Arguments Against: Staff for the California Public Utilities Commission has expressed concern that forcing power from larger plants onto utilities could interfere with a utility's ability to do both long-term and short-term resource planning. What will a utility do with its excess power when a 165 megawatt plant comes on line and who will pay for it?

FUA is another statute in the National Energy Act of 1978 governing cogeneration. The major purpose of FUA is to prohibit the burning of oil or gas in powerplants and in industrial plants, which are referred to under the law as Major Fuel Burning Installations (MFBI's).

Under Section 212 of FUA, cogenerators may petition the Economic Regulatory Administration of DOE for a permanent exemption from the oil and gas-burning ban. ERA may grant the exemption if it finds that "the petitioner has demonstrated that economic or other benefits of cogeneration are unobtainable unless petroleum or natural gas, or both, are used in such facility." ERA may also grant an exemption to a cogenerator if it finds that it is in the public interest, such as maintaining jobs at an industrial facility. ERA has interpreted the statutory phrase "economic and other benefits of cogeneration" to mean that oil/gas savings will be achieved by the petitioner without deterring the development of alternate fuel-fired capacity.

In the two years since ERA published its interim regulations for cogenerators, only one cogenerator has applied for and received an exemption. According to both ERA and cogenerators, the lack of activity in this area is the fault of ERA's extremely complicated and burdensome regulations, not lack of interest on the part of cogenerators.

In a Federal Register notice of August 11, 1980, ERA attempted to streamline its interim rules issued the previous year. The new rules are still in proposed form. Until the new rules are issued in final form, the older interim rules, which were the object of much criticism, remain in effect. ERA is currently awaiting direction from the Secretary of Energy on whether to go ahead with the rules, issued under the Carter Administration.

Interim Rules: ERA issued interim rules relating to cogeneration exemptions on May 17 and July 23, 1979. Under the interim rule, in order to qualify for an exemption, the cogeneration petitioner must demonstrate that the oil and gas to be consumed by the cogeneration facility would be less than that which would otherwise be consumed in the absence of the facility.

The interim rules also defined most cogenerators in such a way as to prevent them from qualifying for an exemption. Under FUA, a unit that sells more than 50 percent of its energy offsite is defined as a powerplant and is thus automatically subject to FUA's ban on oil and gas use. Since PURPA encourages cogenerators to sell all of the power they generate to a utility, most cogenerators following that course would automatically be classified as powerplants under the FUA definition.

Proposed Rules: On August 11, ERA issued new proposed rules proposing to redefine most cogenerators in a way that would eliminate the need for them to petition ERA for exemptions. The rules redefine most cogenerators as MFBI's instead of as powerplants.

The new rules say that a cogenerator is not a powerplant as long as the net electrical power sold amounts to less than half of the facility's electricity generation. Net electrical sales are the power sold by the cogenerator minus the power it has purchased from the utility for its own needs. In its proposal, ERA cautions, however, that it "has reservations about whether this definition is permitted under FUA." For this reason, the State of California, one of FUA's major critics, has urged that the statute be changed to avoid a possible court challenge of the revised regulations.

The three major types of cogenerators dependent on oil and gas fuels — diesels, combined cycle and gas turbines -- would be exempted from having to petition for exemptions. All three types of systems would be reclassified as MFBI's, but since they are not covered under the FUA prohibitions covering MFBI's, they would in essence be automatically exempted.

According to ERA staff, conventional steam turbine cogenerators, which are capable of burning coal, would also be included under the agency's definition of combined cycle units.

In response to comments criticizing ERA's original requirement that each cogenerator provide proof of oil and gas savings over ten years, ERA proposed an alternative state-by-state approach. Under this approach, states with significant amounts of oil- and gas-fired electricity generation would be given a quota of permissible oil- and gas-fired cogeneration. Each state would then decide which cogenerators could be eligible under the quota. In light of the other changes in the rules essentially exempting most industrial cogenerators, ERA staff says that only utility cogenerators would be subject to the requirement to prove net oil and gas savings either on an individual or state-by-state basis.

Proposed Changes to the Fuel Use Act

H.R. 2992 would amend PURPA to provide automatic exemptions from FUA for "qualifying cogenerators" as defined under PURPA.

H.R. 2992 would also exclude certain mechanical cogeneration facilities from the oil and gas ban applying to MFBI's under FUA. Many industries, such as the chemical industry, use their waste heat to produce shaft power instead of electricity. They argue that they can only qualify for a cogeneration exemption if they attach an electric generator to their mechanical cogenerator, thus making less efficient use of the energy.

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Mr. OTTINGER. I understand that Congressman Heftel has been detained. We have a very large group of witnesses today. We have four panels, consisting of three or four, in some cases five, witnesses each. What I propose to do is to allow more or less an hour to each panel, which will take us close to 6 o'clock as it is.

If the first panel would come up. It consists of Mr. Ralph Mitchell III, vice president, conservation and renewable resources, Arkansas Power & Light Co.; Mr. William Nicholson, corporate energy coordinator, Potlatch Corp.; and Mr. Philip M. Huyck, vicepresident, project finance, The First Boston Corp.

I believe our former colleague, Congressman Wilbur Mills, is also here. We are happy to welcome you before this subcommittee, if you would like to introduce Mr. Mitchell. Let me say I have had a chance to meet with Mr. Mitchell, and follow the very progressive efforts of Arkansas Power & Light. And I am very interested in the pioneering work they have been doing, and many of the studies that have been emanating from your company. You could not be better represented than by my former colleague, Wilbur Mills. We are delighted to have you, and have you introduce Mr. Mitchell. Then what I would like to do is to get into a discussion of the issues, rather than have formal statements, because we do have a lot of ground to cover.

STATEMENT OF HON. WILBUR MILLS, A FORMER REPRESENTATIVE IN CONGRESS FROM THE STATE OF ARKANSAS

Mr. MILLS. Thank you, Mr. Chairman. It is a real pleasure to be here today, and especially to see you again and members of the committee. I wanted to take just a minute to congratulate you on the interest that you and the members of the committee are showing in this very important matter. I asked permission to present Mr. Mitchell to you because I have known Mr. Mitchell for a long time, and he has been a personal friend of mine, vice-president of the Arkansas Power & Light Co. in Arkansas, but today he is appearing in behalf of the Edison Electric Institute as well as the Arkansas Power & Light Co. And I am sure that he can make a major contribution to the thinking of the committee in this area. Mr. OTTINGER. I hope his testimony in both capacities coincides. Mr. MITCHELL. I can assure you it does, Mr. Chairman.

Mr. OTTINGER. All right. Why do not each of you just take a very few minutes to tell me where you are at, in your case, Mr. Mitchell, what your company is doing and perhaps what the position of the Edison Electric Institute is with respect to these efforts.

STATEMENTS OF RALPH C. MITCHELL III, VICE PRESIDENT, CONSERVATION AND RENEWABLE RESOURCES, ARKANSAS POWER & LIGHT CO., ON BEHALF OF THE EDISON ELECTRIC INSTITUTE; WILLIAM J. NICHOLSON, CORPORATE ENERGY COORDINATOR, POTLATCH CORP., ON BEHALF OF THE AMERICAN PAPER INSTITUTE; AND PHILIP M. HUYCK, VICE PRESIDENT, FIRST BOSTON CORP.

Mr. MITCHELL. Thank you, Mr. Chairman.

I would say that the position of EEI and Arkansas Power & Light are the same. And I think maybe it might be most helpful if I recap the Arkansas experience quickly.

We have assessed about 1,500 industrial boilers in the State of Arkansas as to their potential for cogeneration. We have located about 33 of those who are high-volume, relatively high-load-factor steam users.

Now, the conclusion that we have reached in interviewing these 33 large steam users is essentially that, while they recognize the fueluse-efficiency benefits of cogeneration, and while they also recognize the incentives provided by the Congress, they are unlikely to make the major capital investments required, for one or more of three

reasons.

First, we find that they have finite capital resources, just as anybody else does, and that they will have difficulty raising the capital required to finance major cogeneration efforts. In fact, when they compare cogeneration investments against their criteria for major new capital investments, they generally find that it will not meet the rate of return required.

Second, we find most of those industries lack the managerial, technical, operating, and environmental expertise to run fuel-burning installations for generation, and particularly solid-fuel-burning facilities. And third, they are concerned about the environmental consequences, because they have finite air and water quality available to them that they would much prefer to reserve for production capacity, rather than for cogeneration or another new energy source. So with that finding, we developed our concept, which involved combined cycle cogeneration plants that would deliver the steam requirement to industry. But for that we needed a clean fuel. So we have three studies under way now investigating gasifying a solid fuel, in one case petroleum coke, in another, Illinois coal, and in still another, Arkansas lignite, to produce a synthetic gas to fire combined-cycle cogeneration plants.

Now, I believe that that kind of concept has the potential of providing all of the advantages of cogeneration in our region, while removing those three constraints to industrial investment. So my first point is that I believe that more cogeneration will happen even more quickly with electric utility involvement. But I also see another benefit from electric utility involvement in cogeneration to society as well. And that is that I think utilities will bring a systems approach to the development of cogeneration that will include a better integration of the centralized and decentralized technologies and will optimize electric production. We find that generally the industries looking at cogeneration will naturally size the plant to their steam requirement with incidential electric production from a simple cycle cogeneration plant. But with a combined cycle plant, we would optimize the electric output from the same fuel source. Also I think you would find the utilities would optimize the reliability of the system to the electric system's grid.

And finally, environmentally, I think there is sound support for utility involvement in that the utilities will look at a systems approach rather than multiple dispersed, particularly solid-fuelburning installations. But the problem is we have to be competitive. And that is competitive with industry or third parties developing their own cogeneration. By competitive, I mean we have to have the same price available on the steam output. Now to do that,

it means we would have to have the same price on the electrical output which PURPA provides as a just and reasonable rate from the utility's system for avoided cost. We would also need an equivalent rate of return on the venture in order to be able to compete for capital in the capital markets and to provide our investors with a higher rate of return commensurate with a higher risk on cogeneration. And finally, we are asking for equivalent tax treatments as those provided to other investors in cogeneration.

Now, to be absolutely candid, why are utilities interested at all in cogeneration? I would say primarily it is to retain our industrial market. We do not want to look at a shrinking market over time. We see a potential of satisfying that market competitively, given the same incentives provided other organizations.

Finally, we see an opportunity to diversify into steam sales and byproducts of gasification to provide some new revenue streams to our electric utility business and a potentially, and I emphasize "potentially," higher rate of return. I think these are valid and compelling reasons for providing an equal competitive ownership opportunity for utilities. It does mean deregulation of one element of an electric utility's business. But I submit the only reason for regulation is to substitute for competition in a franchise monopoly market, and certainly Congress has provided ample competition in cogeneration to assure that a competitive environment does exist, and therefore precludes any need for regulation.

Now, on two other issues, I want to briefly mention EEI has developed some principles we support. One is that we recognize the need for an incentive provided for industrial development of cogeneration, and have been unable to determine a better one than the avoided-cost concept. However, we strongly believe that the ratepayer should have some benefit as well. And we have arbitrarily selected a figure of 90 percent of full avoided costs that we would recommend be the maximum payment in order that all of us may state to the public, the ratepaying public, that they will benefit too from the development of cogeneration. And finally, we do not support any exemption from the Fuel Use Act consequences for cogeneration unless a demonstrated net savings of oil and gas in the region can be demonstrated.

Thank you very much.

[Testimony resumes on p. 53.]

[Mr. Mitchell's prepared statement follows:]