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



 
       CALIFORNIA'S ELECTRICITY MARKET: THE CASE OF PEROT SYSTEMS

=======================================================================

                                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

                               __________

                             JULY 22, 2002

                               __________

                           Serial No. 107-215

                               __________

       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


                     U.S. GOVERNMENT PRINTING OFFICE
                           WASHINGTON : 2003

87-293 PDF

For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpr.gov  Phone: toll free (866) 512-1800; (202) 512-1800  
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001



                     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 
JOHN SULLIVAN, Oklahoma                  (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
JOHN SULLIVAN, Oklahoma

                               Ex Officio

DAN BURTON, Indiana                  HENRY A. WAXMAN, California
                       Dan Skopec, Staff Director
               Robert Sullivan, Professional Staff Member
                         Allison Freeman, Clerk
                     Greg Dotson, Minority Counsel


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on July 22, 2002....................................     1
Statement of:
    Winter, Terry, president, California Independent System 
      Operator; Charles J. Cicchetti, occupant, Jeffrey Miller 
      Chair in Government, Business and the Economy, University 
      of Southern California; George Backus, president, Policy 
      Assessment Corp.; and Paul Gribik, former employee, Perot 
      Systems Corp...............................................    23
Letters, statements, etc., submitted for the record by:
    Backus, George, president, Policy Assessment Corp.:
        Clarification of testimony...............................   181
        Prepared statement of....................................   117
    Cicchetti, Charles J., occupant, Jeffrey Miller Chair in 
      Government, Business and the Economy, University of 
      Southern California, prepared statement of.................    82
    Gribik, Paul, former employee, Perot Systems Corp., prepared 
      statement of...............................................   152
    Ose, Hon. Doug, a Representative in Congress from the State 
      of California:
        Information concerning gaming issues.....................   193
        Letter dated July 19, 2002...............................    22
        Memorandum dated January 30, 1998........................   223
        Memorandum dated April 9, 1998...........................   229
        Prepared statement of....................................     3
    Waxman, Hon. Henry A., a Representative in Congress from the 
      State of California, prepared statement of.................     7
    Winter, Terry, president, California Independent System 
      Operator, prepared statement of............................    26

       CALIFORNIA'S ELECTRICITY MARKET: THE CASE OF PEROT SYSTEMS

                              ----------                              


                         MONDAY, JULY 22, 2002

                  House of Representatives,
  Subcommittee on Energy Policy, Natural Resources 
                            and Regulatory Affairs,
                            Committee on Government Reform,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 2:03 p.m., in 
room 2154, Rayburn House Office Building, Hon. Doug Ose 
(chairman of the subcommittee) presiding.
    Present: Representatives Ose, Kucinich, and Waxman (ex 
officio).
    Staff present: Dan Skopec, staff director; Barbara Kahlow, 
deputy staff director; Yier Shi, press secretary; Allison 
Freeman, clerk; Robert Sullivan, professional staff member; 
Greg Dotson, Elizabeth Mundinger, and Paul Weinberger, minority 
counsels; and Jean Gosa, minority assistant clerk.
    Mr. Ose. Good afternoon, everybody. Welcome to today's 
hearing of the Subcommittee on Energy Policy, Natural Resources 
and Regulatory Affairs. Under the rules of the committee, I am 
going to welcome Mr. Waxman; we now have a quorum. We are going 
to commence with the 2 o'clock hearing.
    In the last few months, the news media has been filled with 
examples of companies attempting to game the California 
electricity market. Many elected officials in my home State of 
California have pointed to these examples as proof that 
Californians were taken advantage of by corporate greed. Today 
this subcommittee will investigate these matters to get a 
better understanding of their true role in the California 
energy crisis.
    I do look forward to the testimony of the witnesses today. 
I am eager to hear firsthand about the activities of Perot 
Systems in particular. Did it, in fact, share confidential 
information with other market participants? Was it running what 
some have called a ``crime school'' in this regard? Did it 
notify the California Independent System Operator or the 
California Power Exchange of the flaws in the market design 
that it found?
    More importantly than the actions of any market 
participant, I am interested in how the CAISO responded to the 
various challenges that it faced. When it learned of the 
outside marketing activities, how did it respond? Did it deem 
such activities a threat to the market? Was the CAISO aware of 
and did it understand these games at the time? If so, did it 
attempt to fix the holes in the market structure? Finally, will 
the CAISO's Market Design 2002 proposal, which FERC approved 
last week, prevent the kind of activities that occurred in 
California from recurring?
    As I continue to state on every occasion I can, getting the 
electricity market design right should be our foremost 
priority. As we continue to review this issue, I will be 
particularly focused on how market design contributed to or 
prevented the types of games that were played in California.
    Now, as an aside, I will tell you, I am not happy today. We 
have asked a couple people to join us, and they have declined 
the opportunity. I happen to think that, particularly in light 
of the activities going on in the financial markets, having 
folks who were actively participating in these efforts is 
critical in assuring the American people that this type of 
thing will be brought to a halt, and that they can be confident 
in corporate America and their personal portfolios, if nothing 
else. I am profoundly disappointed at the absence of Mr. Perot 
and Mr. Belden, and I am not happy about it, and it is probably 
not the last time we are going to hear about this matter.
    [The prepared statement of Hon. Doug Ose follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.001
    
    Mr. Ose. I would like to yield to my friend from 
California, Mr. Waxman, for the purposes of an opening 
statement.
    Mr. Waxman. Thank you very much, Mr. Chairman.
    I, too, share your unhappiness with those witnesses that 
are not here today. Before I give my opening statement, I want 
to point out that you and I have had discussions about other 
witnesses, particularly State Senator Dunn from California, and 
in our conversation you agreed that we would have another 
opportunity to have a meeting of this committee to hear from 
him and other witnesses recommended by the Democrats.
    Mr. Ose. If the gentleman will yield?
    Mr. Waxman. Certainly.
    Mr. Ose. I guarantee you, we will visit this issue, and I 
will work with you to make that happen.
    Mr. Waxman. And that we will have----
    Mr. Ose. And we will have a hearing, and it will be the 
minority witnesses.
    Mr. Waxman. I thank you very much.
    Mr. Chairman, it is important that we investigate what 
happened in the Western energy markets in 2000 and 2001. 
However, the way this hearing has been set up is very odd. It 
is more notable for who is not here today instead of who is.
    This hearing is entitled, ``The California Energy Market: 
The Case of Enron and Perot Systems.'' Yet today not only don't 
we have any witness from Enron testifying, but Ross Perot, who 
is supposed to be this afternoon's key witness, isn't here 
either.
    As of Friday, we had been told that former Enron employee 
Mr. Tim Belden would be testifying today. Mr. Belden would have 
been a very useful witness to hear from since he headed the 
Enron office, which apparently cooked up the trading schemes 
that manipulated Western markets. The odd thing is, Mr. 
Chairman, that we learned over the weekend from Mr. Belden's 
lawyer that Mr. Belden never had any intention of testifying 
today.
    I do not think it is inappropriate to expect that we should 
have Enron witnesses at a hearing that focuses on Enron.
    We should also benefit from other ongoing investigations 
when it is possible to do so. The one person who has uncovered 
the most information on Perot Systems is California State 
Senator Joe Dunn, and I hoped he would be here today, but I 
appreciate that you have offered to have him testify at an 
additional day of hearings.
    It is worth taking a moment to recall how we got here and 
why this is such an important issue. In 2000 and 2001, Western 
families were ruthlessly price-gouged by energy companies. The 
future of families in California and other Western States was 
in effect mortgaged for the short-term benefit of energy 
executives like Ken Lay and Jeffrey Skilling. The economic 
welfare of the entire West was jeopardized as energy prices 
skyrocketed out of control.
    The wholesale cost of electricity for California in 1999 
was $7 billion. In 2000, it was $27 billion. And, if not for 
timely actions taken by the State government, it would easily 
have surpassed that number in 2001. At the time, evidence from 
government, academia and the private sector showed that energy 
companies were manipulating markets to increase profits. For 
example, over 18 months ago Enron chairman Ken Lay publicly 
discussed his view that, ``the system invites gaming,'' yet the 
administration refused to acknowledge the price gouging. Energy 
Secretary Spencer Abraham dismissed claims that energy 
companies were conspiring to drive up prices as a ``myth.''
    What a difference a year makes. Enron has stunningly 
collapsed, and industry documents and admissions confirm that 
market manipulation was an important cause of the energy 
crisis. This market manipulation cost California consumers 
billions of dollars. The most serious manipulation involved 
energy generators exercising market power by selling 
electricity at exorbitant prices or by holding supply off the 
market in order to drive up those prices.
    Power marketers also engaged in various trading strategies 
that increased costs and the possibility of rolling blackouts. 
These strategies are discussed in internal Enron memos which 
became public this spring. They include submitting phony power 
schedules; deliberately overstating load to create the 
appearance of congestion on transmission lines, which would 
result in the State paying Enron to cut back on its load; and 
megawatt laundering or exporting power out of State, and then 
immediately importing it back in order to evade price caps. The 
Enron memos gave these ploys names like Fat Boy, Death Star, 
and Get Shorty.
    Perhaps the most cynical ploy was the simplest: buying 
price-capped power in California and exporting it to other 
regions without a price cap. According to one memo written in 
December 2000, Enron believed that this strategy, ``appears not 
to present any problems other than a public relations risk 
arising from the fact that such exports may have contributed to 
California's declaration of a Stage 2 emergency yesterday.'' In 
their own memos, they said that's what they thought would make 
sense from their perspective, although they worried about the 
public relations problem.
    Recent admissions by at least seven major energy traders 
that they participated in fake round-trip trades have further 
underscored the extent to which energy markets are subject to 
manipulation. Those companies, several of which conducted 
business in California, all conducted trades in which they 
exchanged the same amount of power at the same price with 
another company. The trades were apparently intended to 
exaggerate the company's revenues and make it appear that 
markets were more active than they really were. They may also 
have contributed to higher energy prices. One energy analyst 
described the trades as having enormous potential significance.
    And, we have also recently learned that Ross Perot's 
company, Perot Systems, may have had a hand in California's 
energy crisis. In 1997, Perot Systems gained significant 
expertise with California's newly deregulated energy market by 
contracting with the California Independent System Operator. 
Apparently, Perot Systems then turned around and tried to 
market this expertise to energy companies seeking to increase 
their profits in the West.
    For months, many Members of Congress have been calling on 
the Energy and Commerce Committee to hold hearings about the 
outrages that occurred in Western energy markets. 
Unfortunately, the Republican leadership has refused to allow 
hearings in that committee.
    So, I am pleased that we are finally holding a hearing on 
the schemes that traders used to manipulate the markets in 2000 
and 2001. Unfortunately, I am concerned that this hearing will 
simply provide Perot Systems the opportunity to provide its 
unrebutted side of the story. I understand why that is good for 
Ross Perot, but I don't understand how that will help us 
understand what happened in California and prevent it from ever 
happening again.
    I want to thank the chairman for agreeing to a minority day 
of hearings on this issue. At that hearing we will finally be 
able to hear from Enron and Senator Dunn. I would like to reach 
agreement on a date for that hearing before the end of this 
afternoon's hearing, Mr. Chairman, if that is possible.
    I would also like to ask unanimous consent to introduce 
into the record a prepared statement from Senator Dunn, along 
with a letter he has written to the chairman. And, I would also 
like to request that the hearing record be left open so that 
Members can submit relevant materials and written questions to 
today's witnesses, and those witnesses which declined to appear 
today, so that we can get responses to put into the record.
    Mr. Ose. Mr. Waxman, as it relates to the record, the 
record will be left open for 10 days for Members to submit 
questions.
    I have sent the clerk to get the schedule of the committee 
and the availability of the room, and hopefully during the 
course of the hearing we can work that out. And, let me think 
about the other things you--what were the other items you 
mentioned?
    Mr. Waxman. Whatever else it was to put in the record.
    Mr. Ose. Whatever else it was----
    Mr. Waxman. All the documents that we have available.
    Mr. Ose. We will work together. We will make sure that the 
documents you reference get in the record and the other issues 
that you rose, we'll work those out, too.
    Mr. Waxman. Thank you very much, Mr. Chairman, for your 
spirit of cooperation and your willingness to try to get all 
these facts on the record. It is important that we do so for 
our State. And, it is not a partisan matter; it is a matter of 
simply trying to understand what happened in California and the 
other States in the West, and make sure we don't have this sort 
of thing happen again. I know that's your intent as well.
    Mr. Ose. Thank you, Mr. Waxman.
    [The prepared statement of Hon. Henry A. Waxman follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.002
    
    [GRAPHIC] [TIFF OMITTED] T7293.003
    
    [GRAPHIC] [TIFF OMITTED] T7293.004
    
    [GRAPHIC] [TIFF OMITTED] T7293.005
    
    [GRAPHIC] [TIFF OMITTED] T7293.006
    
    [GRAPHIC] [TIFF OMITTED] T7293.007
    
    [GRAPHIC] [TIFF OMITTED] T7293.008
    
    [GRAPHIC] [TIFF OMITTED] T7293.009
    
    [GRAPHIC] [TIFF OMITTED] T7293.010
    
    [GRAPHIC] [TIFF OMITTED] T7293.011
    
    [GRAPHIC] [TIFF OMITTED] T7293.012
    
    [GRAPHIC] [TIFF OMITTED] T7293.013
    
    [GRAPHIC] [TIFF OMITTED] T7293.014
    
    [GRAPHIC] [TIFF OMITTED] T7293.015
    
    Mr. Ose. I know we delivered a copy of the letter from 
Perot to the minority. We are going to enter this into the 
record also at this time.
    [The information referred to follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.016
    
    Mr. Ose. Now, gentleman, this committee is an investigative 
committee. This is not judgmental in the sense about what we 
are going to do. We swear everybody in. So, we are going to ask 
you all to rise, raise your right hand. Those who would advise 
you, in the background, whose names we may need to have on the 
record; if you think they are going to provide input here, we 
are going to need to have them rise, be identified, and raise 
their right hand and be sworn in also. So, gentlemen.
    [Witnesses sworn.]
    Mr. Ose. Let the record show that the witnesses all 
answered in the affirmative.
    Now, the way we proceed here is that each of the witnesses 
is given 5 minutes for the purpose of an opening statement. We 
have received your written statements, and we have reviewed 
them. I know that Mr. Waxman and I are very interested in 
getting to questions. I am going to be punctual on the 5-minute 
rule this afternoon. So to the extent that you can, you need to 
make sure you can constrain yourselves to 5 minutes.
    Now, we have four witnesses with us today. We have Terry 
Winter, who is the president of the California Independent 
System Operator. We have Dr. Charles Cicchetti, who is the 
occupant of the Jeffrey Miller Chair in Government, Business 
and the Economy, from the University of Southern California. We 
have George Backus, who is the president of the Policy 
Assessment Corp.; and we have Paul Gribik, who is a former 
Perot Systems Corp. employee.
    As Mr. Waxman indicated, we also had invited Mr. Perot and 
Mr. Belden. Those invitations have been declined, and we have 
no written statement from them.
    Mr. Winter, you are our first witness. You are recognized 
for 5 minutes.

 STATEMENTS OF TERRY WINTER, PRESIDENT, CALIFORNIA INDEPENDENT 
SYSTEM OPERATOR; CHARLES J. CICCHETTI, OCCUPANT, JEFFREY MILLER 
 CHAIR IN GOVERNMENT, BUSINESS AND THE ECONOMY, UNIVERSITY OF 
     SOUTHERN CALIFORNIA; GEORGE BACKUS, PRESIDENT, POLICY 
   ASSESSMENT CORP.; AND PAUL GRIBIK, FORMER EMPLOYEE, PEROT 
                         SYSTEMS CORP.

    Mr. Winter. Mr. Chairman, members of the committee, thank 
you for inviting me here to discuss the importance of electric 
consumers in California and throughout the Western United 
States.
    I would like to emphasize four points today. First, you 
have invited me to discuss, among other things, the trading 
schemes described in the materials produced by Enron and Perot 
Systems in the past few months, and I will do so in a moment. I 
must stress, though, that as disturbing as some of the 
strategies described in the Enron and Perot Systems materials 
are, the greatest potential harm to electric consumers in 
California and elsewhere comes not from the games that some 
clever traders may play, but from the persistent exercise of 
market power by suppliers and traders. By market power, I mean 
the ability of a single seller or group of sellers to command 
excessive prices on a sustained basis. It is this exercise of 
market power that cost California literally billions of dollars 
in the last 2 years.
    From startup 4 years ago, the ISO has placed particular 
emphasis on documenting and mitigating both suppliers' exercise 
of market power and their use of gaming strategies such as 
those described by the Enron/Perot Systems materials. I am 
providing the committee with a chronology of activities the ISO 
has pursued in the past 4 years, directed to market power, 
gaming, and providing relief to consumers that have been 
victimized by the market. You will see there a strong and 
consistent emphasis on detecting, constraining, and combating 
market power. Through the turmoil of late 2000 and early 2001, 
our market analysis department and the independent market 
surveillance committee repeatedly documented both the presence 
of market power in the California markets and its impact on the 
consumers, and we have proposed measures to control that market 
power.
    There have been times indeed when people have thought we 
have acted too aggressively. For instance, in June 1998, we 
imposed a $250 price cap when prices suddenly rose to $9,000 
plus.
    How have we responded to market manipulation? First, the 
ISO detected and issued directives specifically prohibiting 
some of the gaming strategies identified in the Enron memo.
    Second, the ISO modified its market designs to withhold 
payments to suppliers who were engaged in gaming strategies.
    Third, the ISO persuaded FERC to impose regional price caps 
to address strategies involving the laundering of powering to 
avoid limitation of bids in the ISO markets and has recently 
asked FERC to extend those regional protection measures.
    Fourth, the ISO levied penalties on suppliers who have 
withheld energy even when we instructed them to provide it to 
avert blackouts.
    Five, the ISO referred other matters involving questionable 
activities by suppliers to FERC for their review and further 
action.
    And, six, the ISO issued directives to participants in its 
markets identifying trading practices, including those in the 
cited Enron memos, that the ISO considered these contrary to 
its market rules and would subject a trader employing them to 
sanctions.
    The ISO's interaction with Perot Systems, which has 
recently been the subject of press reports, represents an 
example of the ISO's efforts in the past to protect its markets 
against manipulation. When the ISO was established in 1997, its 
first task was to oversee the development of the computer 
systems and software needed to run the electric grid in its 
energy markets. In March 1997, the ISO contracted with the ISO 
Alliance, a joint venture of Perot Systems and ABB Power T&D 
Co., for the development of that computerized system. It should 
be noted that a few months after startup, Perot Systems 
withdrew from the ISO Alliance.
    It should also be understood the role that Perot Systems 
had in the development. They were not the market designers; 
they were not the code writers. That was ABB and their 
subcontractor, Ernst & Young, who did the actual code. Perot's 
responsibility was to integrate those systems and make sure 
that all of them worked together, and that they had been tested 
out before we went live. As such, they gained considerable 
knowledge about the systems, but clearly they were not the ones 
writing the code.
    The ISO demanded in 1997--when we learned from a board 
member that there was marketing activity going on--the ISO 
demanded that Perot Systems provide assurances that any service 
that it provided to market participants would employ only 
publicly available information, that it make the limitation 
clear to its potential customers and those that they may 
solicit in the future, and that it enforce what we called a 
Chinese wall so that those working at the ISO would not have 
contact with those who were doing the marketing activities.
    We never came to a resolution to that discussion, but we 
determined that most of the material which they had used, or at 
least the written material that we had seen, in fact was 
publicly available material. We have reviewed that material and 
chose not to continue a discussion with Perot on those items. 
However, with some of the recent information we have had made 
available to us, we are certainly going back and looking at 
those activities.
    The most effective means of deterring the exercise----
    Mr. Ose. Mr. Winter.
    Mr. Winter. Yes.
    Mr. Ose. You are a minute over.
    Mr. Winter. Oh.
    Mr. Ose. How much more have you got?
    Mr. Winter. I have just got one more paragraph.
    Mr. Ose. Please continue.
    Mr. Winter. The most effective means of deterring market 
power and unfair gaming is, of course, establishing the correct 
market rules, and we feel that we have done that with our 
recent market design, which was approved by FERC. They also 
gave us some mitigation control items that we think will tend 
to buffer those. Most important of that is a ``must offer 
westwide,'' so that you don't have the activities going from 
out of State versus power that's produced in State.
    And, with that, I will come to a close. And then, if you 
ask me questions about what Congress can do, I would be happy 
to tell you, but it's in my testimony. Thank you.
    Mr. Ose. Thank you, Mr. Winter.
    [The prepared statement of Mr. Winter follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.017
    
    [GRAPHIC] [TIFF OMITTED] T7293.018
    
    [GRAPHIC] [TIFF OMITTED] T7293.019
    
    [GRAPHIC] [TIFF OMITTED] T7293.020
    
    [GRAPHIC] [TIFF OMITTED] T7293.021
    
    [GRAPHIC] [TIFF OMITTED] T7293.022
    
    [GRAPHIC] [TIFF OMITTED] T7293.023
    
    [GRAPHIC] [TIFF OMITTED] T7293.024
    
    [GRAPHIC] [TIFF OMITTED] T7293.025
    
    [GRAPHIC] [TIFF OMITTED] T7293.026
    
    [GRAPHIC] [TIFF OMITTED] T7293.027
    
    [GRAPHIC] [TIFF OMITTED] T7293.028
    
    [GRAPHIC] [TIFF OMITTED] T7293.029
    
    [GRAPHIC] [TIFF OMITTED] T7293.030
    
    [GRAPHIC] [TIFF OMITTED] T7293.031
    
    [GRAPHIC] [TIFF OMITTED] T7293.032
    
    [GRAPHIC] [TIFF OMITTED] T7293.033
    
    [GRAPHIC] [TIFF OMITTED] T7293.034
    
    [GRAPHIC] [TIFF OMITTED] T7293.035
    
    [GRAPHIC] [TIFF OMITTED] T7293.036
    
    [GRAPHIC] [TIFF OMITTED] T7293.037
    
    [GRAPHIC] [TIFF OMITTED] T7293.038
    
    [GRAPHIC] [TIFF OMITTED] T7293.039
    
    [GRAPHIC] [TIFF OMITTED] T7293.040
    
    [GRAPHIC] [TIFF OMITTED] T7293.041
    
    [GRAPHIC] [TIFF OMITTED] T7293.042
    
    [GRAPHIC] [TIFF OMITTED] T7293.043
    
    [GRAPHIC] [TIFF OMITTED] T7293.044
    
    [GRAPHIC] [TIFF OMITTED] T7293.045
    
    [GRAPHIC] [TIFF OMITTED] T7293.046
    
    [GRAPHIC] [TIFF OMITTED] T7293.047
    
    [GRAPHIC] [TIFF OMITTED] T7293.048
    
    [GRAPHIC] [TIFF OMITTED] T7293.049
    
    [GRAPHIC] [TIFF OMITTED] T7293.050
    
    [GRAPHIC] [TIFF OMITTED] T7293.051
    
    [GRAPHIC] [TIFF OMITTED] T7293.052
    
    [GRAPHIC] [TIFF OMITTED] T7293.053
    
    [GRAPHIC] [TIFF OMITTED] T7293.054
    
    [GRAPHIC] [TIFF OMITTED] T7293.055
    
    [GRAPHIC] [TIFF OMITTED] T7293.056
    
    [GRAPHIC] [TIFF OMITTED] T7293.057
    
    [GRAPHIC] [TIFF OMITTED] T7293.058
    
    [GRAPHIC] [TIFF OMITTED] T7293.059
    
    [GRAPHIC] [TIFF OMITTED] T7293.060
    
    [GRAPHIC] [TIFF OMITTED] T7293.061
    
    [GRAPHIC] [TIFF OMITTED] T7293.062
    
    [GRAPHIC] [TIFF OMITTED] T7293.063
    
    [GRAPHIC] [TIFF OMITTED] T7293.064
    
    [GRAPHIC] [TIFF OMITTED] T7293.065
    
    [GRAPHIC] [TIFF OMITTED] T7293.066
    
    [GRAPHIC] [TIFF OMITTED] T7293.067
    
    [GRAPHIC] [TIFF OMITTED] T7293.068
    
    [GRAPHIC] [TIFF OMITTED] T7293.069
    
    [GRAPHIC] [TIFF OMITTED] T7293.070
    
    Mr. Ose. Dr. Cicchetti, for 5 minutes, please.
    Dr. Cicchetti. Thank you, Congressman Ose.
    First, let me express my pleasure at appearing before the 
committee. I follow electricity matters, and I have done so for 
more than 30 years. I am very aware of the so-called California 
electricity crisis. In fact, I have served at Governor Davis's 
invitation on the ISO's market advisory group, and I was 
principal author of the California State Audit Report on 
electricity deregulation. I also work for the utilities in the 
Pacific Northwest that sold power that kept the lights on 
during the energy crisis; the Navajo Nation that supplies power 
and coal to California; and most recently, Perot Systems, which 
has been accused of training energy companies in the art of 
gaming the California market.
    Let me begin by explaining why people confuse several 
electricity market matters and, in the process, fail to 
recognize that each is quite different. I think part of the 
confusion comes from the fact that all three of these terms 
that I am going to go through include the word ``market.''
    First, there are market forces. These include supply, 
namely, did California build enough generation; demand, did 
anyone forecast the spectacular economic growth in California, 
particularly in the high-tech areas; and the prices for inputs, 
a fivefold increase in natural gas prices nationally and a 
thirtyfold increase in California, as well as a twentyfold 
increase in pollution compliance costs.
    The answers to the supply and demand questions were both 
``no.'' That is, we didn't get supply and demand right in 
California. Worse, the climate shift in the West made supply 
shortages 10 to 20 percent worse than they otherwise would have 
been. That's 5,000 to 8,000 megawatts. And, the input cost in 
California alone associated with natural gas would have made 
the price of electricity $1,000 in late 2000.
    In addition to market forces, there is market power. 
Economists define market power as the ability of one seller or 
an illegal conspiracy of several sellers to withhold supply to 
force up prices; or, alternatively, buyers acting in a similar 
manner to cause prices to fall. The issue is straightforward 
and is related to moving all prices in the entire relevant 
market.
    Despite the claims to contrary, in my work for the State 
Audit Report I found no example of market power abuse in the 
sense of withholding supply from the entire California market.
    The third issue is called ``market gaming,'' or ``market 
manipulation.'' This refers to individual market participants 
engaging in various actions, mostly contrary to the overall 
market. Gamers don't try to move the full market; instead, they 
seek profits from anticipating the moves of others and, in 
effect, betting against the overall market. This is an 
offensive game. Gaming works best when it is applied 
individually, not collectively. In the games in which everybody 
moves the same way, it's simply an equivalent of a horse race 
where everybody bets on the same horse, in which nobody wins 
but the horse and the house that controls the betting arena.
    Of the three, market forces just can't be legislated by 
laws of regulation or by laws of Congress. Any attempts to 
regulate markets almost always fail, and it is utterly futile 
to try to attempt to control market forces.
    Market power is and should be closely regulated, and the 
potential for actual antitrust violations should be vigorously 
ensued and enforced.
    The third issue, gaming, this word is very much often 
confused. Essentially, all commodity markets are gamed. The 
issue is whether or not the games are within the rules, or 
whether they are attempts to frustrate the rules and end run 
around the rules. Those kinds of activities need to be fixed, 
and indeed in the California design the whole market 
surveillance process was put in place in order to inform 
decisionmakers on how to fix and refine the market rules based 
upon the actions of the gamers in the market.
    Let me turn now to Perot Systems. I have prepared a report 
that I submit as part of this testimony today. My conclusions 
are explained in that report, and I repeat them here just for 
emphasis.
    The facts, as I view them, are that in 1997 and 1998, Perot 
Systems offered to provide training to participants in the new 
California power market based on public information, employing 
the accepted principles of game theory, that is, operating 
within the rules. No market participants, however, were 
interested in this training. In late 2000, competitive market 
forces, the kind that I described earlier, combined with 
structural flaws in the design of the California market, as 
well as a series of regulatory and political missteps caused 
the California energy crisis. Allegations that Perot Systems 
was in any way responsible for this crisis are, in my opinion, 
totally unfounded, as I explained to the California Senate 
Committee.
    What happened in California in 2000 and 2001 could not have 
reasonably been anticipated in 1997 and 1998, when Perot 
Systems was marketing its training services. The strategies 
employed by Enron and other market participants evolved in 
quite a different set of circumstances than when Perot Systems 
was making its presentation. There is nothing in any of those 
documents that I reviewed that would come even remotely close 
to supporting the allegations, where people have attempted to 
link Perot Systems to the California energy crisis.
    I will be happy to answer any questions that you might have 
on this or any other subject. Thank you.
    Mr. Ose. Thank you, Dr. Cicchetti.
    [The prepared statement of Dr. Cicchetti follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.071
    
    [GRAPHIC] [TIFF OMITTED] T7293.072
    
    [GRAPHIC] [TIFF OMITTED] T7293.073
    
    [GRAPHIC] [TIFF OMITTED] T7293.074
    
    [GRAPHIC] [TIFF OMITTED] T7293.075
    
    [GRAPHIC] [TIFF OMITTED] T7293.076
    
    [GRAPHIC] [TIFF OMITTED] T7293.077
    
    [GRAPHIC] [TIFF OMITTED] T7293.078
    
    [GRAPHIC] [TIFF OMITTED] T7293.079
    
    [GRAPHIC] [TIFF OMITTED] T7293.080
    
    [GRAPHIC] [TIFF OMITTED] T7293.081
    
    [GRAPHIC] [TIFF OMITTED] T7293.082
    
    [GRAPHIC] [TIFF OMITTED] T7293.083
    
    [GRAPHIC] [TIFF OMITTED] T7293.084
    
    [GRAPHIC] [TIFF OMITTED] T7293.085
    
    [GRAPHIC] [TIFF OMITTED] T7293.086
    
    [GRAPHIC] [TIFF OMITTED] T7293.087
    
    [GRAPHIC] [TIFF OMITTED] T7293.088
    
    [GRAPHIC] [TIFF OMITTED] T7293.089
    
    [GRAPHIC] [TIFF OMITTED] T7293.090
    
    [GRAPHIC] [TIFF OMITTED] T7293.091
    
    [GRAPHIC] [TIFF OMITTED] T7293.092
    
    [GRAPHIC] [TIFF OMITTED] T7293.093
    
    [GRAPHIC] [TIFF OMITTED] T7293.094
    
    [GRAPHIC] [TIFF OMITTED] T7293.095
    
    [GRAPHIC] [TIFF OMITTED] T7293.096
    
    [GRAPHIC] [TIFF OMITTED] T7293.097
    
    [GRAPHIC] [TIFF OMITTED] T7293.098
    
    [GRAPHIC] [TIFF OMITTED] T7293.099
    
    [GRAPHIC] [TIFF OMITTED] T7293.100
    
    [GRAPHIC] [TIFF OMITTED] T7293.101
    
    [GRAPHIC] [TIFF OMITTED] T7293.102
    
    [GRAPHIC] [TIFF OMITTED] T7293.103
    
    Mr. Ose. Dr. Backus for 5 minutes.
    Dr. Backus. Good afternoon, Mr. Chairman, and thank you. My 
name is Dr. George Backus. I am the president of Policy 
Assessment Corp. of Denver, CO. I was originally a nuclear 
design safety engineer, providing simulations to make sure that 
nuclear facilities remain safe and secure under all possible 
events. I trained under the simulationists who helped ensure 
the success of the Apollo space program using the same methods. 
My degree is in system dynamics, which primarily considers how 
physical or economic systems change over time as a result of 
human behavior. I focus on policy assessment. I simulate 
potential behaviors and failure modes and how to modify the 
policies to ensure the desired results.
    In 1978, I coauthored the FOSSIL2 simulation model used by 
DOE for U.S. national energy policy, including oil and gas 
deregulation. I later extended that work to look at State and 
regional energy and utility planning. I currently focus on 
stress testing potential climate change policies for various 
governments.
    In 1986, for the State of Illinois, I looked at potential 
electric utility deregulation and found some discouraging 
dynamics, much like what has now been experienced in California 
and elsewhere. In 1996, I prepared a report for the U.S. DOE on 
the dynamics of deregulation. That report was based on the 
deregulation experience in the U.K. and elsewhere, and showed 
that the United States was now heading for the same problems. I 
presented the results to the Western System Coordinating 
Council in 1996. I then provided a workshop to the Western 
Interstate Energy Board, whose members are all the commissions 
within WSCC. I also made a presentation to the California 
Energy Commission and offered to make presentations to the 
California PX, ISO, and CPUC. I then made presentations to 
trade groups, power authorities, consumer groups, utilities, 
and commissions throughout the United States, as I saw the same 
misguided deregulation efforts appear in the Midwest, New 
England, etc.
    The California approach to deregulation was much worse than 
any I had seen or imagined. It would obviously destroy the 
distribution companies and make the supply market a chaotic 
nightmare. I saw my simulation skills as presenting a 
consulting opportunity.
    In 1997, I assisted Southern California Edison, who had 
seen my WSCC presentation, to review potential California 
market rules for problems as well as to recommend alternatives 
that would alleviate those problems. At Edison, I was 
introduced to Hemant Lall of Perot Systems, who saw the broad 
applicability of my work. We decided that combining Perot 
Systems' IT expertise with my work would provide a capability 
unavailable anywhere else. The product could be offered to 
market operators, commissions, and market participants 
worldwide. It would allow them to understand the market 
dynamics and plan accordingly.
    Perot felt the obvious place to start the effort was in 
California, and specifically with Edison, because we were 
already there. These efforts included no proprietary 
information or data. I had no confidential data or any kind 
related to California or any other markets. All information was 
obtained from published reports and news articles. I never 
advised anyone to do anything unethical or illegal. I made sure 
everyone was aware of the systems problems so that the problems 
could be addressed, hopefully, with my consulting assistance. 
Unfortunately, no such consulting business materialized in 
California.
    The fundamental problem in California is that it violated 
the basic concepts of economics. Ordinarily, supply and demand 
will come into balance orchestrated by price. Some key problems 
were that the California market did not let consumers see the 
market prices. The distribution companies were forced to buy 
independent of the prices. It would take 30 to 60 days before 
the ISO and PX could tell distribution companies and suppliers 
the accounting results, and thus, there was no market 
transparency.
    Further, on the supply side, setting rules precluded needed 
additional supply. Stranded cost agreements initially 
suppressed market prices, further discouraging adequate supply. 
On the demand side, the negotiated reduced consumer prices 
stimulated demand. Confronted with high demand and low supply, 
the market was incapable of achieving balance. This 
precipitated the crisis.
    The fatal flaws come not only from the mistakes in market 
design, but also from not planning for them and in letting the 
problems perpetuate. Public documents show that the ISO and PX 
were aware of many of the problems. Many academic investigators 
demonstrated the problems and proposed solutions.
    While it is easy to cast the blame on the market rules, it 
is the regulatory process that needs to be recognized as the 
crux of the California crisis. The problems and solutions I 
discuss in my written testimony will be revisited until 
regulators recognize that markets are imperfect, and that they 
must plan ahead to accommodate those limitations. Thank you.
    Mr. Ose. Thank you, Dr. Backus.
    [The prepared statement of Dr. Backus follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.104
    
    [GRAPHIC] [TIFF OMITTED] T7293.105
    
    [GRAPHIC] [TIFF OMITTED] T7293.106
    
    [GRAPHIC] [TIFF OMITTED] T7293.107
    
    [GRAPHIC] [TIFF OMITTED] T7293.108
    
    [GRAPHIC] [TIFF OMITTED] T7293.109
    
    [GRAPHIC] [TIFF OMITTED] T7293.110
    
    [GRAPHIC] [TIFF OMITTED] T7293.111
    
    [GRAPHIC] [TIFF OMITTED] T7293.112
    
    [GRAPHIC] [TIFF OMITTED] T7293.113
    
    [GRAPHIC] [TIFF OMITTED] T7293.114
    
    [GRAPHIC] [TIFF OMITTED] T7293.115
    
    [GRAPHIC] [TIFF OMITTED] T7293.116
    
    [GRAPHIC] [TIFF OMITTED] T7293.117
    
    [GRAPHIC] [TIFF OMITTED] T7293.118
    
    [GRAPHIC] [TIFF OMITTED] T7293.119
    
    [GRAPHIC] [TIFF OMITTED] T7293.120
    
    [GRAPHIC] [TIFF OMITTED] T7293.121
    
    [GRAPHIC] [TIFF OMITTED] T7293.122
    
    [GRAPHIC] [TIFF OMITTED] T7293.123
    
    [GRAPHIC] [TIFF OMITTED] T7293.124
    
    [GRAPHIC] [TIFF OMITTED] T7293.125
    
    [GRAPHIC] [TIFF OMITTED] T7293.126
    
    [GRAPHIC] [TIFF OMITTED] T7293.127
    
    [GRAPHIC] [TIFF OMITTED] T7293.128
    
    [GRAPHIC] [TIFF OMITTED] T7293.129
    
    [GRAPHIC] [TIFF OMITTED] T7293.130
    
    [GRAPHIC] [TIFF OMITTED] T7293.131
    
    [GRAPHIC] [TIFF OMITTED] T7293.132
    
    [GRAPHIC] [TIFF OMITTED] T7293.133
    
    [GRAPHIC] [TIFF OMITTED] T7293.134
    
    [GRAPHIC] [TIFF OMITTED] T7293.135
    
    [GRAPHIC] [TIFF OMITTED] T7293.136
    
    Mr. Ose. Our last witness is Dr. Gribik, for 5 minutes.
    Dr. Gribik. Good afternoon, Mr. Chairman and members of the 
committee. My name is Paul Gribik. As you know, I have 
experience in and am familiar with the California energy 
markets. Much of this knowledge stems from my employment with 
Perot Systems Corp.
    I began working for Perot Systems as an associate in May 
1995 and remained employed there until January 2001. I was 
hired to provide consulting to clients on energy market 
matters, which later included the California ISO and P X.
    In March 1997, Perot Systems joined with ABB to create the 
ISO Alliance. Perot was the project manager and computer 
systems integrator, and ABB created the ISO's computer system. 
Perot was not responsible for drafting the ISO's protocol, nor 
was I. My job at the Alliance was to explain the formulation of 
the congestion management problem that resulted from the public 
WEPEX process to the computer programmers. I also read other 
public protocols issued by the ISO to advise the computer 
programmers, when asked, as to how the related elements of the 
market were supposed to work. I also participated in open 
meetings held by ISO where the progress in implementing the 
public protocols was discussed.
    I left the ISO Alliance team in September 1997 to provide 
part-time assistance to the PX. At the PX I reviewed the ISO 
and PX public protocols so I could advise the PX on ways to 
ensure that their markets would work with ISO's. In addition, 
at the PX's direction, I interacted with market participants.
    Outside of my work for the ISO and PX, I only recall having 
contact with two market participants through marketing efforts 
by Perot Systems. The first meeting that I attended was with 
Southern California Edison in early 1997. I did not set this 
meeting up, give a presentation there, or write or create any 
document that was given to Edison.
    In October 1997, I prepared a document for and participated 
in a presentation to San Diego Gas & Electric. I discussed the 
California energy market structure and the gaming process a 
participant would need to employ to make strategic decisions. 
When I use the word ``game'' or ``gaming,'' I am referring to a 
strategic decisionmaking process whereby different strategies 
are used to determine the risks and benefits each strategy may 
present, given the strategies that other participants may 
employ. Of course, these strategies must comply with certain 
market rules.
    It later came to my attention that someone at San Diego Gas 
& Electric misunderstood some of the things I said in the 
presentation, and told the ISO that we were talking about 
proprietary information. That was not the case. At no time did 
I offer to disclose nor disclose any ISO or PX proprietary 
information.
    A meeting with Enron was set for January 13, 1998, but it 
did not occur due to a severe snowstorm. I do not recall 
participating in any subsequent meeting with Enron, and I never 
made a presentation to Enron.
    These marketing efforts, about which much has been made, 
resulted in no consulting work from any market participant. I 
believe that we were not hired by anyone because we were 
offering nothing more than a way to analyze the market and our 
knowledge of the public protocols, nothing particularly unique. 
Much of the misunderstanding about the marketing efforts in 
which I and others at Perot engaged stems from the 44-page 
document that Reliant Energy turned over to the California 
Senate. The facts surrounding this document are laid out by 
full statement, but basically this document was never presented 
to anyone. It was not a blueprint for any type of illegal 
trading. It was created after the markets opened on April 1, 
1998, and I have no idea how the document made it to Reliant 
Energy's files.
    The examples of the flaws in the protocols that appear in 
the 44-page document regarding the real-time market and 
negative price problems are two of the problems I brought to 
ISO's and PX's attention. I also brought an additional problem 
to the ISO--with the ISO's default usage to their attention. 
All three of these were fixed before the markets opened. I 
recommended that the protocols be revised to address these 
problems, because I believe they could have enabled a single 
market participant to create instability in the market.
    Mr. Chairman and members of the committee, I am a 
California resident and have paid more for my electricity and 
suffered the same inconveniences that other California 
residents have encountered. I can assure you, however, and the 
facts show, that neither my nor Perot Systems' work contributed 
in any way, shape, or form to high energy prices, brownouts, or 
blackouts, or other aspects of the California energy crisis.
    Thank you. And, I will do my best to answer any questions 
you may have.
    Mr. Ose. Thank you, Dr. Gribik.
    [The prepared statement of Dr. Gribik follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.137
    
    [GRAPHIC] [TIFF OMITTED] T7293.138
    
    [GRAPHIC] [TIFF OMITTED] T7293.139
    
    [GRAPHIC] [TIFF OMITTED] T7293.140
    
    [GRAPHIC] [TIFF OMITTED] T7293.141
    
    [GRAPHIC] [TIFF OMITTED] T7293.142
    
    [GRAPHIC] [TIFF OMITTED] T7293.143
    
    [GRAPHIC] [TIFF OMITTED] T7293.144
    
    [GRAPHIC] [TIFF OMITTED] T7293.145
    
    [GRAPHIC] [TIFF OMITTED] T7293.146
    
    [GRAPHIC] [TIFF OMITTED] T7293.147
    
    [GRAPHIC] [TIFF OMITTED] T7293.148
    
    [GRAPHIC] [TIFF OMITTED] T7293.149
    
    [GRAPHIC] [TIFF OMITTED] T7293.150
    
    [GRAPHIC] [TIFF OMITTED] T7293.151
    
    Mr. Ose. All right. We are going to start sorting through 
some of this stuff here.
    Mr. Winter, this discussion about Perot Systems' contract 
and contractual constraints with the ISO, I know there was a 
bunch of correspondence back and forth. I want to make sure I 
get the timeframe correct. Perot Systems and their 
subcontractors worked with the ISO and PX on the melding of the 
software systems in what timeframe?
    Mr. Winter. OK. Let me just run back through the 
chronology. First off, the PX and the ISO were separated as two 
entities. So we have to keep those ideas kind of straight in 
our head, too.
    The ISO signed a contract with the Alliance in March 1997. 
They then began the development of the software systems, and it 
was in late September, early October that we learned of the 
Perot activities. Now, all of the----
    Mr. Ose. Just a second. So ABB and Ernst & Young, from 
March 1997 to September or October 1997, had worked on the 
software packages?
    Mr. Winter. Correct. And Perot was part of the Alliance.
    Mr. Ose. All right.
    Mr. Winter. Now, their responsibility was to take--there 
were actually three major systems. The settlement system, which 
Ernst & Young has developed; there was an energy management 
system that was developed on another contract with ABB; and 
then there was a scheduling and pricing system that ABB 
developed. Well, those three all had to be integrated together 
and tested so that it worked as one complete, total system. And 
that was Perot's job was to make sure that testing was 
completed and that the systems all worked appropriately.
    They worked up until--the start date was April 1998, April 
1st, March 31st, and then their work in essence, after they did 
the integration, was completed. And then, they left the 
Alliance contract in June or July of that 1998.
    Mr. Ose. So, from August or September 1997, to some point 
prior to April 1, 1998, Perot was working to integrate the 
software so that they could communicate, and they were checking 
for its operational efficiency. And, if there were flaws, what 
were they supposed to do with the information?
    Mr. Winter. Well, what we had was we had variances that we 
identified. And, any time something didn't connect, then we 
would write up a variance, and they were then responsible for 
getting back with Ernst & Young or ABB and correcting the code 
to make sure that it did work.
    Mr. Ose. Did Perot do the code adjustments, or did somebody 
else do the code adjustments?
    Mr. Winter. I believe that ABB and Ernst & Young did the 
adjustments, but certainly they were working very closely with 
Perot to make sure that it would then work out in the testing 
procedures.
    Mr. Ose. Who had physical control of the code?
    Mr. Winter. At that time ABB and Ernst & Young would have 
physical control of the code. I do not know, but I would assume 
that Perot also had the soft--or the code words to get in so 
that they could change it if it was deemed necessary. We had a 
process in place where any changes would be recorded so that 
everyone knew what had been changed.
    Mr. Ose. Changes recorded? Changes were recorded then; and 
the person doing the change would have to log on, put their 
personal identification in there so you knew who had access and 
who was doing the change?
    Mr. Winter. At that time I don't know whether there were 
personal or whether there were ``blanket codes,'' because we 
were not operational. Now, when we went operational on March 
31st, we did what we call a lockdown of the system; and we went 
in and changed all the codes so that we then had absolute 
control of who was coming in and what changes they were making.
    Mr. Ose. Well, one of the things I am trying to get at is 
whether or not Perot Systems had possession or access to the 
codes. And, if I heard you correctly, you said you don't know.
    Mr. Winter. You are correct. I don't know. I would be very 
surprised if they didn't have access to the code, because, as 
the tester, they had to review it and see how it all fit 
together.
    Mr. Ose. Did your contract with ABB or Ernst & Young allow 
for the code to be shared with other contractors?
    Mr. Winter. When you say other contractors, we had 
confidentiality in there. If there was another contractor 
working for the development of the system, then, yes, it would 
have been able to be shared.
    Mr. Ose. Would they have to come back to the ISO to get 
sign-off from the ISO--or the PX in the case of the PX--for 
sharing that code with another contractor under the 
confidentiality agreement?
    Mr. Winter. I don't know. My guess would be that as long as 
it was the Alliance--in other words, Ernst & Young, ABB, or 
Perot Systems, they would not; if it went beyond that, then 
yes, because then you get into the proprietary of software 
systems.
    Mr. Ose. Was a record made of the code changes that 
occurred from August or September until going live on March 
31st?
    Mr. Winter. There was certainly a variance record made of 
any time that we had the actual code changes. I do not know 
whether there was a documentation of each individual line 
change that may have been made.
    Mr. Ose. When you say variance, do you mean the code is X; 
it is not compliant with what we need, so it varies from what 
we want, and we need to fix this?
    Mr. Winter. Correct. We had those, some 1,045 variances 
that we had found that needed correction.
    Mr. Ose. 1,045?
    Mr. Winter. Right.
    Mr. Ose. All right. And, ABB and Ernst & Young were charged 
with correcting those variances.
    Mr. Winter. That is correct.
    Mr. Ose. Would it be--one of the things I just love about 
elective office is the wordsmithing. Variances, is that the 
same as saying there were flaws in the system?
    Mr. Winter. Yes.
    Mr. Ose. OK. Thank you.
    Now, did Perot's work with the Alliance end when you went 
live on March 31st?
    Mr. Winter. No. They continued. When you go live, you find 
things that you didn't know were broken, so they had to finish 
their reports, and they finally left in about July 1998.
    Mr. Ose. July 1998. OK.
    Now, you had a bunch of correspondence back and forth with 
Perot Systems in the late fall of 1997----
    Mr. Winter. Yes, we did.
    Mr. Ose [continuing]. About the attempts to market the 
information that they were marketing. If I heard you correctly 
today, I think your testimony is that you never signed off on 
the fifth or sixth letter exchange saying, ``Go ahead and do 
it.'' Did you ever affirmatively say, ``Don't do it?''
    Mr. Winter. No, we did not. When we looked at the 
information that was available to us, they, in fact, were not 
using anything that was confidential. However, the contract 
does state that the parties to the contract would not do 
anything that would give the perception of impropriety. And, we 
certainly felt that outmarketing, as a knowledgeable person, 
ways to beat the system was not quite appropriate.
    Mr. Ose. Of course, they didn't do a very good job of 
marketing it, did they?
    Now, the correspondence that went back and forth, I know 
there was a discussion about the Chinese wall issue between 
people who were attempting to market the program to third 
parties and the people who were actually working with ISO and 
PX. There was a disclaimer requirement; there was a letter to 
all clients about the existence of the ethics wall and the 
like. Were there things that you asked for that Perot did not 
do in this correspondence?
    Mr. Winter. Yes. We initially had asked that they cease and 
desist from their marketing efforts. Later on, when we couldn't 
show that it was any confidential information that they were 
providing, then we backed off from that position and just asked 
for a Chinese wall and disclaimer so that no one would think 
that they were getting some secret information out of the 
development of the ISO systems.
    Mr. Ose. And, presumably, that was accomplished?
    Mr. Winter. They told us that they were doing that. Yes.
    Mr. Ose. OK.
    Dr. Backus, in a commodity business, do you find it unusual 
that participants construct a game model or a gaming algorithm?
    Dr. Backus. I take that as being a rather common exercise, 
where a person or a company always goes through the exercise. 
If it's a car manufacturer, should we have zero interest loans 
to stimulate demand at a given time?
    I would, to my knowledge, say essentially all commodities, 
all industries involved with commodities, have a strategic 
planning organization or a marketing organization that tries to 
figure out how to do as best they can in the market to compete 
with their competitors, and that process, as Dr. Gribik has 
pointed out, is what we call gaming; sort of like what 
Beautiful Mind was about in the show about John Nash. And, it 
goes clear back to Antoine Carnot in 1850.
    Mr. Ose. Being on the Agriculture Committee, whether it is 
rice or wheat or corn or soybeans, you have participants in 
those markets who presumably are factoring into their analysis, 
whether in transportation and price variances and supply and, 
you know, number of railroad cars and----
    Dr. Backus. Yes. Given that my family were all farmers 
originally, the answer is yes. You always decide whether you 
wanted to hold the grain until it was midwinter, or whether you 
wanted to dump it on the market early. So even as individual 
farmers, they in a sense were doing gaming.
    Mr. Ose. All right. Now, your computer model, when did you 
create it?
    Dr. Backus. The original work was created for the U.S. 
Department of Energy as the FOSSIL2 model that was used for oil 
and gas deregulation starting in 1978 and used for policy 
through 1998. The first time that it was used in a slightly 
modified version was for the State of Illinois, who developed 
the model to take a look at deregulation in Illinois in 1986. 
That time period was when the new nuclear plants were going to 
come on, and they were worried about prices going up by a 
factor of three as the price shock. They wanted to see whether 
deregulation would help out that process. It didn't go very 
far, but nonetheless that model already showed the dynamics in 
quite good detail of what actually happened as we progressed 
both in the U.K., and in the United States.
    Mr. Ose. How did you go about getting the algorithm figured 
out for your model?
    Dr. Backus. It is almost funny to me, because we are the 
only ones who still use it. The idea is that if you are going 
to deregulate electricity, then why don't you treat it as a 
deregulated market, where prices attempt to clear and that 
people don't have perfect information, because most markets 
aren't perfect? Prior to that--and it is still very much that 
way today--everybody uses these very sophisticated optimization 
models that assume there is a perfect market, just like was 
assumed and could be assumed under the centralized command and 
control of the regulated markets. So the only thing that we 
added to our work is to say, well, market logic worked for gas, 
and it worked for oil, why don't we apply the same algorithm 
for electricity and see what happens?
    Mr. Ose. And, what happened?
    Dr. Backus. Because electricity is not stored very well, it 
ends up that you can have very, very volatile markets. A second 
part of this, that applies even when we talk about the 
deregulation of oil and gas, is that we tend to have a few 
rather large companies actually stabilize the market and a lot 
of niche players. In the United States, we probably still today 
have 4,500 electric utility players, if we take and add 
together all the public powers and such. The market is in no 
shape whatsoever to be a deregulated market.
    So, what the model first showed is that we have got to have 
a lot of mergers and acquisitions. It also showed that during 
that process, that would be quite disruptive, which would also 
mean that people wouldn't know what supply and demand actually 
meant. And, as a customer, who am I buying from today or 
tomorrow? In fact, it is probably not unlike buying Internet 
services in the last couple years. We don't know whether the 
person is going to be there or not the next day.
    Mr. Ose. So, if I understand you correctly, the unique 
feature of your algorithm was the factor accounting for the 
inability to store electricity?
    Dr. Backus. That certainly showed up as a dominant 
characteristic that made things worse. The biggest thing was 
just a change in assumptions that now that we had a deregulated 
market, we would have an imperfect world where people were 
trying to make the best choices they could, and, in a sense, 
would have to make them in a hurry because we don't have the 
storage.
    The biggest fault that I find with the current regulatory 
work and the past regulatory work is that the tools that were 
used for that analysis continued to assume an optimization 
approach only appropriate to a regulated market, and that's 
what I considered as a major failure in trying to assess what 
would be the impacts of deregulation within California, New 
England, wherever.
    Mr. Ose. How did you account in your model for the initial 
60 or 90-day lag in price transparency?
    Dr. Backus. I didn't consider the 60 or 90 days. It was 
just the concept that I would bid, and I didn't know what the 
price was until after everything was done. My model actually 
only runs at a semiannual or annual level, so it is not worried 
about market day-to-day transactions. It is simply the idea of 
trying to deal with the idea that you don't really know what 
prices are, and you as consumer or as a generator have to make 
a decision without having price transparency.
    Mr. Ose. Now, you acted as a consultant under--is it Policy 
Assessment----
    Dr. Backus. Yes.
    Mr. Ose [continuing]. To Perot Systems?
    Dr. Backus. I would say the answer to that is no. Since we 
simply had a joint marketing effort that if it was successful, 
would combine my understanding of how systems worked with their 
IT capabilities, and that we would be able to offer a joint 
product to participants, whether they are commissions or the 
ISO or utilities, on how to best survive within that market.
    Mr. Ose. So your joint venture started when?
    Dr. Backus. It would be, I would say, mid or early 1997. 
It's whatever time I met Hemant while I was working at Edison--
or doing consulting at Edison.
    Mr. Ose. In 1996, you gave a presentation to the Western 
System Coordinating Council. Who was in attendance, and what 
did the presentation entail?
    Dr. Backus. My guess is there was something like--I'm 
guessing here--1,200 people. To my knowledge, every utility and 
commission and consumer----
    Mr. Ose. Can you name them for us?
    Dr. Backus. Sorry, I sort of missed all of those. So, they 
were all there. And, the presentation is basically identical to 
the presentations that you probably see in the data that's on 
the Perot Website, which was provided to Senator Dunn. In that 
sense, it's sort of that one-trick pony, that the 1996 report I 
provided by DOE lays out in very fine detail all the different 
dynamics that are going to occur and how they will evolve if 
people aren't careful. And, as it turned out, nobody was 
careful.
    Mr. Ose. So, in 1996, you made a presentation to the 
Western System Coordinating Council basically describing these 
potential flaws in the market?
    Dr. Backus. Simply the dynamics of deregulation, which just 
simply said, if you follow the deregulation process as was 
followed in the U.K. and South America and New Zealand, which 
the United States was also following, here are the problems you 
are going to find. And, those problems included mergers that 
started up about that time; massive divestitures of the 
different utilities, which we saw, where they broke into their 
different generating and distribution groups; and certainly 
market gaming; and then something called reregulation that we 
are probably talking about right now.
    Mr. Ose. Now, you gave a second series of presentations in 
1997 and 1998 on this material.
    Dr. Backus. I was probably giving presentations 
continuously, probably to hundreds of organizations, almost all 
identical.
    Mr. Ose. Did they track the presentation you made to the 
Western System Coordinating Council?
    Dr. Backus. Yes, they did. In fact, it was quite nice to do 
so, because as time is marching on, 100 percent of the 
forecasts that I had produced, as to where the problems would 
be, what would occur next, were actually occurring exactly in 
the sequence and timing that I had predicted.
    Mr. Ose. Now, in your presentation to the Western System 
Council, you mentioned a game that includes a generator having 
an outage of one of its units in order to drive up the price 
for all other units.
    Dr. Backus. Yes.
    Mr. Ose. I guess the question we would have is whether you 
were advocating such a game in your presentations?
    Dr. Backus. No. I was certainly not. It was simply to 
present that and possibly 20 other games as well that occurred 
in the U.K., including discussions of how to prevent those 
games from occurring. Again, that particular game was developed 
by Antoine Cournot in the 1850's, roughly, and is taught in 
every university in the United States. So it wasn't like a 
secret.
    Mr. Ose. So your testimony is that you were analytical in 
your presentation rather than advocational?
    Dr. Backus. Certainly. In all cases it was simply to point 
out here is the situation, and that both utilities and 
commissions must recognize that, because certainly the people 
who are hurt very significantly are going to be people like 
Edison and PG&E if those prices went up. So it was appropriate 
that both commissioners, regulators, and the utilities and 
market participants understood that problem could exist.
    Mr. Ose. Now, you state in your testimony that the outage 
problem was a particular weakness in the California market 
design.
    Dr. Backus. It was particularly troublesome simply because 
supply and demand were so out of balance, as Mr. Winter has 
pointed out.
    Mr. Ose. Is this something you had also recognized in the 
U.K. system?
    Dr. Backus. Yes, it was.
    Mr. Ose. Now, having recognized this, did you inform the 
CAISO or the PUC or the PX of this problem?
    Dr. Backus. I tried to inform the California Energy 
Commission of that, and certainly had the presentation in 1996 
also to the Western Interstate Energy Board, which is all of 
the commissions. I only had limited contact with the PX and 
ISO, and they were up to their gills or necks in trying to get 
the system put up, so they weren't interested in listening to 
me.
    Any contact that I tried to have with the CPUC did not get 
anywhere either, because they were busy trying to work with the 
different utilities to try to also get the system up and 
running.
    Mr. Ose. OK. I have an e-mail from you to Dr. Gribik, dated 
May 8, 1997.
    In that e-mail, you state, ``I am actually trying to get 
the CPUC'', the California Public Utility Commission, ``to 
recognize the mess they are causing with their pricing and 
marketing rules, and relieve some of the restrictions so that 
the market can actually behave like a market.''
    First, I want to ask you, is that your e-mail?
    Dr. Backus. Yes, it is.
    Mr. Ose. What was the mess that you refer to that the CPUC 
was causing?
    Dr. Backus. I had already been looking at the potential 
rules that were being developed for Southern California Edison. 
Within those rules, as I looked at it, already at that time it 
was to the point where you would say there was a 99.9 percent 
probability that Edison, SDG&R, PG&E, unless it got out of 
business, would go bankrupt.
    It also said that because of the way the stranded costs 
were put in place, initially the prices would be too low to 
stimulate supply. Therefore, it gave an almost absolute 
certainty that the market would start to fall apart by 1999, 
which I also point out in the WSCC presentation, and said we 
should have been having this hearing in 1999 instead of now. To 
have waited that long----
    Mr. Ose. I was not chairman then.
    Dr. Backus. You are forgiven. Thank you.
    Mr. Ose. Mr. Winter, let me ask you a couple of questions. 
I want to read you a couple of quotes. Obviously, I am confused 
here.
    I hear testimony about structural issues, and I have seen 
the quotes about supply issues, and I have seen the quotes 
about abatement and conservation and all of that. Frankly, I am 
a little bit confused. I am trying to determine whether or not 
we had sufficient supply or insufficient supply, or whether it 
was market structure or flaws in the market structure, or 
something else.
    I guess I would ask you, just extemporaneously, for an 
abbreviated response to that. Was it an issue of supply? Was it 
an issue of declining conservation? Was it an issue of market 
structure, in looking back, trying to avoid repeating that in 
the future?
    And, I might ask all the witnesses the same question.
    What is your input here?
    Mr. Winter. My input is twofold. One is clearly, if you 
don't have enough supply, the markets aren't going to work and 
the prices are going to increase. That is the way markets are 
supposed to work, because then that encourages people to add 
generation.
    I think, in California, because those signals were so 
distorted, people were trying to guess whether there was a 
supply or a nonsupply shortage; I think it is kind of 
interesting that we had our outages not during the summer when 
we had high loads, but during the winter when we had actually 
reduced loads.
    So people want to read the nameplate ratings of all the 
generators in the area and say, obviously we had plenty of 
power during that timeframe. As an operator, I don't care what 
the nameplate rating is, I am interested in how many units are 
on and what is going to be my supply that day.
    Mr. Ose. The nameplate rating is when you look at the 
turbine--it has the little brass plate on there--and it says at 
such and such an input, this is the megawattage generated from 
there?
    Mr. Winter. Right--50 megawatts, 500 megawatts, whatever. 
But there are so many restrictions on generators. One is, a 
maintenance unit is out for maintenance or has a tube leak, so 
it can only generate half; or units are out because the owners 
are financially incapable of buying natural gas.
    Certainly, in the Northwest, one of the other things to 
remember about California is when people look at the supply, 
they tend to focus on just the power in California. Well, 
California has always imported 20 to 30 percent of its power 
from outside the State, so you've got to look at what is the 
availability out of the State.
    So, structurally, when the PUC forced the investor-owned 
utilities to buy all their energy from the day-ahead market, 
they really eliminated their ability to make long-term 
contracts and go outside the State and in the State and tie up 
power. So as I look at it, that was a structural flaw.
    Then we start buying in real time and not taking into 
account maintenance, droughts, all the other things, lack of 
conservation, no demand side transparency of the price, no 
demand and supply equilibrium being developed, and we have a 
horrible situation.
    Mr. Ose. Dr. Cicchetti, do you have any input on that?
    Dr. Cicchetti. As I said in my opening statement, all three 
of the factors, supply and demand or market forces, market 
structural design flaws, and a form of market manipulation or 
gaming, all three of those were present in 2000 and 2001 in 
California.
    On the supply side, people just did not build fast enough, 
mostly because the models were all forecasting need in 2001-
2002, so supply was in the works, but it was not to come on-
line until about 2002.
    What made things worse was that the economy in California 
grew much more rapidly in the late 1990's than anticipated. We 
had a return of the California miracle, and we also had new 
buildings and new electronic communications in high-tech 
industries that had a big surge in demand, so demand was way 
up, and people just, quite frankly, missed that fact.
    But the most important thing that caused supply and demand 
problems in 2000 had to do with the weather. In the West, about 
once every 30 years, it is very dry in the north and hot in the 
south. Normally, when it is dry in the north, it is cooler in 
the south, and when it is wet in the north, it is hot in the 
south. This year is a typical year for the West. It is dry in 
the north, it has been dry in the north, and it is a cool 
summer in California.
    All of us, with the exception of that 1 week back in 
Sacramento and San Francisco, about 10 days ago, looked at the 
numbers and said southern California and most of the Southwest 
are much cooler than normal because it is a dry year. That is 
the normal condition, this is not just some kind of quirk, 
because when you cannot import the hydroelectricity from the 
north and it is very hot in the south, and therefore air 
conditioning is running, which happened in the year 2000, the 
summer and spring of 2000. There was effectively about an 8,000 
megawatt hours of shortage created by the weather.
    The California market is 40,000 megawatts in peak 
conditions, more or less, so 8,000 megawatts is a 20 percent 
shortfall. That is the big factor that caused the initial 
problem in the spring and summer of 2000. Up to that point, the 
California markets were oversupplied and prices under 
deregulation were much lower than they had been under 
regulation.
    In fact, when California deregulated in 1998, there was a 
30 percent excess supply, and the pricing the first 2 years of 
California deregulation was half of what it had been under 
regulation. Everybody was claiming credit for designing this 
wonderful system that produced prices half of what they had 
been previously, and this was an incredible success story.
    But when that weather changed, coupled with not building 
the supply fast enough and not forecasting the demand growth 
soon enough, those things created the equivalent of the perfect 
supply and demand storm, which made prices jump dramatically. 
And, in the process, it pointed to the structural design flaw 
problems that I also mentioned.
    Mr. Winter just talked about one of them. That is the issue 
of having no long-term contracts and requiring the utilities to 
divest. California was the only market in the world that went 
to deregulation with virtually 100 percent of its energy to be 
sold in the spot market. Every other part of the world put 
maybe 10 or 15 percent of its energy into the commodity or spot 
market; California put more than 90 percent.
    Today, when California prices are once again stabilized and 
low, we have only 10 percent in the spot market. Back in 2000, 
we had 90-some-odd percent of all the energy that was in the 
spot market, by design. People at the time said that was 
foolish, silly to do, but California did it anyway.
    Another structural design flaw we had was, we denied the 
ability of retail customers to get price signals. This caused 
demand to be high until the Governor convinced people there was 
an energy emergency, and then he talked people into 
conservation. But there were no price signals that anybody in 
California paid attention to during 2000. In fact, California 
retail prices, except for San Diego, were not raised until 
March 2001, well after the height of the energy crisis that 
began back in May 2000. So that was a second design flaw.
    Mr. Ose. Let me go to Dr. Backus here.
    Dr. Backus, do you have anything as it relates to the 
interrelationship on this question? Is it an issue of supply? 
Is it market structure? Is it lack of conservation?
    Dr. Backus. I will always argue that, in a sense, it was 
market structure; and actually if we step back a ways, we can 
say whenever we design anything from an engineering 
perspective, we always include contingency planning and always 
stress-test that system before implementing it in the real 
world.
    Even yet today, for the original and new rules that were 
made for the market in California, my guess is that, there has 
not been a formal process by which those rules have been tested 
on a computer, just as we would on an Apollo spacecraft, to 
make sure it can withstand all the things the market is going 
to throw at it. That is a major failing of how we look at 
determining market structures and deregulation, whether it be 
in California or any place in the United States.
    Mr. Ose. Dr. Gribik.
    Dr. Gribik. I think Dr. Cicchetti gave a masterful summary 
of the problems. There are a few things I might add, though.
    One, the utilities were forced to buy on the spot markets, 
which can be extremely volatile, but then they had to sell to 
their customers at a fixed price. The price signals were never 
being passed through to the end user, so they had no incentive 
to conserve whenever supply got short. Their price was fixed.
    And, as Dr. Backus said, it was very foolish, I believe, to 
design such a complicated system from scratch with a lot of 
different compromises being made, building the systems to 
implement it; and only testing to make sure that the systems 
talked to each other, you put numbers in and got the numbers 
out that you expected. No one sat down and said, let us 
simulate the operation of this market. Let us actually have 
teams of people play the roles of various market participants 
and see how this thing will actually play out, give them 
rewards, see what types of strategies people will employ.
    If we did that, we might have been able to find some of the 
more egregious flaws and fix them before we actually went live 
with this. I thought it was rather a bit of insanity to turn 
over a multibillion dollar segment of the State's economy to a 
market design which essentially was untested.
    Mr. Ose. If I might just be so bold, I want to ask you each 
a yes or no question. It is dangerous up here.
    To those who would contend that this was simply a matter of 
supply, my question to each of the witnesses, and I will go 
from Dr. Gribik to Mr. Winter--to those who would contend that 
this was simply a matter of supply, would you agree or 
disagree?
    Dr. Gribik. I don't think I would agree with just supply. I 
would say no.
    Mr. Ose. That is my question.
    Dr. Backus.
    Dr. Backus. I would say ``no'' with big neon lights on it.
    Mr. Ose. Dr. Cicchetti.
    Dr. Cicchetti. It was more than supply or a lack of supply.
    Mr. Ose. Mr. Winter.
    Mr. Winter. More than supply.
    Mr. Ose. I want to recognize my friend from Cleveland for 
10 minutes.
    Mr. Kucinich. I want to thank the Chair for calling this 
hearing, and certainly our responsibilities as an oversight 
committee become very important when we look at what happened 
in California with the manipulation of the energy market. So I 
appreciate the Chair's calling the hearing, and I appreciate 
the witnesses who are here today.
    I have some questions that I would like to ask the 
witnesses, and in particular, start with Dr. Backus. If a yes 
or no answer would suffice, that would be fine, and we can just 
move from there.
    Dr. Backus, how many meetings did you or Perot Systems hold 
with Enron?
    Dr. Backus. Perot Systems held none with Enron. I made two 
presentations. The first was to the customers of Enron. It was 
in Palm Springs, and I think it was provided on the Perot Web 
site. I guess that would have been late 1996, probably late 
1996 would be my guess.
    Then I also made the same presentation, exactly the same 
presentation, to Enron again up at their Portland office. So 
both of those presentations are basically just replications of 
the WSCC presentation, with some minor updates for the latest 
breaking news as to how that presentation in 1996 was playing 
out as advertised.
    Mr. Kucinich. Who attended these meetings?
    Dr. Backus. At the first meeting there were mostly just 
several customers there. I didn't keep track of all of them; or 
in fact, I kept track of one of the customers, The Northern 
California Power Agency, because they later invited me back to 
go through the process with their members in that regard. 
Certainly there were some executives of Enron there as well. In 
fact, one of them--I am trying to remember his name--Rich 
Davis, was there, who then invited me out to his organization 
out in Portland to make that presentation.
    Mr. Kucinich. Do you have any notes of the meetings? Did 
you take notes at the meetings?
    Dr. Backus. No. I was just making the presentation, coming 
in and leaving. I had no notes.
    Mr. Kucinich. Did people have any questions at the 
meetings?
    Dr. Backus. Yes, people were worried this was going to 
happen. My answer to them was, yes, most of these things were 
going to happen; the problems would occur, the market did have 
problems.
    For the Enron--originally, as Dr. Gribik has pointed out, 
the original Enron meeting was supposed to be a proposal to 
Enron similar to that made for Southern California Edison. That 
did not take place--about that time, it is my understanding, is 
when Perot felt they were going to get the new contract and 
therefore really did have a conflict-of-interest problem, and 
decided that had to stop.
    Mr. Kucinich. Before I came to Congress, I used to do 
marketing strategies. I am curious, when you meet with a client 
and make a presentation, you mean to tell me, after that 
presentation your clients have questions or a prospective 
client has a question and you don't take notes on that?
    Dr. Backus. In this particular case, no. I knew it could go 
nowhere.
    Also, in my case, Dr. Gribik and I are sort of what we will 
call the technical nerds of this. Certainly in the Perot 
process there was the vice president, Ed Smith, who was, I 
guess, the worldwide vice president for energy marketing, and 
Hemant Lall, I believe the Western States marketing. So that is 
the four groups, so certainly the marketing process occurred 
elsewhere.
    Mr. Kucinich. When you say it would go nowhere, what do you 
mean?
    Dr. Backus. On my side, all I have is a simulation model 
that looks at things at a plant-type level; not even plants or 
plant units, it looks at things at a semiannual level, so it is 
good for strategic planning. The Portland office is a trading 
office. There is absolutely nothing that I know or can do that 
relates to that group.
    Mr. Kucinich. I am missing something here. You are 
acknowledged to be an expert in marketing. You meet with 
individuals for some purpose. It is not clear--if you say it 
would not go anywhere, why were you meeting with them in the 
first place?
    Dr. Backus. Because, as noted, I made hundreds of 
presentations. I would get paid for those presentations. I was 
paid a half-day to simply make the presentation.
    Mr. Kucinich. Did you wonder why they wanted you to make a 
presentation?
    Dr. Backus. No, I did not. Most people did find my 
presentation to be quite outrageous, controversial, but it sort 
of hit a chord.
    Mr. Kucinich. I have not been asking questions for that 
long, so I can't say that yet.
    Dr. Backus. I am saying that is what I found. Basically, 
people were coming back to me and saying, we would like other 
people to hear this presentation, because it is a real eye-
opener and will change the way we think about the regulation, 
which was actually, in many cases, my function--that I felt 
that was something very useful.
    Mr. Kucinich. How do people end up looking at it 
differently? Does that mean that they suddenly discover that, 
hey, there is a game here we can play?
    Dr. Backus. I don't think that is the response. People like 
to argue that American corporations run on fear and greed. I 
like to argue they only run on fear.
    Mr. Kucinich. I think there has been evidence in the last 
few weeks that we have both of those covered.
    Dr. Backus. Not that time--maybe I was naive. Most of those 
companies were very afraid of what was going to happen in the 
marketplace. I think that is what dominated most of their 
concerns.
    Mr. Kucinich. You were there to address their fears. Would 
you be surprised to learn that you also appealed to their 
greed?
    Dr. Backus. No, I would not be surprised at all. In fact, I 
do believe that Enron--and certainly in those days it was 
considered as good a company as any other company in the sense 
of its approach to business--also needed to understand that the 
old methods of the regulated market no longer applied and that 
they had to think differently about how the system would 
operate, and that the experience that I had and was telling 
everybody about, how the markets worked everywhere, including 
indications they were going to work that way in the United 
States, that they needed to know that.
    Mr. Kucinich. When you were in these meetings, can you 
recall whether or not the participants discussed gaming or any 
gaming strategies?
    Dr. Backus. Certainly they discussed gaming. It is more the 
idea of a war story, that almost everybody likes to hear. It 
doesn't matter whether you are at the Commission or wherever 
you are, they want to hear about what happened in the U.K.
    In my regard there, I take it as simply that I was 
reporting public information. There was no discussion there to 
say, here is a game that you should do and this is going to 
make you lots of money. It was merely saying, here is the full 
spectrum, and here are all the problems that caused.
    Mr. Kucinich. Did you discuss self-created congestion, for 
example?
    Dr. Backus. That was a line item already in the WSSC 1996 
report that I talked about.
    Mr. Kucinich. Let's talk about that for a moment. Let us 
recreate the discussion. You can be the market strategist and I 
will be Enron.
    What is this about self-created congestion?
    Dr. Backus. I don't think I ever received a question like 
that. Note that I am not a market strategist; my work is 
designing simulation models. That is my expertise, as an 
engineer. So certainly, given that I am a one-person company--
--
    Mr. Kucinich. Let us talk for a moment about the simulation 
model of self-creating congestion. Tell me about it.
    Dr. Backus. All I can tell you is that it exists in the 
U.K., it exists in any system, and that all price differentials 
in the market occur across congestion.
    My own work, just because of your interest----
    Mr. Kucinich. Do you want to translate that? Let us say I 
am just a person who pays exorbitant electric rates, and I want 
to know how that happens, if you want to translate that.
    Dr. Backus. If there is an abundant demand on one side of 
the transmission line where that load cannot be delivered by 
generation on that side, then the plants on the other side of 
the transmission line simply cannot deliver, and the price now 
must be determined on the side where the demand is, which could 
be a very high price, especially in an isolated market. So that 
would be what basically causes prices to rise.
    Eighty percent of the time the WSSC is one market, and the 
price is basically uniform everywhere, and 20 percent of the 
time there is usually congestion somewhere, either across the 
Rockies, where I am, or on line 15, the north-south----
    Mr. Kucinich. The net effect of one of those self-created 
congestions is that a company would get paid for moving energy 
to relieve congestion without actually moving any energy or 
relieving congestion?
    Dr. Backus. That is something I had not actually thought 
about trying to think----
    Mr. Kucinich. Think about it right now. What do you think?
    Dr. Backus. The answer to that is, that is correct, but 
again that is not the problem. I would argue with the ISO 
rules--that if the ISO had the ability to dictate how that 
congestion would be relieved, that the ISO was actually part of 
the market, those problems could not have occurred.
    Mr. Kucinich. Isn't it also a possibility when you are 
talking about creating congestion, self-created congestion, 
that one effect of such an action would be to create the 
appearance of congestion through overstating loads?
    Dr. Backus. The answer to that is, yes, but I also have 
to--I can go back to the idea that I simply reported that all 
these things existed, reported it to everybody that it existed.
    For my own work in simulation, I do not have transmission 
lines, so I can't really simulate that other than in a broad 
sense to think about it. It was merely me trying to tell 
everybody that this is a problem that needs to be solved within 
the marketplace.
    It also is a rather obvious problem, that the prices change 
across transmission. So, again, it is not in any way informing 
people, especially traders, who know much more about this than 
I do, about how this process would work.
    Mr. Kucinich. But your awareness of this self-created 
congestion--are you aware now that there is a symmetry between 
information, according to your testimony, that you presented 
and the memorandum that Enron's lawyers wrote about Enron's 
gaming activities with respect to their Death Star strategy, 
which was where Enron would get paid for moving energy to 
relieve congestion without actually moving any energy or 
relieving congestion, which you've said can occur, and their 
load shift strategy, which is an action to create the 
appearance of congestion?
    Dr. Backus. Yes. I would say roughly about 40 percent, 
maybe more, of the Enron games and memoranda were included in 
my presentations. Again, those presentations were presented to 
everybody very early on, long before the markets opened, in 
fact, and certainly everybody knew about those. They could get 
them from the United Kingdom, and therefore the idea was to 
make sure that everybody was aware that those problems could be 
resolved in the sense that the ISO could certainly develop 
rules to prevent those things from happening.
    [Clarification of testimony follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.152
    
    Mr. Kucinich. So, in your view, you were marketing 
knowledge or informing people of knowledge of legal gaming, as 
opposed to illegal gaming?
    Dr. Backus. I never made that distinction. I was simply 
reporting all the things that happened.
    Mr. Kucinich. Thank you. Right, that is important to state. 
Because in a way, retrospectively, questions, Mr. Chairman, 
have been raised about whether or not Enron's activities have, 
in fact, constituted a violation of law.
    That doesn't mean that you were coaching them to break the 
law, but it also represents the possibility that you were 
giving them information that they may have taken to create 
strategies that ran contrary to the law.
    Dr. Backus. I suppose anybody could pick up any textbook on 
economics and read the Cournot's duopoly and come up with the 
same conclusion.
    Mr. Kucinich. It is always helpful to find people who carry 
the textbook along and meet with individuals who then break the 
law.
    Dr. Backus. Which is why we try to talk to all the 
commissions and to all the customers, so that everybody knew 
that they needed to deal with this problem.
    Mr. Ose. I thank the gentleman. Let me ask a couple of 
questions here.
    Dr. Gribik, it is obvious, if you have possession of the 
algorithms and the code that ISO and PX used in their systems, 
it would be a competitive advantage in terms of being able to 
draw the algorithm out and replicate it accordingly.
    Now, my question of you is did you know that CAISO had 
computer codes or algorithms?
    Dr. Gribik. I did not have any access to the ISO's computer 
codes or algorithms, but what I had access to was the public 
protocols, the public tariffs, the public problem formulations 
that came out of the WPEX process.
    Mr. Kucinich. WPEX?
    Dr. Gribik. The Western Power Exchange.
    Mr. Ose. I just wanted to make sure we got that on the 
record.
    Dr. Gribik. It was the process that was set up to develop 
the initial set of protocols for the ISO and the PX. So I knew 
the problem formulations, which were in the public domain.
    I had no access to the ISO's computer codes. I didn't know 
the algorithms. I believe those were considered proprietary by 
ABB and their subcontractors.
    Mr. Ose. All right.
    Did you have access to any proprietary information? If so, 
did you share it with other Perot Systems employees or other 
market participants?
    Dr. Gribik. During the time we were engaged in these 
marketing efforts, I know of no proprietary information that I 
had ever received, and I certainly didn't share any with people 
outside, since I don't know of any that I would have had.
    Mr. Ose. So your analyses and proposals were based entirely 
on public information?
    Dr. Gribik. Yes. I was reading the public protocols and 
trying to decide how people would operate with them, see if I 
could find any potential problems that I would alert the ISO 
and PX to.
    Mr. Ose. So, for instance, if I or any of my colleagues in 
Congress had been schooled in this type of analysis, we could 
have gone and read the public protocols?
    Dr. Gribik. Yes. I think you could have gotten the public 
protocols, the documents exchanged in the WPEX process, freely. 
You could have seen how the problems were formulated, read it 
through; and you would, if you were schooled in the various 
fields of mathematics, you would know as much as I would.
    Mr. Ose. So you got probability analysis, you have 
algorithms, you have all sorts of things. I want to make sure I 
understand this very carefully. That is, you are telling me 
your analysis was based entirely upon public information?
    Dr. Gribik. Yes, it was.
    Mr. Ose. All right.
    Dr. Backus, the input that you provided, your analysis 
provided to whomever your consultants were, was it based on 
public information in its entirety, or was there proprietary 
information included in your proposals and presentations?
    Dr. Backus. There was absolutely no proprietary 
information. It was all publicly available, well-known 
information.
    Mr. Ose. Were there other people who have been schooled in 
this particular mathematical skill, that you are aware of, who 
are doing similar analyses to what you were doing?
    Dr. Backus. No, there was not. Everybody was assuming 
everything was perfect, whereas I started off with the position 
that things were maybe not so perfect.
    Mr. Ose. Dr. Gribik, how about you?
    Dr. Gribik. I know at least on one of the problems I 
identified and brought to the ISO, there was a problem with how 
the real-time market was structured. I went to the ABB 
programmers who were developing the software for the real-time 
market--and I believe there was an ISO person there at the 
time--and outlined the problem I saw in the protocols.
    I was told by them that this process--let's see, I think I 
notified them around May 1, 1997. I was told by them that this 
problem had been identified in the WPEX process, that it had 
been discussed, and a solution had been developed for the 
problem, but that somehow it fell through the cracks.
    It was kind of surprising that whenever--they told me that 
they would take care of it, it would be fixed, it was not my 
concern. I was surprised in October, October 31, 1997, the ISO 
published a new set of protocols. I read them and saw the same 
problem was still there.
    So I would say, yes, people knew about the problems, but 
one of the big problems that was faced was that sometimes they 
would fall through the cracks and they would not be addressed.
    Mr. Ose. Mr. Winter, one of the things that would be 
critical to me as a Californian is whether or not CAISO has 
hired such skill to help them protect, prospectively, the 
interests of California consumers; in other words, to keep a 
constant look at how the market is evolving and how it 
interacts with the system that we have in terms of the ability 
of people who have had this training either in the marketplace 
or in academia, to, in effect, calculate out this question: if 
this happens, if that happens?
    Does CAISO have that kind of service available to it?
    Mr. Winter. Yes. Very clearly, our whole Department of 
Market Analysis is made up of Ph.D. economists who--that is 
their very role, to watch what is happening in real time, 
whether that has market impacts.
    We further implemented a market surveillance committee that 
is made up of Dr. Wolack and a group of other academics who 
then review what is happening in the market, using the data 
that our market development or our market analysis people pull 
off of real time; so that they constantly monitor the market 
and identify any shortfalls that happen.
    Now, do we have a computer model that we go into and do 
experimental things? No. We tried to develop one of those in 
conjunction with some people from Los Alamos, and it is my 
understanding that we have not been able to develop one that we 
felt was sufficient to actually look at the future.
    Mr. Ose. So you have people on staff who are gaming the 
system in a protective sense?
    Mr. Winter. They certainly are looking at it.
    Mr. Ose. In a protective sense, trying to anticipate from 
where the attacks are going to come?
    Mr. Winter. Right. And as some of the other witnesses have 
identified, the whole development was an open process. During 
those processes, we would come up and say, well, what about 
this? People could do this or could do that.
    So we would look at it, and if it appeared to be a major 
flaw, then we would correct it. If it was something that would 
raise its level to, gee, you had better watch this the first 
couple of weeks in the market operation to make sure people are 
taking care of it, we looked at those. Some of them, we 
recognized very clearly that we did not have the knowledge or 
the ability to go outside the State and see what people were 
doing on circulating schedules, etc. So we pointed that out to 
FERC many times.
    Mr. Ose. Now, FERC issued an order, I think in December 
1999, regarding the manner in which ISO handled market 
congestion.
    It asked ISO to implement this particular order, and in the 
content of that order, there were a number of things from a 
rulemaking standpoint that FERC wanted to see done. Now, this 
corresponded quite closely to the period of time during which 
the then-existing 26-member board of the CAISO was replaced 
with the five-member board of CAISO. It is my understanding 
that particular order never was implemented.
    Do you have any recollection of that?
    Mr. Winter. You know, we have received like 40 orders from 
FERC, and I would have to go back and review which one it is.
    Mr. Ose. We will followup on that in writing. That is fine.
    Now, I just want to go back to the point: You have people 
on staff, what we call really smart guys, who sit and they look 
at the market and they try and anticipate where the imbalances 
might occur, and move the system accordingly to prevent those 
imbalances from occurring.
    Mr. Winter. Actually, what they are trying to do is look at 
market design and see whether or not people are ``gaming the 
system,'' and then they look at the real data that is coming in 
and identify those areas where we think there is market power 
abuse, whether or not when a line goes out, people suddenly 
have upped the price, the bidding price, because they said 
congestion will be there. They are monitoring all of those 
activities.
    Mr. Ose. All right. Just for simplicity's sake, I am going 
to thank you for putting people on staff to do the anti-game 
thing in favor of the California consumer. I do appreciate 
that.
    Dr. Cicchetti, in your testimony, you state, ``nothing 
remotely illegal, unethical, or even questionable about what 
Perot Systems did and/or offered to do in California's 
markets.''
    Following up on Mr. Winter's comments that they even have 
people on ISO's staff who look at this stuff, if this kind of 
marketing activity that did take place unsuccessfully, is that 
unusual? Does it take place in other commodity markets?
    Again, if there is a smoking gun here, I am trying to find 
it.
    Dr. Cicchetti. I think that the idea of trying to teach 
utility types of employees about competitive markets and about 
how to be armed both offensively and defensively in commodity 
markets was an obvious place to try to attempt to offer 
services, as I think Dr. Backus and to some extent Perot 
Systems attempted to offer this training, because the culture 
of those industries was that they were cost-plus engineers; and 
there is nothing wrong with that, but that is what they were.
    They were not economists or traders. They were not used to 
dealing with commodities.
    Mr. Ose. You are referring to the type of structure that 
they had previously existed?
    Dr. Cicchetti. Correct.
    Mr. Ose. All right.
    Dr. Cicchetti. What happened was, when the California 
system was going to go not just to a deregulation market but to 
virtually a 100 percent commodity market, some people thought 
that it would be a good business to go out and teach people 
from this old culture how to participate and be wary of what 
could go wrong in this new commodity market.
    What happened was that essentially nobody who tried to do 
that training got hired because the industry went out and hired 
traders from other commodities, thinking that it was easier to 
teach people who knew how to trade corn and rice and wheat 
about electricity than it was to teach electrical engineers and 
people who knew about the electric business in a traditional 
sense about commodity markets.
    Mr. Ose. Why didn't the investor-owned utilities like PG&E 
or Southern California Edison do the same thing?
    Dr. Cicchetti. They did. In fact, I think that both the 
utilities in California----
    Mr. Ose. You say, they did do that?
    Dr. Cicchetti. They did do that. They understood trading 
needed outside experts.
    Mr. Ose. So the investor-owned utilities had their own, so-
to-speak, gaming department?
    Dr. Cicchetti. Correct. And, certainly they had a strategy. 
In fact, the problems in California, I think, began in terms of 
the gaming, if you will, by buyers underscheduling demand in 
the day-ahead market of the California Power Exchange to get a 
lower price there for buyers, or for consumers, knowing that 
they might be paying a higher price in the real-time market 
that the ISO ran.
    What happened was, after the buyers started that process--
this is something we discovered and reported in the State Audit 
Report--that is when the sellers adopted a similar strategy. 
What happened was, the real-time market which was supposed to 
have maybe 2 or 3 percent of the total energy in the State of 
California flow through it, by late 2000, some 35 percent of 
all the energy traded in California was going through the CAISO 
market. They were having to go out of market, buying power from 
other States in the region much beyond the levels that would 
normally have been the case. This is where the game of megawatt 
laundering was discovered.
    None of this--the underscheduling, which was mostly started 
by buyers, and megawatt-hour laundering--was something that 
anybody would have imagined would have been the natural 
evolution of this market back when Perot Systems and Dr. Backus 
were offering their services to teach people about what 
happened in the U.K. These were purely California problems, and 
it was the strategic buying behavior of the utilities in 
California that first started both the so-called 
``underscheduling issue,'' and then second, the ``megawatt-hour 
laundering issue,'' that came about as a result of people 
trying to avoid the price cap that emerged, quite foolishly, 
only in California, but not in the West.
    Mr. Ose. So you are saying in a ``regularly functioning 
market'' you would have buyers and sellers taking or doing 
offensive and defensive tactics to protect themselves?
    Dr. Cicchetti. Correct. And, even the ISO takes offensive 
and defensive tactics. They are not quite doing what Mr. Winter 
suggested.
    Mr. Ose. We just got that on the record.
    Dr. Cicchetti. Mr. Winter is suggesting they are playing a 
defensive game. I think the ISO even plays an offensive game. I 
think they attempted last week on a stage I emergency to get a 
lower price cap in effect. The Federal Energy Regulatory 
Commission saw that this was at least the result, whether it 
was a strategy or just simply a result, and said no, we are not 
going to let the price cap fall below the cap that has been 
working pretty well since last summer, and restored the cap to 
$92.
    Mr. Ose. I actually think the problem was when they went to 
$57 the supply dried up, so they had to go back to the $92.
    Dr. Cicchetti. The fear was that would happen. But I even 
doubt whether or not, in my mind, that the $57 was a new result 
as opposed to at least the possibility that the CAISO was 
involved in gaming the system.
    In fact, I was at discussions of the market advisory group 
that I serve on, where we discussed just that kind of strategy 
and just that kind of opportunity, where the ISO could either 
cause prices to go lower in an emergency or take actions to 
keep it from going higher in an emergency.
    Mr. Ose. Let me just go back for a minute. You are on the 
Market Advisory Committee?
    Dr. Cicchetti. Of the CAISO, appointed by Governor Davis.
    Mr. Ose. Appointed by Governor Davis?
    Dr. Cicchetti. Yes.
    Mr. Ose. The Market Advisory Committee is discussing how to 
game the market?
    Dr. Cicchetti. Both how to game it and how to be protected 
from gaming the market, yes. This is not some kind of--you 
should know that gaming is not some kind of illegal process if 
you play within the rules. It is a process that is meant to 
understand the rules, play within the rules, and protect 
yourself when the rules are going to work against you; and take 
advantage when the rules, playing within them, will allow you 
to get a benefit.
    Mr. Ose. Which brings me to my next question for Dr. 
Backus.
    Dr. Backus, I am in possession of an e-mail dated May 9, 
1997 in which you state that a game to overbook power in the 
PX--and again, this is before the market is up, so certainly it 
is prospective--you state that a game to overbook power in the 
PX could be worth over $50 million to Edison; and I believe you 
mean by that Southern California Edison.
    Dr. Backus. That is correct.
    Mr. Ose. Can you explain the game that you are suggesting 
here? You can read it on the screen if you would like.
    Dr. Backus. With one eye. Thank you. Yes, that was an 
important consideration. We had already very clearly determined 
that Edison would go bankrupt, along with PG&E, already at this 
very early stage before the markets opened at all.
    Mr. Ose. Who is ``we?''
    Dr. Backus. Edison and myself, because we had gone through 
and looked at what the proposed rules looked like. My analysis 
said there is no way this market is going to work, and you are 
going to lose a lot of money in a big hurry as soon as supply 
and demand get out of balance and prices go up, and you cannot 
pass on that price.
    Mr. Ose. Edison had at least one consultant telling them 
that they were toast?
    Dr. Backus. Yes. At least one, but I think multiple people 
were already saying that they were toast.
    Mr. Ose. You may want to provide me with the names of the 
other consultants who were telling them that, too.
    Dr. Backus. I will try to think of who those are.
    Mr. Ose. Let's go back to my question. Explain this game.
    Dr. Backus. The process here is to try to hold off the 
marketplace, and also cause a little volatility so everybody 
could see that there was a very, very big problem encroaching 
on the marketplace, which actually requires a lot of things to 
go on, so it actually goes one way and then the other.
    So the first logic--and we will go through the sequence, we 
already went through some of those--is that we would first 
overbook the market dramatically.
    Mr. Ose. Overbook it on the day ahead?
    Dr. Backus. The day-ahead market. Instead of Edison bidding 
in their normal amount, we would bid in much higher than we 
would normally bid.
    Mr. Ose. Multiples thereof?
    Dr. Backus. Multiples? Just merely a fraction. If it was 
multiples, it would be the end of life as we know it; just a 
small percentage over the amount. So that would actually cause 
them to see higher prices in that process, but it would also 
scare the generators into feeling that there was now a 
shortage; that Edison knew about some load that they did not, 
so in all their cleverness they would raise their prices in the 
hour ahead and in the imbalance market.
    When the time actually came in the imbalance market for 
Edison to buy the energy--which would now be very, very 
expensive--it actually would sell the energy, and in so doing, 
its net average price would be lower than it otherwise would 
have been.
    This would upset the suppliers.
    Mr. Ose. Just a minute. Let us say you have 1,000 
megawatts. Southern California said we are going to generate 
1,100; and then some private generator over there says, whoa, 
what do they know that we don't? So they ramp up----
    Dr. Backus. The price to a very large value. I mean, it 
might be 100----
    Mr. Ose. Then they bid into the hour-ahead market. 
Accordingly on the next day, in anticipation of the tight 
supply, then all of a sudden, 100 megawatts worth of scheduled 
demand goes poof?
    Dr. Backus. Actually, it is different than that. In those 
days you could sell the demand back into the ISO as if it was 
generation, because you essentially own that generation from 
the day-ahead market. So you were----
    Mr. Ose. So Southern California Edison then puts money in 
its pocket for that increment that it sells into the hour-ahead 
market?
    Dr. Backus. Yes. On that, it only needed the 10,000 
megawatts. So therefore the net average price they had to pay 
was much less, so it could survive a little bit longer.
    Now, this would certainly upset the suppliers. So the next 
day, if you would think they were not too clever, you would 
grossly underbid and all the suppliers would say, oh, my gosh, 
Edison must know there is a storm coming and the market is 
useless, we have to keep our plants running, so bid your 
minimum cost into the hour-ahead market and into the imbalance 
market just to keep our plants running, because we cannot stand 
to shut down nukes and coal plants.
    So now Edison, when it finally comes to be the day ahead, 
really does demand a lot of energy, but the price is low so 
they are still better off.
    Mr. Ose. So the rules of the marketplace allowed this 
phantom demand to be entered into the market?
    Dr. Backus. There was the hope that was the case. It was on 
the books. To my understanding, Edison then went to the general 
counsel who then went to the CPUC, and the answer was no, they 
would not allow that.
    Mr. Ose. You went to whom?
    Dr. Backus. The general counsel of Southern California 
Edison.
    Mr. Ose. Whose name is?
    Dr. Backus. I think it was Mr. Forney at that time, I don't 
remember his first name, or somebody in his group.
    They went to the CPUC to ask whether this would be a 
legitimate process, or do we have to actually bid in, as Dr. 
Gribik pointed out, the 90 percent into the PX market and 
another 3 into the day-ahead, and the rest of the imbalance or 
whatever the numbers are, whether they could actually make this 
a variable number to try to prevent prices from going up. They 
would not go bankrupt and not see these huge prices on the 
marketplace.
    My understanding is that the answer came back that no, the 
CPUC would look disfavorably at that. So Edison--and actually I 
had managers who were ready to cry, saying it really is 
hopeless for us.
    Mr. Ose. So this request of the CPUC was made between May 
9, 1997 and March 31, 1998?
    Dr. Backus. Yes.
    Mr. Ose. Do you know to whom the request was made at the 
CPUC?
    Dr. Backus. No. When I brought up the process they said we 
will check on it, and several months later I heard back to say 
they would not go forward.
    Mr. Ose. How many months later?
    Dr. Backus. It could have been after the markets started. I 
simply don't remember the concept of what the timing was. I 
just know they said that they would check it out. They came 
back later at a visit I had taken there and said, by the way, 
it was not allowed, so therefore we are in bad shape.
    Mr. Ose. At that point, the Edison people with whom you 
were working----
    Dr. Backus. Their strategy then became--which is the 
strategy I believe they pursued--they said, our only hope is to 
become the perfect victim; that is, we will do nothing to 
defend ourselves, we will do nothing on offense, we will just 
simply ride this through and hope that California bails us out 
when all this is said and done.
    Mr. Ose. If I understand you correctly, Edison took the 
precaution of hiring consultants who would help them, from a 
financially defensive standpoint, game the system for 
protective purposes; and then the California Public Utility 
Commission said, that is all great, but you can't do that?
    Dr. Backus. That is correct. In fact, I understand--and 
maybe Dr. Gribik has more examples of this, of many other cases 
where perfectly legitimate gaming processes were proposed--and 
the statement was, no, you will follow the rules this way.
    Mr. Ose. The CPUC not only prevented investor-owned 
utilities from entering into the forward contract market after 
August 1999, but then they also basically emasculated them in 
terms of defending themselves financially by reversing the game 
on the guys who were just hammering them?
    Dr. Backus. Yes. In fact, I always called it the wolf, 
because you always knew every day--the generator always knew 
exactly how much demand was going to go on the day-ahead market 
and can do whatever they wanted to stop them.
    Mr. Ose. This was a function of the rules and regulations 
under which the ISO market operated, or the PX market operated?
    Dr. Backus. Now it gets to be a little more complicated, 
because you could have designed different rules, like allow a 
forward market----
    Mr. Ose. My next question was, was anything ever done to 
fix that? I may direct that to Mr. Winter.
    Dr. Backus. To my knowledge, nothing. Certainly, again, 
starting very early, we were showing all sorts of problems. Dr. 
Gribik was trying to show problems. Many of those problems were 
already obvious almost immediately when the market opened.
    To my knowledge, nobody was fixing the problem. I mean, 
that my yelling and screaming when I went everywhere to 
commissions, hundreds of presentations, to try to wave the flag 
to say these are big problems, you should fix them. It is all 
right to make mistakes, but the bigger problem is when you 
don't fix them. That is what was going on in California.
    Mr. Ose. It is your testimony between May 9, 1997 and March 
31, 1998, Edison knew they were going to get hammered? They had 
figured it out?
    Dr. Backus. Yes. So did PG&E. My closing remark to PG&E 
was, ``In 4 years you will be bankrupt,'' which was not a very 
good selling pitch, but nevertheless that was the truth.
    Mr. Ose. Mr. Winter, your perspective, please.
    Mr. Winter. Well, certainly I am not aware of any 
activities between Edison and PG&E and the PUC. I would not be 
privy do that.
    I guess I am a little curious. The first 2 years we very 
clearly saw a market that was extremely beneficial to the 
investor-owned utilities. They certainly made back a large 
portion of their stranded costs during that timeframe. So in 
the beginning, even though we were monitoring the market and 
were aware of some of these programs or games, if you will, 
they obviously were not being played to any extent.
    As other people pointed out, clearly when we started 
getting into the demand and supply preliminaries is when things 
took off and became very unstable.
    I guess beyond that, I am not too clear on exactly what was 
being proposed and what was not being proposed.
    Mr. Ose. Dr. Cicchetti.
    Dr. Cicchetti. Dr. Backus talked about one of the things 
that the CPUC said could not be done, which was the game that 
was a complicated game, where you would overschedule in the 
day-ahead market so as to create conditions of instability in 
the real-time energy imbalance, or CAISO market, and to be able 
to make money as a utility trading.
    The CPUC--and it is my understanding that it agrees with 
Dr. Backus--said, ``no, you can't do this.'' But the CPUC 
didn't stop the utilities in California from underscheduling, 
as opposed to overscheduling, in the day-ahead market.
    And, in fact, it was the underscheduling of the utilities 
in terms of saying they wanted to buy less than they really 
needed in the day-ahead market that caused this incredible 
shift of the energy supply in California onto the backs of the 
CAISO, which had the responsibility in real time to make 
certain that there would be sufficient power that caused them 
to go out of State, out of market, out of sequence, and to do 
literally anything that it took to keep the lights on.
    It was when that happened, in conjunction with the supply 
demand imbalance or gap, if you will, that things literally in 
November or December 2000 went absolutely into these chaotic 
prices that we are all aware of, when the price of electricity 
jumped from the level it had been in 1999 of $25, I think 
Congressman Waxman said, to over $1,000.
    It was this strategy of gaming on behalf of the buyers, 
followed then by a matched strategy on the part of the sellers, 
that shifted the burden onto the California Independent System 
Operator. And I think the numbers were in December 2000 for the 
CAISO to have to meet 35 percent of the total energy 
requirements of California, when it was designed to be about 
maybe 2 or 3 percent on the extreme, and certainly not anything 
like the 35 percent the CAISO had to find the ability to go out 
and acquire the electricity for California.
    This, of course, also set up--because of price caps put 
into effect in that same period in the CAISO market only for 
California market participants--this caused the so-called 
megawatt hour laundering practices to begin where either the 
municipal utilities in California or out-of-State entities 
could either buy power or take their power that they would have 
otherwise sold to the CAISO, but to sell it roundabout back 
into the State at a much higher price and avoid those price 
caps.
    Both of these problems are things that in the State Audit 
Report we pointed to: the underscheduling and the megawatt hour 
laundering. Eventually the Federal Energy Regulatory Commission 
went ahead and took steps to prevent those kinds of things from 
happening.
    They continue to take steps, as recently as this week at 
the Federal Energy Regulatory Commission, to modify the rules, 
now having a restriction on a single bid price, which the CAISO 
proposed as to get around the kind of gaming between markets 
that we saw back in 2000.
    So it is like a train wreck that occurred in 2000 in the 
California energy market. Many things have been fixed. It is 
not safe to say there will never be another train wreck, but 
many of the things that were done in 2000 and in 2001 are now 
prohibited by the actions of the Federal Energy Regulatory 
Commission; after the fact, to be sure. But this is 
preventative in terms of keeping things that happened as they 
occurred back then from happening again. You can't megawatt 
hour launder, you can't game the system through bidding between 
markets or different prices between markets. There are 
penalties for underscheduling that have some bite in them, and 
there are prohibitions against the so-called overloading 
congestion lines that are associated with Enron.
    These are fixes that have been made, but the fundamental 
problems are still potentially present, except for the fact 
that now the market is mostly a long-term market and less 
volatile, because so much of the energy is under a long-term 
contract.
    Mr. Ose. Dr. Cicchetti, in your opinion, had the California 
Public Utilities Commission allowed the investor-owned 
utilities to enter into long-term contracts, pursuant to their 
requests in August 1999, would our difficulties ever have 
arisen?
    Dr. Cicchetti. There would have been high prices because of 
supply and demand conditions, just as there was in the Midwest 
in 1999. But the Midwest, when they had the high prices in 
1999, had about 85 percent or so of the energy that was under 
long-term contract, or owned by the midwestern utilities. 
Therefore the high prices, when they flew up, only affected 10 
to 15 percent of the market. They got the same headlines as 
California, but they did not cause the same damage in terms of 
bankrupting the utilities or causing the States in the Midwest 
to have to come in and buy the power.
    Mr. Ose. Your point is not only the ability of the long-
term contract, but that portion of the total portfolio that had 
to be purchased in the day ahead market?
    Dr. Cicchetti. Exactly. That is the thing that eventually 
caused California as a State to step up and sign both the 
purchase contracts as well as enter into its own long-term 
contracts. Because unlike the utilities, California as a State 
was able to enter into long-term contracts beginning, as they 
did, in February or March or so of 2001.
    Mr. Ose. I want to be clear; Mr. Winter, neither of those 
decisions or rules are jurisdictional to ISO? Those are both 
PUC regulations?
    Mr. Winter. That is correct.
    Mr. Ose. All right.
    Dr. Gribik, in your opening statement you mentioned that on 
several occasions you brought market design flaws to the 
attention of the ISO and the PX. According to what you have 
given us, you alerted ABB of a design flaw in the real-time 
market in early May 1997. I have a document, document No. 11.
    And then, when you noticed the problem had not yet been 
fixed, you made a November 7, 1997 presentation to the ISO 
explaining the flaw, and that is document No. 12.
    [The information referred to follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.153
    
    [GRAPHIC] [TIFF OMITTED] T7293.154
    
    [GRAPHIC] [TIFF OMITTED] T7293.155
    
    [GRAPHIC] [TIFF OMITTED] T7293.156
    
    [GRAPHIC] [TIFF OMITTED] T7293.157
    
    [GRAPHIC] [TIFF OMITTED] T7293.158
    
    [GRAPHIC] [TIFF OMITTED] T7293.159
    
    [GRAPHIC] [TIFF OMITTED] T7293.160
    
    [GRAPHIC] [TIFF OMITTED] T7293.161
    
    [GRAPHIC] [TIFF OMITTED] T7293.162
    
    [GRAPHIC] [TIFF OMITTED] T7293.163
    
    [GRAPHIC] [TIFF OMITTED] T7293.164
    
    [GRAPHIC] [TIFF OMITTED] T7293.165
    
    [GRAPHIC] [TIFF OMITTED] T7293.166
    
    [GRAPHIC] [TIFF OMITTED] T7293.167
    
    [GRAPHIC] [TIFF OMITTED] T7293.168
    
    [GRAPHIC] [TIFF OMITTED] T7293.169
    
    [GRAPHIC] [TIFF OMITTED] T7293.170
    
    [GRAPHIC] [TIFF OMITTED] T7293.171
    
    [GRAPHIC] [TIFF OMITTED] T7293.172
    
    [GRAPHIC] [TIFF OMITTED] T7293.173
    
    [GRAPHIC] [TIFF OMITTED] T7293.174
    
    [GRAPHIC] [TIFF OMITTED] T7293.175
    
    [GRAPHIC] [TIFF OMITTED] T7293.176
    
    [GRAPHIC] [TIFF OMITTED] T7293.177
    
    [GRAPHIC] [TIFF OMITTED] T7293.178
    
    [GRAPHIC] [TIFF OMITTED] T7293.179
    
    [GRAPHIC] [TIFF OMITTED] T7293.180
    
    [GRAPHIC] [TIFF OMITTED] T7293.181
    
    Mr. Ose. Can you explain the nature of this problem and the 
steps that led to it being fixed?
    Dr. Gribik. OK. The problem was a flaw in the ISO's real-
time market protocol. At a high level, the flaw, a generator to 
place unscheduled power on--into the ISO's real-time market, it 
would start dumping power in. And, it could submit some bids to 
buy back power, which would in effect cause the real-time 
market price to go to whatever level that participant desired. 
So it could pump power into the ISO's real-time market and 
simultaneously set the price that would be paid for that power 
to any level.
    As I said in the testimony, I alerted the ISO and ABB 
programmers to this in the beginning of May 1997. They told me 
that this process was known or this problem was known. They had 
discussed it in the WEPEX process. They had a way to fix it; 
that somehow it just fell through the cracks, they would take 
care of it.
    At the end of October 1997, I was at that time providing 
consulting services to PX, and I read the ISO's protocols and 
saw that the problem still was there. I alerted Jim Kritikson, 
who was then director of scheduling at the Power Exchange, 
about this problem and devised an example to show how serious 
this flaw could be. In essence, I showed him a strategy a 
market player could use to dump power and simultaneously set 
the price.
    He had me explain it to the CEO and the president of the 
Power Exchange, and they instructed us to go to the ISO and 
inform him of the Power Exchange's concern. We went up, gave 
them a presentation where we outlined the problem, outlined the 
strategy. I believe the ISO recognized the seriousness of the 
problem, and I believe they took it to their market participant 
process, because I received calls afterwards from several 
market participants asking me to explain the problem. And, the 
ISO fixed the problem by, in essence, adjusting the bid prices 
that people would submit to prevent the problem from occurring 
before the market opened. So it was patched well before the 
market opened.
    Mr. Ose. OK. And the market opened, again, on?
    Dr. Gribik. April 1, 1998.
    Mr. Ose. April 1, 1998. And, you had this fixed roughly by 
the end of December 1997.
    Dr. Gribik. I believe they had it fixed by December 1997.
    Mr. Ose. Mr. Winter, my compliments.
    Mr. Winter. Thank you.
    Mr. Ose. Now, Dr. Gribik, you also noticed a problem with 
transmission congestion pricing. And, on--according to my 
information, on January 30, 1998, you brought that problem to 
the attention of Jim Kritikson at the PX, who instructed you 
again to contact the ISO. That's document No. 13 on the screen 
right now.
    [The information referred to follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.182
    
    [GRAPHIC] [TIFF OMITTED] T7293.183
    
    [GRAPHIC] [TIFF OMITTED] T7293.184
    
    [GRAPHIC] [TIFF OMITTED] T7293.185
    
    Dr. Gribik. Yes, sir.
    Mr. Ose. Now, who is Jim Kritikson?
    Dr. Gribik. Jim Kritikson was director of scheduling for 
the Power Exchange, and he was the Power Exchange person 
responsible for--basically, did oversight of the work that the 
Perot Systems was doing for the Power Exchange.
    And, see, the problem in this case was the way that the ISO 
was going to set what they call default usage charges. The 
problem could have caused high prices and adversely affected 
reliability in the ISO's system.
    In essence, to explain this in detail would take several 
hours, but I will try to give you a very highlighted----
    Mr. Ose. Abbreviated, please.
    Dr. Gribik. Yes. Unfortunately, this stuff gets very 
convoluted.
    Roughly, the ISO allocates--or scheduling coordinators 
submit schedules to the ISO. The ISO checks to see if it can 
accommodate those schedules without overloading any of the 
transmission elements. If any transmission elements are 
overloaded, it allocates transmission to the scheduling 
coordinators who place the highest value on using the 
transmission as indicated by bids that they submit. The ISO 
allocates the transmission to the highest volume use first, the 
next highest, and so on, and at the end it sets the price for 
using the transmission to the value set by the last person that 
gets on.
    The problem is that people do not have to submit bids for 
using the transmission. They could say, ``I'm willing to pay 
anything to use them.'' Now, if the ISO runs out of bids to 
manage the transmission based on economics, it will allocate 
pro rata the transmission to those who did not submit bids, who 
in essence said, ``I will pay anything to use it.'' It still 
has to, however, charge them for using the transmission. The 
ISO protocols as of October 31, 1997, said that they were going 
to pick the usage charge, in this case the default usage 
charge, when they ran out of economic bids by looking at the 
price for power in yesterday's real-time market, and they would 
set the usage charge equal to yesterday real-time market price.
    What I pointed out to Mr. Kriticzen is if yesterday real-
time market price was very low, say, $1 per megawatt--which 
could happen; in fact, sometimes it was zero--you have 
destroyed any incentive for people who value the path more than 
$1 to submit a bid, because why would I bid to use the path at 
$10 whenever I may be taken off and it is given to somebody 
else for $1? In essence, it becomes a free-for-all. Everyone 
comes rushing in to submit the schedules to use transmission. 
They will not give you adjustment bids, because why should they 
bid to use it when they say, ``I'll pay anything; I only pay 
$1?''
    Mr. Ose. You're saying that drove the price to zero? 
Whatever the situation, it would drive the price to zero 
because the guys who needed the transmission figured it out.
    Dr. Gribik. Yeah. They'd figure it out and say, ``Hey, I'm 
looking at yesterday's price; it's only $1. I will just 
overload this transmission line, knowing that I will only be 
charged $1.''
    Mr. Ose. Right.
    Dr. Gribik. And, because it was pro rata allocation, they 
would even have incentive to bid to use more.
    Mr. Ose. Now, if I understand what you did, working with 
Kritikson first and then the ISO, you were able to fix this 
problem?
    Dr. Gribik. Yes. Jim Kritikson told me to take it to the 
ISO stakeholder process. There were a series of conference 
calls and meetings, I believe, that the ISO was holding on the 
congestion management process, and at those meetings and 
conference calls I raised this issue and said that you cannot 
set the price for using transmission today using yesterday's 
energy price. It was a hard sell to people, because, in 
essence, I was trying to tell them----
    Mr. Ose. They had to pay.
    Dr. Gribik [continuing]. You should be willing to pay more.
    Mr. Ose. Right.
    Dr. Gribik. No one wants to hear that.
    Mr. Ose. But, in effect, at the end of the day prior to the 
March 31 operational date, this issue got fixed.
    Dr. Gribik. Yes. The ISO submitted two amendments to its 
tariff, I think amendments 4 and 6, which alleviated the 
problem.
    Mr. Ose. All right. Now, on April 9, 1998--first of all, 
let me go back and say, Mr. Winter, my compliments on fixing 
it, again.
    In the April 9, 1998, memo from you to Fred Mobasheri, you 
discussed the need for market surveillance capabilities at the 
PX. Now, we have talked about market surveillance capabilities 
that exist at the ISO. Document 14 is on the screen, I believe. 
Who is Fred Mobasheri?
    [The information referred to follows:]
    [GRAPHIC] [TIFF OMITTED] T7293.186
    
    Dr. Gribik. Fred Mobasheri was the manager of the market 
moderating unit at the Power Exchange; in essence, the sister 
organization to the market surveillance unit at the ISO.
    Mr. Ose. Was the PX vulnerable to being gamed by market 
participants?
    Dr. Gribik. Well, I would say that anyone out there was 
going to start developing strategies to try to defend 
themselves, and also to take advantage of the rules where 
possible. What I was concerned about, because I had found these 
flaws sitting on the surface of the ISO and PX protocols 
whereby a single participant could have destabilized the 
markets, I was concerned that there might be more of these 
floating around out there, and I was recommending to Dr. 
Mobasheri that the PX should set up a team that would 
proactively seek out those types of flaws, identify them, 
identify the types of strategies people might make, figure out 
what the markers were that you could detect when somebody was 
using them, and either, if they could, change their protocol so 
those things could not be employed, or at the very least start 
looking for the markers whenever inappropriate behavior was 
being done so that they could take action.
    Mr. Ose. So you gamed the system on behalf of the PX, 
purely in a theoretical manner.
    Dr. Gribik. I was recommending----
    Mr. Ose. Actually, at that point it would not have been 
theoretical; it was post-April 1st.
    Dr. Gribik. Yes.
    Mr. Ose. So you gamed the system, sent a memo to Mobasheri. 
Did the PX take your advice?
    Dr. Gribik. Nothing came of it. They did have a market 
moderating unit. My estimation was that they were more in a 
reactive mode than a proactive mode; that they were reacting to 
what they saw in the market rather than trying to get ahead of 
the participants to patch holes before people used them.
    Mr. Ose. Let me move on in the interest of time here. I do 
appreciate your attempts at trying to fix these holes.
    Mr. Winter, I have to admit to some serious concern about 
the revelations laid out in the Enron memos, you know, about 
Fat Boy and Ricochet and all this other stuff, and yet I am 
trying to determine whether or not those practices were illegal 
at the time they were done. Were they illegal at the time they 
were done?
    Mr. Winter. Well, this is going to sound evasive. I'm not 
an attorney and really can't determine the legality, but having 
said that, certainly if you come in and tell someone that you 
are providing firm power, and then you are not providing firm 
power, I would call that somewhat illegal and violates WSCC 
criteria. I think if you say that you have got a unit that is 
available to run, and I am going to provide you 1,000 
megawatts, and then you find out the unit's been broken and was 
never able to run, I think that is totally--I wouldn't--I don't 
know that I would say illegal, but certainly not--not something 
that you could do.
    I think as far as arbitraging between markets, that is 
something that clearly was permitted, and if you have 
sufficient infrastructure, transmission, and generation, that 
is exactly what you want the market to do, because it will then 
find its equilibrium, and the markets will then become very 
efficient as you use those.
    But I think to say whether or not they were illegal, I 
would refer you to my appendix 2 of my testimony where we went 
through each of them and explained, you know, what the practice 
was, what we had done about it, and whether or not it was 
prohibited by our market monitoring rules.
    Mr. Ose. Do the rules prevent it now? Let me rephrase the 
question.
    Can California's consumers be comfortable with the nature 
of the market now being such as to prevent such gaming?
    Mr. Winter. Well, clearly we came out with five points, 
five of the practices, and sent out a market notice saying that 
these were illegal and people should not practice. And, again, 
you can read those in my testimony.
    As far as the others, we have been very concerned about 
activities that happen outside the State because we don't have 
visibility to that. I think FERC's recent decision has gone a 
long ways to correct that.
    Mr. Ose. They must offer.
    Mr. Winter. Must offer the maximum bid cap at 250. They are 
on an automated program that kicks in if you suddenly spike 
your bid prices. I think these go a long ways to protect it.
    Now, if I have learned anything in the last 4 years, it's 
no matter what kind of rule you come up with, there are very 
clever people who try to find ways around that and often do. So 
I can't stand here and just absolutely give you assurance that 
it would never happen again, but I think there has been enough 
attention on it that if we saw something in the marketplace 
that was clearly out of line, we would get the action of FERC 
and those others very quickly.
    Mr. Ose. Gentlemen, I need to confer with my counsel here 
for a couple minutes. We are going to take a 2-minute recess.
    [Recess.]
    Mr. Ose. When Dr. Backus comes in, we will just go ahead 
and proceed accordingly.
    Mr. Winter, one of the things I keep coming back to is the 
confidence that the California consumer can have as to whether 
or not market participants are, in effect, unethically or 
illegally gaming the system, what measures are being taken by 
the appropriate government entity to protect the California 
consumers from that, and then the range of who is participating 
in this. I do want to ask you for an update on the issue having 
to do with, I believe, one of ISO's people on the floor.
    Let me just state my question here. In July 2001, a 
conversation took place between one of ISO's employees and an 
Enron trader in which the employee asked the Enron trader to 
submit a specific bid. This employee was fired, and an 
investigation was ordered. I would like to know the status of 
that investigation.
    Mr. Winter. OK. When we learned through documents that 
Senator Dunn had gathered, we found reference to a person who 
was on the floor that had had a conversation with an Enron 
employee. We reviewed that. First, I think we got that 
information on a Friday. We hired an independent law firm to 
come in and do an investigation for us. In the meantime, we 
talked to the employee. He admitted that he had done it. It was 
clearly in violation of our code of conduct, and so we 
terminated him.
    The investigation then went on, and the law firm had 
reviewed both vertically and horizontally different members of 
the corporation, different schedulers, the chain of command, 
and found out that this did appear. And that is the finding of 
the report, that this was one individual's action, and it was 
not widespread throughout the corporation.
    That report has been completed and given to our board, and 
that's the status of it. And, Senator Dunn has also been 
informed.
    Mr. Ose. Two questions. Can I get a copy of the report at 
the conclusion of the investigation?
    Mr. Winter. Yes. It was a confidential report since it 
dealt with personnel but I don't see why you could not get it.
    Mr. Ose. I do appreciate that.
    The second question: You used the phrase that these were 
not widespread practices. I mean, there is just one person?
    Mr. Winter. Just one person.
    Mr. Ose. So they are very unique to this person?
    Mr. Winter. Yes, it was.
    Mr. Ose. According to the investigation. OK. So it is not 
widespread.
    Mr. Winter. Not at all.
    Mr. Ose. All right.
    Dr. Cicchetti, the new rules on trading practices that the 
ISO has adopted, do you believe these will be successful?
    Dr. Cicchetti. I think that they will be successful in 
terms of eliminating the pricing gaming between markets. But 
two other things that the Federal Energy Regulatory Commission 
has started were also necessary. The first is the Federal 
Energy Regulatory Commission has effectively ordered the ISO to 
develop nodal pricing so that the kind of congestion gaming 
that has received so much attention today and as part of the 
Enron memo wouldn't be one of the games that could be played, 
because nodal pricing would effectively replace the kind of 
congestion path pricing or valuation that's in the current 
tariff.
    And, the second thing that the Federal Energy Regulatory 
Commission has ordered is to change the CAISO board to make it 
an independent board. The current board is a political board. 
There is no other way around it. I don't think that's 
particularly a problem or has been a particular problem that's 
caused gaming. But the old stakeholder boards, both of the 
CAISO and the CPX, in the work I did for the State Audit Bureau 
as well as the Federal Energy Regulatory Commission's own 
review, we both found that the market monitoring committees and 
staff of both the CAISO and the California Power Exchange 
reported problems, and the process of getting those problems 
reported and then out to Federal Energy Regulatory Commission, 
so as to fix the problems, was stalled by the stakeholder board 
process.
    And so, the independent boards are an important part of 
restoring faith, which is an important part of any commodity 
market; that is, policing markets is an important function--
that those policing activities of the staffs of both in the 
case of the CPX, which no longer really exists, but in the case 
of the CAISO, very excellent staff, so that material gets out 
and in the hands of the Federal Energy Regulatory Commission 
sooner rather than later.
    And now, to complete the process I think the Federal Energy 
Regulatory Commission this past week has ordered California to 
develop a purely independent board, not a stakeholder board, 
not a Governor appointee board, but one that is purely 
independent, and that will help restore some of the market 
confidence along with the new locational nodal pricing that 
will be put into effect.
    Mr. Ose. Thank you, Doctor.
    Let me follow on, if I may. We have had a large debate 
about a regional transmission organization, whether California 
should or should not participate. What is your opinion on that 
issue?
    Dr. Cicchetti. Personally I think that a regional 
transmission organization for the West makes a great deal of 
sense. In fact, we saw problems that occurred through megawatt-
hour laundering, Ricochet, whatever you want to call it, 
because we had essentially a two-tier market. That's been fixed 
to some extent by the fact that the Federal Energy Regulatory 
Commission came up with a Western States price cap. But, 
fundamentally, I think we have to do more than that because we 
have to deal with the congestion problem for transmission that 
exists throughout the entire West, not just in California.
    The problem is that, given California's terrible crisis in 
2000 and 2001, not very many other Western States want to 
partner or participate in a regional transmission organization 
with California. So, while I think it is the right way to go, 
it is the right model, it is ultimately going to be necessary; 
I think that it is probably more likely that the Southwest and 
then the Pacific Northwest will form their own RTOs eventually 
to be merged together, as well as to be merged with California.
    But for the short term I think California has to continue 
to do what it has been doing, which is to regain stability and 
see the return of competition and lower prices, as we have been 
seeing in the past 12 months or so. But we need probably a bit 
more time to convince the neighboring States to go along with 
an RTO that would include California, unless somehow or another 
Congress orders such a thing to happen, which I don't see 
happening.
    Mr. Ose. Thank you. I have a couple more very specific 
questions.
    Mr. Winter, down in the San Diego area, there is some 
debate as to whether or not to build a transmission line north/
south linking the San Diego market to Southern California 
Edison. Are you positive toward that, ambivalent? Are you 
negative toward it? What is your perspective?
    Mr. Winter. I'm extremely positive toward it, but it is 
just first a small link in what we need to do. It is called the 
Valley Rainbow 500 Interconnection from northern San Diego up 
to a valley substation in the Los Angeles area. Now--but what 
we need to do is then complete the next link of that, which is 
Rainbow to Miguel, which brings us next to the Mexican border. 
Right now we are seeing about 1,000 megawatts plus being 
developed in Mexico, and the way that is going to get into the 
entire grid is up through San Diego. So we have got to add to 
the infrastructure in that area as well as Path 15 to allow the 
north/south transfer of large blocks of energy out of the 
Southwest and Northwest.
    Mr. Ose. I will tell you for a fact that most of the 
California delegation is very supportive of Path 15, working 
through the Bureau and others. Can you give us some sense of 
the status of the negotiations on that, given the different 
stakeholders?
    Mr. Winter. It is my understanding that there are actually 
two proposals, one before the Public Utility Commission that 
would have PG&E build the entire line. In the other one, the 
Western Area Power Authority would be the Federal agency that 
would build it, and an independent transmission company would 
provide about 85 percent of the money, with the remainder 
coming from PG&E. And, both of those proposals are moving 
ahead. As to which one is going to win, I don't know at this 
time.
    Mr. Ose. But both are integral to solving the transmission 
problem?
    Mr. Winter. Yes, sir.
    Mr. Ose. All right.
    Mr. Winter. Either one of them would do it.
    Mr. Ose. All right. I want to summarize here. I just want 
to be clear. I heard all four of you say you don't know of any 
nonpublic information that Perot or--some of you actually 
testified you had not used it. Do any of you know of any 
nonpublic information that was used in the presentations to 
various parties about the structure of the ISO market?
    Mr. Winter.
    Mr. Winter. I certainly am not aware of any. However, all I 
saw was what I had been provided at this point.
    Mr. Ose. All right. Dr. Cicchetti.
    Dr. Cicchetti. No. And I will only add to what Mr. Winter 
said by pointing out that I found some of the identical 
material being used in the Perot Systems that the CAISO, or the 
California Independent System Operator, uses in its own 
training materials.
    Mr. Ose. All right.
    Dr. Backus, you've testified that you didn't have any 
nonpublic information that you used in your presentation.
    Dr. Backus. All I knew is the public information. That's 
all that could be contained within the presentations.
    Mr. Ose. And, Dr. Gribik, your testimony was consistent 
with that?
    Dr. Gribik. Yes. Used absolutely no proprietary 
information.
    Mr. Ose. All right, gentlemen. First of all, I want to 
thank you all for coming. One of the things we struggle with 
back here is, frankly, getting to the bottom of it without a 
lot of hue and cry. We have a continuing problem in our State 
about supply of energy and the ability to obtain energy at 
reasonable prices. Frankly, I can understand why Mr. Winter and 
his colleagues at the ISO were upset when they learned what 
possibly Perot System was doing. I have to applaud your logical 
means of resolving that, where you actually sat down and 
communicated to each other your concerns, worked it out. 
Frankly, based on the testimony today and the documents we have 
received to date, I am at a bit of a loss to explain all the 
allegations I am familiar with.
    The other aspect of this that I think is germane is that, 
No. 1, the work that Perot Systems did took place prior to the 
market opening, and then that which they tried to do with what 
is alleged to be nonpublic information, nobody bought. I mean, 
I just don't understand this. Maybe I'm missing something. 
Based on the information we have today, I just am afraid we 
have used 2\1/2\ hours for little purpose.
    Now, the other things I want you to understand is that to 
the extent, Mr. Winter, that you or, Dr. Cicchetti, your 
colleagues on the market committee can continue to use gaming 
theory to protect California's consumers, I want to encourage 
you to do that. I just think it's great for California's 
consumers to have that as a defensive effort. I don't know how 
you massage this thing with the CPUC who says, well, you can 
have some tools, but you can't have others, even though you 
know your competitors have them to stick it to you.
    This market design issue is going to stay with us. I know 
it is going to evolve over time. I look forward to working with 
all four of you as we try and address these things in an 
evolutionary fashion.
    Again, I thank you for coming today. I appreciate your 
testimony. We are adjourned.
    [Whereupon, at 4:32 p.m., the subcommittee was adjourned.]
    [Additional information submitted for the hearing record 
follows:]
[GRAPHIC] [TIFF OMITTED] T7293.187

[GRAPHIC] [TIFF OMITTED] T7293.188

[GRAPHIC] [TIFF OMITTED] T7293.189

[GRAPHIC] [TIFF OMITTED] T7293.190

[GRAPHIC] [TIFF OMITTED] T7293.191

[GRAPHIC] [TIFF OMITTED] T7293.192

[GRAPHIC] [TIFF OMITTED] T7293.193

[GRAPHIC] [TIFF OMITTED] T7293.194

[GRAPHIC] [TIFF OMITTED] T7293.195

[GRAPHIC] [TIFF OMITTED] T7293.196

[GRAPHIC] [TIFF OMITTED] T7293.197

[GRAPHIC] [TIFF OMITTED] T7293.198

[GRAPHIC] [TIFF OMITTED] T7293.199

[GRAPHIC] [TIFF OMITTED] T7293.200

[GRAPHIC] [TIFF OMITTED] T7293.201

[GRAPHIC] [TIFF OMITTED] T7293.202

[GRAPHIC] [TIFF OMITTED] T7293.203

[GRAPHIC] [TIFF OMITTED] T7293.204

[GRAPHIC] [TIFF OMITTED] T7293.205

[GRAPHIC] [TIFF OMITTED] T7293.206

[GRAPHIC] [TIFF OMITTED] T7293.207

[GRAPHIC] [TIFF OMITTED] T7293.214

[GRAPHIC] [TIFF OMITTED] T7293.215

[GRAPHIC] [TIFF OMITTED] T7293.216

[GRAPHIC] [TIFF OMITTED] T7293.217

[GRAPHIC] [TIFF OMITTED] T7293.208

[GRAPHIC] [TIFF OMITTED] T7293.209

[GRAPHIC] [TIFF OMITTED] T7293.210

[GRAPHIC] [TIFF OMITTED] T7293.218

[GRAPHIC] [TIFF OMITTED] T7293.219

[GRAPHIC] [TIFF OMITTED] T7293.220

[GRAPHIC] [TIFF OMITTED] T7293.221

[GRAPHIC] [TIFF OMITTED] T7293.222

[GRAPHIC] [TIFF OMITTED] T7293.223

[GRAPHIC] [TIFF OMITTED] T7293.224

[GRAPHIC] [TIFF OMITTED] T7293.225

[GRAPHIC] [TIFF OMITTED] T7293.226

[GRAPHIC] [TIFF OMITTED] T7293.227

[GRAPHIC] [TIFF OMITTED] T7293.228

[GRAPHIC] [TIFF OMITTED] T7293.229

[GRAPHIC] [TIFF OMITTED] T7293.230

[GRAPHIC] [TIFF OMITTED] T7293.231

[GRAPHIC] [TIFF OMITTED] T7293.232

[GRAPHIC] [TIFF OMITTED] T7293.233

[GRAPHIC] [TIFF OMITTED] T7293.234

[GRAPHIC] [TIFF OMITTED] T7293.235

[GRAPHIC] [TIFF OMITTED] T7293.236

[GRAPHIC] [TIFF OMITTED] T7293.237

[GRAPHIC] [TIFF OMITTED] T7293.238

[GRAPHIC] [TIFF OMITTED] T7293.239

[GRAPHIC] [TIFF OMITTED] T7293.240

[GRAPHIC] [TIFF OMITTED] T7293.241

[GRAPHIC] [TIFF OMITTED] T7293.242

[GRAPHIC] [TIFF OMITTED] T7293.243

[GRAPHIC] [TIFF OMITTED] T7293.244

[GRAPHIC] [TIFF OMITTED] T7293.245

[GRAPHIC] [TIFF OMITTED] T7293.246

[GRAPHIC] [TIFF OMITTED] T7293.247

[GRAPHIC] [TIFF OMITTED] T7293.248

[GRAPHIC] [TIFF OMITTED] T7293.249

[GRAPHIC] [TIFF OMITTED] T7293.250

[GRAPHIC] [TIFF OMITTED] T7293.251

[GRAPHIC] [TIFF OMITTED] T7293.252

[GRAPHIC] [TIFF OMITTED] T7293.253

[GRAPHIC] [TIFF OMITTED] T7293.254

[GRAPHIC] [TIFF OMITTED] T7293.255

[GRAPHIC] [TIFF OMITTED] T7293.256

[GRAPHIC] [TIFF OMITTED] T7293.257

[GRAPHIC] [TIFF OMITTED] T7293.258

[GRAPHIC] [TIFF OMITTED] T7293.259

[GRAPHIC] [TIFF OMITTED] T7293.260

[GRAPHIC] [TIFF OMITTED] T7293.261

[GRAPHIC] [TIFF OMITTED] T7293.262

[GRAPHIC] [TIFF OMITTED] T7293.263

[GRAPHIC] [TIFF OMITTED] T7293.264

[GRAPHIC] [TIFF OMITTED] T7293.265

[GRAPHIC] [TIFF OMITTED] T7293.266

[GRAPHIC] [TIFF OMITTED] T7293.267

[GRAPHIC] [TIFF OMITTED] T7293.268

[GRAPHIC] [TIFF OMITTED] T7293.269

[GRAPHIC] [TIFF OMITTED] T7293.270

[GRAPHIC] [TIFF OMITTED] T7293.271

[GRAPHIC] [TIFF OMITTED] T7293.272

[GRAPHIC] [TIFF OMITTED] T7293.273

[GRAPHIC] [TIFF OMITTED] T7293.274

[GRAPHIC] [TIFF OMITTED] T7293.275

[GRAPHIC] [TIFF OMITTED] T7293.276

[GRAPHIC] [TIFF OMITTED] T7293.277

[GRAPHIC] [TIFF OMITTED] T7293.278

[GRAPHIC] [TIFF OMITTED] T7293.279

[GRAPHIC] [TIFF OMITTED] T7293.280

[GRAPHIC] [TIFF OMITTED] T7293.281

[GRAPHIC] [TIFF OMITTED] T7293.282

[GRAPHIC] [TIFF OMITTED] T7293.283

[GRAPHIC] [TIFF OMITTED] T7293.284

[GRAPHIC] [TIFF OMITTED] T7293.285

[GRAPHIC] [TIFF OMITTED] T7293.286

[GRAPHIC] [TIFF OMITTED] T7293.287

[GRAPHIC] [TIFF OMITTED] T7293.288

[GRAPHIC] [TIFF OMITTED] T7293.289

[GRAPHIC] [TIFF OMITTED] T7293.290

[GRAPHIC] [TIFF OMITTED] T7293.291

[GRAPHIC] [TIFF OMITTED] T7293.292

[GRAPHIC] [TIFF OMITTED] T7293.293

[GRAPHIC] [TIFF OMITTED] T7293.294

[GRAPHIC] [TIFF OMITTED] T7293.295

[GRAPHIC] [TIFF OMITTED] T7293.296

[GRAPHIC] [TIFF OMITTED] T7293.297

[GRAPHIC] [TIFF OMITTED] T7293.298

[GRAPHIC] [TIFF OMITTED] T7293.299

[GRAPHIC] [TIFF OMITTED] T7293.300

[GRAPHIC] [TIFF OMITTED] T7293.301

[GRAPHIC] [TIFF OMITTED] T7293.302

[GRAPHIC] [TIFF OMITTED] T7293.303

[GRAPHIC] [TIFF OMITTED] T7293.304

[GRAPHIC] [TIFF OMITTED] T7293.305

[GRAPHIC] [TIFF OMITTED] T7293.306

[GRAPHIC] [TIFF OMITTED] T7293.307

[GRAPHIC] [TIFF OMITTED] T7293.308

[GRAPHIC] [TIFF OMITTED] T7293.309

[GRAPHIC] [TIFF OMITTED] T7293.310

[GRAPHIC] [TIFF OMITTED] T7293.311

[GRAPHIC] [TIFF OMITTED] T7293.312

[GRAPHIC] [TIFF OMITTED] T7293.313

[GRAPHIC] [TIFF OMITTED] T7293.314

[GRAPHIC] [TIFF OMITTED] T7293.315

[GRAPHIC] [TIFF OMITTED] T7293.316

[GRAPHIC] [TIFF OMITTED] T7293.317

[GRAPHIC] [TIFF OMITTED] T7293.318

[GRAPHIC] [TIFF OMITTED] T7293.319

[GRAPHIC] [TIFF OMITTED] T7293.320

[GRAPHIC] [TIFF OMITTED] T7293.321

[GRAPHIC] [TIFF OMITTED] T7293.322

[GRAPHIC] [TIFF OMITTED] T7293.323

[GRAPHIC] [TIFF OMITTED] T7293.324

[GRAPHIC] [TIFF OMITTED] T7293.325

[GRAPHIC] [TIFF OMITTED] T7293.326

[GRAPHIC] [TIFF OMITTED] T7293.327

[GRAPHIC] [TIFF OMITTED] T7293.328

[GRAPHIC] [TIFF OMITTED] T7293.329

[GRAPHIC] [TIFF OMITTED] T7293.330

[GRAPHIC] [TIFF OMITTED] T7293.331

[GRAPHIC] [TIFF OMITTED] T7293.332

[GRAPHIC] [TIFF OMITTED] T7293.333

[GRAPHIC] [TIFF OMITTED] T7293.334

[GRAPHIC] [TIFF OMITTED] T7293.335

[GRAPHIC] [TIFF OMITTED] T7293.336

[GRAPHIC] [TIFF OMITTED] T7293.337

[GRAPHIC] [TIFF OMITTED] T7293.338

[GRAPHIC] [TIFF OMITTED] T7293.339

[GRAPHIC] [TIFF OMITTED] T7293.340

[GRAPHIC] [TIFF OMITTED] T7293.341

[GRAPHIC] [TIFF OMITTED] T7293.342

[GRAPHIC] [TIFF OMITTED] T7293.343

[GRAPHIC] [TIFF OMITTED] T7293.344

[GRAPHIC] [TIFF OMITTED] T7293.345

[GRAPHIC] [TIFF OMITTED] T7293.346

[GRAPHIC] [TIFF OMITTED] T7293.347

[GRAPHIC] [TIFF OMITTED] T7293.348

[GRAPHIC] [TIFF OMITTED] T7293.349

[GRAPHIC] [TIFF OMITTED] T7293.350

[GRAPHIC] [TIFF OMITTED] T7293.351

[GRAPHIC] [TIFF OMITTED] T7293.352

[GRAPHIC] [TIFF OMITTED] T7293.353

[GRAPHIC] [TIFF OMITTED] T7293.354

[GRAPHIC] [TIFF OMITTED] T7293.355

[GRAPHIC] [TIFF OMITTED] T7293.356

[GRAPHIC] [TIFF OMITTED] T7293.357

[GRAPHIC] [TIFF OMITTED] T7293.358

[GRAPHIC] [TIFF OMITTED] T7293.359

[GRAPHIC] [TIFF OMITTED] T7293.360

[GRAPHIC] [TIFF OMITTED] T7293.361

[GRAPHIC] [TIFF OMITTED] T7293.362

[GRAPHIC] [TIFF OMITTED] T7293.363

[GRAPHIC] [TIFF OMITTED] T7293.364

[GRAPHIC] [TIFF OMITTED] T7293.365

[GRAPHIC] [TIFF OMITTED] T7293.366

[GRAPHIC] [TIFF OMITTED] T7293.367

[GRAPHIC] [TIFF OMITTED] T7293.368

[GRAPHIC] [TIFF OMITTED] T7293.369

[GRAPHIC] [TIFF OMITTED] T7293.370

[GRAPHIC] [TIFF OMITTED] T7293.371

[GRAPHIC] [TIFF OMITTED] T7293.372

[GRAPHIC] [TIFF OMITTED] T7293.373

[GRAPHIC] [TIFF OMITTED] T7293.374

[GRAPHIC] [TIFF OMITTED] T7293.375

[GRAPHIC] [TIFF OMITTED] T7293.376

[GRAPHIC] [TIFF OMITTED] T7293.377

[GRAPHIC] [TIFF OMITTED] T7293.378

[GRAPHIC] [TIFF OMITTED] T7293.379

[GRAPHIC] [TIFF OMITTED] T7293.380

[GRAPHIC] [TIFF OMITTED] T7293.381

[GRAPHIC] [TIFF OMITTED] T7293.382

[GRAPHIC] [TIFF OMITTED] T7293.383

[GRAPHIC] [TIFF OMITTED] T7293.384

[GRAPHIC] [TIFF OMITTED] T7293.385

[GRAPHIC] [TIFF OMITTED] T7293.386

[GRAPHIC] [TIFF OMITTED] T7293.387

[GRAPHIC] [TIFF OMITTED] T7293.388

[GRAPHIC] [TIFF OMITTED] T7293.389

[GRAPHIC] [TIFF OMITTED] T7293.390

[GRAPHIC] [TIFF OMITTED] T7293.391

[GRAPHIC] [TIFF OMITTED] T7293.392

[GRAPHIC] [TIFF OMITTED] T7293.393

[GRAPHIC] [TIFF OMITTED] T7293.394

[GRAPHIC] [TIFF OMITTED] T7293.395

[GRAPHIC] [TIFF OMITTED] T7293.396

[GRAPHIC] [TIFF OMITTED] T7293.397

[GRAPHIC] [TIFF OMITTED] T7293.398

[GRAPHIC] [TIFF OMITTED] T7293.399

[GRAPHIC] [TIFF OMITTED] T7293.400

[GRAPHIC] [TIFF OMITTED] T7293.401

[GRAPHIC] [TIFF OMITTED] T7293.402

[GRAPHIC] [TIFF OMITTED] T7293.403

[GRAPHIC] [TIFF OMITTED] T7293.404

[GRAPHIC] [TIFF OMITTED] T7293.405

[GRAPHIC] [TIFF OMITTED] T7293.406

[GRAPHIC] [TIFF OMITTED] T7293.407

[GRAPHIC] [TIFF OMITTED] T7293.408

[GRAPHIC] [TIFF OMITTED] T7293.409

[GRAPHIC] [TIFF OMITTED] T7293.410

[GRAPHIC] [TIFF OMITTED] T7293.411

[GRAPHIC] [TIFF OMITTED] T7293.412

[GRAPHIC] [TIFF OMITTED] T7293.413

[GRAPHIC] [TIFF OMITTED] T7293.414

[GRAPHIC] [TIFF OMITTED] T7293.211

[GRAPHIC] [TIFF OMITTED] T7293.212

[GRAPHIC] [TIFF OMITTED] T7293.213

[GRAPHIC] [TIFF OMITTED] T7293.419

[GRAPHIC] [TIFF OMITTED] T7293.420

[GRAPHIC] [TIFF OMITTED] T7293.421

[GRAPHIC] [TIFF OMITTED] T7293.422

[GRAPHIC] [TIFF OMITTED] T7293.423

[GRAPHIC] [TIFF OMITTED] T7293.424

[GRAPHIC] [TIFF OMITTED] T7293.425

[GRAPHIC] [TIFF OMITTED] T7293.426

[GRAPHIC] [TIFF OMITTED] T7293.427

[GRAPHIC] [TIFF OMITTED] T7293.428

[GRAPHIC] [TIFF OMITTED] T7293.429

[GRAPHIC] [TIFF OMITTED] T7293.430

[GRAPHIC] [TIFF OMITTED] T7293.431

[GRAPHIC] [TIFF OMITTED] T7293.432

[GRAPHIC] [TIFF OMITTED] T7293.433

[GRAPHIC] [TIFF OMITTED] T7293.434

[GRAPHIC] [TIFF OMITTED] T7293.435

[GRAPHIC] [TIFF OMITTED] T7293.436

[GRAPHIC] [TIFF OMITTED] T7293.437

[GRAPHIC] [TIFF OMITTED] T7293.438

[GRAPHIC] [TIFF OMITTED] T7293.439

[GRAPHIC] [TIFF OMITTED] T7293.440

[GRAPHIC] [TIFF OMITTED] T7293.441

[GRAPHIC] [TIFF OMITTED] T7293.442

[GRAPHIC] [TIFF OMITTED] T7293.443

[GRAPHIC] [TIFF OMITTED] T7293.444

[GRAPHIC] [TIFF OMITTED] T7293.445

[GRAPHIC] [TIFF OMITTED] T7293.446

[GRAPHIC] [TIFF OMITTED] T7293.447

                                   - 
