Inefficiency of Avoided Cost Pricing of Cogenerated Power

Section 210 of the Public Utility Regulatory Act of 1978 requires that the rates paid to qualifying small power production facilities (QFs) should be "just and reasonable" and "shall not discriminate against qualifying cogenerators." However, the rates should not "exceed the incremental cost to the electric utility of the alternative electric energy." Armed with this federal regulation, the California Public Utilities Commission (CPUC) in July 1985 issued Decision No. 85-07-022 for the Phase I of the Order-Instituting-Rulemaking No. 2 (OIR-2) arguing that privately owned electric utilities should pay QF's the cost of owning and operating a power plant that can be displaced by QF production. The total avoided cost is the difference between total cost of utility generation before QF production and after QF production (see Appendix 1 of the CPUC decision).