Testimony of Matt Burkhart

Vice-President, Electric and Gas Procurement
San Diego Gas & Electric Company

February 20, 2008

Introduction:

San Diego Gas & Electric Company (SDG&E) supports and is working toward the goal of acquiring 20% of energy from renewable sources by 2010. This effort, along with energy conservation and efficiency programs will be an important element in meeting the greenhouse gas (GHG) reduction goals implied by the AB32 climate change law, which is an important backdrop to the Renewable Portfolio Standard (RPS).

Since the RPS program was initiated in 2002, we have worked diligently toward meeting the 20% target but have faced three major obstacles – the availability of economically priced resources, significant regulatory uncertainty (for example, timely approval of needed transmission), and renewable developers who themselves face an array of business and regulatory uncertainties.

• We have had some success in our solicitation efforts. In the 8 Request for Offers (RFOs) for RPS resources we have held since the initiation of the program, we have received almost 200 proposals. SDG&E evaluated these proposals using a least-cost, best-fit selection criteria, as required by statute. Over 50 of these proposals showed viability as projects which could be delivered on-time and within a cost range acceptable to consumers and were short-listed for negotiations. However, we have had a continual struggle to identify sufficient projects that most advantageously provide renewable supply for our customers consistent with statutory criteria.
   
• Regulatory uncertainty with regard to transmission has a dramatic impact both on SDG&E and on developer interest. This uncertainty relates to both siting/building transmission needed for a renewables project, and navigating through the California Independent System Operator’s (CAISO) generation interconnection queue process. Without improvements in these areas, our ability to attract adequate developer proposals as well as our eventual ability to deliver the production from the renewable resources will be compromised.
   
• Our developers also face an array of business and regulatory uncertainties, which, in various ways, are passed along to us in the form of higher cost proposals and uncertainty of delivery. The inaction thus far in 2007-2008 by the United States Congress to renew renewable tax credits for solar and wind (the Investment Tax Credit and the Production Tax Credit are both scheduled to expire this year), has a chilling effect on the renewables market. In addition, as with many building projects, developers of renewable energy projects face a variety of localized site and permit issues/uncertainties which affect their ability to commit to delivery prior to 2011.

Background on SDG&E RPS:

When the law establishing the RPS became effective in 2002, SDG&E’s portfolio consisted of only about 1% renewables, largely from landfill gas projects. Like the other Investor Owned Utilities (IOUs), SDG&E has issued Requests for Offers (RFOs) each year since. We have also accepted renewable energy offers out of all-source RFOs and negotiated bilateral deals with developers. Altogether, we have negotiated over 30 contracts with developers. A number of these projects are now on-line. In 2007, over 5% of our bundled retail load supplied came from renewables projects that we contracted with -- 22 contracts with a nominal 250 MW of capacity. These projects cover the range of renewable technologies: over half wind, one-quarter biomass, and the balance in landfill gas, digester gas and small hydro.

In addition to projects already on-line, we have executed 10 contracts with developer counterparties for projects that are not yet in production. This portfolio of projects under development consists of concentrating solar power, wind, geothermal and biomass projects. These projects are scheduled to be on line at various times between late 2008 and late 2011. If they meet expected delivery dates, this set of contracts, when combined with the renewable resources already in operation, will provide SDG&E with 13% of delivered energy in 2010 and 19% in 2011.

SDG&E is also continuing its efforts to obtain additional renewable energy resources. We are now pursuing another dozen opportunities -- representing wind, solar, geothermal and biomass – based on proposals we received in past RFOs and bilateral offers. If a sufficient number of these proposals result in successful contract negotiations, we will contract up to and beyond the 20% goal for the year 2010. SDG&E intends to build in a ‘margin of safety’ and contract beyond the 20% goal – into the 24- 26% range -- in order to offset the potential for contract failure. At present, we cannot predict how many of these negotiations will be successful.

Hurdles to Project Development

There are barriers to the successful and timely completion of projects already under contract, as well as projects proposed to us that are not yet under contract. These barriers have the potential for being more serious for projects that are not under contract since they are still early in the development phase and tend to face more economic risk.

For the 10 projects we have under contract that are not yet operating, we see four major categories of risks that could keep one or more of those projects from being viable and achieving commercial operation on a timely basis. These risks are in addition to the normal risks that developers face that affect their economics (e.g., whether the resource exists in sufficient quantities or whether fuel will be available at an acceptable cost). Some projects face multiple major risks, some one, some none. We summarize the major, viability risks as follows:

• Transmission
• Tax
• Site control and local permitting
• Rising costs and cost uncertainty

I discuss each of these barriers in more detail below:

1. Transmission Issues: Transmission risk is a major issue for five of the projects currently under contract but not yet operational. The issue is whether a project is located in a constrained area and depends on a new transmission project to reach the market. Indeed, both sellers and SDG&E face this regulatory uncertainty of not knowing when, or if, the transmission required to deliver power from a new resource that supports RPS and GHG goals will be authorized by the CPUC. For example, SDG&E understands that the Tehachapi Renewable Transmission Project, developed through a statewide planning process, may not result in the final segments being completed until late 2013. For sellers, this type of long time frame, in some cases, has meant focusing limited resources on projects that have a better chance to proceed in a timely fashion. For utility buyers, this has meant living with uncertainty whether they will achieve the 20%, based on the progress of transmission projects. This has affected SDG&E most acutely with Sunrise, but it has also affected a promising wind project originally due in service by 2007/2008. This in-service date has been delayed to late 2011 as a result of the Tehachapi project construction plan-of-service noted above, which was designed to bring all of the area’s wind resources on line as soon as practical.
   
   In addition to transmission siting uncertainty, many in the State have raised a concern that the current federal rules governing the CAISO's processing of interconnection requests has created a roadblock to project proposals and project development. According to the CAISO, it currently has 188 active interconnection requests totaling over 62,000 MW (over 42,000 of which are renewable). The ISO has indicated that this large number of requests and the high level of capacity in the CAISO's interconnection queue have overwhelmed the ISO and led to significant delays. We cannot say with certainty the extent to which this issue has prevented projects from bidding into our RFOs or resulted in higher bid prices. However, it is clear that the current process does impose project delays that could have that effect.
   
   The FERC, the ISO, and stakeholders are now involved in a process to reform the existing rules. We expect this reform process to be completed later this year. Until it is, the interconnection queue process will remain a potential impediment to project development.
    
2. Tax Credit Extensions: Federal law currently provides investment tax credits and production tax credits for certain renewable technologies. These tax credits expire at the end of 2008, and Congress has not yet enacted an extension. While Congress has considered both extensions of one year and longer extensions reaching into the next decade, it has failed to approve any of them and Congressional inaction jeopardizes project viability. These credits are the largest single risk facing our group of 10 contracted projects that are not yet operational. Over 650 MW of potential new capacity is affected by this risk. Moreover, to the extent that Congress fails to enact extensions beyond one or two years, that failure is likely to impact future potential projects, as well as the willingness of companies to invest in new projects or manufacturing facilities for specialized generation equipment. These tax credits are an important element in the nation’s renewable energy program and SDG&E has urged Congress to extend the incentives for as long as possible as soon as possible.
    
3. Site Control and Local Permitting: SDG&E has three projects under contract that are having issues with either local permitting or with action by the Bureau of Land Management to issue leases on a timely basis. These issues jeopardize the continued viability of those projects.
    
4. Rising Costs: It is well-known that the costs of underlying equipment are rising, leading to increased development costs and decreased project viability. For example, there have been steep increases in the cost of raw materials like copper, steel, and concrete which have driven up project costs and restricted equipment supplies. To the extent that contract pricing is fixed, rising cost of equipment would impact project viability, absent an increase in contract price (which may or may not be competitive or justifiable), unless the developer had already hedged his equipment cost. We believe that the rising cost of equipment is negatively impacting at least three projects currently under contract with SDG&E.
   
   Where a developer faces these kinds of viability risks would prevent a project, the contract terms may provide an off-ramp through the operation of Conditions Precedent (CP) in the contracts. Typically, the CP in a contract includes certain external milestones or events occurring by a particular date that a seller requires as a condition for moving forward. Some require transmission project approvals by a certain date; some require a favorable outcome with respect to land and permitting; others require an extension of the ITC and PTC. Some require project financing by a certain date, which, in turn requires good project economics from the point of view of a lender or other investor, and serves as some protection for the developer against rising costs and new technology risks.
    
5. Other Impacts
   These risks affect not only projects already under contract, but also prospective projects with which we are negotiating to achieve a contract. But, in addition, because projects not yet under contract tend to be less far along, they are even more susceptible to high and rising costs (construction costs, turbines, steel, glass), long-lead times for equipment deliveries (due to limited manufacturing capacity), and a resource base where many of the best projects have already been built or spoken for (e.g. the availability of attractive wind resources). Transmission tends to be an even larger hurdle for such prospective projects, as these projects tend to be less far along in the interconnection process. All of these uncertainties will affect both the price demanded by sellers in contract negotiations, as well as the willingness of a developer to enter into a contract at this time.
   
   During our negotiations, we have also seen a lack of urgency on the part of many sellers. This appears to be partly due to uncertainty over project economics and technology. Many of the projects we are currently negotiating with are in the very early stages of development, rather than ready to proceed right away. Accordingly, they are anxious to remove project risk uncertainty by making progress on their projects before committing to a contract.
   
   We believe that this lack of urgency is also due, in some cases, to an apparent belief on developers’ parts that prices the IOUs will pay will rise over time as the 2010 deadline approaches and the utilities are placed in a ‘must-buy’ position. It appears that they perceive that there is no downside to waiting and potentially significant upside. As a result, some of our negotiations have taken over a year. And, we’re also seeing an increasing proportion of deals offered as bilaterals, where the seller can simultaneously offer the project to multiple buyers to get the price bid up and the terms made more favorable.
   
   The net effect of these difficulties is that the prices being offered to and paid by utilities in renewable energy contracts are rising rapidly. With the “low hanging fruit” of lower cost renewable energy supply largely gone, we may be approaching a point where higher levels of renewables will start having a real impact on customer rates. The State needs to prepare for this.

Policy Issues and Recommendations

Meeting Current Renewables Targets:

Uncertainty is the largest roadblock to timely renewables development. This uncertainty manifests itself in many ways – uncertainty about transmission siting, uncertainty about interconnection queue impacts, uncertain project permitting, uncertain tax incentives, uncertain project cost. The State cannot manage all of this uncertainty, but there are areas that it could address.

With respect to transmission siting, we believe that the State needs to consider carefully whether it can implement rules that would reduce the period of uncertainty associated with transmission. For example, under current Texas law, transmission permit proceedings for facilities to transmit renewables energy must be expedited so that they are completed within 180 days from the date of application. Whether that is a useful model for California remains to be seen, but it is worth exploring.

Stakeholders are already in the process of developing proposed revised interconnection queue rules. Once these new rules are in place and we have experience under them, hopefully they will eliminate the concerns and potential negative impacts that the current rules may be causing.

Another potentially helpful area for policy improvement involves the regional nature of the renewables market. At present, renewable energy must be delivered into California to count toward RPS goals. Accessing renewable energy in other western states requires transmission arrangements that can be complex and costly. Relaxing the in-state delivery requirement in some way would allow utilities and other buyers to access more projects at a lower cost to California ratepayers.

Federal tax incentives need to be extended for a number of years to reduce project economics uncertainty. California should be at the front of urging Congress to act quickly on this extension. Ideally, California could consider additional incentives within the State. We recognize that these incentives would come at a cost that could create budget impacts. However, it is an approach used in many states already, and is worth serious consideration.

Future Renewables Targets and Climate Change:

Another factor has influenced the RPS program has been policy and regulatory developments relating to climate change. SDG&E believes that renewables will play a central role in meeting climate change targets in California, as well as nationally. However, there has grown a realization that climate change regulation and renewables programs are largely different ways of dealing with the same environmental issue. As climate change regulation becomes more specific, it will put utilities onto a “glide path” toward reduced greenhouse gas emissions in which reductions achieved by renewable resources will be one tool for meeting state targets.

Future renewables policy will need to recognize that renewables’ role in meeting climate change targets will be one choice among competing options that may best meet those goals at the lowest cost to California’s citizens. Any new policy or rules governing renewables will need to reflect that more flexible role for renewables. We anticipate that such a policy will also relieve some of the stress on costs for renewables currently created by relatively high demand for renewables, and relatively limited supplies of renewables. It will also afford the CAISO and the CEC to continue their work in assessing the operational and related impacts of increasing levels of renewables and identifying any needed actions.