[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]



 
   CALIFORNIA INDEPENDENT SYSTEM OPERATOR: GOVERNANCE AND DESIGN OF 
                    CALIFORNIA'S ELECTRICITY MARKET
=======================================================================

                                HEARING

                               before the

                 SUBCOMMITTEE ON ENERGY POLICY, NATURAL
                    RESOURCES AND REGULATORY AFFAIRS

                                 of the

                              COMMITTEE ON
                           GOVERNMENT REFORM

                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                           FEBRUARY 22, 2002

                               __________

                           Serial No. 107-133

                               __________

       Printed for the use of the Committee on Government Reform


  Available via the World Wide Web: http://www.gpo.gov/congress/house
                      http://www.house.gov/reform





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                     COMMITTEE ON GOVERNMENT REFORM

                     DAN BURTON, Indiana, Chairman
BENJAMIN A. GILMAN, New York         HENRY A. WAXMAN, California
CONSTANCE A. MORELLA, Maryland       TOM LANTOS, California
CHRISTOPHER SHAYS, Connecticut       MAJOR R. OWENS, New York
ILEANA ROS-LEHTINEN, Florida         EDOLPHUS TOWNS, New York
JOHN M. McHUGH, New York             PAUL E. KANJORSKI, Pennsylvania
STEPHEN HORN, California             PATSY T. MINK, Hawaii
JOHN L. MICA, Florida                CAROLYN B. MALONEY, New York
THOMAS M. DAVIS, Virginia            ELEANOR HOLMES NORTON, Washington, 
MARK E. SOUDER, Indiana                  DC
STEVEN C. LaTOURETTE, Ohio           ELIJAH E. CUMMINGS, Maryland
BOB BARR, Georgia                    DENNIS J. KUCINICH, Ohio
DAN MILLER, Florida                  ROD R. BLAGOJEVICH, Illinois
DOUG OSE, California                 DANNY K. DAVIS, Illinois
RON LEWIS, Kentucky                  JOHN F. TIERNEY, Massachusetts
JO ANN DAVIS, Virginia               JIM TURNER, Texas
TODD RUSSELL PLATTS, Pennsylvania    THOMAS H. ALLEN, Maine
DAVE WELDON, Florida                 JANICE D. SCHAKOWSKY, Illinois
CHRIS CANNON, Utah                   WM. LACY CLAY, Missouri
ADAM H. PUTNAM, Florida              DIANE E. WATSON, California
C.L. ``BUTCH'' OTTER, Idaho          STEPHEN F. LYNCH, Massachusetts
EDWARD L. SCHROCK, Virginia                      ------
JOHN J. DUNCAN, Jr., Tennessee       BERNARD SANDERS, Vermont 
------ ------                            (Independent)


                      Kevin Binger, Staff Director
                 Daniel R. Moll, Deputy Staff Director
                     James C. Wilson, Chief Counsel
                     Robert A. Briggs, Chief Clerk
                 Phil Schiliro, Minority Staff Director

Subcommittee on Energy Policy, Natural Resources and Regulatory Affairs

                     DOUG OSE, California, Chairman
C.L. ``BUTCH'' OTTER, Idaho          JOHN F. TIERNEY, Massachusetts
CHRISTOPHER SHAYS, Connecticut       TOM LANTOS, California
JOHN M. McHUGH, New York             EDOLPHUS TOWNS, New York
STEVEN C. LaTOURETTE, Ohio           PATSY T. MINK, Hawaii
CHRIS CANNON, Utah                   DENNIS J. KUCINICH, Ohio
JOHN J. DUNCAN, Jr., Tennessee       ROD R. BLAGOJEVICH, Illinois
------ ------

                               Ex Officio

DAN BURTON, Indiana                  HENRY A. WAXMAN, California
                       Dan Skopec, Staff Director
                         Allison Freeman, Clerk






                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on February 22, 2002................................     1
Statement of:
    Wood, Patrick, III, chairman, Federal Energy Regulatory 
      Commission; Terry Winter, president and chief executive 
      officer, California Independent Systems Operator; Richard 
      A. Drom, vice president, general counsel, PJM 
      Interconnection, L.L.C.; James C. Feider, president, 
      California Municipal Utilities Association; Jan Smutny-
      Jones, executive director, Independent Energy Producers; 
      and Walter P. Drabinski, president, Vantage Consulting, 
      Inc........................................................    28
    Wright, Roderick D., chairman, California State Assembly 
      Committee on Utilities & Commerce; and Anthony Pescetti, 
      vice chairman, California State Assembly Committee on 
      Utilities & Commerce.......................................     6
Letters, statements, etc., submitted for the record by:
    Drabinski, Walter P., president, Vantage Consulting, Inc., 
      prepared statement of......................................   132
    Drom, Richard A., vice president, general counsel, PJM 
      Interconnection, L.L.C., prepared statement of.............    98
    Feider, James C., president, California Municipal Utilities 
      Association, prepared statement of.........................   110
    Ose, Hon. Doug, a Representative in Congress from the State 
      of California:
        Chart on ISO and RTO Independence Traits.................   159
        Prepared statement of....................................     4
    Pescetti, Anthony, vice chairman, California State Assembly 
      Committee on Utilities & Commerce, prepared statement of...    14
    Smutny-Jones, Jan, executive director, Independent Energy 
      Producers, prepared statement of...........................   119
    Winter, Terry, president and chief executive officer, 
      California Independent Systems Operator, prepared statement 
      of.........................................................    47
    Wood, Patrick, III, chairman, Federal Energy Regulatory 
      Commission, prepared statement of..........................    30


   CALIFORNIA INDEPENDENT SYSTEM OPERATOR: GOVERNANCE AND DESIGN OF 
                    CALIFORNIA'S ELECTRICITY MARKET

                              ----------                              


                       FRIDAY, FEBRUARY 22, 2002

                  House of Representatives,
  Subcommittee on Energy Policy, Natural Resources 
                            and Regulatory Affairs,
                            Committee on Government Reform,
                                                    Sacramento, CA.
    The subcommittee met, pursuant to notice, at 9 a.m., in 
room 1450, Sacramento Board of Supervisors, 700 H Street, 
Sacramento, CA, Hon. Doug Ose (chairman of the subcommittee) 
presiding.
    Present: Representative Ose.
    Staff present: Dan Skopec, staff director; Yier Shi, press 
secretary; and Allison Freeman, clerk.
    Mr. Ose. Good morning, everybody. I want to welcome you to 
this hearing before the House Committee on Government Reform, 
Subcommittee on Energy Policy, Natural Resources and Regulatory 
Affairs. I apologize for starting 4 minutes late.
    The way these things work is, we'll have some opening 
statements and we'll get to questions, we'll welcome our 
witnesses before the questions and their statements. Everybody 
in these hearings gets sworn in under the Government Reform 
Committee's normal policies, so if we don't swear you in, 
remind us, we'll swear you in.
    Californians are well aware that in 2000 and 2001 our State 
experienced an energy crisis that impacted every citizen in the 
State. Some Californians experienced blackouts. Others were 
asked to curtail energy use at key moments. All Californians 
saw huge increases in their natural gas and electricity bills. 
However, through the help of the FERC, the Federal Energy 
Regulatory Commission, through its adoption of a market 
mitigation plan, with the advantage of a cool summer, as well 
as normal precipitation in the West, particularly in the 
Pacific Northwest, and with conservation efforts by individual 
Californians, energy prices have now dropped back to expected 
levels and are far more affordable.
    The energy crisis seems to have disappeared as quickly as 
it emerged. Given the empirical data, many people could come to 
that conclusion easily, and I can understand that. The fact of 
the matter is, energy prices are low and the lights are on. 
That's pretty good. Why are we having this hearing? What's the 
problem?
    The reality is that California is not out of the woods yet. 
Today's witnesses will tell you that the fundamental factors 
that exacerbated the energy crisis are still with us today. 
California lacks an adequate energy supply. Our transmission 
system is old and overburdened, and, most importantly, the 
structure of the electricity market is dysfunctional. The 
market suffers from inefficiencies in terms of pricing, 
transparency, transmission, and settlement policies.
    California must take action now to address these problems. 
If we don't, once the economy revives or we experience a hot 
summer or suffer another drought, we'll be confronting 
potential blackouts and prices will escalate again. Frankly, 
for a State facing significant budget deficits, we can ill 
afford another energy calamity.
    At today's hearing, we will discuss the steps that 
California needs to take to reform its electricity markets and 
ensure the public that their lights will stay on and their 
businesses will keep running.
    First and foremost in this endeavor is restoring 
independence to the California Independent System Operator. On 
January 17, 2001, the Governor dissolved the original Board of 
Governors of the CAISO and hand picked a new board answerable 
only to him. In doing so, Governor Davis violated FERC's orders 
of November 1 and December 15, 2000, which called for the 
establishment of a new board of Governors. The Davis-appointed 
board also violated FERC's groundbreaking Order 2000, which 
clearly states that Independent System Operators must be 
independent of all market participants. As the largest 
purchaser of electricity, the State of California certainly 
qualifies as a market participant.
    In previous hearings before this subcommittee, we heard 
testimony from FERC's former General Counsel claiming that 
independence of the board was a ``linchpin'' of a properly 
functioning electricity market. Phillip Harris, the president 
and chief executive officer of the Pennsylvania, New Jersey, 
Maryland Interconnection, known as PJM, called independence of 
an ISO ``absolutely crucial.'' In that hearing and in 
subsequent letters to FERC, I strongly criticized the makeup of 
the Governor's board. I continue to strongly criticize the 
makeup of the Governor's board, and I've called on FERC to do 
an operational audit of the CAISO to assess the lack of 
independence of the board.
    On October 9, 2001, FERC commissioned an operational audit 
of the CAISO. The audit was completed by Vantage Consulting, 
Inc., and released to the public a couple weeks ago on January 
25th. The audit stated that the board was not independent. 
Furthermore, it went on to say that the lack of independence 
was the ``root cause of many other communication, culture and 
trust problems.''
    Lack of independence meant that in order to accommodate the 
Governors' long-term contracts, the CAISO requested generators 
with less expensive power to reduce their output. Lack of 
independence led to a breakdown in the relationship between the 
CAISO and market participants. The result is that the CAISO 
often had to make last-minute energy purchases from expensive 
out-of-state suppliers rather than from in-state sources. And 
finally, lack of independence continues to hinder important 
market reforms.
    The president of Vantage Consulting is with us today to 
talk about how the lack of independence has damaged 
California's electricity market and cost consumers millions of 
dollars. It is clear to me that independence must be restored 
to the CAISO board before we can solve the many other energy-
related problems that face the State of California.
    The other purpose of today's hearing is to begin a public 
discussion about what types of reforms are needed in 
California's electricity market. This is very timely for a 
number of reasons. At FERC, the Commission is grappling with 
how to create a standardized market design. The CAISO is also 
in the midst of contemplating market reforms. On January 8th of 
this year the CAISO introduced a draft Market Design 2002 
proposal. I look forward to the testimonies of the FERC 
chairman, Mr. Patrick Wood, and CAISO president and CEO, Terry 
Winter, on this particular subject. I am sure that they will 
agree with me that getting the market design correct is the 
only way to provide incentives for new energy supplies and 
prevent the high prices, or a repeat of the high prices, we 
experienced in California in the immediate past.
    I want to be clear that today's hearing is about the future 
of California's electricity markets. While I have been critical 
in the past of many actions taken by the Governor, I am here 
today to look for productive solutions. I do not want to go 
through what we went through in the past couple years again. I 
recognize that many people want to continue to play this blame 
game in order to avoid taking responsibility for their actions. 
The fact of the matter is, California is a team, Republicans 
and Democrats, Governors, legislators, Members of Congress, 
Senators, the FERC people, we are a team. We have to solve this 
problem.
    I look forward to the testimony of the witnesses today.
    [The prepared statement of Hon. Doug Ose follows:]
    [GRAPHIC] [TIFF OMITTED] 82667.001
    
    [GRAPHIC] [TIFF OMITTED] 82667.002
    
    Mr. Ose. We are going to start with two good friends, Rod 
Wright and Anthony Pescetti, members of the legislature, the 
chairman and the State legislature's vice chairman of a very 
important committee having to do with energy. As I said, we 
swear in our witnesses just as a matter of course here. I 
should say that we usually swear in non-elected official 
witnesses, so we are not going to swear the two of you in.
    Anyway, I do want to welcome our witnesses today. We have 
with us Rod Wright, assuming I'm right, Mr. Chairman, you are 
the chairman of the----
    Mr. Wright. Utilities and Commerce, and Energy Cost and 
Availability of Utilities.
    Mr. Ose. At the State legislature and assembly.
    Mr. Wright. Yes, and the subsequent, the second committee I 
mentioned is actually an extraordinary session committee, and 
when we get out of the extraordinary session that committee 
will go away.
    Mr. Ose. All right. We need to fix the mic down here.
    Mr. Pescetti, you serve as the vice chairman of the?
    Mr. Pescetti. I'm the Vice Chairman of the same two 
committees that Mr. Wright just mentioned.
    Mr. Ose. OK.
    Well, let me flip the coin up here, and we've determined 
that Mr. Wright is going to go first. So, we welcome you to our 
committee today.

 STATEMENTS OF RODERICK D. WRIGHT, CHAIRMAN, CALIFORNIA STATE 
    ASSEMBLY COMMITTEE ON UTILITIES & COMMERCE; AND ANTHONY 
PESCETTI, VICE CHAIRMAN, CALIFORNIA STATE ASSEMBLY COMMITTEE ON 
                      UTILITIES & COMMERCE

    Mr. Wright. OK, and let me apologize, Mr. Chair, I actually 
got the notice late and got back in town early this morning, 
but I think there are a couple of things I'd like to state.
    Things are never as simple as folks might have them. You 
know, for the person, for example, who argued about the 
independence of the committee, the previous FERC was somewhat 
independent of the Governor and that didn't work well either. 
If it was as simple as saying who appointed the board members 
then we'd probably be talking about something else right now 
anyway.
    It was that board that made the idiotic decision to have a 
market order where they purchase power in real time and 
undermined the PX. So, it clearly isn't simply a function of 
saying, you know, how the board is independent.
    It was clear we needed to get rid of the old one because 
that stakeholder board had interest in terms of how power was 
purchased, and you had the potential for conflict of interests 
between those persons who were scheduling the load on the 
system and those people who were selling load into the system. 
And, the reality is, well, they said, I don't know that you are 
ever going to have anything that's completely independent 
because everybody is related in some way.
    I can appreciate the gentleman from PJM discussing what 
they do, but California and PJM are so different in terms of 
the physical composition of the distribution system that their 
system and ours are almost not analogous. We have, for example, 
almost 35-40 percent of the wires in California that belong to 
municipal utilities, the Department of Water and Power, SMUD 
and other munis, by Federal law, not FERC law, but by the IRS. 
You can't take their wires and merge them, which created a huge 
problem because some of the congestion that was described is 
actually a function of not being able--for a single ISO to be 
able to coordinate those wires.
    Other folk in the West also have municipal utilities where 
those wires can't be blended, which is a problem that's going 
to have to be resolved, probably at a Federal level as well.
    I think one of the other things that happens, and if you 
asked me, what was the principal contributor to the price 
spikes in California wasn't the independence or lack thereof of 
the ISO. That would actually go way down on the list. What I 
think was the principal contributor was the fact that we 
entered a restructured market, and we entered that market by 
selling off a substantial portion of the retained generation 
assets of the utilities, and we did that without purchase power 
contracts for the power that was sold. Then we neglected to get 
contracts on the power plants or contracts to cover that power. 
You could call it hedging, whatever you might call it, but the 
lack of those two things probably precipitated where we were 
because it put us into a position where we were buying too much 
of the net short position on a daily basis, which is no way to 
play.
    In the PJM, for example, they sometimes have power that 
goes to $1,500 or $1,600 a megawatt hour, but it's only for 1 
or 2 percent of the load so it doesn't cause the severe rate 
spike that we got. We were buying in the net short position 
somewhere in excess of 40 percent of the load. That's way too 
great an amount to buy on a daily basis. That, I think, 
contributed more than anything else.
    One of the other things that I thought in the preparation 
of what I was able to do for this hearing is that we have some 
internal conflicts to resolve in California. I agree with what 
little part I read of your auditor's report relative to the 
relationship between the ISO and the PUC. If the PUC is going 
to regulate the rate, for example, it would be very difficult 
for them to also be involved in determining who gets to 
participate over the grid schedule. That, to me, I think would 
result in something of a conflict, and I think that issue would 
need to be resolved.
    Going further, and I'm not sure what our time sequence is, 
but going further, one of the things that I think is going to 
need to be resolved, relative to the ISO, is if we're going to 
enter into an RTO format that would be a multi-state RTO as has 
been proposed by FERC, then I think that whether or not we have 
Governor's appointees on the ISO becomes irrelevant, because 
ultimately, that body would be dissolved anyway, and it won't 
matter who is on it. So, before we spend a lot of effort 
determining what the ISO composition ought to be, we are going 
to have to make the decision as to whether or not we are going 
to go to an RTO and eliminate it anyway.
    I think, certainly, one of the considerations that you'd 
have to have as a Federal official--I'm a State official and I 
can be California first--you also are a Federal official, but 
you represent California. The issues, I think, that are of 
concern are that the ISO has some relationship to what happens 
to electricity in Nevada, and Arizona, and Washington, and 
other parts, we exchange power between all of those regions now 
in the Western Power Trading Forum, and the thing about the 
independence is not so much in terms of the market participants 
inside of California. The issue would be making sure, and this 
would be FERC's job, that Nevada is not disadvantaged because 
of the ISO situation in California, or Arizona, or Idaho, or 
any of the other States that participate in receiving power 
from that Western grid.
    I think the argument that FERC made a long time ago, the 
fact that the California ISO actually serves to sell and import 
power from outside the State, means that there's got to be some 
level of Federal cooperation.
    With respect to the Governor's contracts, and the Governor 
certainly doesn't need me to defend him, I would disagree with 
your premise about the ISO board having to acknowledge the 
contracts. What I mention about the contracts is, you have to 
take the contracts from the point where you were. What the 
contracts have done, is the contracts have assured that there's 
going to be power generated, and with the help of your motion, 
and that of Chairman Wood, that means that the generators are 
running and that mitigation worked. And I agree with you 
relative to the weather and the other things that were 
cooperating to make that work.
    But, I can assure you that those contracts also serve to 
provide stability in the market. If, for example, you look at 
what has happened in the financial markets post-Enron, people 
who don't have contracts ain't going to build no power plants, 
and I say ``ain't'' on purpose, even though I do come from 
south central Los Angeles, and I'm just a poor kid from the 
'hood, but, even though people may criticize the contracts 
today, Mr. Chair, whether it be the CalPine contract, or the 
Sempra contract, or the other contract, none of the power 
plants were currently on queue, that are not funded in the 
California Energy Commission program, are going to get built, 
because most of those plants were being built on spec. 
Financial markets changed dramatically post-Enron, and there 
will be no more spec-built plants. So, if your plant doesn't 
have a purchase power contract going in, power plants are going 
to function pretty much like building a mall. If you ain't got 
no anchor tenant you ain't building the mall. It is going to 
pretty much function like that for power plants. If you don't 
have a purchase power contract that assures that there's going 
to be a return of investment, for both operating and a 
reasonable return, people simply won't build the plant.
    I would close, and I don't know the time, Mr. Chair, and 
I've got a little time I can stay. Going forward, one of the 
things that I think that's going to happen is that we are going 
to have to separate the two issues of price and supply. The 
reason that becomes important is that the solutions to the two 
problems are achieved on different roads.
    If you believe that the problem is supply, then what you 
are going to have to do is encourage the development of new 
supply, and in order to do that, you are going to probably have 
to pay more. If your concern is that you are paying too much, 
then you can do price caps, but you have to understand that 
when you cap the price, you inhibit the development of new 
supply.
    The California Generation Asset Base is almost like driving 
around in 1962 Oldsmobiles; it's 30 some odd years old, and 
those Oldsmobiles, unless you go to Cuba where they still drive 
those old General Motors cars, they are not going to continue 
to hold up, and you are going to end up with significant 
reliability problems trying to keep those old units running.
    So, I think as I look at where we are, I'm afraid that 
there's a potential supply problem relative to the constriction 
of capital for building new plants. I think that we are going 
to end up with contracts that could very well provide for the 
fact that the power might cost more than the spot market. But, 
I think what people confuse in that, Mr. Chair, and I'll hush 
and let my Vice Chair talk, what people confuse about the spot 
market price, and the contracted price, is something like 
insurance. When you buy insurance you pay a premium, and if you 
don't have a loss, some can argue that the money you pay for a 
premium was wasted investment, because you didn't get a loss 
and you paid money, and you didn't get anything. But, you did. 
What you paid for was risk avoidance. The contracts that you 
have are going to be slightly more, because what you are buying 
is certainty. The equation that we're going to have to look at 
in California is a difficult equation of how much risk are we 
prepared to absorb, and how much certainty are we prepared to 
pay for. The more risk you absorb the cheaper the price, but 
the more risk you absorb if the market turns, then you get 
burned.
    Again, we started off this energy deregulation 
restructuring program at 100 percent net short. If you go to 
Vegas and you sit at the table, I assure you that if you play 
long enough, you are going to lose, because the people who 
build casinos are not in the gambling business. They play 
percentages.
    We have to determine what is an adequate percentage for us 
to play. So back to the ISO issue, if you play the percentages 
right I think that our position in the spot market today should 
be somewhere in the neighborhood of 6 percent, 5 percent. If 
the margin of spot market purchase drops to that level, you 
could stand market fluctuation in prices and it won't matter, 
because in order to get to that level of spot market 
participation all the other generating facilities will be 
running.
    What confuses people when they look at the spot market 
price today, is that it's irrelevant, because most of the power 
has already been bought. So what you are talking about is a 
spot market price, and comparing that to the bogey of the 
contract, means that you are looking at people who have already 
bought. Much of the power that's in the spot market today isn't 
going to be purchased, because the customers, who are the major 
buyers, have already bought. You are talking about the residual 
power that's left over from power plants that no one needs to 
get.
    So, I think before we say, whoa, we are buying over market, 
no you are not. If you want to find out if you are buying over 
market, take all the Governor's contracts, dump them back into 
market. Then what you'll see is that the spot price will go 
back up substantially above the current market price, because 
suddenly you have people competing for what power is left.
    I could give you a whole bunch more stuff. You don't want 
it at this juncture, but suffice it to say again that we are 
going to have to determine if we are going to go RTO or ISO. If 
we are going RTO, the ISO really is irrelevant, and we are just 
talking interim, and is it worth going through all the effort 
to figure that out.
    We are going to have a supply problem in the near future, 
because there won't be enough capital to finance that. Mirant 
is not going to be able to build some of the plants that they 
talked about. CalPine is having difficulty getting money to 
build some of their stuff. If you void the contracts you'll 
bankrupt CalPine, and you'll bankrupt Sempra, and you'll lose 
that power as well.
    It is not as simple as saying that you rescramble it. Even 
if you take our Southern California Edison, and PG&E, who are 
currently insolvent, and PG&E is in bankruptcy, and Edison is 
insolvent even though they had a settlement. Moody's announced 
last week that they ain't going to return credit worthiness to 
them until they are assured that the ratemaking process will 
prevent what happened to them before from happening again.
    So, in this paradigm where we play, it's clear to me that 
once upon a time, as policymakers, we could make all of the 
decisions. Now, Moody's, Standard & Poors, Smith, Barney, 
Solomon Brothers, and all of the other people who provide 
capital are going to participate in the decision as well, so we 
have to make sure that the decisions we make recognizes how we 
deal with capital into the market.
    Thank you, Mr. Chair.
    Mr. Ose. Thank you, Mr. Wright.
    I wish we'd had you at our hearing last April, because 
these were the points we were trying to make. Thank you for 
coming this morning.
    Mr. Pescetti.
    Mr. Pescetti. Thank you, Mr. Chair, good morning, and 
thanks for the opportunity to address you about the future of 
the California ISO.
    Before I talk about the ISO, I want to make some brief 
comments about some of the broader issues facing the energy 
market in California, because the shape of the ISO will be 
determined by broader decisions we make about our energy 
future. There is a great deal of nervousness in California 
about continuing down the path of ``deregulation'' that was 
begun in 1996, and some have suggested that instead we should 
return to full regulation. If we decide to return to a command-
and-control market as we had before 1998, there will be little 
need for the ISO.
    I'm not here to advocate for either position. The AB 1890 
model of deregulation was so flawed as to be unworkable, and in 
many ways places a higher level at risk at the doorstep of 
ratepayers, just the opposite of what a functional deregulation 
system would do.
    Returning to a command-and-control based system, however, 
would be an even worse option for California. As our history 
shows, California does the worst job of any State in the Nation 
of regulating its energy industry. The fact that our 
electricity costs were 50 percent above the national average 
led the initial drive to deregulate, and our role as one of the 
first States in the Nation to take such action led to a boom in 
the technology sector here. Pulling the rug out from under 
these high-tech businesses would be economically disastrous.
    Furthermore, a ``cost-of-service'' based system is not 
likely to spur the kind of investment we need to create enough 
new power supplies to provide our market with a healthy reserve 
margin. The legislature recognized this problem last year and 
decide to create a Power Authority to deal with it. The Power 
Authority was designed to go into generating business in a 
cost-of-service market, to buildup and maintain a publicly 
financed reserve margin for electricity. Fortunately, this tool 
is not being used. I believe the only impact would be to 
``crowd out'' future power plants that would have been built 
with private dollars. Taxpayers would have become more and more 
involved in the electrical generation business, and I doubt 
that's the direction they want to go.
    Therefore, I believe a new path must be charted. We must 
create a market that is predominantly fueled by private 
investment and places the risk for those decisions on 
investors, not the ratepayers. But at the same time we must 
maintain a key role for government in ensuring stability of 
supply, encouraging demand-side efficiency, and stabilizing 
rates. In such a scheme, the State would play a strong role, 
would be responsible for the ensuring the adequacy of energy 
infrastructure, and have the tools and resources to react 
quickly and decisively to sudden changes in the market.
    This regulatory structure would require an ISO that 
maintains as open a market as possible with the other Western 
States and with substantially similar pricing mechanisms, 
likely including membership in a Regional Transmission 
Organization.
    The structure and role of the ISO is key to making any 
decisions about the future of our energy markets.
    As all of us know, markets rely upon open and widely 
available methods of transporting goods from the producer to 
the consumer. Whether they are highways, rail, the seas, or 
transmission lines, those pathways must be open to all 
participants and sufficient for the amount of commerce needed. 
Californians discovered last winter that the natural gas 
pipelines within the State were not sufficient to meet the peak 
demand of electrical generators. As a result, California 
natural gas prices rose many times higher than in neighboring 
States. Likewise, on the electricity side, the San Francisco 
Bay Area suffered more blackouts than in other areas because of 
insufficient transmission, and is still at-risk.
    Plentiful and accessible transmission, therefore, is 
fundamental to a workable electricity market.
    It is important that our transmission rules allow 
California energy companies to compete for energy supplies 
outside of California. California must not isolate itself in 
the energy market.
    I know there has been some controversy about RTOs, but I 
believe it is important for California to become part of a 
Western RTO. California utilities import up to 25 percent of 
peak energy needs from Washington and other Western States. It 
is essential that we remain in the market for these resources.
    There has been some discussion about making California 
``self-sufficient'' for its energy needs, but to do so would be 
a waste, in my view. There is a unique opportunity in the 
Western electricity market, more so than in most other regions, 
to exchange resources, because the seasonal demand patterns of 
the Pacific Coast States are exactly the opposite of each 
other. California consumers benefit tremendously from the 
ability to purchase off-peak power from sources like the 
Bonneville Power Administration for their own peak use, rather 
than build more peaking plants or keeping old, polluting ones 
on-line.
    There are some other issues with our market design that 
need to be changed. The ISO is now at work creating a new day-
ahead market for spot power, which we have not had since the 
California Power Exchange folded last year. This will fill a 
huge need for consumers by further reducing the level of 
``panic-buying'' at the ISO on the day power is needed.
    It was not the legislature's intent, or at least I don't 
believe it was our intent, to have the ISO so heavily involved 
in energy purchases, which is part of the reason why I also 
think the issue of multiple qualified exchanges needs to be 
reexamined. In 2000, a statute was passed that banned private 
exchanges outside of the ISO and the Power Exchange. The idea 
was to keep all spot market power in one place, which in theory 
would produce a true reflection of the market conditions. If we 
had allowed outside exchanges at that time, perhaps California 
would still have a day-ahead market today.
    Finally, I have a couple of points to make that are 
somewhat external to the business of the ISO, but that I think 
are relevant to the discussion. First, the State of California 
must get itself out of the power-buying business. It is now 
clear that the State is ``over its head'' in dealing with power 
producers in the marketplace, and for years to come, ratepayers 
in the PG&E and Edison territories will pay billions of dollars 
above the market price for spot power and long-term contracts. 
Improvements in the spot market will not have the impact for 
ratepayers that they can have as long as we are negotiating 
poor deals for ourselves. The investor-owned utilities are 
simply better equipped to protect the consumer interest in 
power purchasing.
    The State also needs to give the utilities the tools to buy 
the power needed to avoid future calamities such as we saw last 
year. Ratepayers would not be in the financial situation they 
are today had the Public Utilities Commission acted to allow 
utilities the ability to purchase longer-term bilateral 
contracts for power. Utilities need the authority to make these 
contracts, along the guidelines set forth in Chairman Wright's 
assembly bill 57.
    Finally, with all of the other reforms that are needed in 
terms of market design, there is also need for a fundamental 
reworking of the State's energy bureaucracy. I said in my 
introduction that California needs more uniform policy with 
regard to energy, and the ability to respond to crises like we 
saw last year.
    I would propose that the way to do this is to create a 
State Department of Energy, a Cabinet-level agency that would 
be directly answerable to the Governor. Under our present 
system, there is too much finger-pointing and too little 
accountability. There is too much regulatory uncertainty and 
too little coordination of action.
    State government must continue to play an important role in 
the energy market, but it cannot do so within a regulatory 
structure design for yesterday's world. The State should 
continue its work with respect to forecasting supply and demand 
and evaluating the state of the market, but the same agency 
must have the ability to respond to those forecasts by 
streamlining the regulatory process or putting emergency 
conservation measures into place. Today, doing these things can 
require discussion and agreement between three, four, or five 
different agencies. And as we saw last year, it's often 
entirely ineffective.
    I have introduced legislation, assembly bill 2062, to 
consolidate all of our various energy agencies into a 
department, with the exception of one--the ISO. We've left the 
ISO outside in the hopes that it can gain become an independent 
agency.
    As a legislator who voted to reconstitute the ISO Board 
last year and take away its independence, I will say today that 
I believe the time has come to undo that legislation. At the 
time, in the midst of the energy crisis, the Governor asked the 
legislature to remove the stakeholder board with an appointed 
board. Many of us thought that this was needed to ensure the 
public's confidence in the operation of our grid.
    Now that FERC has taken appropriate measures to restrain 
energy costs in the West, I do not see a need to hang on to the 
appointed board any longer. An independent ISO is key to 
reassuring market participants that a stable and less political 
environment exists in California.
    This will not remove our ability to protect consumers. 
Quite the contrary, the State can and should do more for 
consumers by taking an active role in energy markets in the 
manner I mentioned earlier. If in the future the State sees the 
need to impose radical price control measures, it will only be 
because it has failed to do its part in ensuring balance in the 
energy markets. As I see it, energy price controls are not just 
a band-aid solution for market failure, they are a shield 
behind which politicians and pertinent agencies can hide the 
fact that they are not doing their job.
    I hope this gives you a little bit of insight. I think 
California has a bright future, but we need to be able to work 
in a manner that's beneficial to not only the industry, but to 
the ratepayers as well.
    That concludes my comments, Mr. Chairman.
    [The prepared statement of Mr. Pescetti follows:]
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    Mr. Ose. Thank you. Mr. Pescetti.
    I want to make sure I understand; I was following your 
testimony here, I have a copy of it, and at the top of the 
fourth page you used the word ``without'' but your written 
statement says ``within.'' You said, ``. . . but it cannot do 
so without a regulatory structure,'' and your written remarks 
are, ``. . . but it cannot do so within a regulatory structure 
. . .''
    Mr. Pescetti. You know what, I kind of missed my page here.
    Mr. Ose. I think you meant within.
    Mr. Pescetti. I probably did, if that's what the written 
remarks say.
    Mr. Ose. We are going to go with the written ones.
    Mr. Pescetti. Yes.
    Mr. Ose. We'll correct the verbal statement----
    Mr. Pescetti. Please.
    Mr. Ose [continuing]. To comply with the written statement.
    Mr. Pescetti. Thank you.
    Mr. Ose. All right.
    Well, thank you both for coming today. I do want to look 
prospectively in terms of where we are going.
    Chairman Wright, you had mentioned maintenance standards in 
your comments earlier, and one of the problems that we 
experienced in the immediate past were unplanned outages by 
generators. It appears, or at least there has been testimony 
given, that the generators contend they bought old plants, that 
they proceeded to run them hard, if you will, and that as a 
result they experience, subsequent to that, higher than average 
outages. Others have testified that the outages were staged in 
order to raise prices.
    CAISO has been working on maintenance standards for all 
generating plants in the State, and yet they've delayed filing 
their proposal with FERC in order to allow the PUC to have some 
input. It's my understanding that the PUC wants the legislature 
to pass 39XX, which would give the PUC authority to do 
maintenance checks on all present and future generators who 
supply energy into California, including those outside the 
State.
    Do you have an opinion on that bill?
    Mr. Wright. Well, I don't know that we can give the PUC the 
authority to inspect anything outside the State. Some of us 
question how good a job they are going to do inside the State, 
so I certainly wouldn't want to send them outside.
    The issue that tied up 39 wasn't inspecting plants; I mean, 
the PUC did over 800 inspections so there's not a question as 
to whether or not they can inspect. I forget which of the 
Federal laws it was, but wholesale generators in California 
enjoy an exemption, and it's that exemption that allows them to 
even build power plants in the first place on a private basis, 
and that was done long before there was a ever a restructuring 
or deregulation movement. That was how you were able to get 
plants, because the California Constitution specifies that if 
you generate electricity you are a utility. As a utility, you 
are going to be structured substantially differently.
    The law that was drafted by the PUC would have removed the 
EWG, or Exempt Wholesale Generator, provision, under current 
California law. That dog won't punt in the legislature, and so 
what we had to do was say to them that we are not going to 
create a situation where we attempt to regulate a private 
wholesale generator as a utility, because what that would do is 
immediately dry up all of the capital that would have gone to 
the people who were trying to do that.
    What we are trying to do is grant to the PUC, in statute, 
without removing the EWG provision, the ability to inspect 
plants, but we have to make sure that we do another thing as 
well. The other thing that has to be done is to make sure that, 
for example, if the PUC specifies maintenance standards that 
differ from those of the manufacturer of the equipment, and the 
equipment breaks down who assumes liability? I mean, there are 
a number of things that need to be done there to make sure 
that's accomplished.
    You also have the issue of scheduling, and in some 
instances, for example, last year there was this great furor 
about the guy at Duke said that during a middle of a shortage 
that Duke shut its plant down. Well, what he didn't know--and 
it becomes one of the reasons, you know, I guess in the Chicken 
Little theory about the sky falling, the fact that an apple 
hits you up side the head doesn't mean that the sky is falling, 
it just means that an apple fell--this particular plant was 
shut down because the ISO needed to do that in order to relieve 
transmission congestion.
    And so, if you were looking and saying that whoa, you know, 
we are in shortages today and this plant is shutting down. If 
you didn't know the entire picture then you would provide an 
erroneous thing. I mean, the newspaper never----
    Mr. Ose. So, they decked the plant, they decrementally had 
the plant go down to take the power off the line, to ease the 
congestion.
    Mr. Wright. Right, see, because if you don't do that then 
you'll blow up the whole system. And again, the problem is that 
the newspapers were so quick to jump on the testimony of this 
idiot that they never were able to get back to the fact that it 
was a managed outage. No, it wasn't planned, but it had to be 
scheduled so that you didn't crash the entire system.
    So, I mean, as you began the question about maintenance, 39 
is something that we're going to work with. We are still doing 
that. In its initial form, the legislature was not prepared to 
grant to the PUC the ability to do that.
    And, let me amplify that in the 800 inspections that they 
did, they did not find one incidence of outage that they were 
prepared to file a grievance against. The one incident that 
people discussed was one where a plant in southern California 
that was fined by FERC, but the issue there did not have to do 
with withholding, the issue had to do with the fact that one of 
their units had an RMR contract, the other unit did not have an 
RMR contract.
    AES brought up the plant first that did not have the 
contract; FERC ruled, and I think properly, that they should 
have brought up the RMR contract plant first, and fine them the 
difference. That's been reported as catching someone 
withholding. It's not true, and so, I mean, the difficulty in 
all of this is that people take a little bit of truth and push 
it in a way that isn't true.
    We'll fix 39 to make sure that the PUC has the ability to 
inspect plants, without taking away the Exempt Wholesale 
Generator, without having the PUC try to determine maintenance 
standards for which they have no qualifications to do.
    Mr. Ose. I think that's the key point. I think you are 
right on the point there in terms of a manufacturer of, let's 
say, somebody that makes turbines, says you have to maintain 
this turbine in such and such a manner, we've got to make sure 
that these maintenance standards that might be adopted align 
themselves with the manufacturer's experience on them. So, 
that's what I'm trying to get at, is why wouldn't we just 
adopt--maybe this is too simple, but why wouldn't we just adopt 
the manufacturer's standards for maintenance and tailor those 
standards to the specific equipment that's in a plant?
    Mr. Wright. Because that makes too much sense.
    Mr. Ose. OK.
    Mr. Wright. See, part of the problem, I think, that 
happened as well, in the year prior to the crisis, Mr. Chair, 
the ISO asked a number of the people who were running plants to 
exceed their manufacturer's recommendations.
    Now again, we are talking about old plants, and so that 
meant that by missing standards, or deferring maintenance that 
you should have done, you are going to have unplanned outages, 
because now you are really going to have to do it for fear of 
critically damaging your equipment.
    I think where again we have to be particularly careful, is 
that in California there's another layer they'd I'd like to put 
on top. For example, in Pittsburg, California, not very far 
from me, Mirant operates a plant that they bought from Pacific 
Gas & Electric. They ran so many hours in the year 2000 that 
when we got into the middle of the crisis, the Air Board in 
Contra Costa County said, ``Oh, you can't run anymore because 
you've already exceeded the amount of time that you can run.''
    And, I would remind you, Mr. Chair, that all of the plants 
that were purchased actually exceeded the output when they were 
operated by the utility by, in some cases, as much as 80 
percent. So, it's not a question where you've got less power 
out of them.
    Now, you could shape that in a way where you could still 
manipulate and produce more, but I think it would be a little 
bit disingenuous to suggest that people were simply withholding 
so that they could drive up the price. If you go back and look 
at the incident in totality, it doesn't mean that you couldn't 
do it, and it doesn't mean that it didn't happen. That needs to 
be investigated, whether more power was produced. But in some 
cases you had plants go off line because air boards were 
directing. And, that plant in Pittsburg that I just told you 
about. I'm not telling you what I heard, and I'm not telling 
you what somebody else told me. I went to the plant and saw 
them take down a boiler on the largest power plant in 
California. They had to take down the boilers on a couple 
systems because the air board, not the ISO or the PUC, ordered 
that be done.
    So, you know, the Governor would later on realize that he 
had a problem, because the air board could also come in and 
provide fines.
    During the energy crisis as well, in Los Angeles we fired 
up an old power plant and people said that the DWP gouged when 
we did. What people didn't take into account is that DWP paid 
several million dollars to the SCAQMD for fines to run the 
plant. When you pay those fines, that cost is going to be 
incorporated into the cost of the plant.
    That plant that I described to you that Williams runs, or 
AES and Williams run, they have a totaling agreement with 
Williams. I think in 1998 and 1999 the air emissions cost 
exceeded the cost of the fuel. In most places in the country, 
the cost of the fuel is the largest single operating expense of 
a plant, except in those plants in southern California where 
the emissions credit exceeds the cost of the fuel.
    So, I'm just saying, and it goes back to my original 
statement, Mr. Chair, if price is the issue that we're 
concerned about, there are a number of things that we can do to 
mitigate price.
    Mr. Pescetti mentioned, for example, that the prices were 
higher in California. The Federal Government helped with that. 
When they did PURPA, and they dictated that utilities had to 
buy at the short run of what it cost power from somebody else 
who built the plant, and they based it on the cost of a nuclear 
plant, where the cost of the plant was front loaded, in some 
instances Edison, and PG&E and Sempra had to take 3 cent plants 
off line to buy power for 8 and 9 cents. But again, at the time 
somebody said that gas is going to be--oil is going to be $100 
a barrel and it will be scarce. Well, it ain't $100 a barrel. 
We guessed wrong.
    But now, even if you go back and look at the contract that 
people criticized the Governor for, they are a cent and a half 
less than the QF contract that utilities are still obligated to 
pay for.
    So, it's not as simple as saying, well, they screwed up. 
There's enough blame to go around where everybody comes away 
from this with a little bit of mud on their shoes.
    Mr. Ose. Your point on the maintenance standards is that we 
ought to listen to the manufacturers, they tend to know what 
their equipment can do.
    Mr. Wright. And they provide warranties, and if you don't 
follow the warranties what happens is, when it blows up you 
don't get any money back. It's kind of like you buy a nice new 
car and they give you a maintenance schedule, if you don't keep 
it you void the warranty.
    Mr. Ose. I do take care of my 1989 pick-up.
    Mr. Pescetti, on SB 39XX, do you have any thoughts that we 
could take into consideration?
    Mr. Pescetti. I like keeping things, as well, Mr. Chair, 
very simple. I think we should just kill the bill. I mean, we 
attempted to kill it last year, personally, I don't think you 
can make a bad bill any better. So, I would like to see 39X die 
in the assembly.
    Mr. Wright and I worked very hard the last night to stop 
the bill from getting out, and personally, I think that's the 
best thing that would happen for Californians and our energy 
market, is to kill 39X.
    Mr. Ose. Do these maintenance standards need to be adopted 
by regulatory process, is that what you are saying?
    Mr. Pescetti. No, what I'm saying, as you and, I think, Mr. 
Wright alluded to earlier, is that there are manufacturing; 
standards for maintenance, that's what we should adopt. We 
don't need any regulatory agency going in and saying we should 
change that process.
    Mr. Ose. Is it your opinion that PUC's involvement in this 
is superfluous?
    Mr. Pescetti. Yes. Personally, I think that the PUC would 
like to have its hands in more parts of the energy market than 
it needs. I don't think we need to increase the scope of the 
Public Utilities Commission.
    Mr. Ose. Mr. Wright, correct me if I'm wrong; if I 
understand your point, it is that if someone buys one of these 
pieces of equipment and puts them in their plant and runs it, 
and runs it in such a way as to void the warranty--I mean, they 
are not going to do that because it's not in their financial 
interest, if they screwed it up they wouldn't be able to get 
recovery.
    Mr. Wright. Right.
    Mr. Ose. So, you think, if you will, the manufacturer's 
relationship with the buyer is sufficient to handle this issue?
    Mr. Wright. Well, I think a couple of things. 39 really 
wasn't drafted in conjunction with, but it's now kind of linked 
with 28, which is an Assembly bill, that is on the Governor's 
desk.
    Mr. Pescetti is right. In its current form, the bill should 
and will die. If we are able to make 39 work, it needs to be 
clear that the ISO, and not the PUC, would be involved in the 
scheduling of the power plants when they schedule their 
maintenance.
    In some instances, for example, the operator, or the 
manufacturer, will say you have to shut down this equipment for 
maintenance over a period of hours. It becomes an ISO function 
to determine which plant in which region, relative to 
congestion management, needs to go down for scheduled 
maintenance at a given time.
    And so, in some instances it might be that you say to the 
guy in Pittsburg, we are going to take you down in April so 
that when we take someone else down, you can't have them all 
down at the same time. So, those maintenance plans, within the 
manufacturer's guidelines, also have to be scheduled for the 
reliability of the grid, so that everybody doesn't go down at 
one time.
    One of the problems that did occur before--and this was a 
shortcoming of the ISO in part, but again, ISO had the problem 
of also keeping the lights on--was that, because a lot of 
people blew maintenance schedules earlier on, it meant that as 
you got to the crunch time, a lot of people had to go down 
because they were now at the critical point of losing the 
equipment.
    So, I think that the ISO needs to do the scheduling of 
maintenance around the manufacturer's schedule, and in 
consideration of the congestion management requirements of the 
grid. Then the PUC role would be to determine if the plant was 
not functioning under the prescribed guideline set forth 
between the ISO, the generator, the PGA that they had with 
FERC, the generator agreement that they had with FERC. The 
PUC's role, in my view, should be much as happens with the PUC, 
say, in the telephone business. They become the enforcement 
arm, the eyes of FERC on the ground. Because in the event that 
there was withholding, you do need somebody to be able to serve 
as the cop, so to speak, to say that somebody is gaming the 
system.
    But, I submit to you that the more efficient way to achieve 
that would be by contract, because contracts are much easier to 
enforce than trying to figure out at 2 a.m., whether or not a 
plant is off line. It becomes a much more laborious task to 
figure that out. A contract is much easier to manage, which is 
why I get back to my earlier discussion. If you had contracts 
for most of the power, and your spot position is de minimus, 
then you are not trying to play cops and robbers in the middle 
of the night to figure out who is running the plant and who is 
not.
    Mr. Ose. You are both in agreement that these maintenance 
standards are more suited to the ISO then.
    Mr. Wright. Yes.
    Mr. Pescetti. Yes.
    Mr. Ose. OK.
    Now, the second subject I want to talk to you about--and I 
appreciate your compliment earlier, Mr. Chairman--is the market 
mitigation plan that's in effect right now that FERC adopted.
    Mr. Wright. At your urging, Mr. Chair. Thank you.
    Mr. Ose. I'm sorry?
    Mr. Wright. That was at your urging, I understand. Thank 
you for your work.
    Mr. Ose. Is it working? Is the mitigation plan working, in 
terms of bringing power at an affordable price, because if it's 
not we need to change it.
    Mr. Wright. Well, I think it does. I mean, what it does is 
assure that the plants are going to run. And it assures that 
the price is going to be within a certain range.
    Where you have to be careful with price caps is that, often 
times the cap becomes the floor if you are not careful. We saw 
that, when there were price caps before, where suddenly you 
say, oh, OK, I can charge $2.50, we'll just make it $2.50, 
since that's what I'm able to get.
    What I think we need to have going forward is, if, for 
example, we've got contracts for a substantial amount of power, 
so we are assured that plants are going to run and the people 
who own the plants are assured that they are going to get paid, 
then I think we would be able to begin retreating from the 
mitigation measures, because we've got power purchased and the 
plants are going to run.
    But contrary to what people may have said, that the DWR 
bought too much power, the shape of what they bought doesn't 
really conform to the load profile of the State. So, we are 
going to have situations where we are going to have peak load 
times, we are going to have to go out and buy power anyway. We 
are going to have to, say, on Sunday afternoons, end up having 
to sell power at a substantial loss, or, in some cases, give it 
away. That was a function, I think, of not buying wisely, not a 
function of having paid too much.
    So, yeah, I think that had we not had that, and if we 
didn't get the winter, and if you didn't get other things--the 
Fortnightly, a utilities magazine, has a great article that 
talks about what caused what. I think it was a combination of--
I think most experts would agree--the price mitigation, the 
weather cooperating, and we spent a lot of money publicizing 
the need for conservation. Californians cooperated with that. 
All of those things, taken together, I think contributed to 
that. We don't want to be in the position, again, of depending 
on good weather, and depending on things we can't manage, which 
is why contractual relationships are the best way to go. It's 
kind of why a lot of folk get married and quit dating.
    Mr. Ose. Remind me never to match wits with you.
    Mr. Pescetti.
    Mr. Pescetti. Mr. Chair, I'd agree.
    I think the market mitigating plan helped us get several 
things in order to get to the position where we are, a little 
bit more stable as far as price goes, so I'd agree with Mr. 
Wright's comments.
    I think also we can't undermine the benefits that we've 
had, and all Californians have made, with the energy 
conservation, because with a plan and with conservation and 
with good fortune and with the weather, I think everything 
worked out well. So, I think that was a good first step for us, 
and I also want to thank the Chair for his help.
    Mr. Ose. Now, the FERC's order expires on September 30th. 
One of the purposes of today's hearing is to take input about 
what we do from there. I mean, is this order a long-term 
solution? I hear you saying we need to tweak it to a certain 
extent.
    Mr. Pescetti. I agree. I think there needs to be some 
tweaking, and I think we have between now and before the order 
is up at the end of the September to take a look at areas that 
we can improve and some areas that we may want to scale back, 
take a look at where California has gone.
    I think the contracts have helped also with some stability. 
I think maybe we may have committed too much in 2003, 
especially based on where we've seen the demand go, but I would 
hope that between now and the end of September we'll have an 
opportunity to look at ways to improve the plan, fine tune it, 
and move forward on those areas that are beneficial to 
Californians.
    Mr. Ose. Mr. Chairman, one of the things you mentioned was 
the fact that we've been buying, or at least we were buying, 40 
percent of our net short in the daily market, and you hinted at 
the percent of the portfolio, if you will, that should be 
acquired in the spot market, as opposed to what is being 
acquired in the spot market.
    The direct implication of that is we need to give these 
power generators and power suppliers the opportunity to forward 
their contract. Do the power suppliers have the ability right 
now to forward their contract under PUC guideline?
    Mr. Wright. Well, they do, Mr. Chair, but they do so at 
their own peril. Mr. Pescetti mentioned AB 57, which I authored 
and it went through the assembly, and God forbid that we inject 
politics into the policy process, but 57 is now on the Senate 
side awaiting approval.
    What 57 did is specify in statute that there would be a new 
framework for how the review of the prudency of a plan is done 
for the purchase of electricity.
    When I say the purchase, I mean what could happen now. For 
example, let's say that PG&E bought--well, this would be the 
good old days when PG&E bought, since in bankruptcy they can't 
buy nothing, but let's say that PG&E bought a contract for 6 
cents. If the PUC determined that they should have only paid 4 
cents, then what the PUC could do is grant them only 4 cents in 
rate dollars, which means that PG&E would eat the 2 cents.
    Given that risk, the company won't buy anything that the 
PUC won't approve in advance. Since the PUC was not going to 
approve contracts in advance, and there still is no procedure 
at the PUC to approve contracts in advance, then the companies 
are reluctant, and you can't blame them.
    Mr. Ose. Wait a minute. We had a hearing in Sacramento last 
April, where I took testimony under oath from the person who 
runs the PUC, Ms. Lynch, that the PUC had, in fact, adopted 
Safe Harbor provisions for forward contracting. Is that not the 
case?
    Mr. Wright. No. They began working on a 57 framework after 
57 was introduced, but that framework is not yet completed, and 
it is more important now that it be by statute than by 
regulation, because what the financial markets have come to 
realize is that the PUC can change its mind on a dime, but they 
can't change statute on a dime.
    So, it is the ability to purchase forward contracts. In 
some respects, the PUC has granted minimal ability for them to 
do that, but there is no standard procedure in place in 
California today for a utility to go out and buy power without 
necessarily facing a subsequent prudence review.
    Mr. Ose. No safe harbor provision.
    Mr. Wright. Negative, not that exists right now.
    They are beginning, at the PUC as a regulatory process, to 
look at adopting what was done in 57, but that does not yet 
exist to my knowledge.
    So, I was with some utility people yesterday who were 
urging me to move 57, particularly, with a San Diego company, 
because they've got some power contracts that they want to 
begin negotiating, and they'll need to do that in January. They 
need the protection of 57. San Diego was the San Diego Gas & 
Electric/Sempra combination. They need the safe harbor 
provisions in 57 to give them a comfort level with their 
bankers, to be able to go out and play.
    So, it is not currently in effect, that they are able to 
have a safe harbor, as you term it, to go out and make purchase 
power contracts.
    Mr. Ose. Do you share that opinion, Mr. Pescetti?
    Mr. Pescetti. I do.
    Mr. Ose. This is my last question. I'd be happy to 
entertain what further thoughts you might have, but, Mr. 
Wright, you had indicated that the percent of the portfolio 
that should be acquired in the spot market should be somewhere 
in the 5 to 6 percentage, and then you would end up melding 
that with what comes off your base generation and what have 
you, your long-term contracts.
    It is my understanding that we've been buying all in net 
short, at least until recent times, in the spot market, but if 
I understand PUC guidelines for the past couple years it was 
that they wanted a threshold of around 20 percent purchased in 
the spot market. You have your native generation, and they 
didn't want any generator having more than about 80 percent of 
their generation within their own control. So, you'd be forced 
to go out and buy around 20 percent of your demand, either in 
the forward or in the daily market.
    Am I correct in that understanding?
    Mr. Wright. OK. Well, the current profile in California, 
ball park, is that about 25-28 percent is retained generation 
asset by the utility. About 30 some-odd percent is QF or 
contracted power, and the balance was what we termed net short.
    The problem is that the net short, as a percentage, 
fluctuates given the demand. So, the amount you have as 
retained generation is a fixed amount of power. The amount 
that's contracted is a fixed amount. Now, what you have left as 
a percentage is going to vary with how much the demand is. If 
the demand goes up, then that means your net short percentage 
can go from about 30 some odd percent to maybe 50 percent, 
depending on what the demand is for a given day.
    The PUC, pre Ms. Lynch, said that because the spot market 
was so good, that they wanted all of the purchases to be there, 
because the consumer was getting the advantage of the low price 
of the spot market at the time.
    Mr. Ose. That's the 100 percent.
    Mr. Wright. Yeah.
    Mr. Ose. OK.
    Mr. Wright. But, remember that when we first embarked on 
the deregulation effort the surplus of power in the State was 
also somewhere in the neighborhood of about 20 percent on an 
average day. The demand in California began to grow subsequent 
to 1996, and that ate up all of that reserve. As the reserve 
was eaten up, that meant that the prices were going to go up 
because now the commodity became scarcer. This is Economics 
101. If the supply goes down and the demand goes up, then the 
price goes up as well.
    Mr. Ose. Actually, it's an undergraduate, it's a lower 
graduate course, it's Economics 1.
    Mr. Wright. Yes.
    Mr. Ose. Not 101.
    Mr. Wright. This is way, way down, and, you know what? That 
still works in this market. Which is why what I mentioned 
earlier, the contract in effect with a merchant operator serves 
as an insurance policy. What that insures is that if you buy 
the contract, that operator is assured that he's going to get 
paid. He doesn't have to go out and worry every day whether or 
not somebody is going to buy it from him.
    You are assured of getting power at a certain price. It 
goes back to what I told you, though, about insurance policies. 
You pay a premium to get that certainty. If the price goes down 
on the other end, you can't look and say, oh, my God, the spot 
market is loaded. Because the problem is that, if it had gone 
up, then you would have paid the higher price.
    And, what you can't try to do is say, ``I want to get the 
lower price when it's low, but if the price goes back up, I 
want FERC or somebody to come in and rescue me from my own 
mistake.''
    We've got to determine, and why I say the contract becomes 
so important, that the lowest price is not necessarily the best 
price. In dominoes, in my neighborhood, they say all money 
ain't good money. The fact that you got the low price today 
doesn't mean that you are going to get it tomorrow. Since 
electricity is something for health and safety that you have to 
have, you can't ultimately get the lowest price because that 
exposes you, as we now know, to the highest price.
    So, let's say that you take the price of, say, 5 or 6 
cents, 6.5 as the current, I think, as the current contracts 
are. There's a whole lot more risk for you south of 6.9 cents, 
than north of 6.9 cents. So, if you chase that 1 or 2 cents 
that you think you'll get by playing the spot market, then you 
can't complain if it goes to 10 or 11 cents. The reason that 
I'd leave some purchase in the spot market is because you have 
elasticity in the market. A plant may shut down. Something may 
happen that truncates the demand on a given day. But the reason 
you'd like to have the ability to reduce what you buy, so that 
you are not as wasteful, so that, at the end day, you can 
reduce your exposure to risk by ensuring that you have power 
delivered to you on a reliable basis.
    Mr. Ose. That's the forward contract.
    Mr. Wright. And, I want to be careful that we don't say 
that they are all long-term. You may have some contracts that 
are 6 months and some may be 2 or 3 years.
    Mr. Ose. Right.
    Mr. Wright. But, you may have a contract like the one you 
have with CalPine that's a multiple-year contract, because it 
serves as a basis for development. So, the contract portfolio 
will actually be a whole lot of little contracts that cover 
periods of time.
    Mr. Pescetti. Mr. Chair, you have to have some flexibility, 
you have to have, you know, 10 percent or less on the spot 
market, not only if a plant goes down, but also the demand 
shifts throughout the course of the day.
    You know, I spent several years, as you know, on the SMUD 
board, and we always loved to get businesses to run off of 
peak, especially at night, because electricity was floating 
anyway. So, you need to have that flexibility and, you know, 5 
or 6 percent is probably the ideal amount.
    In regards to the contracts, I think those ended up being 
advantages for Californians. I think the fact that we have some 
stability in the price, we have some that we can buy on the 
spot market, helps us as well. I think that also helped us with 
some reliability, therefore, the lights haven't been off for a 
while. So, I think those are all benefits.
    Mr. Ose. I want to thank the two of you for coming today, I 
appreciate you taking the time out of your day to come over.
    Mr. Pescetti. Thank you.
    Mr. Ose. It's been very educational for me. I appreciate 
you coming in.
    Mr. Wright. Thank you.
    Mr. Pescetti. Thank you, Mr. Chair.
    Mr. Ose. We're going to take a short break here and then 
the second panel comprising Patrick Wood, Terry Winter, Richard 
Drom, James Feider, Jan Smutny-Jones and Walter Drabinski will 
be here with us.
    [Recess.]
    Mr. Ose. OK, we are still looking for Mr. Drom and Mr. 
Drabinski, are they here yet? We're going to give them a 
minute. Tell you what, we're going to proceed, I'm going to 
have to swear all of you in; when they come in I'll swear them 
in.
    Gentlemen, would you rise, please, and raise your right 
hands?
    [Witnesses sworn.]
    Mr. Ose. Let the record show that these four answered in 
the affirmative, that would be Mr. Wood, Mr. Winter, Mr. Feider 
and Mr. Smutny-Jones.
    We'll pick up Mr. Drom and Mr. Drabinski when they come in.
    Gentlemen, I know that some of you have a 12 o'clock 
schedule constraint. We have your testimony. If you can 
summarize in 5 minutes each it would help us get straight to 
some direct interaction.
    Patrick Wood, the chairman of FERC, welcome.

   STATEMENTS OF PATRICK WOOD III, CHAIRMAN, FEDERAL ENERGY 
   REGULATORY COMMISSION; TERRY WINTER, PRESIDENT AND CHIEF 
  EXECUTIVE OFFICER, CALIFORNIA INDEPENDENT SYSTEMS OPERATOR; 
     RICHARD A. DROM, VICE PRESIDENT, GENERAL COUNSEL, PJM 
INTERCONNECTION, L.L.C.; JAMES C. FEIDER, PRESIDENT, CALIFORNIA 
 MUNICIPAL UTILITIES ASSOCIATION; JAN SMUTNY-JONES, EXECUTIVE 
     DIRECTOR, INDEPENDENT ENERGY PRODUCERS; AND WALTER P. 
         DRABINSKI, PRESIDENT, VANTAGE CONSULTING, INC.

    Mr. Wood. Glad to be here, Mr. Chairman.
    The last time that I had the pleasure to visit Sacramento 
at the time I was newly appointed to the Commission, as was 
Commissioner Brownell, we had the pleasure to meet the 
California Energy Commission with a group of experts talking 
about the sufficiency of the infrastructure in the California 
market, and it's fitting that my second time attending 
Sacramento we are talking about the balanced market rule. Those 
two aspects of the world, sufficiency of the energy 
infrastructure and the presence of balanced market rules to 
govern the trade back and forth on that infrastructure, are 
really the two prerequisites for a healthy and competitive 
market to work, to deliver to benefits to customers.
    I am pleased that your focus, as well as the focus of a lot 
of the key parties here in California, is on getting the 
balanced market rules in place. I think that is such a critical 
part of getting this part of of the Nation returned back to 
economic health on the energy front, that we really do need to 
focus on.
    The FERC, for its part, is looking at balanced market rules 
on a national scale. We have had a number of instances, and I'm 
pleased to see Mr. Drom here from PJM being a good example of 
one, but certainly there are others, of instances of energy 
markets that are healthy, that have worked, that do survive 
stress, that were designed and are malleable enough to improve 
as they discover flaws in their mechanisms, and I'd like to 
hope that we can get California to that same level, as well as 
the rest of the West.
    It's important to remember that California, while it's the 
dominant player in the West, is part of a bigger electric grid. 
The laws of physics dictate where power goes, not the law of 
the man, and those laws tend to make power spill over back and 
forth between Oregon, and Nevada, and Arizona, and even as far 
away as British Columbia, back into New Mexico as well. So, 
that interconnectivity of the California Region and, I think, 
the gentlemen on the first panel did speak to that, 
acknowledging that interdependence is an important part of the 
mix here. So, California's solution has got to include the 
other players in the Region, and certainly FERC is mindful of 
that, as we move forward in talking about market designs that 
should work for the whole country.
    There is a real urgency, I think, at this point to complete 
the transition. This began in 1992, when Congress laid out the 
Energy Policy Act and said, we think that competition at the 
wholesale level, which is between the wholesale players, is a 
good thing for America and we ought to move forward toward 
that. That's been 10 years, and with probably the exception of 
the Northeast, from maybe D.C. toward Maine, it is really only 
a promise, not really an actuality. And so, we'd like to see 
that promise be expanded across the country.
    This is very separate from the local decision by a 
legislature, such as here in Sacramento, to decide to open its 
retail market, that is in my mind, and always has been, a State 
decision, and it's very separate, it's a political decision as 
to whether customers ought to be alcoved to a government 
selected utility or be able to pick their own supplier. That's 
a political decision, but what we have been about, and always 
were about, and what I think the discussions that you have 
welcomed here are about, are the economic benefits of having a 
market, and having a market work well.
    We are committed to that at FERC. We are committed to the 
institutions, such as the one that Mr. Winter heads and the 
others in the country, that those be good regional leaders for 
making these markets work on a regional basis. It's not 
necessarily a Federal issue, but often in cases it's bigger 
than a single State issue, and that's the difficulty here, we 
don't have a government of the region. There's a Federal 
Government in the Nation's Capital, and there's a local 
government here in Sacramento, but there's not one that kind of 
represents where the electric markets really are, which is 
somewhere in between.
    So, we are doing our best to try to create institutions 
that can make that work and work well for the benefit of 
customers, and I trust that with discussions like today's, and 
the collaboration that can lead from that, among all the 
parties here in California and in the broader West, we can get 
to a market that is viable for the long haul.
    I look forward to any of your questions.
    [The prepared statement of Mr. Wood follows:]
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    Mr. Ose. Thank you, Mr. Chairman.
    Mr. Winter, welcome.
    Mr. Winter. Thank you, sir.
    Five minutes, I'm not sure I can even get warmed up.
    Mr. Ose. I did see your testimony. I've gotten through 
about three quarters of it, so if you could summarize that 
would be great.
    Mr. Winter. I will summarize very quickly.
    You asked me to talk on two subjects. One was the market 
redesigned effort that we are involved in, and the other was 
the operational audit that we underwent.
    I'm going to go very quickly and at a very high level, but 
clearly in my view the things that have caused the problems in 
California have been the lack of generation, lack of 
transmission, lack of price-responsive demand, lack of forward 
contracting and underscheduling in the forward market, lack of 
feasible schedules and the exercise of market power.
    In our new design, we have tried to put particular emphasis 
on each of those. For generation, we have gone to what we are 
calling an available capacity obligation to force the 
suppliers, not the suppliers, but the people who supply the 
customer, that he have sufficient generation to meet the needs, 
which means he's probably going to have to buy more than he 
actually needs on any one particular time.
    Lack of transmission, in our new design we have put in 
locational marginal pricing, which we hope will send better 
signals and, therefore, will help the transmission. It's an 
area I'm very concerned in, and getting lines built that we 
absolutely need, because as the generation comes on, if we 
can't get it to the customer, it does us little good.
    In the area of responsive demand, we think those are retail 
programs that have to be done by others. We are certainly 
willing to accommodate them in our wholesale markets, but we do 
not take the lead on that.
    Forward contracting and underscheduling, again, the 
available capacity obligation, and we are proposing in our day-
ahead market that we develop what we call a residual unit 
commitment, which is after the day-ahead market we will look at 
the shortage that exists and looking at our congestion patterns 
actually identify units that have to come on from the available 
capacity that is there.
    Lack of scheduling feasibility, this in the day-ahead 
market will be taken care of through the internal congestion, 
and that lack of schedules will then be identified and we'll 
handle that with the residual unit commitments that we perform 
in the day ahead.
    Exercise of market power is an area that in itself would 
take considerable time, but let me just say that we have a 
three-tiered approach. One is, we think the market structure 
with the capacity design is one way of not letting it happen at 
the beginning. If we get through that, then we think we do need 
a damage control bid cap that many of the other ISOs now have, 
and if that fails then we think we need to go to a just and 
reasonable safety trigger that would, in fact, avoid prices 
getting completely out of control.
    Let me just very quickly comment on the audit. You have in 
your package a filing of all the items that we responded to the 
audit in FERC. I think that, No. 1, I am not happy with the 
audit. The ISO has self-audited itself several times, it's not 
the quality of the audit or what it says, it's more about I 
think that we have done a better job than that, and so I think 
people need to look at the circumstances we were operating 
under.
    I cannot tell you how proud I am of the operators here. 
They worked under very, very difficult conditions. We had 
bankrupt utilities that were not buying. We had generators that 
were not getting paid. The operators, you know, from the time 
they begin their training are taught never to drop load, yet 
they had to face dropping load in January, and I don't think 
people recognize, and some of the criticism we get is, oh, you 
took a unit out a few minutes early. It makes a large 
difference whether you take units out in the middle of the 
night when it's dark or around peak hours. So, we would 
actually make decisions to try and get additional power for the 
5:30 to 6 timeframe, those we were criticized for. I think the 
Commission, or the way the people have performed, was 
outstanding, and I would feel derelict if I did not mention 
that.
    In summary, let me say that the ISO can't do it all alone. 
It's going to take the people in California. It's going to take 
the regulators in FERC in California. It's going to take the 
ISO. It's going to take RTOs. It's going to take regional 
planning. All of those have to come together to make this work. 
So, I certainly applaud your comments of not looking back, we 
must learn from the past but we have to go forward.
    And finally, I think that it's going to be extremely 
difficult until we get the financial stability developed to 
really put in place a lot of the things that are more long 
term, and toward that regard I do become a little nervous when 
we have an arbitrary date of September 30th, that says I lose 
all the mitigation protection and I may not be able to have in 
place all the protection that we have in our redesign by that 
time.
    Thank you.
    [The prepared statement of Mr. Winter follows:]
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    Mr. Ose. Mr. Drom and Mr. Drabinski, would you please rise 
so I can swear you in?
    [Witness sworn.]
    Mr. Ose. Let the record show that the gentlemen answered in 
the affirmative.
    Mr. Drom, if you could summarize, 5 minutes.
    Mr. Drom. Yes, thank you.
    Good morning. I am not an expert on the California ISO 
governance, and I am not an expert on the California market 
design. However, I think some of the things that PJM has 
accomplished in the last 5 years can help to understand what 
good governance is and what an effective market design is. So, 
I'd like to talk a little bit about governance and market 
design in that context.
    Governance really has a number of factors, and I mention 
them in my paper, I'll just review them. You have to get the 
right people in the governance. You have to make sure that they 
have explicitly defined fiduciary obligations, and you have to 
develop appropriate practices and procedures to govern their 
actions. And there is a fourth factor that I didn't mention 
that I'd like to also have, because I kind of assumed it, but I 
didn't realize other organizations are different than our's. 
Very strong stakeholder input is essential to good governance. 
We have a members committee that consists of every single 
member, we have over 200 members now. They all participate and 
they are entitled to participate in all the committees, and 
including the members committee, which is our most important 
voting mechanism, which endorses or approves all the major 
changes before PJM files them. So, those four elements are 
critical.
    Let me just give you a quick example of how they work 
together in reality. Back in 1997, when PJM was approved as an 
ISO, one of the conditions was that we form a market monitoring 
unit that wasn't part of our original filing. So, we worked 
with our stakeholders during a 5-month process, developed with 
them effective mechanisms that everyone could buy into. Then at 
the last minute our members said you must file the mechanisms 
as part of the operating agreement, rather than part of the 
tariff.
    Now, as a lawyer, I immediately realized that in the 
operating agreement members have a two-thirds vote in order to 
change it, whereas the tariff PJM has unilateral control over 
it to make changes. So, we talked to the board members, and the 
board had a real gut check and they rejected the will of the 
members. They filed it as part of the tariff, because they felt 
that fiduciary obligations of maintaining a robust and 
competitive marketplace required that they have control over 
the market monitoring unit changes, as it evolved over time.
    FERC, within 60 days, approved our filing and agreed that 
it should always be in the tariff, not in the operating 
agreement. But, that's an example, a real world example, of 
where the board has to look at its fiduciary obligations, look 
at the will of the members, and then do what's right, not 
necessarily what's politically popular.
    Our board has made a number of decisions, luckily not many, 
about four in the last 5 years, where our members were not in 
favor of our steps. In each case, FERC promptly approved our 
actions and said we did the right thing. So, we have a history 
of working with our members, but also being independent.
    One of the phrases that Phil Harris uses a lot is, when the 
arrows in the front equal the arrows in the back, you know you 
are doing a good job. One thing that PJM's board is very proud 
of, is that we look at the arrows from all directions before we 
take a course of action.
    Second, market design, I'm a lawyer, not an engineer, so I 
can't go into detail, but the essential elements in an 
effective market design, first of all, is information 
transparency. We need real information, under real time, to 
create real markets. Phil calls that the three Rs. And, it's 
essential to our business, is that information be available to 
all the participants so they can make the right business 
judgment in the competitive marketplace.
    Second, you have to give customers as many choices as 
possible. We believe that a marketplace is only effective if 
customers can do different things to achieve their objectives, 
rather than being forced in a single line to all do the same 
thing. We believe in giving people options. For example, when 
you meet your load obligations at PJM you can self-schedule 
your generation, you can do bilaterals with a third party, or 
you can buy and sell on the spot market. On a daily basis you 
can change. Because of this robustness, we think the market is 
more effective than it would be otherwise if everyone was 
arbitrarily forced, for example, to buy or sell off the spot 
market, or to do bilateral contracts.
    In addition, you have to make sure you have a sufficient 
information technology to enable customer choices and make sure 
this real information gets to the parties. We are very proud of 
our Internet Web site activities, which a lot of the customers 
can individually utilize, and PJM can step back and monitor the 
process, rather than a command and control mechanism, that 
might get involved in too much detail in the process.
    Finally, I think in order to have an effective market 
design, you have to have the trust of the marketplace, and 
that's one thing that our Code of Conduct emphasizes. We work 
very hard to maintain the trust of our consumers with 
integrity, communication, accountability, respect and 
excellence, our five core values.
    Thank you.
    [The prepared statement of Mr. Drom follows:]
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    Mr. Ose. Thank you, Mr. Drom.
    Mr. Feider, welcome.
    Mr. Feider. Thank you, Mr. Chairman, for the opportunity to 
be here.
    The Municipal Utilities serve approximately one third of 
the electric power usage in California. We are community-based 
organizations that are owned by our customers and our mission 
is to provide reliable, low-cost, and a stable supply of 
electricity.
    To do so, we have invested heavily in both transmission and 
generation. Our customer-oriented mission makes us risk averse 
and, therefore, we procure our supply in forward markets and do 
not rely on spot markets to meet our customer demand. We look 
for durability in market design.
    CMUA members also have a regional perspective, due to the 
significant investments that we've made in neighboring States 
and, in fact, many of our trading partners are located outside 
the State. The Western grid is largely made up of long lines 
connecting specific central generation plants to load centers. 
There is simply not enough wire in the air to accommodate the 
wishes of all market participants. FERC and policymakers must, 
therefore, be flexible to allow market design to accommodate 
regional and geographic differences.
    The audit report that we are discussing here today confirms 
the observations of many segments of the electric industry 
about what is wrong in California. The most difficult task, 
however, is in not identifying the problems, but agreeing on 
the correct solutions. We are eager to get down to the business 
of fixing the industry so that it once again operates to the 
benefit of consumers.
    The audit report concludes that the overwhelming view in 
the industry is that the existing ISO board is not independent. 
Fair or unfair, that perception is a barrier to progress. 
Practically speaking, to the extent that market participants 
perceive the decisionmaking process as biased, reform efforts 
are not likely to succeed. In that instance, the stability 
necessary to foster long-term infrastructure development in 
both generation and transmission will be jeopardized. For this 
reason, this issue must be addressed.
    CMUA supports the goals of the audit report recommendations 
on governance. There is a need for both real and perceived 
independence of the board and formalized stakeholder input to 
that board. CMUA also notes that the independence is not 
assured simply by installing a disinterested governance board, 
there is an inherent conflict in a market structure that places 
a procurement obligation on the independent grid operator, thus 
placing the operator in a potentially adversarial position to 
market participants.
    Defining the ISO role properly is, therefore, a necessary 
first step to California Independent System Operator 
independence. Clearly delineating its mission is, perhaps, the 
single, most important issue on which the ISO can make progress 
in the near future. Resolution of other issues, such as market 
design and cost control would be facilitated by a clear mission 
statement.
    The California market participants, regulators, and 
legislators need to have realistic expectations about what the 
ISO can do and what it cannot do. The ISO is well suited to 
perform independent grid operation. The ISO is not well suited 
in running markets and procuring energy. What began as a model 
in the ISO as the air traffic controller of the interstate 
electricity grid has evolved to a point where the ISO is the 
pilot, the mechanic, the flight attendant, and the caterer, as 
well as the air traffic controller.
    CMUA would prefer that the ISO do a few things well, rather 
than try to do too many things not so well. CMUA has long held 
the belief that a minimalist ISO, one that focuses on reliable 
grid operation and open access to transmission, and stays away 
from markets and resource procurement, would best serve the 
interests of California and the West. This model will relieve 
complexity, reduce cost, and let the ISO focus on its core 
mission of running the grid.
    CMUA strongly supports market reforms that require load 
serving entities, whether they be municipal utilities or 
investor-owned utilities, to procure adequate supply with 
associated reserves and ancillary services to meet their 
customers' needs.
    In the old paradigm, this was called the obligation to 
serve. This obligation to serve was retained by our members, 
and needs to be re-created for any entity that wants to serve 
customers throughout the market.
    As noted in the audit report, the California ISO has 
relatively high costs compared to other ISOs throughout the 
Nation. Even though that report identifies those high costs, it 
does not fully capture the myriad of other charges that can 
accrue to customers as a result of the ISO operations. These 
miscellaneous charges can be significant, unpredictable, and 
ultimately dwarf the administrative costs.
    The audit states succinctly and accurately that the 
economic incentive for municipal utilities to join the ISO has 
simply not been there. The core reason is because the ISO 
market does not match our business model. We, the municipal 
utilities in this State, want to continue to be an integrated 
type of utility; we want to operate our generation and our 
transmission assets to meet our load.
    In conclusion, CMUA agrees with the audit report that the 
opportunity exists to solve the problems that have plagued the 
California electric utility industry since the inception of 
restructuring. Now is the time to redefine the California 
Independent System Operator's mission to better serve consumers 
in the State of California. CMUA is hopeful that this hearing 
and this audit report will be a step in that direction.
    Again, thank you for the opportunity to be here today.
    [The prepared statement of Mr. Feider follows:]
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    Mr. Ose. Thank you for joining us, Mr. Feider.
    Mr. Smutny-Jones.
    Mr. Smutny-Jones. Thank you very much, Mr. Chairman.
    My name is Jan Smutny-Jones, I'm the executive director of 
the Independent Energy Producers, and I was formerly chair of 
the Stakeholder Board of the ISO.
    When I was at the back of the room earlier today, Mr. 
Chairman, looking for my colleague's testimony, I came across a 
licensing application which was subtitled, ``Lost Dogs and Cats 
Find Their Way Home,'' and I hope at the end of the day we 
collectively find our way home here. I think that's very 
apropos.
    Mr. Ose. Mr. Smutny-Jones, that is out of order. I'm going 
to gavel you out of there.
    Mr. Smutny-Jones. Sorry, Mr. Chairman.
    What I'd like to do today is summarize my testimony by 
basically pointing out that at the end of the day we need 
several things to occur. One is, we need to continue the 
reliability of the overall grid. We need market stability, that 
is imperative both for a new infrastructure of investment and 
to ensure that our utilities become credit worthy, and we need 
an independent transmission organization.
    I spent a considerable amount of our testimony documenting 
how we got here, and I did that deliberately because I think 
recently there's been a significant amount of revisionist 
history in terms of ignoring the underlying fundamentals of 
what happened in California. Those underlying fundamentals are 
still there. We were over relying on the spot market, that was 
driven by hydro electricity in the Northwest, that hydro 
electricity was gone. We had a significant run up in demand. We 
had significant increases in gas prices. The point being, while 
things are stable now, what we just went through, which was 
traumatic and no one's idea of a good market structure or a 
good time can reoccur.
    I want to commend the committee for taking this step in 
terms of looking into this very, very important issue.
    The fact of the matter is, we've characterized this as sort 
of the perfect storm, which was a convergence of very adverse 
market fundamentals of historic proportions. This basic 
underlying market force ran into a market structure, which I 
think you've already heard a significant amount of testimony 
on, that was fundamentally flawed in the fact that it was 
basically completely dependent upon a short-term market. I 
think we should have learned from that.
    I would commend the ISO; they are looking at least with 
their market design reform at least trying to open up a 
capacity market which would go a long way toward providing some 
stability.
    The net effect of going short had a significant impact in 
terms of the run up of actual prices for the power in the West. 
That led to a long, agonizing debate that apparently continues 
today on price caps. And, as being the first person to 
authorize the use of price caps in the ISO, back in July 1998, 
I find it ironic that we are now in February 2002 and this 
still seems to be a topic. Price caps is arguing about 
bandages, we need to get to the fundamentals of the market 
structure and fix that.
    One of the key issues that we need out of all of this is a 
clear definition of market power, and this is something that 
hopefully FERC will be taking up. Right now, market power means 
different things to different people. We don't have a standard 
under which we know what one means when you abuse market power. 
Basically, what we need is the speed limit sign on the front 
end of the street so everybody knows what the rules are and 
everybody knows what happens if you violate them.
    I think that needs to be monitored on a regional basis, not 
just sort of that it be the basis from ISO to ISO in terms of 
the way it is being done now.
    With respect to governance the fact of the matter is, this 
is an integrated transmission system that services 11 States, 
two Mexican states, two Canadian Provinces. We need a clear 
governance structure of an RTO. I'd go that direction. I think 
the lack of political independence has undermined the ISO's 
credibility and its ability to address real operational issues, 
and I'm very much concerned that the lack of needed market 
reforms is not moving fast enough because of over deference to, 
in particular, the California Public Utilities Commission, and 
other political interests.
    I am not saying that the ISO should not coordinate with 
State agencies, far from that, but I, basically, think that 
it's very important to recognize that this is an interstate 
organization that needs to interact. I have a very high respect 
for the current ISO, I don't believe the Governor calls them on 
a daily basis and tells them what to do, but I don't think 
there's any question that the ISO board, as it is currently 
constituted, is a political board and was designed to do that. 
Simply put, I don't believe politics and physics mix.
    In closing, I think it's very important, as I said earlier, 
that we get to the fundamental market reforms that we need to 
do now, before we start seeing a run up once more in demand. We 
need a reliable grid. We need market stability, and I mean that 
from a political and regulatory sense, and we need an 
independent RTO. That will only be accomplished through 
significant State and Federal cooperation. So, we welcome 
further inquiry on this, and hopefully, will at the end of the 
day find our way home.
    Mr. Ose. Thank you, Mr. Smutny-Jones.
    [The prepared statement of Mr. Smutny-Jones follows:]
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    Mr. Ose. Finally, our last witness, Mr. Drabinski, welcome.
    Mr. Drabinski. Thank you very much, Mr. Chairman. I 
appreciate this opportunity.
    I won't take a long time. I think our report speaks for 
itself, and I'd be happy to answer all the questions that you 
have.
    I would like to make a couple points. When we started the 
audit, through auditing, using the standards of the tariff, and 
very shortly we learned that the causes fell way outside of 
tariff, outside the ISO. For that reason, with the agreement of 
the FERC, we decided to really address the overall problem, not 
the specific little pieces within the ISO, and the results of 
that were five global recommendations. I won't repeat them. One 
deals with fiscal stability, jurisdictional cooperation, 
process for interaction, market design, and the CAISO's role.
    They are so intertwined that without solving all of these 
problems in some logical sequence it is destined to continue to 
have a repeat of problems from the past.
    Mr. Winter is correct when he says that he's got a group of 
people that have worked very hard, and they've worked on a 
difficult situation, and many of the problems came from outside 
of his organization, and I agree 100 percent with that. He's 
got the finest, brightest people you could ever expect to 
assemble. He also has to deal with the problems of them dealing 
with their own day-to-day problems, and I think we addressed 
them in a fair amount of detail. However, he's correct in 
saying that many of the solutions are outside the reach of the 
ISO. I think that's why this group and others within government 
and regulatory agencies in California need to take action.
    The last point I'd like to make, I think everybody needs to 
leave this room with, is that the crisis in California still 
exists. A group of experts I brought in as part of our team, as 
we looked to where we were, we looked at the perfect storm 
scenario, and you've gone from the perfect storm to the perfect 
calm at this point, but all of the basics are still there and, 
in fact, with the implosion of Enron and the concern on the 
part of a lot of the major merchants for expending capital, I 
fear that a year or two down the road you could see another 
major problem occur, and people just need to keep that right in 
front of them all the time. With that, I'll just answer any 
questions you have.
    [The prepared statement of Mr. Drabinski follows:]
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    Mr. Ose. Thank you, Mr. Drabinski.
    Let me just go through this. Our witnesses, we have the 
chairman of the Federal Energy Regulatory Commission, Mr. 
Patrick Wood, we have Mr. Terry Winter, who is president and 
CEO of the California Independent Systems Operator, we have 
Richard Drom, who is the vice president and general counsel for 
the Pennsylvania, New Jersey, Maryland Interconnection, we have 
James Feider, who is the president of California Municipal 
Utilities Association, we have Jan Smutny-Jones, who is the 
executive director of the Independent Energy Producers, and 
Walter Drabinski, who is the president of Vantage Consulting, 
who wrote the audit that we've become so familiar with. I want 
to thank you all.
    Gentlemen, I did not adequately and appropriately introduce 
you prior to your testimony, for which I apologize.
    Now, we've had previous witnesses testify and I asked them 
a number of questions about the market mitigation plan; some of 
you I am going to ask similar questions.
    Mr. Winter, did the market mitigation plan work?
    Mr. Winter. I think as some folks have said we are now in 
the perfect calm and that had a lot to do with it. Did the 
market mitigation work? Yes, I think so. It identified a must-
offer component that put in the market units that for whatever 
reasons may have not been there before. Clearly in the West, it 
forced them to deal with the supply that we needed in 
California.
    I think probably the threat of hitting different price 
levels within their mitigation plan had a lot to do with people 
wanting to make sure that didn't occur, because as gas prices 
dropped from $15 down to around $60 or something, that trip 
wire would have caused the price to drop dramatically.
    So, yes, I think it helped. I don't think it was the only 
thing. I think the availability of power, more hydro, etc., we 
were importing a year ago this time anywhere from 1,000 to 
2,000 megawatts, now I'm importing anywhere from 8,000 to 9,000 
megawatts. That makes a tremendous difference.
    Now, some of that is due to long-term contracting, most of 
it is due to available hydro in the Northwest and additional 
capacity in Arizona. So, I can't just say by itself it did 
everything, but it's something I would want as a back stop as 
we move forward, if we do not have a new design completely put 
in place and the financial ability of people to protect their 
positions is not there.
    Mr. Ose. Mr. Smutny-Jones, same question, is the mitigation 
plan working?
    Mr. Smutny-Jones. I think the market fundamentals had a lot 
more to do with driving prices down and stabilizing the market 
than did the market mitigation plan.
    What troubles me most is that while the market mitigation 
plan was designed to be a short-term solution to a problem, we 
are still not addressing the underlying problem. And we can 
argue about whether or not we need to leave the band-aid on any 
longer, but I think we need to be dressing, if you will, the 
wound, and we are not doing that. And, that really is at the 
heart of the issue.
    We, as I said, have spent literally 4 years arguing about 
price caps, which was an early form of the price mitigation 
measure, and we are having the wrong debate. What we should be 
doing is making sure that there's adequate tools that address 
the types of price run ups that we have seen, and if you do see 
something that's causing the market some trouble, that's 
relatively limited in terms of its impact and duration.
    Mr. Ose. So, Mr. Winter, you believe that there's some 
value to continuing the market mitigation plan, Mr. Smutny-
Jones you think there are limitations to continuing the market 
mitigation plan.
    Mr. Smutny-Jones. Yes, I do, I think we would be better 
spending our time between now and September 30th coming up with 
something that obviates the need for the current market 
mitigation plan that's in place, and my concern is that times a 
wasting and we are not focusing on those issues.
    Mr. Ose. Mr. Winter.
    Mr. Winter. I would like to respond to that from this 
standpoint. One of the things that I think is crucial as we go 
forward is what we are calling the capacity, you know, the A-
cap design component. I find it very difficult to justify that 
in an arena where I have a bankrupt entity that I'm asking to 
now go out and buy capacity, and yet it has no financial 
wherewithal to do that.
    And so, while I agree totally with Jan, my concern is that 
we are not able to get the proper balance until such time as 
those entities become financially capable to enter into those 
negotiations on an ``even'' basis, so that you have the 
supplier with some competition and the buyer with the ability 
to shop the market, rather than be held hostage to any one 
person.
    Mr. Ose. Chairman Wood, would you comment on the reasons 
why FERC has set a deadline of September 30th for the market 
mitigation plan?
    Mr. Wood. Well, quite frankly, the State government in 
their pleadings last year asked for two summers, and so rather 
than do August 30th we did September 30th, just to get through 
the full summer.
    So, that was longer than I think we were inclined to do at 
the FERC, but we all voted for that, and we supported that 
date, and I think we stuck to it, but I think we also, as Mr. 
Smutny-Jones just pointed out, made that kind of cooling off 
period time so we can get some healing done here, get new 
infrastructure on the ground, and get market rules rewritten.
    And, I should add some observation that attached to Terry's 
was a good chart that he had, that the California ISO and their 
staff had put together as a draft for discussion by parties out 
here, that I think clearly is a very positive step forward in 
getting that done.
    Time is short, but quite frankly we do need an incentive to 
get this done, and the expiration of that date at the end of 
the summer is to me a tight timeline but sufficient to get 
going. There's a certain level of detail in this document in 
the detail that the Commission is talking about for national 
standards, so clearly they've got that going and I think it 
needs to be converted into some detail. I certainly envision 
that the Commission, through its staff, will be helping to 
participate in that effort, but I do think that, really, a lot 
of the right things are in the plan here, and I just would 
encourage Terry and all the folks out here to really take this 
seriously and move forward on that in an aggressive timeframe.
    Mr. Ose. Do you think the deadline serves a valid purpose 
then?
    Mr. Wood. Yes, sir.
    Mr. Ose. I want to go on to the independence, the purpose 
for which Mr. Drabinski was engaged. Chairman Wood, why did 
FERC think it necessary to commission an audit of CAISO? I 
mean, is this unusual? Is it unique?
    Mr. Wood. It's our first, it won't be our last. I think we 
view the ISOs as real extensions of Federal Power Act authority 
to the regions. As I mentioned, it's unusual California happens 
to be a region contiguous with the boundaries of the State, but 
the other ISOs that are up and operating and the new formed 
Midwestern RTO cover multiple states, and I expect that we, in 
our responsibility, fiduciary and otherwise, to the American 
people, want to make sure that these organizations work well.
    This is one that clearly was under a significant amount of 
stress. Issues were raised in a significant number of pleadings 
that when I came to the Commission inherited about the 
independence issue that was written up substantially here and 
has been discussed today.
    And, I really, quite frankly, for me, I know the other 
Commissioners might have their own reasons, but I needed just 
some objective eyes to look at this, kind of outside of the 
policy realm, and tell me exactly what is the implication of 
how this organization is running on the effectiveness of that 
market.
    Mr. Ose. And, I presume that if circumstances arise 
elsewhere in the country where you have similar concerns, 
audits there will be requested, too?
    Mr. Wood. We may not wait for there to be a stress or 
crisis there. I think it's probably something we want to do 
routinely. In fact, I've set up an Office of Market Oversight 
and Investigation that will be kind of continuing liaisons with 
the market oversight institutions, which is a part of what the 
ISO does, but I expect that we'll use our allocated resources 
from Congress to keep good tabs on all the ISOs, up in New 
England, New York, Midwest, PJM as well.
    Mr. Ose. Tell Mr. Drom, not me.
    Mr. Drabinski, I've read the audit, I want to hear in your 
own words your description of the level of the independence of 
the Board of Governors to CAISO.
    Mr. Drabinski. Certainly.
    Let me start out by saying, we weren't retained to look at 
the independence issue. We were retained to audit the tariff.
    Mr. Ose. But, you did get some input on it.
    Mr. Drabinski. Well, it was clear from the get-go that it 
was a major issue, however, we were taking a much broader 
approach. What constantly rose to the surface as we interviewed 
management, middle-level employees at the ISO, as we talked 
with the various players within California and the major load 
serving entities and generators, is that the issue of 
independence just came up and it became the linchpin issue that 
we needed to address.
    Mr. Ose. Now, Mr. Wright earlier today cited an example 
where somebody working at Sempra didn't have a comprehensive 
view of the whole picture and they, frankly, made some comments 
that proved to be inaccurate. To what degree can you satisfy 
our concerns that the feedback you received on governance was 
not, or lacked knowledge of the larger picture?
    Mr. Drabinski. Well, I think by the breadth of our 
interview and analysis; we looked at all of the board meetings, 
all the decisions from the original stakeholder ISO through to 
the existing board. We looked at the types of issues that they 
face, the decisions that were made and not made. We interviewed 
all of the senior management with specific questions, as to 
whether they believed the current board was (A) independent and 
(B) addressing the short-term and long-term decisions that 
needed to be addressed.
    But then, we went out and we talked to every major 
generator and every load serving entity. I say we talked with 
them, we went to Houston, we had conference calls in Salt Lake 
City, L.A., San Diego, San Francisco, Washington; we were 
flying all over the country over a period of 2 or 3 weeks. In 
each case, we would sit down with a group of as many as 8 or 10 
representatives of Reliant, and Mirant, and Dynagy, with people 
from--regulatory people right on down to the nuts and bolts 
operations people. So, there was such a consistent message from 
every level, from every type of organization that we spoke 
with, that there was no question in our mind very quickly that 
the perception of independence, of lack thereof, existed with 
virtually every player that has to deal with the ISO on a 
regular basis.
    Mr. Ose. Were these interviews--obviously, you kept the 
notes, but in reading the audit the identities of the people 
participating were kept out of the audit.
    Mr. Drabinski. We did that intentionally. We did not want 
any individuals to be reluctant to speak freely because their 
name would be included in the report. We have the notes that we 
took.
    Mr. Ose. You took input from all sorts of market 
participants, did you visit with Mr. Winter, or did you visit 
with anybody who works with Mr. Winter?
    Mr. Drabinski. We interviewed 25 people at the ISO, 
including, I believe, we interviewed every officer, most of the 
department heads, the chairman of the Board of Governors, one 
of the other members of the board. We submitted numerous 
information requests with specific questions that needed to be 
answered in detail.
    We had a number of meetings with the entire management of 
the ISO.
    Mr. Ose. So, it was full-scale, it was comprehensive.
    Mr. Drabinski. Oh, absolutely.
    Mr. Ose. I mean you didn't just take one side, or this 
side, or that side.
    Mr. Drabinski. We met with representatives from the 
Electric Oversight Board. I met with Mr. Smutny-Jones as a 
representative of the industrial generators. I met with a 
representative of CDWR. We had a number of meetings with the 
CPUC.
    Mr. Ose. Right. My concern was the comprehensive nature of 
who you met with.
    Let me ask you a question. From your interviews, what types 
of operational problems arose that the people you interviewed 
attributed to a lack of independence?
    Mr. Drabinski. There was a general consensus that while the 
operational people at the ISO would oftentimes reach a one-on-
one consensus of what needed to be done, but then it got around 
to the legal and regulatory flagpole and went to the board, and 
somehow things got changed and stopped, and the view was that 
all the people in the pits at the ISO were trying to do the 
right things, oftentimes there was direction from the Board of 
Governors that precluded them from implementing what they would 
have liked to have implemented.
    Mr. Ose. Well, how is that unusual? I'll give you an 
example; I get all sorts of suggestions from my staff about 
what I should or shouldn't do. Sometimes I do it and sometimes 
I don't. I mean, why is that unusual?
    Mr. Drabinski. I think the difference here is that we 
operate an electrical system; it's done on an instantaneous, 
minute-by-minute basis. Typically, once the rules are set the 
people in the field work out deals, they are cutting deals, 
buying and selling, making sure that the lights are on. When a 
deal is cut, and the details of the transaction are agreed 
upon, that's pretty much what they are.
    And there's very seldom a legal representative or some 
senior management person then coming back and saying, no, we're 
not going to do it that way, or we're changing the way we 
interpret the rule, and the view of many of the participants 
were that often times there were people in the back room who 
were stepping in.
    Mr. Ose. The interviews you conducted indicated there were 
people in the back room?
    Mr. Drabinski. That's correct.
    Mr. Ose. All right. Thank you.
    Mr. Smutny-Jones, your members are independent energy 
producers, they deal with this on a day-to-day basis. Can you 
give us some examples of how this lack of independence is 
hampering either your operations or the function of the market 
as a whole?
    Mr. Smutny-Jones. I think the best example, actually, you 
talked about previously with Mr. Wright and Mr. Pescetti, which 
is this maintenance standard issue.
    Last year, the Governor actually issued an Executive order 
that there become a maintenance coordination and maintenance 
standards be set. The ISO went to work doing that; my members 
spent a significant amount of time and energy in the 
stakeholder process to put together both a coordination 
protocol and some standards.
    The coordination protocol was filed at FERC. They did adopt 
it. The standards, basically, were adopted by the Board of 
Governors of the ISO on November 7th of last year, and my 
understanding, with the instructions that staff solicit input 
from the members.
    Mr. Ose. November 7, 2001?
    Mr. Smutny-Jones. Correct, and solicit opinions from the 
Public Utilities Commission, which by the way, could have, and 
maybe did participate in the promulgation of the standards in 
the first place.
    That was on November 7th. We had been involved in this 
battle with regard to the proper role of the PUC with respect 
to inspections of power plants throughout last year and into 
the beginning part of this year. We still do not have those 
standards filed at FERC. Let me be very specific, I have no 
evidence that anybody has told Mr. Winter do not file those 
documents, but I think that there is the concern about, and 
this is what I meant by an excessive deference to the Public 
Utilities Commission. Those standards need to get out there so 
they can be approved and we can get on with making sure that 
these power plants are operated according to standards that 
everybody understands.
    Mr. Ose. Let me make sure I understand. The November 7th 
document you are talking about, were they draft standards?
    Mr. Smutny-Jones. My understanding was these were standards 
that were voted upon by the Board of Directors. Our opinion is 
that they are ready for prime time, and that the staff was 
asked to coordinate with other agencies, which is fine, but 
again, we are now at the end of February and it's time to get 
down to the business of getting those maintenance standards in 
place.
    Mr. Ose. So, give me some examples of how the lack of these 
maintenance standards is impacting you.
    Mr. Smutny-Jones. Well, right now there's a significant 
amount of a grand conspiracy theory, that somehow people are 
breaking their power plants to adjust prices in the wholesale 
market. I think the facts do not demonstrate that at all, in 
fact, these power plants run significantly higher in 2000 and 
2001 than previously. But that aside, people do take their 
power plants out for specific maintenance requirements, and 
what would be nice is a set of standards where people could 
basically say, we took our plant out according to a schedule 
that we submitted to the ISO for the following reasons to 
address the following issues, and there's no question that the 
power plant needed to go down for maintenance.
    We don't have that right now. As Mr. Wright indicated 
earlier, the PUC has apparently conducted about 800 
inspections. To date, we don't believe they've found anything 
because they haven't reported in the public record any problems 
they found with the maintenance of power plants. But, this 
still hangs over the overall ability of generators to take 
plants out when they need to, basically, provide basic 
maintenance.
    Mr. Ose. All right.
    Mr. Winter, is Mr. Smutny-Jones accurate in the sense that 
the ISO board did adopt maintenance standards on November 7th? 
Is that accurate?
    Mr. Winter. I do not remember whether we had a board 
meeting on November 7th. I thought it was near the end of the 
month.
    Mr. Ose. But, they've been adopted.
    Mr. Winter. I could be wrong.
    Mr. Ose. OK. So, let's say on or before November 30th.
    Mr. Winter. OK.
    Now, what you have to understand is, what we bring to the 
board is a program, and I would like to go into the maintenance 
standard because I think it's an example of a lot of things 
that can happen, but just very quickly, our process is that we 
develop a program and go to the board and say, ``board, we 
would like to have your approval to prepare the documents to go 
to FERC.'' And so, the board--and again, I'm sorry, Jan, I 
don't remember exactly which day it was, but the board, at that 
time, said that yes, they really liked the program we had put 
together, but would we please get with the PUC and the 
regulatory EOB and others and discuss what changes they would 
like in them.
    At the same time, we began to prepare what we call the 
final language that we then have to file at FERC. At the time 
it's a program, it is nothing but a program, then we have to 
prepare all the legal language that then makes it acceptable 
where FERC can look at it and say, yes, that's in your tariff, 
or it's not in your tariff, or it's in your protocol.
    So, between November the--let's say the 28th, we began 
preparing that; we call it FERC language for short cuts, and 
during that time we met with the PUC. They wanted some things, 
and we could not come to an agreement of whether or not we were 
going to put in some of the requests that they had.
    In the meantime, we had the stuff going through the 
legislature. Coupled with that, I was given some very strong 
instructions from the board that we had to start cutting our 
cost. Generator maintenance was not a program that the ISO 
looks at as part of its core business, and the reason it 
doesn't is we are very, very concerned about the scheduling. We 
schedule with transmission lines and generators almost 38,000 
outages a year, and have to combine all of those. So, up until 
last year we didn't have authority to do the scheduling.
    We filed at FERC, they gave us that authority. We now have 
the authority to handle the schedules, but the maintenance of 
the generation, all I am really concerned about is an 
availability factor. If the unit is available 92 percent of 
time, that's a good standard, that's what people do. I don't 
necessarily have to go in and inspect the plant and work on it, 
but because the Governor had asked that we develop this plan we 
went ahead and did what we call a preventive maintenance plan, 
and to do that we involved the generators and everyone else and 
we felt that was a good way to go.
    Who does it did not matter to the ISO, whether it's the PUC 
or ourselves.
    Mr. Ose. I think you bring up an excellent point. You are 
responsible for scheduling.
    Mr. Winter. Right.
    Mr. Ose. How can you schedule if you don't also align the 
schedule with the maintenance programs?
    Mr. Winter. OK. The way we do that is, the generator comes 
to us and says, ``We want to schedule an outage for such and 
such a timeframe.''
    Mr. Ose. Right.
    Mr. Winter. What normally happens is, they all want to 
group around different periods of time, in other words, 2001, 
after we had run the units hard all summer, October, everybody 
wanted to go out, and that's what brought us to filing to FERC 
to allow us to schedule those.
    What we do when we get that request is, we ask why are you 
taking it out? And, they will give us several reasons. One is, 
boiler tube leaks. Some will be, I split the tubes and I'm 
taking it out no matter what, because it's not operational. 
Some will be for preventive maintenance or annual maintenance 
on a unit, and they will ask for 4 weeks. Others will say air 
quality modifications that we have to put on. So, we take all 
of those, put them on a large scheduling chart, and then we 
start calling the generator and say, OK, you want preventive 
maintenance, you need 3 weeks, we agree everybody needs 3 weeks 
once a year, can you shift it to December instead of October 
15th?
    So, I don't have to know all the details of their 
maintenance program to actually schedule them, all I am is a 
big clearinghouse that's trying to make sure that they get 
their time for maintenance, that they get their time for 
whatever happens.
    Mr. Ose. OK, so you don't need to know why they need to go 
off, you just need to know whether they need to go off.
    Mr. Winter. And when they want to.
    Mr. Ose. And when, right.
    Mr. Winter. And then, I try to work with them to make sure 
that they get the time they need, at the same time not letting 
everybody go at once.
    Mr. Ose. You are responsible for scheduling----
    Mr. Winter. That's correct.
    Mr. Ose [continuing]. When the plants are up or when they 
are coming up?
    Mr. Winter. I have to maintain that authority, because I'm 
balancing it with transmission line outages, and, you know, we 
do several hundred a day that we're switching out.
    Mr. Ose. So, why are we waiting on the PUC on the 
maintenance standards?
    Mr. Winter. Because they are really not an issue that I 
have to have before the FERC. I mean, I have the authority to 
do the scheduling now.
    Mr. Ose. But, you can't schedule without knowing what the 
maintenance schedules are.
    Mr. Winter. Well, they will tell me, the generator will 
come in and tell me what the maintenance schedules are.
    Now, the question is, do we, as either the PUC or the ISO, 
need to get in and determine whether these are appropriate 
maintenance issues.
    Mr. Ose. You need their authority to make that decision.
    Mr. Winter. That's right.
    Mr. Ose. But, apparently, the PUC is electing to make the 
decision.
    Mr. Winter. Correct.
    Mr. Ose. As to whether or not to supercede, for instance, 
the manufacturer's recommended run rate and what have you.
    Mr. Smutny-Jones. And, that's a problem.
    Mr. Ose. I'm sorry?
    Mr. Smutny-Jones. That would be a problem. That would be a 
serious problem.
    Mr. Ose. Well, why wouldn't the PUC be able to dictate to 
the manufacturer what the run rates on the equipment should be?
    Mr. Smutny-Jones. I think you'll end up with a lot of 
broken equipment. I do not believe that the PUC has any 
fundamental basic expertise in that area. I think what is 
important about all this is that we have a commonly understood 
set of standards, so if someone takes their plant out to fix a 
boiler tube everybody knows why that's important.
    Mr. Ose. OK.
    Mr. Smutny-Jones. And it is coordinated. Believe me, we 
believe that coordinating the schedule of outages is a very 
important thing. It's a positive thing, but we need one set of 
standards, not two. We don't want a set of standards that the 
ISO has in place, and then a second standard that the Public 
Utilities Commission has in place.
    Mr. Ose. All right, let me cut to the chase. How do we--
quit the mumbo jumbo and get it to the point where he can 
schedule and you can run?
    Mr. Smutny-Jones. We have a schedule and what we would like 
to see is the tariff amendments that we understand have already 
been adopted by the board filed. If the PUC has comments that 
they want to make on those, they are perfectly capable, just 
like we are, to make them in front of you.
    Mr. Ose. You just said you haven't adopted tariffs, you 
have adopted scheduling only.
    Mr. Smutny-Jones. There's two sets of issues here, Mr. 
Chairman, let me see if I can clarify this. There is a 
coordination protocol, which I believe was filed some time 
earlier last year, April/May timeframe. I may have these dates 
wrong, but don't hold me to that, but that coordination tariff 
the FERC has already given Mr. Winter the authority.
    The second sort of prong here is maintenance standards, in 
other words, an identified sort of understanding of how plants 
will be maintained, to assure their availability to the ISO. 
That is what is in dispute here.
    There is, as I said, a separate political effort in 
legislative to give what we view as an extraordinary power to 
the Public Utilities Commission to adopt maybe even different 
maintenance standards, and we can't live in a world where 
you've got two different maintenance standards. That's the 
issue.
    Mr. Ose. Mr. Drom, how do you handle this at PJM?
    Mr. Drom. All the generators are required to coordinate 
their schedules in advance with us, and we approve the 
coordination. As Terry was saying, they do it with the CAISO, 
to ensure that there is reliability at all times.
    We do not need the authority to force people to maintain 
facilities at particular times, because we have a collaborative 
model where we get everybody in the room together and say, OK, 
everybody wants to do it October 15th, how can we solve this 
problem? People volunteer for different times and then we work 
it out voluntarily.
    Mr. Ose. So, from your perspective, do you or do you not 
think there's any reason to go ahead and file this scheduling?
    Mr. Drom. I think that's beyond my level of expertise. I 
mean, the issue of whether generators should have specified 
criteria seems to be a hot issue in California, because, as Jan 
has said, there are allegations that people are doing it 
improperly.
    In our area, there's no allegations like that, we have a 
very effective market monitoring unit which verifies issues 
like that and does studies, and we have not found any instances 
where any generator in PJM has intentionally withheld like that 
because of alleged maintenance problems.
    So, our situation is different than California.
    Mr. Ose. All right. Well, I have to admit there's some 
confusion as to why it is we can't move this ball forward.
    Mr. Drabinski, again, I've read your audit. You have at 
least passive familiarity with the many challenges we have here 
in California. Is the Board of Governors of the ISO effective?
    Mr. Drabinski. No.
    Mr. Ose. How do we fix it?
    Mr. Drabinski. Well, I think the fix is to implement a 
board of Governors, and I say no for the long run, for the 
long-term solution, the answer is no. I think over the last 
year they've faced a challenge that they had to do, going 
forward you need a board of Governors that, first of all, is 
perceived to be effective, by all the players, so that you then 
get input and involvement on an active basis by the players, 
not strictly to legal challenges.
    You need a board of Governors that begins to look at long-
term strategies, long-term capital, budgets, market reform 
issues, with the expectation that they are going to be there 
for some years.
    Mr. Ose. How do you ensure that occurs? I mean, the PUC 
guys, they serve specified terms.
    Mr. Drabinski. Well, I think, let's look at the existing 
board. All of the existing board thought that they were brought 
on in a stop gap measure until the crisis was solved.
    Mr. Ose. Is that what they told you?
    Mr. Drabinski. The chairman told me he didn't expect to be 
there more than a few months. And, I think I read something 
recently where after reappointment Mr. Flosio made a comment 
that even criminals are paroled occasionally, and I'm 
paraphrasing that.
    So, I mean----
    Mr. Ose. You are not saying anybody is doing anything 
inappropriate.
    Mr. Drabinski. Oh, no, no, no.
    Mr. Ose. OK.
    Mr. Drabinski. Their point was, they expected to be brought 
on for a short period of time, while the crisis was resolved, 
and then they could go on to their normal lives.
    When you bring in a professional board, you are bringing in 
a group of people who are brought on, they are receiving some 
compensation, they have specific expectations. The firm that 
does the selection are selecting people who know that they 
are----
    Mr. Ose. Describe the characteristics of a professional 
board. We know what the characteristics of the existing board 
are; describe the characteristics of a professional board.
    Mr. Drabinski. Well, it typically would be individuals who 
have a general level of professional expertise in the areas of 
banking, whether it be legal banking, financial, engineering, 
education, energy.
    Mr. Ose. Why would you put a banker on the board of 
Governors for the CAISO? Why wouldn't you put an energy person, 
either on the consumer side or----
    Mr. Drabinski. Well, I think you would want one of each.
    Mr. Ose. Do we have that now?
    Mr. Drabinski. No, without looking at the resumes of the 
existing five, I don't believe--first of all, you would not 
have anybody on the board that probably has a vested interest 
in, oh, industrial activities in California. So, most boards 
generally have people who are either from outside the State or 
if they are within the State they are academic experts or 
retirees.
    Mr. Ose. Let me interrupt here.
    Mr. Drom, how do you deal with this at PJM, your Board of 
Governors?
    Mr. Drom. Yes, our board was established by an independent 
consultant based upon the protocols in the operating agreement, 
page 3 of my testimony lists that corporate leadership is one 
of the elements, professional disciplines of finance or 
accounting, engineering, utility laws and regulation, 
transmission dependent utility experience, experience in 
operation, planning of transmission systems, commercial 
markets, trading, risk management. We don't have a single 
category for each individual board member. We just have a group 
of characteristics and we try to fill a board that has all of 
those traits. And, our current board actually does demonstrate 
every one of those traits.
    Mr. Ose. OK. There's a chart on the podium right behind Mr. 
Drom and Mr. Feider; can we go to the overhead please? You just 
need to move it right down in that white square. There you go.
    Does this accurately reflect what you are talking about in 
terms of skill sets and the like?
    [The information referred to follows:]
    [GRAPHIC] [TIFF OMITTED] 82667.116
    
    Mr. Drom. I'm sorry, but my eyes aren't good enough to read 
that.
    Mr. Ose. Use this.
    Mr. Drom. Yes, we have independent members. We do have 
seven members. Members were selected by an independent 
consultant and then approved by the members committee. We have 
a very strong stakeholders committee, and all members, 
including ex-officio members from the States, are entitled to 
be on it.
    Mr. Ose. Well, as I look across that top line, every single 
one of them is an independent, made up of independent members, 
and there's six, seven, eight, nine. On that second line, you 
have different membership and the source of the selection is 
based on the skill sets they bring to the table, is that 
correct?
    Mr. Drom. I can't vouch for the lines except PJM, but I do 
believe that a board like the PJM board does demonstrate the 
characteristics of independence that lead to success.
    Mr. Ose. The members of the board that you are familiar 
with, are they subject to legislative confirmation?
    Mr. Drom. Not at all.
    Mr. Ose. Who appoints them?
    Mr. Drom. An independent consultant selects a slate of 
candidates, and then the members approve them. They have 
staggered 3-year terms.
    Mr. Ose. So, let's say the six of you currently serve on 
PJM, and one of you wants to retire, you would engage the 
services of an independent consultant, they'd give you a list 
of potential candidates, and then you'd decide who it was that 
you were going to select.
    Mr. Drom. The board issues to the members a slate of 
candidates for the members' approval, and either two or three 
have gone up each year for the members' approval, yes.
    Mr. Ose. When you say the members' approval, you are 
talking about the participants in the industry, would that, for 
instance, involve Mr. Winter? I mean, explain to me how it 
works.
    Mr. Drom. Yes, I'd be happy to.
    The members committee that PJM has, it's a two-tier 
governance that FERC has endorsed in the past. The Board of 
Governors are at the top, and a very vibrant members committee 
is below. It's composed right now of four sectors: generators, 
transmission owners, end users, and load serving entities. All 
the members, the 200, fall in one of those four categories, and 
they divide up the vote for each category.
    So, if there are 25 generators, each gets 1/25 of a vote in 
a sectoral voting arrangement. It takes a two-thirds sectoral 
vote to pass anything at PJM, and in this case to approve the 
board it takes a two-thirds sectoral vote. So, we have a very 
vibrant input by our stakeholders, and if our board members are 
not achieving their goals, the stakeholders have a very easy 
way, when their terms expire, to just replace them with someone 
else.
    Mr. Ose. Now, Mr. Smutny-Jones and Mr. Feider, FERC 
proposed a similar formula for California, for choosing a 
board, and I perceive from your written testimony that there's 
some discomfort you have, the two of you, in terms of the 
current board. Would this new formula, if the Board of 
Governors were based on the FERC formula, would it satisfy the 
concerns you have?
    Mr. Feider. I would have to take a look at the formula 
proposed by FERC, but from the Municipal Utilities perspective 
we support the model that PJM has for independence, independent 
board members are put forward.
    Mr. Chairman, you may or may not be aware of the evolution 
of the Western Systems Coordinating Council that has been 
changed into the Western Energy Coordinating Council, and a 
similar board approach by member class is being used. And, 
although the Municipal Utilities haven't agreed on a specific 
model, those types of models are the ones that we'd like to 
see.
    Mr. Ose. Where you have some stakeholder participation.
    Mr. Feider. Yes, we think independent board members with 
strong stakeholder participation is an important element.
    Mr. Ose. Mr. Smutny-Jones.
    Mr. Smutny-Jones. We would agree with that completely. I 
think I have to publicly admit Mr. Drom and I used to have a 
public debate over whether or not independent boards or 
stakeholder boards were a superior way of going. He won the 
debate.
    The stakeholder board, while in its inception the ISO did, 
I think, a phenomenal job of creating the ISO, putting together 
a staff that is second to none, basically, started falling 
apart when we were put into a rule of quasi ratemaking, which 
is what we were basically doing in the summer of 2000.
    And, in that process, I think we lost the confidence of 
FERC and we lost political legitimacy here in California. It 
was replaced by the current board. I don't think there's a 
debate that in the current board independence was the watch 
word.
    In terms of going forward the stakeholder process needs to 
be reinvigorated, because I think we end up with a better 
product and we need an independent board.
    We also need an independent board that has political 
legitimacy, not only in California, but throughout the rest of 
the West, and this is where it gets tricky, because California, 
rightly or wrongly, has a persecution complex right now, and 
the concern about who runs the ISO is obviously a significant 
political issue, and we need to kind of figure out how we 
transition to a board of professionals that can actually 
operate the system.
    It shouldn't be that--I have to believe that the political 
leadership of Pennsylvania, your colleagues in Congress, the 
Governor, the Pennsylvania Legislature, worry as much about 
their constituents as the political leadership here in 
California. Yet, somehow Pennsylvania has their transmission 
system operating in a multi-state, with an independent board. 
So, I think it is doable and it's the preferred model.
    Mr. Ose. Mr. Winter, any feedback?
    Mr. Winter. I was going to just say I didn't want to 
respond to any questions on the board. Holding that thought 
that I made later, if you continue to question me, take the 
fifth, I would like to make a couple of comments.
    No. 1, I served under two boards in this corporation now, 
and I think both of them met a tremendous need at the time. The 
stakeholder board, when we were starting up, it was a way to 
get a lot of buy in. It had very knowledgeable people right 
down to, you know, how I should write my memos.
    The new board clearly came in with a mandate, and I'm not 
so sure one of them wasn't to get rid of me, but, nonetheless, 
they did not do that, and I have to say that on day-to-day 
operations clearly that is--I have been given the leeway to do 
what I thought was required.
    I get along with the new board just like I try to get along 
with everyone. I think the biggest issue that I see is the 
perception, that it is not what people want in 
``independence.'' And, I think clearly there the State and FERC 
have to work together to determine what is the proper structure 
for ISOs.
    While I'm on this subject, there seems to be the idea that 
if you form an RTO the ISO isn't necessary. I think whether you 
call it a control area or an ISO, that to get the local, and I 
won't call it regional because to me regional is the Western 
United States, but to get local input you are going to need 
local ``ISOs'' or some forum that allows for the immediate 
constituents to get their input into how the system operates in 
a bigger scheme. Then I think once you go multi-state then 
clearly you've got to have an independent board that is made up 
of people that are from the industry, or independence there of.
    Mr. Feider. Mr. Chairman, I'd just like to add one further 
thing to my comments.
    We believe that designing the board, the independent board 
that we all are striving for, will be made easier by first 
establishing the mission of the independent system operator, 
that if their mission is confined to grid management, grid 
operations, that board will be easier to form and easier to 
design.
    Mr. Ose. Well, you did make clear that you thought that was 
the appropriate role of the ISO, as opposed to running the 
markets and procuring electricity.
    Mr. Feider. Yes, that's correct.
    Mr. Ose. OK.
    I do want to, Mr. Drabinski, I want to go back to 
something. You've made extensive recommendations in terms of 
improving the cooperation among the regulatory agencies, and 
you held what I would call a special role for FERC. Could you 
describe those recommendations for us?
    Mr. Drabinski. Certainly. One of the recommendations, let 
me read it, for improving the cooperation, is to develop among 
FERC and the various California regulators and agencies formal 
policies committed to enhancing cooperation in the design, the 
subsequent oversight of the California electric industry.
    When we looked at the players, and there are a myriad of 
them just within California, would be the legislative, the DUC, 
the Energy Commission, CERS, power authority, you know, then 
you've got FERC, you've got Congress itself, and one that I 
left out, I can't believe it since my background is finance, 
certainly is Wall Street, because without the capital markets 
buying in to what's going on in California you are not going to 
get the development that's required, or the credit readings 
that Terry needs in order to have offices that are a suitable 
size for the employees.
    I think that our point, and we've made some specific 
comments in the report, that it's time to put politics aside, 
it's time to put the blaming individual groups or parties 
aside, to sit back and say what is the correct overall 
solution. What role should everybody be playing on a long-term 
basis, you know, get through the crisis, get the system set up 
right, and then look to see what you need to go forward in the 
long term.
    I think someone made the point that in other parts of the 
country they've been able to do this, gotten away from the 
politicizing of the decisions role. FERC has to be the leader. 
FERC, ultimately, is the one that controls the interstate and 
the transmission elements of the ISO, and they've got the 
greatest leverage for getting things done. Unfortunately, they 
don't have the opportunity to make 100 percent of it, the CPUC 
and the other parties that I mentioned also have to play, and 
if they are at odds, I'm one of the parties to going forward, 
and I guess what we tried to express in the report is that 
California citizens, billions and billions in the last few 
years, and if you want to avoid it in the future it's time to 
put the politics aside and a real solution. We think FERC is 
the natural focus point. I think someplace in our report we 
have a triangle that shows the ISO, the customers and FERC, 
they are the natural point of authority here. And, to the 
degree that the State legislature has to come to some 
agreement, or some acquiescence, I think it's time for that to 
occur.
    Mr. Ose. Mr. Wood, that's quite a load.
    Mr. Wood. We're up for it. I mean, that's partly what we 
asked for, managed to do the audit, we expected there would be 
some recommendations coming out that we were going to have to 
do, and that's why it's helpful sometimes when you are trying 
to think through a new process that we are not particularly 
adept at to have somebody come in and make a suggestion. We've 
asked parties, ISO a couple days ago, and then all the other 
interested parties, to respond to his audit, and particularly 
we asked them to prioritize the 19 things that he suggested be 
done, a big part of which is the role of FERC in being the 
facilitator or convener of the multilateral process, to really 
get back to the table and negotiate this stuff back out, 
because it is, I mean, I heard from the first panel there's a 
strong State interest here of, you know, we could do a lot of 
things on the wholesale level, but if the State doesn't have a 
corresponding retail match up to it, which we heard about 18 
months ago, it doesn't work.
    And so, as much as FERC has to do to set up the wholesale 
market, it is integrally connected to the rest of the picture. 
So, without question, we do have to work in a bilateral or 
multilateral mode, and we are up for it. I'm getting staffed 
for that effort. We have to also include the non-California 
parties in the West in that effort as well. So, it is--yes, 
sir, to answer your question, we are up for it.
    Mr. Ose. It is not going to be easy. I want to shift here a 
little bit. We've talked a lot about the governance issue. 
Ultimately, when rubber meets the road it's the market design 
piece of this.
    Now, Mr. Drom, you've talked about locational marginal 
pricing, can you explain that to us in English?
    Mr. Drom. As an attorney, I can give you a very simplified 
explanation. But when you dispatch a system, you try to keep 
the lights on at all times; you have a multitude of generation 
sources that you can rely upon. At PJM, over 75 percent of the 
time when we dispatch more generation in an economic order the 
prices rise everywhere at the same time. That's our normal 
situation, because if we only need, you know, 20,000 megawatts 
we'll have like $15 power, but as we ask for more megawatts 
they charge more. It's just the nature of the way generation is 
scheduled into our system.
    Occasionally, and in some places it's frequent and in some 
places it never happens, we have congestion. Where there's 
congestion, it means that----
    Mr. Ose. Congestion on the transmission lines.
    Mr. Drom [continuing]. On the transmission, the wholesale 
transmission system. I'm not talking about retail or low 
voltage lines, I'm talking about the big lines.
    Mr. Ose. The 500 kilovolt lines.
    Mr. Drom. We control down to 69 in some areas, up to 500 
for sure.
    Mr. Ose. OK.
    Mr. Drom. At some times during the system you can't do 
that. In order to serve a particular load you have to dispatch, 
meaning tell a generator who is higher than the normal cost, to 
go out of order and generate.
    Now, there's two solutions to that. One is you spread the 
costs among everybody, and that's what many organizations do, 
and the other is locational marginal pricing. And that simply 
means the area where the higher cost generation is produced 
pays more than everyone else. So, there's disparity within the 
system.
    Now, we have got it down to like 1,700 different points in 
our system, so we have very fine granularity over a five-State 
area, and with those 1,700 points in theory they can all be 
different on a given hour. They rarely are. Most of the time 
it's about 75 percent generally are all the same price, but in 
certain areas, like peninsula areas, the Delmarva Peninsula for 
example. It's a radial area and it's more prone to congestion 
because you can't get power from the East through the Atlantic 
Ocean, for example.
    So, in simplicity, all LMP is, is pay the actual cost of 
dispatching the system in order to have congestion borne by 
those who caused the congestion. In essence, if a load in a 
pocket has to have higher cost generation, they should pay more 
than the one who is not in a pocket.
    Mr. Ose. Conceptually, what you are talking about is 
pulling it to time of day pricing, in other words when the 
demand is really high you charge more, as a conservation 
measure or something.
    Mr. Drom. There's an analogy to that time. Obviously, our 
prices are calculated every 5 minutes and integrated over an 
hour, so the locational marginal prices, the LMP, which we post 
on our Web site in real time, may vary constantly. We have a 
tool called E Data that anyone can subscribe to for free, and 
you can see the LMPs at any point over 4 hours, 12 hours, 24 
hours, and it's graphed. So, people can immediately see the 
prices.
    The advantage of LMP in my mind is very simple. It sends 
very powerful real time price signals to the load that 
experiences the problem and encourages them, encourages new 
generation in particular, to locate in those areas.
    Mr. Ose. But what you are doing is quantifying transmission 
costs.
    Mr. Drom. The congestion costs, exactly----
    Mr. Ose. Right.
    Mr. Drom [continuing]. Quantified and allocated to those 
areas where they occur, rather than being socialized over 
everyone.
    Mr. Ose. So, if you route it through one point and that 
point gets congested, you price it in such a manner that, 
perhaps, the person producing or the person receiving might 
choose to wheel it a different way and ease that congestion.
    Mr. Drom. That analogy is a little off, because it assumes 
contract path. In reality, in a network grid, our power flows 
everywhere simultaneously. There isn't a path that's congested. 
But, our engineers, monitor particular facilities if they go 
out--if a generator goes off, or a transmission line goes down 
or something, we manage the grid reliably. That's when we have 
to dispatch certain generation off cost, namely, everybody else 
has one cost, and you are at a higher cost in this particular 
area.
    If you look at the facts, you'll see in the last 3 years 
since we've had LMP we've had tremendous generation joining our 
area and building steel on the ground. We had over 3,000 new 
megawatts in the last 12 months alone, and the reason is, is 
because they can get these higher LMP prices. So, the price 
signals directly affect the market price, and guess what, when 
the generator locates there, the LMP goes down, which is great 
for everybody, because we not only have reliability, but we 
have supply.
    Mr. Ose. You end up with distributed generation.
    Mr. Drom. In a sense the generators are like distributed 
generation, and that's a separate initiative that PJM is 
pursuing now, because we strongly believe we have to encourage 
demand side management more than we have in the past. We have a 
proposal on March 4th for the members that we hope will pass 
and send on to Pat Wood for approval, a 3-year program.
    Mr. Ose. Now, Mr. Winter, I know in your Market Design 2002 
you've looked at locational marginal pricing, and you're 
proposing to adopt it, if I understand correctly.
    Mr. Winter. That is correct.
    Mr. Ose. What kind of an impact do you think that will have 
on overall prices?
    Mr. Winter. Well, first off, I think it's always kind of 
interesting to note that we, in fact, our model runs on 3,000 
points, which was what Mr. Drom was referring to. However, what 
we did at the beginning is, we broke it into zones. We picked 
those areas that we felt were going to be constricted, and 
rather than make all the calculations and go to all the 
different generators we jumped to the zones.
    Now, I personally was not that concerned with that, because 
I always felt that the real model would eventually migrate. I 
thought PJM's model, and if I understood him right, they 
started with several points, many of which they don't look at 
anymore because they find there is no congestion there. On 
others, they find there is. So, we had gone from four, then we 
added a couple more zones.
    When we go to the LMP, we are going to get much more 
defined. The result of that is going to be that there will be 
areas which have much higher costs than others within a zone. 
For instance, there's no use ducking it, in northern California 
San Francisco is a very restricted peninsula area.
    Mr. Ose. Much like Delmarva.
    Mr. Winter. Yes. So, when you go to an LMP the residents of 
San Francisco are going to see an increased cost. That will be 
met with some, probably, opposition.
    Mr. Ose. Now, Chairman Wood, from your perspective is the 
LMP a good model? What are the benefits or the problems? I 
think Mr. Winter just highlighted one, when you have an 
isolated peninsula clearly you have a problem because there's 
obvious congestion unless you are extremely lucky, but are 
there benefits or particular problems that you foresee?
    Mr. Wood. Well, I was slow coming to LMP, too, mostly 
because it moves from a level of simplicity to complexity 
really fast. I mean, there's not really a fading to grey there, 
it's kind of cut No. 2, a more complicated system.
    So, when I was at Ercot, and we set up our wholesale market 
in Texas, we favored more of a zonal model like he just laid 
out, Terry, that California had, and it became clear right as I 
was leaving to come to FERC that model could be gamed, and 
people could play that congestion, because the costs were not 
borne by the people who caused them, they were kind of spread 
over everybody else. So, one of the benefits is that you are 
allocating--you are removing a big gaming opportunity from a 
trader, or market, or generator, or load, to kind of, 
basically, game the system to make some money and then spread 
the cost to the rest of the system, because those costs then 
under the new system come back to you. So, you cause a problem, 
you pay for it. So, that's actually a very positive thing.
    I mean, generally, regulators like to have the cost causer 
be the cost bearer, and so if you can align those incentives 
then I think some of the things Mr. Drom was pointing out about 
where new generators decide to build, if the load takes 
advantage of demand side reductions, or puts small-scale 
generation on their site or nearby, distributes generation, 
those kind of things where people start to say, hey, I don't 
want to pay this excess cost, I'm going to do something about 
it.
    That's not a spatial problem, that's a problem that's their 
problem, they have a much greater incentive to fix it, so it's 
really hard to improve on that.
    I guess my only lament is that it is complicated, and the 
administration of an LMP model is not something you do with a 
GED, I mean, it's for the big league. And, I mean, that's OK.
    Mr. Ose. That leaves me out.
    Mr. Feider, how do the munis feel about this?
    Mr. Feider. Well, as a director of the electric utility for 
the city of Redding in Shasta County, in the shadow of Shasta 
Dam, where there's probably 2,000 plus megawatts of generation 
in the county compared to 500 megawatts of load, it would be 
easy for me to say I don't care about this problem. But, 
several of our members live in the Bay Area, the city of Palo 
Alto, Santa Clara, and Alameda, and they are faced with this 
congestion issue.
    We prefer a market that is simple, not complex, and so we 
are concerned about moving to this complex model. And, as I 
said in my remarks, we don't believe that there's enough wire 
in the air. If we had enough wire in the air, we wouldn't have 
as much a problem. So, that issue really needs to be taken head 
on as a part of this.
    In the meantime, we think we need to be able to protect the 
existing rights that we have on the transmission, what we term 
physical rights, and we appreciate the fact that FERC rules in 
our favor in many cases to protect those pre-existing rights 
and those arrangements, because it's all about cost to our 
consumers. If we move to this model quickly, or too quickly, 
our rate payers are going to incur increased costs, and I don't 
think that's the right thing to do when we made the investments 
we think that needed to be made.
    Mr. Ose. OK.
    Mr. Smutny-Jones, how about you, any ideas on LMP?
    Mr. Smutny-Jones. Well, I used to have a very strong 
religious conviction that LMP was very problematic. The events 
of the last 2 years have sort of worn me down.
    My members do function in PJM, we believe it can be 
modified in a way that actually can work. I think the issues 
with respect to complexity is an important consideration, and 
the debate in terms of whether it should be put into the 
California market, or how it would work, I think the ISO's 
market reform forum is the proper place to discuss that.
    I think that there are several things, though, that I would 
like to point out. The problem California faced in 2000-2001 I 
don't think would have gone away with LMP. If I'm correct, I 
think PJM has, you know, 90 percent of the power prescheduled, 
in other words, it's purchased, you know, it's not in real 
time.
    Mr. Drom. No, that's actually not true. We have the option 
of self-scheduling, bilaterals and the spot market, and at any 
given day the spot market may be 5 to 25 percent and the 
bilaterals may be 10 to 35 percent, and the self-scheduling 
would be the difference.
    So, there isn't just 10 percent.
    Mr. Smutny-Jones. Well, the point is that there are 
mechanisms there which allow for a significant amount of 
bilateral trading, whether it's 10 percent or 25 percent.
    Mr. Drom. Yes.
    Mr. Smutny-Jones. Or whatever. We did not have that there 
for our load serving entities, and that was a fundamental 
problem.
    The second area is that load really needs tools to be able 
to adjust. Here again this is a problem if you have entities 
within a node, that's what it's called, that can respond either 
by shedding load, or by cranking up generator. But we found in 
2000-2001 often times we saw a run up in prices where people 
couldn't respond, load couldn't respond, consumers, let's not 
call them a load, customers couldn't respond because they 
didn't have the tools to respond. So, sending them a price 
signal that they couldn't respond to didn't make anyone 
particular popular. We need to address that issue with respect 
to having those kind of tools.
    And last but not least is the issue that Terry addressed, 
which is that at this point in time you do have certain areas, 
San Francisco is the clearest one, of where, for lack of a 
better definition, San Francisco is being subsidized by the 
rest of northern California. The costs are higher to run power 
in San Francisco, and you are constrained with respect to 
transmission generation on the peninsula. We just need to get 
that out on the table and have a discussion about how you 
address that or how you segue into a program where you are not 
picking winners or losers, more importantly, is this a huge 
problem or is it a relatively small problem, because it may 
turn out at the end of the day that the actual ``cost'' to the 
end use customer is so de minimus that no one cares. I don't 
know that anyone has done that analysis, but that would be an 
area that I think needs to be looked at very closely as we 
migrate into more of an LMP model.
    Mr. Drom. If I could just respond to that last point. 
Historically, LMP costs do vary tremendously, congestion costs. 
When we were designed in 1997, a lot of opponents of LMP said, 
hey, $5 to $10 million, why are we going through all this 
trouble for LMP congestion? They opposed LMP.
    FERC, in its wisdom, approved LMP, and when we entered it 
the first year congestion was only about $5 million. The next 
year it was about $35 million, and then it was about $100 
million. So, the amount of congestion varies dramatically 
depending on what generating sources are available, what the 
day of the week is, and what transmission is available. So it's 
very complex, and you are very right, Jan, that it's not a de 
minimus problem, though some make it out that way.
    Mr. Ose. Well, if I understand your testimony then, Mr. 
Feider and Mr. Smutny-Jones in particular, confirmed by you, is 
that there is a transfer going from those who have efficient 
distribution systems, for whatever reason, to those who have 
inefficient distribution systems, for whatever reason. There's 
a financial transfer going on under the current rules, am I 
correct?
    Mr. Drom. Yes, I would say, I would describe it simply as 
socialization of these costs. They are inevitable. In order to 
run a grid Terry has to turn on high and low cost generators, 
but the question is, do you allocate those costs just to the 
area where you turn them on or do you spread the costs among 
everybody? That's the basic issue before you.
    Mr. Wood. Well, I think it also minimizes the costs.
    Mr. Ose. It quantifies what the expense is.
    Mr. Wood. And then, the person who----
    Mr. Ose. You supply the power to come in.
    Mr. Wood [continuing]. Right, so the gaming opportunity, 
which is another part of the California Market Design 2002 
addresses and some call it an ink and debt game, and that's 
more than we need to talk about, but there is an incentive 
there to take behavior that would make costs go up for 
everybody. So, the overall amount that's being socialized is 
also higher than the sum of all the different amounts in the 
current market structure out here.
    I don't know if that's true of the pre-LMP PJM, but----
    Mr. Drom. I think that's exactly what our history was, 
because our first year we didn't have LMP, and our next year we 
did, and we found the congestion was actually lower when we had 
LMP because any free rider principle tells you that people will 
use it more knowing they are not going to pay the full costs. 
So, I think there is not only an equity element, but there's 
also an actual reduction in congestion as a result.
    Mr. Ose. Mr. Smutny-Jones.
    Mr. Smutny-Jones. I was just going to respond. I think 
there's no question that the signals, in terms of the cost of 
congestion, are very clear in that model, and actually the 
question that I'm raising is once you've established the fact 
that the costs are higher it's a ratemaking question. Does PG&E 
take the cost of serving people in San Francisco, and does the 
PUC basically say we are going to spread it out through 
everybody at PG&E, OK, we are going to encourage PG&E to build 
local generation, or transmission, or something, to basically 
lower that cost, or are we going to leave it the way it is, 
which is basically spread over all the PG&E's customers.
    So, this is kind of where we got, you know, LMP will result 
in a need to sort of have a State and Federal discussion of, 
OK, as congestion costs we know will rise in the San Francisco 
peninsula, what are we going to do about it, and that actually 
would be a State issue, and I would, you know, venture to guess 
that the PUC would have some opinion in terms of how they would 
address such an issue.
    There's no question that the market signals are pretty 
crisp.
    Mr. Ose. Do you confirm?
    Mr. Drabinski. I was just going to say, from a long-term 
standpoint, what LMP does is essentially collect market 
signals, generators and transmission builders, as to where they 
should be putting the ark.
    Mr. Ose. So, we would have to address the embedded or the 
stranded cost issues, if you will, the stranded revenue issues 
that the munis have at the very least to move toward this 
model.
    Mr. Feider. Yes.
    Mr. Ose. Now I want to go to the RTOs, I know our time is 
evaporating here, and I'm trying to be respectful of people's 
desire to be out of here by noon.
    The FERC has been trying to establish RTOs throughout the 
country, Chairman Wood, can you give us a status report on your 
progress?
    Mr. Wood. Yes, Mr. Chairman, the 1999, December 1999, the 
FERC has put forth the standards for setting up regional 
transmission organizations. The point of an RTO, was the basic 
knowledge that there was a regionality to the power business, 
and that we needed to basically treat it as if it were, and set 
up an organization that would be the equivalent of the air 
traffic controller at the Sacramento Airport for the 
transmission grid of a given region of the country.
    And, as a result of that, it was voluntary, but they put a 
very strong suggestion that RTOs be up and going in 2 year's 
time. Well, that time period came and went last December, and 
we did approve the first RTO in the country for the Midwest. It 
covered about 16 States, ranging from Ohio over to, oh, gosh, 
part of Manitoba, and then down south toward Missouri and 
Kansas, so that whole swap is now the Nation's first RTO.
    PJM has applied for one. We are encouraging them and the 
two parties in the Northeast to consider joining forces. We are 
also working with parties in the Southeast, but it's pretty 
much a work in progress. Our hope is that, really, there is 
clarity to all the grid in the country by the end of the year, 
that we do have these organizations set up.
    Out here in the West, it appears there's kind of a pretty 
strong, at least political, meaning not necessarily at your 
level, but political at the parties levels across the West, 
that the California, the RTO West, which is in the Pacific 
Northwest, and then West Connect, which is from the Desert 
Southwest up to Wyoming, that those would be three RTOs that 
would encompass the whole Western grid.
    Mr. Ose. So, what are the benefits in cost to California of 
joining such an RTO?
    Mr. Wood. Well, we've actually done, and we've got coming 
out Wednesday of next week our cost benefit analysis that we 
have a consultant to do for us, again, that broke it out region 
by region for the whole country, because it's certainly helpful 
for us to discuss in the context of why we are doing this, to 
look at if there are benefits or not.
    So, we've asked that be done, and I don't know exactly what 
the details are, but assuming that there are some benefits, the 
benefits certainly on the financial level of integrating the 
system together, to take advantage of the fact that rather than 
California having to build 100 percent of the power plants 
needed to serve California, it's recognized that weather and 
resources are different across the whole grid, it might be 
useful, as California has done for many years, to use hydro in 
the winter--or, to use hydro in the summer when there's a lot 
of it, power from the Northwest outside of California to 
supplement California's needs, and then use, when California is 
not using so much power in the winter, to export power off the 
grid to the Northwest. It's been kind of a natural back and 
forth relationship that I think has worked and benefited the 
West pretty well.
    This, quite frankly, would not be plowing tremendous new 
ground, it's just to kind of institutionalize what has been 
kind of an informal practice for many years, and it gives some 
coherence, some long-range planning, some standardization of 
how commercial practices are done around the grid.
    So, I would consider it an evolutionary step, not a 
revolutionary step, of trying to set up an RTO out here.
    Mr. Ose. Here in Sacramento County we have a public utility 
governed by a seven-member board. Mr. Feider, I'm kind of 
interested in how the munis react to the proposal of California 
being part of an RTO.
    Mr. Feider. We're very supportive of California joining a 
broader regional RTO to take into account the regional aspects 
and dynamics in the West, including making sure that the 
operation and scheduling protocols are consistent across the 
West.
    Mr. Ose. When you say geographically, how big of an area 
are you talking about, California?
    Mr. Feider. California, and actually the entire Western 
Interconnected Grid, we think, ultimately, could be one large 
RTO, but we would acknowledge that there are regional 
differences, and so an intermediate step that we see as a 
minimum is the Pacific Northwest as an RTO, the Desert 
Southwest, and the Rocky Mountain Region. Whether or not 
California could move to that RTO quickly is maybe 
questionable. We certainly would like to see it sooner rather 
than later.
    Mr. Ose. All right.
    Mr. Winter, how about from the ISO's standpoint on this 
RTO, any feedback?
    Mr. Winter. I'd say I believe 1999 was when I proposed that 
the Western Region ought to be one large RTO, right after that 
came out. Tomatoes, a few rocks, things were thrown at me for 
proposing that, but I still believe it.
    And so, however the State of California recognized that, 
passed a law saying that I could not become a member of an RTO.
    Mr. Ose. So, you were statutorily prohibited from it?
    Mr. Winter. Yes.
    Mr. Ose. OK. So, I'm not going to ask you to break the law.
    Well, gentlemen, I do want to thank you for coming. Given 
the constraints of time--I know what time the county told us we 
had today--I will leave the record open for 10 days for any 
comments you wish to include.
    First of all, let me thank you all for coming, as well as 
the two members of the legislature. I learned a lot today 
regarding the market design and reform that is, frankly, 
essential, to ensuring that Californians pay only reasonable 
prices for power.
    I think we are all in agreement that markets don't work 
well if they aren't designed well, that they'll collapse of 
their own weight, and consumers will pay more than they should 
if they aren't properly designed.
    I will say, in my opinion, we have a market that has 
significant design flaws in it today, and I know we are all 
trying to work on it. I appreciate your efforts accordingly.
    I do think that the independence of the CAISO Board is a 
critical step. I've served on corporate boards. Frankly, they 
serve a valuable role here, and their independence is at the 
heart of their ability to do their job. The establishment of 
that independent board of directors needs to take place sooner 
rather than later. My people don't want to be paying high 
prices because of inaction on this question.
    I thank you all for coming, look forward to working with 
you in the future. Have a great day.
    [The hearing was adjourned at 11:58 a.m.]
    [Additional information submitted for the hearing record 
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