California - Regulatory Update

Overview
Prior to 2001, Direct Access (DA) was the energy deregulation program in California. On September 20, 2001, the California Public Utility Commission (CPUC) suspended DA, therefore the right of consumers to buy energy from Electric Service Providers (ESPs), like Direct Energy Business, who buy and sell retail electric in a competitive, deregulated market. DA suspension applies to all customers in the three major utilities in California: Pacific Gas & Electric, Southern California Edison and San Diego Gas & Electric. Current regulations allow Direct Energy Business to service only those customers that are:

• Current Direct Energy Business customers interested in extending or renewing their initial contracts;
• Current customers of other ESPs; or
• Customers who have valid contracts with an ESP executed on or before September 20, 2001.

The History and Future of Direct Access in California
In September 1996, legislation was enacted to restructure the California electric utility industry and implement retail access for electricity customers. In 2000 and 2001, California experienced a statewide electricity crisis. Falling reserves, rolling blackouts, escalating wholesale prices and financial instability of utilities resulted. The Department of Water Resources (DWR) was allocated $400 million to purchase and sell electricity to California customers and the responsibility for purchasing additional long-term power contracts. As a result of the power crisis, Direct Access was indefinitely suspended in California, leading to the current situation.

In October 2002, the CPUC approved an order allowing Pacific Gas & Electric, Southern California Edison and San Diego Gas & Electric to buy their own power starting in January 2003. The operating order for which these utilities have taken over energy procurement may lead to more competitive opportunities in the future. A more efficient purchasing plan, along with a dedicated CPUC focus could provide progress to re-open Direct Access.

The defeat of Proposition 80 in 2006 and the imminent repayment of the DA CRS are positioning the California marketplace for a reinstatement of Direct Access. Reinstating Direct Access is crucial to being able to offer customers choice and control of their energy management.

Direct Access Re-opening Status
The CPUC has opened a proceeding that is examining the re-opening of Direct Access. The Commission has established this Rulemaking to occur in three phases. The phases are outlined as follows:

Phase I: Commission's Legal Authority to Lift the Direct Access Suspension in compliance with AB 1X.

Phase II: Public Policy Merits of Lifting the Direct Access Suspension and Applicable Wholesale Market Structure/Regulatory Prerequisites.

Phase III: Rules Governing a Reinstituted Direct Access Market: e.g., Entry/Exit/Switching; Default Arrangements, and Cost Recovery Issues.

While the Commission has ruled that they do not have the authority to lift the suspension unilaterally at present, they are moving forward with the proceeding in order to explore the alternatives that would permit them to implement Direct Access on a more expedited basis. This proceeding at the Commission, led by President Peevey, is moving forward cautiously and deliberately toward Direct Access re-opening. It is our understanding that the commitment to re-open the market remains strong.

Direct Energy Business will continue to keep you updated as additional details are available. Click here for more information on California's Direct Access requirements.

Resource Adequacy Requirements (RAR)
In October 2005, the CPUC issued Decision (D.05-10-042) which promulgated key policies for RAR that are applicable to the three major investor-owned utilities, Electric Service Providers and community choice aggregators (collectively, Load Serving Entities, or LSEs). In adopting these policies, the Commission said that it was "providing a framework to ensure resource adequacy by laying a foundation for the required infrastructure development and assuring that capacity is available when and where it is needed." Among the RAR policies adopted in D.05-10-042 are the following:

Beginning in 2006

• Each LSE has an obligation to acquire sufficient resources and reserves to cover its customers' loads.
• Each LSE is subject to a planning reserve margin requirement of 15-17% for all months of the year.
• Each LSE must demonstrate forward contracting for 90% of its summer (May through September) peaking needs (loads plus reserves) a year in advance.
• Each LSE must demonstrate it has fully contracted for at least 115% of peak loads on a month ahead basis.

Additionally D.05-10-042 called for a local Resource Adequacy Requirement to begin in 2007 which would require each LSE to procure adequate resources within each load pocket to meet customer needs. This phase of the proceeding is ongoing with decisions expected in the second half of 2006.

Renewable Portfolio Standards (RPS)
California has enacted a Renewable Portfolio Standard (RPS), which requires that 20% of retail electric sales delivered to customers come from eligible, certified renewable resources by 2010.

This means that over the course of the year 2010, all load serving entities will need to procure renewable energy from eligible sources equivalent to 20% of each entity's 2009 California Retail Electric Sales. After 2010, each year's RPS obligation is based on the percentage of "prior year's retail sales." The requirements for the RPS are as follows:

• The RPS calls for in-state resources or resources from out of state that have been certified as eligible by the California Energy Commission (CEC) and have the associated renewable energy delivered to California.
• Prior to 2010 the RPS calls for an incremental 1% of renewables to be procured each year.
• Renewable energy certificates (RECs) are not yet permitted for use in compliance. A proceeding is actively underway that is likely to allow RECs in future years, but it will take legislative action to remove the associated delivered energy requirement. This makes RECs under the likely regime an excellent tool for flexibility, but not something that will broaden current pool of available resources.
• As a sub-requirement of the RPS, all load serving entities each year are required to contract for purchases totaling a minimum of .0025% of their prior year's retail sales from either a "new generation" resource or enter into a contract of 10+ years duration. If this requirement is not met, no shorter term procurements made in the calendar year can be counted toward the RPS.
• There are currently no alternative compliance payments in lieu of meeting the RPS—there is a $.05/kWh penalty for non-compliance and that annual penalty is capped at $25 million per load serving entity.

Market Updates
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