STATE OF NEW YORK PUBLIC SERVICE COMMISSION At a session of the Public Service Commission held in the City of Albany

on December 13, 2012 COMMISSIONERS PRESENT: Garry A. Brown, Chairman Patricia L. Acampora Maureen F. Harris James L. Larocca Gregg C. Sayre

CASE 12-E-0400 - Petition of Cayuga Operating Company, LLC to Mothball Generating Units 1 and 2.

ORDER DECIDING RELIABILITY ISSUES AND ADDRESSING COST ALLOCATION AND RECOVERY (Issued and Effective December 17, 2012)

BY THE COMMISSION: INTRODUCTION On July 20, 2012, Cayuga Operating Company, LLC (Cayuga) filed a notice pursuant to the Retirement Notice Order, 1 which stated that Cayuga intended to mothball Units 1 and 2 at its Cayuga Generating Facility in Lansing, New York, (Cayuga Facility) by January 16, 2013. 2 In response to Cayugas notice,

Case 05-E-0889, Policies and Procedures Regarding Generating Unit Retirements, Order Adopting Notice Requirements for Generation Unit Retirements (issued December 20, 2005) (Retirement Notice Order). According to Cayuga, it intends to place the Cayuga Facility in protective lay-up to limit the costs that are incurred at the facility. Cayuga Retirement Notice, p. 1. The terms mothball and protective lay-up are synonymous with a retirement for purposes of providing notice under the Retirement Notice Order.

CASE 12-E-0400

New York State Electric & Gas Corporation (NYSEG) conducted an analysis of the proposed mothballing and identified adverse reliability impacts that could occur if the mothballing proposal were effectuated. Although NYSEG also identified system

reinforcements as one potential mitigation measure that would remedy those reliability impacts, it estimated that all of those reinforcements would not likely be completed until at least the end of 2016. Because the upgrades necessary to mitigate the

reliability impacts would not be in-service until after the proposed mothball date for the Cayuga Facility (i.e., January 16, 2013), NYSEG determined that the Cayuga Facility would need to remain capable of operating and available for commitment in order to maintain system reliability on an interim basis. On October 29, 2012, NYSEG submitted a proposed Term Sheet for Reliability Support Services (RSS) between NYSEG and Cayuga that would support the continuing availability of the Cayuga Facility for maintaining reliability. The Term Sheet

provides that RSS would be procured from the Cayuga Facility for one year beginning January 16, 2013, and ending January 15, 2014. During this period, NYSEG would identify and consider NYSEG and Cayuga requested

alternative reliability solutions.

approval of the Term Sheet, without material modification, before entering into a bilateral contract implementing its terms. NYSEG also proposed to recover the costs that would be

incurred under the contract from its retail delivery customers through its Non-Bypassable Charge (NBC).

BACKGROUND The Cayuga Facility consists of two coal-fired units with a combined capacity of over 312 MW. Cayuga Unit 1 was

placed in service in 1955, and has a net capacity rating of 154 MW. Cayuga Unit 2 entered service in 1958, and has a net -2-

CASE 12-E-0400 capacity of 158.7 MW. 3

Cayugas notice explained that the

proposed mothballing was attributable to its conclusion that current and forecasted wholesale electric prices in New York are, and will be, inadequate to support continued operations. On July 25, 2012, Department of Public Service Staff (DPS Staff) requested that the New York Independent System Operator, Inc. (NYISO) and NYSEG analyze the effects of mothballing the Cayuga Facility on bulk and local electric system reliability. In addition, DPS Staff requested that

solutions be proposed to address any adverse reliability impacts that were identified. In letters dated August 24, 2012, NYSEG and the NYISO provided analyses to DPS Staff. 4 NYSEG advised that mothballing

the Cayuga Facility would cause adverse reliability impacts under certain conditions. NYSEGs preliminary studies

identified a need to retain both units at the Cayuga Facility as available and capable of being committed to maintain reliability in the interim. NYSEG also identified system upgrades to

relieve the adverse impacts in the Auburn area, and proposed to pursue those upgrades by filing an application pursuant to Article VII of the Public Service Law by the end of 2012. The

first phase of the reinforcements is estimated to be in-service by the end of 2016. NYSEG indicated that it needed to conduct a

coordinated study with the NYISO and National Grid to identify

The Cayuga Facility was formerly owned by NYSEG, and was referred to as the Milliken Station. Letter from Mary R. Smith, NYSEG Vice President Engineering and Asset Management, to Thomas Dvorsky, Department of Public Service (dated August 24, 2012). Letter from Wesley Yeomans, NYISO Vice President of Operations, to Thomas Dvorsky, Department of Public Service (dated August 24, 2012). The NYISOs letter was provided under our regulations governing the submission of confidential information. -3-

CASE 12-E-0400

any additional system reinforcements that may be needed outside of the Auburn area. In conformance with the State Administrative Procedure Act (SAPA) 202(1), notice of Cayugas proposed mothballing of the Cayuga Facility was published in the State Register on September 26, 2012 (SAPA Notice). In addition, a Notice

Directing Filings and Soliciting Comments was issued by the Secretary on September 28, 2012 (Secretarys Notice) directing NYSEG and Cayuga to file either an agreement or proposed terms recommended by each party, along with justifications and complete supporting documentation, no later than October 29, 2012. On October 29, 2012, NYSEG submitted a proposed Term Sheet between NYSEG and Cayuga to procure RSS from the Cayuga Facility for a one year period beginning January 16, 2013, and ending January 15, 2014. NYSEG would continue to procure RSS

from the Cayuga Facility beyond this period, if necessary, dependent upon the implementation of NYSEGs planned system reinforcements or alternative reliability solutions. NYSEG also

proposed to recover the costs it would incur in procuring RSS from Cayuga through its NBC. The period for interested parties to submit comments in response to the SAPA Notice and the Secretarys Notice expired on November 13, 2012. On November 13, 2012, comments

were filed on the Term Sheet, the proposed use of the NBC for cost recovery, and the process for review, by National Grid, Sierra Club, Indicated Transmission Owners, 5 Nucor Steel Auburn, Inc. (Nucor Steel), and Multiple Intervenors (MI). NYSEG filed Nucor

a response to Nucor Steel and MI on November 26, 2012.

5

The Indicated Transmission Owners include Central Hudson Gas & Electric Corporation, Consolidated Edison Company of New York, Inc., Orange and Rockland Utilities, Inc., the Long Island Power Authority, and the New York Power Authority. -4-

CASE 12-E-0400

Steel and MI filed comments responding to NYSEG on November 28, 2012, and November 30, 2012, respectively. comments are summarized and discussed below. On November 16, 2012, Cayuga filed a proposed, but unexecuted, reliability must-run (RMR) agreement with the Federal Energy Regulatory Commission (FERC). 6 Although the RMR The parties

applied to the Cayuga Facility effective January 16, 2013, Cayuga requested that the RMR filing be held in abeyance pending our determination in this proceeding. Pursuant to the proposed

RMR, if approved, NYSEG would compensate Cayuga through a monthly fixed-cost charge of $6,633,307.70, less certain credits for NYISO-administered market revenues earned by Cayuga. Cayuga

characterized these amounts as based on its cost-of-service (COS).

THE PETITION Term Sheet The Term Sheet provides that Cayuga would provide RSS by deferring any mothballing actions on the Cayuga Facility from January 16, 2013, through January 15, 2014. In the meantime, Under

NYSEG would consider alternative reliability solutions.

the Term Sheet, NYSEG would pay Cayuga a monthly fixed-price charge of $2,431,388/month for RSS, totaling $29,176,656 over 12 months. In addition, NYSEG would fund certain capital NYSEG would also pay Cayuga one-

expenditures up to $4,325,000.

half of the reasonable expense it incurred, up to $150,000, for the COS study for the Cayuga Facility that was filed in this proceeding on November 9, 2012. NYSEG would also reimburse

Cayuga for cumulative incremental forced outage repair costs that exceed $450,000.
6

FERC Docket No. ER13-405-000, Cayuga Operating Company, LLC RMR Filing (filed November 16, 2012). -5-

CASE 12-E-0400

Under the Term Sheet, Cayuga would offer the Installed Capacity (ICAP) associated with the Cayuga Facility into the NYISO ICAP auction at a de minimis price, in compliance with NYISO market rules. Any ICAP revenues received by Cayuga would Cayuga

be credited against NYSEGs monthly payment to Cayuga.

would retain any combined energy and ancillary service revenues, net of variable production costs, up to $7 million annually, while NYSEG would share equally in any such revenues in excess of $7 million annually. Furthermore, in the event that the Cayuga Facility experiences a positive Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) in one or more of the five years following expiration of the Term Sheet, a portion of such earnings would be credited to NYSEG for the benefit of its customers (Annual Refund Amount). More specifically, if Cayuga

operates the facility beyond January 15, 2014, Cayuga would reimburse NYSEG for one half of the capital expenditures that were paid by NYSEG, at the rate of 20% per year for each of the next five years of operation. In each such year, up to $432,500 If Cayugas

in Cayugas EBITDA would be paid back to NYSEG.

EBITDA in any year is less than the Annual Refund Amount, Cayuga would not have an obligation to pay NYSEG more than its EBIDTA for that year. The Term Sheet would also subject Cayuga to a

performance penalty of $787.67 for each hour that an RSS unit is requested to run but does not. The Term Sheet contemplates the potential renegotiation of terms and conditions for any necessary extension of the contract until such time as NYSEG implements sufficient transmission enhancements, or alternative solutions are identified and developed to obviate the need for the Cayuga Facility. NYSEG further explains that the option to extend the

Term Sheet is necessary to account for deviations in the planned -6-

CASE 12-E-0400

schedule for deployment of transmission enhancements and to retain flexibility to address other reliability needs, if any, which may be identified as resulting from the mothballing of the Cayuga Facility. NYSEG and Cayuga seek approval of the Term Sheet, without material modification. Following such approval, NYSEG

and Cayuga intend to prepare, execute, and file a final contract based on the Term Sheet. In support of the Term Sheet, NYSEG maintains that it represents a reasonable resolution of the issues presented, and is fair, equitable, and in the public interest. The information

NYSEG relied upon in evaluating the reasonableness of the Term Sheet costs was provided by Cayuga under confidentiality protection. Cayuga argues that the Term Sheet reflects 1) compensation

significant compromises on its part, including:

at a level below what the COS study indicates is appropriate; 2) acceptance of responsibility to pay for capital expenditures that exceed $4,325,000; and, 3) reimbursement for half of the capital expenditures paid by NYSEG if certain conditions are met. Cost Recovery The Term Sheet is also subject to approval of a complete and immediate cost recovery mechanism for NYSEG. In

its October 29, 2012 filing, NYSEG proposed recovery of the RSS costs on a volumetric basis through its NBC. NYSEG explained

that the NBC is an existing mechanism through which it currently recovers the market value of NYSEG-owned hydro plant output valued at the generation source; the net market value of the purchased power contracts with Non-Utility Generators and the New York Power Authority (NYPA) (market value of the purchased power contract costs determined at the generation source less the contract costs); monthly payments received by NYSEG from -7-

CASE 12-E-0400

NYPA under the Recharge New York Residential Consumer Discount Program (New York Public Authorities Law 1005(13-b)); all actual transmission wheeling expenses; and, certain actual wholesale transmission-related revenues. NYSEGs Lost Revenue Recovery Mechanism. The NBC also includes The NBC is set monthly

based on a forecast and is subject to a monthly true-up for all components to reflect actual after-the-fact costs and load subject to the NBC. All items collected through the NBC are

symmetrically reconciled and trued-up monthly in a competitively neutral manner. The credits or charges related to the

reconciliation are included in the subsequent monthly NBC. NYSEG contends that the NBC is the appropriate mechanism to recover all RSS costs because it would allow for the fair, equitable, and nondiscriminatory recovery of the RSS costs from virtually all of NYSEGs delivery customers. Moreover, NYSEG proposes that the NBC be utilized to flow through, for the benefit of ratepayers, any net ICAP revenues that may be credited to NYSEG under the provisions of the Term Sheet. NYSEG suggests that it may be appropriate to allocate RSS costs to National Grid, based on the outcome of the on-going study it is conducting with the NYISO and National Grid related to the full reliability impacts stemming from the mothballing of the Cayuga Facility. According to NYSEG, this study may

demonstrate that continued operation of the Cayuga Facility is necessary for the reliability of National Grids local and bulk system, as well as NYSEGs local system.

-8-

CASE 12-E-0400

COMMENTS National Grid National Grid disagrees with NYSEGs suggestion that it may be appropriate to allocate a portion of the RSS costs to National Grid in the future, based on the results of the study expected to be completed by the NYISO, NYSEG, and National Grid by the end of January 2013. Although that study is expected to

identify any additional system reinforcements and long-term solutions needed on NYSEG and National Grids systems, National Grid maintains that mothballing the Cayuga Facility would primarily affect facilities used to serve NYSEGs customer load. According to National Grid, the benefits to National Grid customers from those facilities are de minimis. Despite some reliability concerns related to facilities used to serve its customers, National Grid argues that those concerns are far less immediate and much more contingent than the situation facing NYSEG. 7 National Grid

contends that it can still serve its Syracuse area load under normal system conditions and specified single contingencies, and its reliability concerns arise under multiple-element outage conditions and certain generation dispatch conditions. Accordingly, National Grid believes that it should not be allocated any portion of the RSS costs. Sierra Club Sierra Club contends that it is uncertain whether NYSEG has a plan to minimize adverse impacts to ratepayers by expeditiously, cost-effectively, and permanently eliminat[ing] the reliability need for Cayuga. 8 In the absence of such a

plan, Sierra Club urges that NYSEG engage in a competitive solicitation for generation, transmission, and non-transmission
7 8

National Grid comments, p. 4. Sierra Club comments, p. 2. -9-

CASE 12-E-0400

alternatives, such as demand response, which could address the reliability needs created by mothballing the Cayuga Facility. Sierra Club also argues that NYSEG should not contribute to the cost of any capital expenditures that are not absolutely necessary to maintain the Cayuga facility during the duration of the reliability need. Finally, Sierra Club notes the various examples where New York coal plants are facing challenges to remaining in operation that may raise reliability issues. To eliminate the

need for any future out-of-market reliability payments, Sierra Club recommends that detailed reliability analyses be prepared for the four remaining coal plants (S.A. Carlson, Huntley, Somerset, and Danskammer) to identify any needed transmission upgrades. Indicated Transmission Owners The Indicated Transmission Owners do not take a position on the substance of the Term Sheet Agreement. They

request, however, that it be expressly stated that any decision rendered in this proceeding will not have a precedential effect in future requests for out-of-market compensation. According to

the Indicated Transmission Owners, alternative approaches may be appropriate to address the specific facts and circumstances surrounding future requests. Nucor Steel Nucor Steel acknowledges the need to ensure reliable electric service in the Auburn area and, therefore, does not oppose the approval of the Term Sheet Agreement. It is

concerned, however, that NYSEG is not making the necessary transmission upgrades in a timely manner in order to mitigate the utilitys continued reliance on the operation of the Cayuga facility. Nucor Steel maintains that the Auburn 345 kV

transmission upgrade appears to be at least a full year behind -10-

CASE 12-E-0400

schedule, based on NYSEGs reduced capital expenditure estimates for the project through the end of 2013. Nucor Steel suggests

that NYSEG be directed to prioritize the Auburn 345 kV upgrade by establishing an expedited schedule, and to incent timely completion by suspending further RSS cost recovery until NYSEGs next rate case in the event that it fails to meet established milestones. In addition, Nucor Steel suggests that recovery of the RSS costs should be deferred until NYSEGs next electric base rate case. Nucor Steel asserts that NYSEGs proposed recovery

through a volumetric (i.e., per kWh) NBC is inadequate, inefficient and will impose excessive costs on NYSEG ratepayers in an inappropriate manner for too long. 9 Alternatively, Nucor

Steel requests that the RSS costs be recovered on a demand (i.e., per kW) basis, which, it argues, would ensure costs are recovered in a manner that reflects cost causation. Nucor Steel

likens the RSS costs to those incurred to ensure reliability and points out the costs are a substitute for forthcoming infrastructure investments. by nature demand related. 10 Multiple Intervenors (MI) MI supports the decision to keep the Cayuga facility in operation for the purpose of maintaining reliability, but is concerned that the Term Sheet has not been adequately justified to support a conclusion that it is reasonable. It suggests that Thus, it contends, RSS costs are

the Term Sheet should be rejected or modified pending additional justification. MI argues that it is not in a position to evaluate the Term Sheet because of the exclusion of intervener parties from settlement negotiations, the limited amount of time allotted
9 10

Nucor Steel comments, p. 3. Nucor Steel comments, p. 9. -11-

CASE 12-E-0400

for comments, and the lack of justification proffered publicly for the negotiated compensation level for RSS. 11 MI proposes

that an alternate process should be developed for evaluating RSS agreements, which includes: 1) specified cost and other records that must be disclosed; 2) use of non-disclosure agreements and protective orders to facilitate participation by interested interveners while protecting confidential generator cost information; 3) technical conferences and/or settlement negotiations on notice to all parties; and, 4) designation of a settlement judge to oversee confidentiality matters, expedite discovery, and provide information regarding the reasonableness of any settlement. Notwithstanding the constraints on its ability to participate, MI maintains that the Term Sheet compensation is exorbitant and would over-compensate Cayuga if one or both units are unavailable due to a forced outage. MI asks that the

recovery of RSS costs through the NBC, as proposed by NYSEG, be rejected and that issues pertaining to the recovery of RSS costs be deferred to NYSEGs next rate case, which could be filed as soon as February 1, 2013. Alternatively, if the issue of cost recovery is decided in this proceeding, MI asks that volumetric recovery of costs via the NBC be rejected. MI argues that volumetric

recovery would be inconsistent with cost causation principles, inequitable to high-load-factor customers, and unfairly exempt wholesale customers from paying RSS costs. MI suggests that the

RSS costs should be treated in a manner comparable to costs of electric system investments that are made to ensure reliability, which are recovered on a demand-related basis. For example, MI

points to the tentative agreement in National Grids pending rate case as a model, which would allocate RSS costs to service
11

MI comments, p. 2. -12-

CASE 12-E-0400

classes based on the most recent transmission plant allocator and assessed on a volumetric basis; per kWh for non-demand service classifications and per kW for demand service classifications. 12 Further, MI contends that, in addition to

the proposed recovery from retail customers, RSS costs should also be recovered on an equitable basis from wholesale customers.

REPLY COMMENTS NYSEG In comments filed out-of-time on November 26, 2012, NYSEG responded to several of the points raised by Nucor Steel and MI. NYSEG argues that deferring cost recovery for a year or

longer until NYSEGs next rate case, as suggested by Nucor Steel and MI, is inappropriate. NYSEG asserts that matching cost

recovery with the timing of cost incurrence is appropriate to ensure that the cash flows of NYSEG are not negatively impacted, which could have detrimental impacts on the financial and credit metrics of [NYSEG]. 13 To address Nucor Steel and MIs objections to recovering RSS costs through the NBC, NYSEG indicates that it is amenable to creating separate RSS surcharges by service class based on the 2008 embedded cost of service study from its last rate filing. NYSEG would create volumetric and demand-based

class specific surcharges from that studys transmission plant allocation factors (the average of the 12 monthly coincident peaks by service class), with a minor adjustment to include the stand-by class. To allocate the costs to each service class,

NYSEG would then set class-specific surcharge rates on a /kWh basis for non-demand metered classes and on a $/kW basis for
12 13

MI comments, p. 22. NYSEG reply comments, p. 2. -13-

CASE 12-E-0400

demand metered service classes.

NYSEG's proposed allocation

factors are set forth in Attachment A of its reply comments. NYSEG estimates that this approach could be implemented by March 1, 2013. If such surcharges are

authorized, however, NYSEG requests that any deferred costs be recovered, with interest, over the remaining billing months of calendar year 2013 to allow for full recovery during the applicable period in which costs are incurred. Finally, NYSEG contests MIs suggestion to recover RSS costs from NYSEGs wholesale customers, similar to the approach taken in the Dunkirk Retirement Order. According to NYSEG,

wholesale customers would only account for approximately 7.0% of the total RSS costs, based on their portion of NYSEGs total transmission load served over the most recent 12 month period ending October 2012. NYSEG points out that unlike National Grid

in the Dunkirk Retirement Order, NYSEG does not have a transmission formula rate which allows for annual updates. To

implement such a formula, NYSEG would need to file a proposed Transmission Service Charge rate change at FERC. Nucor Steel In comments filed out-of-time on November 28, 2012, Nucor Steel reiterated its initial position. In the event

immediate recovery of RSS costs is authorized, Nucor Steel supports the alternative approach identified in NYSEGs reply comments. MI In comments filed out-of-time on November 30, 2012, MI indicated its general support of the alternative approach identified in NYSEGs reply comments, which it contends is consistent with cost causation principles and is equitable to all customers. MI continues to maintain, however, that the

updated approach inappropriately excludes recovery from the -14-

CASE 12-E-0400

utilitys wholesale customers.

Further, MI asks that the 2008

data relied upon to allocate costs to NYSEGs service classifications should be updated periodically, such as part of NYSEGs next electric rate case. Lastly, MI requests that

standby customers be treated comparably with customers in their parent classifications for purposes of recovering RSS costs.

DISCUSSION In the Dunkirk Retirement Order addressing the proposed mothballing of the Dunkirk generating station, we noted the challenges that arise in the context of the competitive electricity markets in maintaining adequate generation resources to ensure reliability. 14 The mothballing of the Cayuga Facility

raises potential adverse reliability impacts similar to those addressed in the Dunkirk Retirement Order. Accordingly, we are

taking action here to ensure the continued maintenance and availability of the Cayuga Facility in order to avoid any adverse impacts that its mothballing may have on system reliability.

Reliability Needs In response to Cayugas notice of intent to mothball its Cayuga Facility, NYSEG performed reliability studies that indicated that the mothballing on January 16, 2013 would result in reliability criteria violations on the local transmission system in the Auburn, New York area. Nothing in the

confidential NYISO analysis suggests that we should not take

14

Case 12-E-0136, Dunkirk Power LLC and NRG Energy, Inc., Order Deciding Reliability Issues and Addressing Cost Allocation and Recovery (issued August 16, 2012)(Dunkirk Retirement Order), p. 14. The Dunkirk Retirement Order also confirmed our jurisdiction over reliability matters, including proposed retirements that may require the use of RSS payments. -15-

CASE 12-E-0400

action based on NYSEG's analysis.

NYSEG plans several system The

reinforcements to address these reliability violations.

first phase of the reinforcements to address the identified reliability needs is scheduled to be completed by the end of 2016. Although we are not prejudging the outcome of any

applications that may come before us for approval, it is extremely important that these facilities be pursued expeditiously in order to minimize the RSS costs imposed on ratepayers. Accordingly, NYSEG shall develop, in coordination

with DPS Staff, a detailed schedule, with major milestones, for the development and deployment of its planned reinforcements. NYSEG shall alert DPS Staff to any issues that may jeopardize the timely achievement of its development milestones. We are

also directing NYSEG to identify any alternatives that may satisfy the identified reliability needs more cost-effectively and efficiently than either continued reliance on the Cayuga Facility or the system reinforcements identified by NYSEG. We agree with Sierra Club that a competitive solicitation process is needed to determine whether any alternative solutions can meet the reliability needs arising from the mothballing of the Cayuga Facility. As part of this

process, NYSEG should also identify whether any market-based solutions exist that would resolve those reliability needs without direct ratepayer support. These procedures should

ensure that ratepayers pay no more than necessary to preserve reliability, and are consistent with our policies supporting reliance on competitive markets. Therefore, we direct NYSEG to

consult with DPS Staff and National Grid, and to file a proposed schedule and process for soliciting alternative regulated and market-based solutions. We expect DPS Staff will work with

NYSEG and National Grid to review any responses to the

-16-

CASE 12-E-0400

solicitation and to report to us on specific projects that may warrant our further consideration.

Term Sheet Agreement In the Dunkirk Retirement Order, it was decided that when reviewing whether the costs incurred under an RSS Term Sheet are just and reasonable, our inquiry begins with an examination of the economic impacts of a temporary shut-down of a generating facility (i.e., mothballing) as an efficient market response to currently unfavorable economic conditions. In such

circumstances, an appropriate level of compensation may include the costs that a generation owner could avoid by mothballing a generation unit. Examples of the types of costs that an owner

may avoid or minimize by mothballing a generating unit include: 1) labor and other operating and maintenance costs; 2)

capital expenditures; 3) taxes or agreements for Payments In Lieu Of Taxes; 4) operating risks (e.g., risks of equipment failures during operation); and, 5) corporate overhead costs. These avoidable costs do not include sunk costs, such as past investments in environmental controls. equity costs are considered sunk costs. Similarly, debt and

While depreciation

costs begin as sunk costs, they reflect expected service life of the plant. By mothballing a unit, the owner can avoid operating

risks and thereby extend the remaining service life of that unit once more favorable economic conditions exist (e.g., higher natural gas prices relative to coal) and the plant can return to profitability. Thus, depreciation costs could be regarded as a

proxy for the operating risks avoidable through mothballing. Taking all these factors into account, we estimate that avoidable costs for procuring the Cayuga Facility under the Term Sheet would be between approximately $20.9 million and $38.3 million, depending on the treatment of Administrative & -17-

CASE 12-E-0400

General (A&G) corporate expenses, capital expenditures, and depreciation. 15 We reviewed the supporting documents and data

provided by Cayuga to evaluate the reasonableness of the Term Sheet, though the accuracy of the information was not verified in all of its detail. Cayugas filing at FERC, which was characterized as a COS rate, provides another means for measuring the reasonableness of the costs incurred under the RSS Term Sheet Agreement. In the COS filing at FERC, Cayuga claimed that the

compensation for continuing both Cayuga units should be set at a rate of approximately $79.6 million. This rate, however,

includes recovery of sunk costs on the same basis as if Cayuga were a regulated supplier. A COS rate, however, yields poor operating incentives because, under that approach, Cayuga would lack the incentive to operate its units efficiently. Moreover, a COS approach is

problematic from the perspective of promoting competitive markets, as it allows a generation owner such as Cayuga to earn market-based returns (potentially in excess of a COS rate) when market conditions are favorable, and to obtain a regulated COS rate, including profits, when market conditions are not favorable. By mothballing its facility instead of retiring it,

Cayuga could return its generation unit to a more lucrative

15

Based on the costs identified by Cayuga in its RMR filing with FERC, the upper bound of the avoidable costs for twelve months ($38.3 million) could be estimated by reducing the fully embedded COS amount ($83.9 million based on Exhibit 1, Schedule 1, RMR cost of $79.6 million plus $4.3 million in capital expenditures) by cost of capital ($23 million, net of working capital) and related income taxes ($22.6 million). The lower bound of the avoidable costs ($20.9 million) could be estimated by further reducing from the upper bound potentially sunk costs associated with depreciation ($11.2 million), A&G ($1.9 million), and capital expenditures ($4.3 million). -18-

CASE 12-E-0400

market-based rate if market conditions improve, as Cayuga hopes they will. By taking this approach, some merchant generation

owners could avoid market risks and shift the risks of higher costs to ratepayers. The Term Sheet Agreement covers a term of twelve months, at a cost of approximately $29 million, plus capital expenditures of up to $4.3 million. The proposed condition in

the Term Sheet, whereby Cayuga would be required to refund a portion of its capital expenditures when revenues are above a certain threshold amount, could further reduce ratepayer costs. The ultimate costs that would be borne under the RSS are less than what Cayuga sought in its COS filing at FERC and are within the range of estimates of avoidable costs. Allowing Cayuga to retain the first $7 million of net energy revenues, and 50% of any such revenues beyond that amount, is reasonable since it creates an incentive for the efficient operation of the facility. Net energy revenues in

excess of $7.0 million annually would be shared evenly between NYSEG and Cayuga. NYSEGs Statement in Support of the Term

Sheet is silent on the treatment of its potential 50% share of the net energy and ancillary services revenues received from Cayuga. Because NYSEGs customers would bear the costs incurred

in procuring RSS from the Cayuga Facility, we find it reasonable to interpret the Term Sheet such that NYSEG would credit any net energy and ancillary services revenues it receives to customers. Accordingly, the Term Sheet is approved contingent upon this interpretation. Under the proposed Term Sheet, all capacity revenues are credited to ratepayers. This is reasonable, as the capacity

revenues will help to reduce the burden on ratepayers of the contract payments. However, because Cayuga will not retain the

capacity revenues, this provision could vitiate Cayugas -19-

CASE 12-E-0400

incentive to offer the Cayuga Facility competitively into the capacity market. Indeed, Cayuga might profit from offering them

at a price so high they would fail to clear the capacity market, effectively withholding that capacity in order to increase the market price of capacity received by its other generating units remaining in the market. The Term Sheet addresses this concern

by committing Cayuga to offer its units into the capacity market at a de minimis price. We reject MIs assertion that the Term Sheet compensation would over-compensate Cayuga if one or both units are unavailable due to a forced outage. MI provides no basis In

supporting its theory that Cayuga would be over-compensated. fact, Cayuga would incur costs under forced outage conditions, which would have been avoided if the Cayuga Facility were mothballed. Therefore, we find the compensation is reasonable

under the circumstances. We find that the Term Sheet Agreement between NYSEG and Cayuga for the provision of RSS on an interim basis would ensure the maintenance of adequate generation resources necessary for safe, adequate, and reliable service. Accordingly, the Term Sheet is approved, subjected to the filing of an executed copy of the contract implementing its terms and conditions.

Cost Recovery As MI and Nucor Steel contend, volumetric recovery of RSS costs through the NBC, as proposed by NYSEG, is inappropriate because it does not sufficiently reflect cost causation principles. Those parties, however, have not

justified their contention that NYSEG should be required to defer recovery of RSS costs until its next electric rate case. Unlike the circumstances considered in the Dunkirk Retirement -20-

CASE 12-E-0400

Order, NYSEG is not currently engaged in a pending rate case and it does not hold significant deferred customer credits. By

delaying cost recovery for up to one year, as would be needed to conduct a rate case, NYSEG would incur significant carrying charges on the RSS costs. These charges could unreasonably Therefore, a new

increase the total costs paid by customers.

rate mechanism should be developed and implemented to ensure cost recovery on a current basis in an equitable manner. We find that the allocation of RSS costs should be done in a manner consistent with other approaches for allocating costs associated with maintaining reliability, such as the costs of necessary transmission upgrades. NYSEG shall file tariff

amendments to effectuate such a recovery mechanism, consistent with its reply comments, as soon as practicable, but no later than March 1, 2013. The RSS costs shall be allocated based on

the respective contribution of each service class to the coincident peak demand according to the transmission plant allocation factors proposed by NYSEG. The class-specific RSS

surcharge rates shall be set on a /kWh basis for non-demand metered classes and on a $/kW basis for demand metered service classes. Any RSS costs incurred prior to the implementation of

the RSS surcharge shall be deferred, and recovered via the RSS surcharge over the remaining billing months of calendar year 2013. We agree with MI that the 2008 data proposed by NYSEG for allocating RSS costs to the various service classifications should be updated periodically, and accordingly direct NYSEG to update the allocations as appropriate (e.g., as part of NYSEGs next electric rate case). We also share MIs concerns that

NYSEGs proposed allocation to standby customers may be inappropriate, and are therefore establishing a process for

-21-

CASE 12-E-0400

receiving comments on the proposed tariff revisions before approving the proposed revisions on a permanent basis. While NYSEG estimates that wholesale customers contribution to RSS costs is approximately 7.0%, there is no readily available mechanism to accomplish recovery from such customers, unlike the circumstances present in the Dunkirk Retirement Order. To the extent that such a mechanism becomes

available in the future, such as a NYSEG filing to amend its transmission revenue requirement at FERC, we expect NYSEG to include in its filing an allocation of RSS costs to wholesale customers. The wholesale customers share of the costs,

expected to be recovered through the FERC Transmission Service Charge, would be credited to retail customers. Turning to National Grids objections against an allocation of the RSS costs to it, we find that NYSEG has not adequately justified that allocation at this time. Based on the

reliability studies presented, NYSEGs customers will realize direct and significant reliability benefits in procuring RSS, while National Grids customers would only experience reliability benefits under multiple contingency scenarios. the on-going reliability studies cited by NYSEG eventually demonstrate that National Grids benefits are more than de minimis, NYSEG should propose an appropriate allocation methodology for our consideration then. If

Procedural Matters and Precedential Value MI misapprehends the nature of the process in this proceeding. The Dunkirk Retirement Order contradicts MIs claim

that it was excluded from settlement negotiations, which must be predicated on a belief that our settlement guidelines are applicable. As decided in that Order, a proposed RSS Term Sheet

is not a settlement of issues pursuant to the settlement -22-

CASE 12-E-0400

guidelines.

Instead, the RSS Term Sheet was a decision made by

NYSEG in furtherance of its responsibilities as a fullyregulated electric retail utility. In so doing, NYSEG proceeded

in accordance with the usual Public Service Law regulatory process, where decisions a regulated utility makes are subject to subsequent review. Therefore, the settlement guidelines are

not applicable in this situation, and arguments to the contrary are rejected. We note, however, that our regulations regarding discovery contained in 16 NYCRR Part 5 provided an opportunity for interested parties to ascertain information relevant to developing their positions, subject to applicable confidentiality restrictions. We are unaware that any parties

availed themselves of this process in this proceeding, but encourage parties to do so in any future proceedings. We will

not adopt MIs suggested alternative process and procedures at this time, given that the existing discovery process has not been demonstrated to be inadequate. Moreover, we note that such

alternative processes and procedures should not be permitted to unnecessarily delay resolution of an imminent adverse reliability impact under a retirement notice process, especially given that an adverse impact may not be identified until well into the six-month notice period. Indicated Transmission Owners request an explicit determination that the decisions reached here will not have a precedential effect on future proceedings. We note that the

facts involved in the review of each notice submitted in compliance with the Retirement Notice Order are unique, and may warrant different treatment on a case-by-case basis.

-23-

CASE 12-E-0400

Other Reliability Studies Finally, with respect to Sierra Clubs request to conduct reliability studies of the other coal plants within the State, we will not formally require such studies at this time. We note that DPS Staff has been working closely with the affected utilities to identify system reinforcements that may be needed to address any reliability impacts attending the retirement of the other coal facilities in the State. To the

extent a more formal process may be needed in the future, we note that we have recently initiated a proceeding to develop Reliability Contingency Plans that anticipate and plan for the potential retirement of significant generation resources in the State. 16

CONCLUSION It is essential that the mothballing of generation units that are subject to a lightened ratemaking regulation regime not jeopardize the reliability of the electric system. We have taken here the necessary steps to ensure that NYSEG continues to prepare transmission reinforcements, while also providing an opportunity for alternative solutions to come forward. The Term Sheet governing NYSEGs procurement of RSS

from Cayuga for the interim period represents a balance of the interests of electric consumers and the generation owner, provides for a level of compensation that is within the zone of reasonableness, and is otherwise just and reasonable and in the public interest. justified. Therefore, approval of the RSS Term Sheet is

16

Case 12-E-0503, Generation Retirement Contingency Plans, Order Instituting Proceeding and Soliciting Indian Point Contingency Plan (issued November 30, 2012). -24-

CASE 12-E-0400

The Commission orders: 1. New York State Electric & Gas Corporation shall

procure Reliability Support Services from Cayuga Operating Company, LLC, and Cayuga Operating Company, LLC shall provide Reliability Support Services to New York State Electric & Gas Corporation, in accordance with the Term Sheet, which is approved, as discussed in the body of this Order. 2. New York State Electric & Gas Corporation and

Cayuga Operating Company, LLC, shall file a final executed copy of the contract implementing the Term Sheet at least five days prior to the commencement of Reliability Support Services. 3. New York State Electric & Gas Corporation shall

consult with Department of Public Service Staff and file, within 30 days of the date of this Order, a schedule and process for soliciting alternative solutions to address the identified reliability needs created by the mothballing of the Cayuga Facility. 4. New York State Electric & Gas Corporation is

directed to file tariff revisions, to become effective March 1, 2013, on not than 30 days notice, as are necessary to effectuate the provisions adopted by this order. New York State Electric &

Gas Corporation shall serve copies of the filing on all parties to this case. Any comments on the filing must be filed within The revisions

14 days of service of the proposed revisions.

specified in the filing shall not become effective on a permanent basis until approved by the Commission. 5. The requirements of Section 66(12)(b) of the

Public Service Law as to newspaper publication of the tariff amendments described in Ordering Clause No. 4 are waived. 6. New York State Electric & Gas Corporation shall

coordinate with Department of Public Service Staff in developing a detailed schedule for pursuing, on an expedited basis, the -25-

CASE 12-E-0400

needed system reinforcements to address the reliability needs attending the mothballing of the Cayuga Facility, and shall file such schedule, with major milestones, within 30 days of the date of this Order. 7. The Secretary may extend the deadlines provided

for in this Order. 8. This proceeding is continued. By the Commission,

(SIGNED)

JEFFREY C. COHEN Acting Secretary

-26-