.  EPMI at 3.  The ISO agrees with EPMI. 

IV.	Conclusion
The ISO respectfully requests that the Commission accept its Answer to Motions to Intervene and Reply Comments and further requests that the Commission accept the Studies Conducted Pursuant to the October 30 Order, pending the filing of the ISO’s response to the Commission’s Order on Amendment No. 23, discussed supra.
Respectfully submitted,

________________________		____________________________
Roger Smith					Edward Berlin
Senior Regulatory Counsel			Kenneth G. Jaffe
California Independent System 		Julia Moore 
  Operator Corporation			Swidler Berlin Shereff Friedman, LLP 
151 Blue Ravine Road			3000 K Street, NW Suite 300
Folsom, CA  95630				Washington, D.C.  20007
Tel:  (916) 608-7135			Tel: (202) 424-7500 
Fax:  (916) 351-4436 			Fax: (202) 424-7643
	
Counsel for the California Independent 
System Operator Corporation

Dated: January 27, 2000

CERTIFICATE OF SERVICE

	I hereby certify that I have served the foregoing document upon all parties on the official service list compiled by the Secretary in the above-captioned docket, in accordance with the requirements of Rule 2010 of the Commission’s Rules of Practice and Procedure (18 C.F.R. § 385.2010).
	Dated at Washington, D.C. this 27th day of January, 2000.

							___________________
							Julia Moore

ATTACHMENT A