[Senate Hearing 107-27]
[From the U.S. Government Publishing Office]
S. Hrg. 107-27
CALIFORNIA'S ELECTRICITY CRISIS
=======================================================================
HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
on
CALIFORNIA'S ELECTRICITY CRISIS AND IMPLICATIONS FOR THE WEST
__________
JANUARY 31, 2001
Printed for the use of the
Committee on Energy and Natural Resources
______
U.S. GOVERNMENT PRINTING OFFICE
72-191 DTP WASHINGTON : 2001
_______________________________________________________________________
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC
20402
COMMITTEE ON ENERGY AND NATURAL RESOURCES
FRANK H. MURKOWSKI, Alaska, Chairman
PETE V. DOMENICI, New Mexico JEFF BINGAMAN, New Mexico
DON NICKLES, Oklahoma DANIEL K. AKAKA, Hawaii
LARRY E. CRAIG, Idaho BYRON L. DORGAN, North Dakota
BEN NIGHTHORSE CAMPBELL, Colorado BOB GRAHAM, Florida
CRAIG THOMAS, Wyoming RON WYDEN, Oregon
RICHARD C. SHELBY, Alabama TIM JOHNSON, South Dakota
CONRAD BURNS, Montana MARY L. LANDRIEU, Louisiana
JON KYL, Arizona EVAN BAYH, Indiana
CHUCK HAGEL, Nebraska DIANNE FEINSTEIN, California
GORDON SMITH, Oregon CHARLES E. SCHUMER, New York
MARIA CANTWELL, Washington
Andrew D. Lundquist, Staff Director
David G. Dye, Chief Counsel
James P. Beirne, Deputy Chief Counsel
Robert M. Simon, Democratic Staff Director
Sam E. Fowler, Democratic Chief Counsel
Howard Useem, Senior Professional Staff Member
C O N T E N T S
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STATEMENTS
Page
Bailey, Keith, Chairman, The Williams Companies, Inc., Tulsa, OK. 85
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................ 5
Boxer, Hon. Barbara, U.S. Senator from California................ 11
Burns, Hon. Conrad, U.S. Senator from Montana.................... 38
Campbell, Hon. Ben Nighthorse, U.S. Senator from Colorado........ 33
Cantwell, Hon. Maria, U.S. Senator from Washington............... 49
Craig, Hon. Larry E., U.S. Senator from Idaho.................... 35
Crisson, Mark, Director/CEO, Tacoma Public Utilities, Tacoma, WA. 112
Dorgan, Hon. Byron L., U.S. Senator from North Dakota............ 4
Feinstein, Hon. Dianne, U.S. Senator from California............. 6
Ferreira, Richard, Executive Advisor, Sacramento Municipal
Utility District, Sacramento, CA............................... 87
Fox-Penner, Dr. Peter S., Principal, The Brattle Group, Inc...... 19
Frank, Stephen E., Chairman, President & CEO, Southern California
Edison, Rosemead, CA........................................... 61
Gale, John R., General Manager, Pricing and Regulatory Services,
Idaho Power Company, Boise, ID................................. 104
Hildebrand, Curtis A., Vice President, Project Development,
Calpine Corporation, Pleasanton, CA............................ 119
Johansen, Judi, Executive Vice President, Regulation and External
Affairs, PacifiCorp, Portland, OR.............................. 116
John, Frederick E., Senior Vice President, External Affairs,
Sempra Energy, San Diego, CA................................... 67
Karier, Dr. Tom, Council Member, Northwest Power Planning
Council, Spokane, WA........................................... 95
Kean, Steven J., Executive Vice President & Chief of Staff,
Enron, Houston, TX............................................. 72
Kline, Steven L., Vice President, Federal Governmental &
Regulatory Relations, PG&E Corporation......................... 64
Konolige, Kit, Managing Director, Morgan Stanley Dean Witter, New
York, NY....................................................... 24
Landrieu, Hon. Mary L., U.S. Senator from Louisiana.............. 54
Makovich, Lawrence J., Ph.D., Senior Director of Research, North
American Electric Power, Cambridge Energy Research Associates,
Cambridge, MA.................................................. 12
Murkowski, Hon. Frank H., U.S. Senator from Alaska............... 1
Nickles, Hon. Don, U.S. Senator from Oklahoma.................... 55
Perkins, Joe Bob, President and Chief Operating Officer, Reliant
Energy Wholesale Group, Houston, TX............................ 76
Schumer, Hon. Charles E., U.S. Senator from New York............. 58
Thomas, Hon. Craig, U.S. Senator from Wyoming.................... 43
Wilcox, Brett E., Chief Executive Officer, Golden Northwest
Aluminum Inc., The Dalles, OR.................................. 109
APPENDIXES
Appendix I
Responses to additional questions................................ 149
Appendix II
Additional material submitted for the record..................... 169
CALIFORNIA'S ELECTRICITY CRISIS
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WEDNESDAY, JANUARY 31, 2001
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 9:40 a.m. in room
SH-216, Hart Senate Office Building, Hon. Frank H. Murkowski,
chairman, presiding.
OPENING STATEMENT OF HON. FRANK H. MURKOWSKI,
U.S. SENATOR FROM ALASKA
The Chairman. Let me welcome you to the Energy & Natural
Resources Committee hearing. The hearing today is on the
California electric crisis and its effect on other Western
States.
In view of the lengthy number of witnesses that we have,
with the exception of Senator Bingaman and myself, and we have
agreed upon this, we are going to defer opening statements and,
as we all know, Senators can abbreviate their opening
statements in their questioning period. However, we are going
to make an exception and allow the two Senators from California
to make statements relative to the significance of what this
crisis has done to their State and Senator Bingaman and I have
agreed that is probably the best way to expedite this hearing.
We are certainly aware of the seriousness of the problems
in California, and I am not going to go into that today.
However, I think it is fair to say that those that characterize
the California deregulation as a failure do not fairly evaluate
deregulation. California really does not have a deregulation in
the strict sense of the word. With the capping of retail
prices, why, clearly that changes the structure.
I think Chairman Greenspan has indicated in his statement
before the Budget Committee that that type of deregulation
really is questionable. I think he noted that power can be
supplied in a regulated market or a deregulated market, and I
quote, ``but if you try to mix the two it is clearly, as
evidence demonstrates, not the desirable way to go.'' I think
that's an understatement.
In any event, we have what we have, and the California
problems affect nearly everyone connected to the grid, the
entire West. The Idaho Power may have to raise their rates as
much as 24 percent. Tacoma Power in the State of Washington has
already raised their rates 50 percent. Utilities serving
Arizona's Tahonaho Indian Reservation will have to raise rates
an additional $1 million collectively on top of a 30-percent
rate increase last summer.
We are seeing other States--Governor Leavitt of Utah said,
``what is at stake is the economic competitiveness of the
West,'' and we have seen Chairman Greenspan's analysis of the
situation.
Having come from the bankruptcy community I have seen what
a bankruptcy judge can do in a bankruptcy in dictating the
rates the consumer may have to pay to restructure the utilities
if, indeed, it should come to that.
Now, so far California has had 12 days of stage 3 emergency
electric reserves of less than 1.5 percent, or prevalent
margins that should be in the range of 15 to 20 percent are not
there. It will be interesting to see what happens when the 12
days are up, whether California will actually have a workable
plan that has the confidence of the investment community, or
whether they will come back into the Federal Government for an
extension of time.
We have seen statements from the administration that they
do not intend to extend that sales order, but as bad as the
trouble sounds, many of us on this committee fear the worst is
yet to come. It is anyone's guess what is going to happen this
summer when the air conditioners are turned on. Given the
reservoir levels in the Northwest even less power may be
available to California.
Now, some of us feel that California created this problem
by betting that it could rely on electricity produced in other
States to meet the growing demands in California. The
realization that no major powerplant has been built in a decade
is a reality, and the fact that 25 percent of California's
electric energy comes from outside the State I think sets a
parallel.
It sets a parallel, if you will, on the reliance that our
Nation has on imported oil. We're 56 percent dependent on
imported oil. See what happens to a State that is 25 percent
dependent on electricity coming from outside the State, and the
exposure of the Federal Government and the United States in
relying on 56 percent of oil coming from outside this Nation.
We also have inconsistencies. Take the case of Cisco, which
fought the construction of a new powerplant near its office
building in California. The irony of an electricity-dependent
high-tech company locking the construction of an electric
generator is simply--well, it is not-in-my-backyard mentality.
Again, this crisis was a result of California's scheme of
partial deregulation. I have already covered that. The Governor
and the State legislature are struggling with the immediate
crisis, but I think California needs to look at the future, the
long term. It needs to recognize that electricity does not
appear magically at the plug, as some seem to suggest. Somebody
has to produce it. It has to come from the power of nuclear,
the power of coal, clean coal, hydro, natural gas, wind, and
other renewables.
I think some in the California environmental community
forgot where it came from. Now there is a credit problem here
and the ability of California to pay for its power, as well as
an energy problem. If California expects to achieve a
meaningful solution to the problems, the path is clear. It is
going to have to allow and encourage new generation and
transmission to be built. The question of the State taking over
the industry is something that we can explore today, so I am
not going to comment on that, but the reality is, somebody has
got to pay for it. There is no free ride.
I think there is a lesson here for the other States both in
the East and the West, and there is also a lesson here for the
Federal Government, Congress and the administration. For far
too long we have not had a workable, functioning energy policy
in this country.
What California has taught us is, we cannot rely upon
others to provide our energy security, so what we have today is
a number of expert witnesses, but we do not have FERC, and we
do not have the Secretary of Energy. Some of us see this in
spite of our sympathy and recognition that we all have to do
something about the problem, that this initially in this stage
is a California problem, and it is appropriate that we have
primarily California witnesses.
We will explore whether, indeed, there is a legitimate role
for FERC and the Federal Government. Again, some of us are
almost of the opinion that the government of California was
trying to protect the consumer, the consumer ratepayer from
themselves. Now, I do not know whether you can do that. Maybe
we can find that out in this hearing today.
So what we have in these three panels is an effort to try
and find factual information and gain an accounting of what is
really occurring, and what it is going to take to fix the
problem, not fix it temporarily with a band-aid, but fix it so
it will work and progress.
The first panel consists of industry experts and a Wall
Street analyst. I hope that the Wall Street analyst will call
them as he sees them from the standpoint of what Wall Street
sees going on in California, whether they're going to step up
and finance new energy in California, or whether they feel that
corrective action is sufficient or not.
The second panel is going to consist of three California
investor-owned utilities, followed by those in the generation
of electricity in California, and the marketers who sell power,
and lastly, the second largest municipally owned utility in
California.
We had invited the California independent system operators
and the Los Angeles Department of Water & Power, but they
declined the opportunity to testify.
Finally, the third panel consists of public and private
utilities and others who are located outside of California, and
they can testify as to the impact California is having on them.
Senator Bingaman.
[The prepared statements of Senators Murkowski and Dorgan
follow:]
Prepared Statement of Hon. Frank H. Murkowski, U.S. Senator From Alaska
Today's hearing is on the California electricity crisis and its
effects on other Western states.
California has serious problems. Shortages. Blackouts. Families
sitting in the dark. Traffic lights out. People stuck in elevators.
Production lines shut down. Utilities on the brink of bankruptcy.
Stockholders and pension funds suffering major losses.
California's problems are affecting everyone connected to the
grid--the entire West. Idaho Power may have to raise rates 24 percent.
Tacoma Power has already raised them 50 percent. The utility serving
Arizona's Tohono Indian reservation will have to raise rates an
additional $1 million on top of a 30 percent rate increase last summer
despite a 20 percent unemployment rate on the reservation.
Utah Governor Leavitt said that ``what is at stake is the economic
competitiveness of the West.'' Federal Reserve Chairman Greenspan
warned that California's crisis threatens the Nation's economic
expansion.
So far California has had 18 days of a ``Stage 3'' emergency--
electric reserves of less than 1.5 percent--margins that should be in
the range of 15 to 20 percent. As bad as that sounds, I fear that the
worst is yet to come. It is anyone's guess what will happen this summer
when the air conditioners are turned on. Given the reservoir levels in
the Northwest, even less power is going to be available this summer for
California to import.
California created this problem by betting that it could rely on
electricity produced in other States to meet its growing needs. No
major powerplant has been built in California for more than a decade.
Take the case of Cisco which fought the construction of a new
powerplant near its office building in California. The irony of an
electricity-dependent, high-tech company blocking the construction of
an electric generator is simply too much. No wonder there is little
sympathy in other states.
This crisis is also the result of California's scheme of partial
deregulation--deregulate wholesale sales and continue to regulate
retail sales. As Chairman Greenspan noted last week--power can be
supplied in a regulated market or a deregulated market--``but if you .
. . try to mix the two . . . it is clearly, as evidence demonstrates,
not the desirable way to go.''
In this connection, I understand that the California public utility
commission has claimed that FERC has approved California's retail
rates. I would observe that under the Federal Power Act, FERC has
exclusive jurisdiction over wholesale rates, but that States have
exclusive jurisdiction over retail rates. It is well settled law--the
so-called ``Filed Rate Doctrine''--that States may not deny the
passthrough of Federally approved rates, such as FERC-approved market-
based rates. Nine days ago, a Federal Court held that the State may not
deny California's utilities the passthrough in retail rates of
prudently incurred wholesale power costs. If the State of California
acts promptly to comply with this Federal court decision, that could
help address the financial stability of California's utilities, which
is a major element of the California crisis.
Governor Davis and the State legislature of California are
struggling with the immediate crisis. But California also needs to look
to the future--the long-term. It needs to recognize that electricity
does not appear magically at the plug--it comes from generators.
Nuclear, coal, hydro, natural gas, wind and other renewables.
If California expects to achieve a meaningful solution to their
problems the path is clear--allow new generation and transmission to be
built--not have the State take over the industry and try to run it.
There is a lesson here for other States--both in the East and the
West. You too must look to the future. You too must make sure that
energy is available for homes and businesses.
There is also a lesson here for the Federal government--Congress
and the Administration. For too long, we haven't had an energy policy.
What California has taught us is we can not rely upon others to provide
our energy security.
It is high time we have one so that consumers and industry have the
energy needed to sustain our economy and way of life.
______
Prepared Statement of Hon. Byron L. Dorgan, U.S. Senator
From North Dakota
Mr. Chairman, I am pleased that we are holding this hearing. The
California energy crisis is significant, and it is important for us to
learn what is causing this crisis, and what we can do to solve it. We
also must learn from this experience and avoid similar problems in the
future.
I have long said that deregulation of industries such as the
airlines, railroads and telecommunications have ended up hurting rural
states like North Dakota. The California experience is reinforcing my
belief that electricity deregulation, or restructuring, could cause
similar harm.
I am very concerned about the energy problem the U.S. faces. I held
a hearing in North Dakota on Monday to learn first-hand about some of
the problems my constituents are facing as a result of high energy
costs, particularly of natural gas. Natural gas supply is an issue in
the California market, too, and I know this will be examined during the
course of today's hearing and beyond.
Some will argue that ``the free market'' will take care of
problems, such as those being experienced in California and elsewhere.
However, when a dysfunctional and only partially deregulated market is
created, it is a recipe for failure, and the free market will not solve
the resulting problems.
National Public Radio and other media have been reporting profits
in the hundreds of millions of dollars for some companies selling into
the California market. This is wrong--especially at a time when
blackouts are occurring and the California companies are going
bankrupt.
In addition, the California companies also reaped billions of
dollars in profits in the early years of California's electricity
restructuring. The issue is what happened to these funds that made them
unavailable when the recent crisis hit? Reports indicate that the
profits went to the parent companies, and to pay dividends, pay off
debt, reinvest in capital, and more. Thus, the funds weren't available
when power supply shortages occurred and prices rose dramatically.
Mr. Chairman, I do not have the answers to all of these questions--
it's unlikely that anyone does--that's why we're here today. However, I
do know that the California system does not work. The Power Exchange
has contributed another layer of bureaucracy and complexity that has
contributed to California's problems.
I believe that some of the recent federal actions and state actions
in California have been appropriate to begin to alleviate the crisis
that State is facing. For example, elimination of the requirement that
power be purchased and sold through the Power Exchange seems practical.
The imposition of the ``soft price cap'' ($150 per megawatt hour) on
wholesale power sales also appears not only appropriate, but necessary,
at this time. The cost-based rates may also be a solution, at least in
the near term. Cost-based pricing has enabled federal power facilities
to recover their investment and power supply costs, while keeping the
cost of electricity affordable for commercial and residential
consumers. North Dakota benefits from cost-based rates and will
continue to benefit, at least until real restructuring legislation that
creates true competition is enacted into law.
We need to look at longer-term steps, too, however.
For example, California's retail price caps means that there has
not been any market responsiveness so, consequently, there are no
incentives for consumers to respond to the current crisis.
We need to provide incentives for consumers to conserve energy. We
need to look to renewable and alternative measures, not as entire
solutions in and of themselves, but as part of an overall, long-term
solution.
Let me also point out that utilities' claims that environmental
regulations are prohibiting construction are not altogether plausible.
Information from the California Energy Commission indicates that delay
in the construction of new power plants in the state during the past
decade was due largely to plans that were underway to deregulate the
State's energy market. Until the deregulation plan was completed in
1996, generating companies were reluctant to invest in new plants due
to uncertainty over future profits in a deregulated market. Unusually
low demand for electricity during the mid-1990s, and historically low
prices for power, led companies to shun new plant construction. When
the prospect for large financial returns improved, however,
construction of substantial quantities of new generating capacity
actually began in California--apparently uninhibited by any
environmental regulations.
I look forward to hearing from our witnesses and to working with
all of the relevant stakeholders to craft a national energy policy that
corrects past mistakes, and that works for all of us in the future.
Thank you, Mr. Chairman.
STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR
FROM NEW MEXICO
Senator Bingaman. Thank you very much, Mr. Chairman. What
is happening in California is extremely serious. It is serious
not just for the people of California, but for people
throughout the West, and, of course, throughout the rest of the
Nation. California is not an island unto itself. Its electrical
system is inseparably connected to the western power grid. Its
economy is inseparable from our national economy.
The roots of California's problem may or may not hinge upon
California's restructuring plan, and I think we will hear a lot
of testimony about that today, but the effects of the problem
extend to the rest of the West and to the Nation.
To his credit, President Bush has recognized that
California has a problem, and that the problem is spreading
beyond California's borders. Unfortunately there seems to be,
at least from some statements made by the President and the
administration, there seems to be a perception that this is
California's problem and should be left to California for a
solution.
About the only solution I have heard so far from the
administration is the opening of ANWR. Many factors seem to
have contributed to the California electricity crisis, but the
ban on oil drilling in ANWR is not one of them. Less than 1
percent of California's electricity is generated by oil-fired
plants, and all of the oil in Alaska will not fix what is wrong
with California's electricity market.
I look forward to hearing from our experts as to what they
think the best solution is to this electrical power crisis. It
may be to impose some sort of price caps or cost-of-service
rates on wholesale sales. It may be something else. Whatever
the answer is, I believe the administration and the committee
have an obligation not just to California but, of course, to
the entire Nation to try to find a solution and put that
solution into effect before the crisis worsens.
Sixty-six years ago, when our predecessors here in the
Congress passed the Federal Power Act, they asserted Federal
jurisdiction in that act over interstate power and the
interstate power grid. They said they wanted the Federal
Government to be ``ready to do all that can be done in order to
prevent a breakdown in electric supply.''
Clearly, the Federal Government has not done and is still
not doing all that can be done and needs to be done to fix this
national crisis. I hope we get some insights into what steps
need to be taken in today's hearing.
Thank you.
The Chairman. Thank you very much, Senator Bingaman. I
would call on Senator Feinstein, who is a member of the
committee, and then we will hear from Senator Boxer.
STATEMENT OF HON. DIANNE FEINSTEIN, U.S. SENATOR
FROM CALIFORNIA
Senator Feinstein. Thank you very much, Mr. Chairman. I
want to thank you and I want to thank Senator Bingaman for
holding this hearing. I think it is a very good list of
witnesses, and I am hopeful that we can learn a great deal.
I would also like to extend my thanks both to Secretary
Richardson and Secretary Abraham. Both Secretaries have gotten
fully involved in the California problem. Secretary Abraham has
carried that out, I am very pleased to say, and I frankly am
very grateful to him for extending the emergency order both on
electricity and natural gas.
As he said, it would have to take some very compelling
circumstances to continue to extend that, particularly for
electricity. The natural gas crisis appears to be looming in a
very serious manner, and I believe his comments did not extend
to natural gas.
Mr. Chairman, I have prepared a rather lengthy formal
statement which I would just like to enter in the record.
The Chairman. It will be entered in the record.
Senator Feinstein. I would like to summarize, and let me
begin by quoting from the letter that I just handed you dated
January 30 from the Governor of California addressed to both
Senators Murkowski and Bingaman, and I would ask that this full
letter go into the record.
The Chairman. Without objection.
Senator Feinstein. The Governor points out that a number of
steps are being taken, and I would like to just quote a few
parts. We are now focusing our efforts in the following four
main areas, 1) increasing the energy supply through expedited
plant construction and other sources of power generation; 2)
decreasing energy demand and increasing efficiency; 3)
expanding the use of long-term energy contracts, rather than
relying on the volatile and expensive spot market, and 4)
maintaining the financial viability of California's public
utilities.
The Governor goes on to say that supply clearly has not
kept pace with demand. In the 10 years prior to my taking
office, there was no significant powerplant construction. To
address this imbalance we are rapidly siting over 20 new
powerplants, including 9 that have been permitted and 5 that
are currently under construction. By year's end, California
should have 2000 megawatts in new power production online. He
submits an attachment which details that.
We are also streamlining the process to approve new
powerplants, cutting the time by one-half in some cases. In
addition to plant construction, we are looking at creative ways
to get substantial megawatts online for the coming two summers
through a variety of alternative and innovative technologies. I
might add that six new powerplants should be online prior to
the end of 2002, but not before then, and that is why this part
is important.
In addition, we are finding flexible ways to allow for
power generation while continuing to protect our environment.
We are also coordinating powerplant maintenance schedules
through the ISO and legislation recently passed, I might add,
has reconstituted the ISO, has changed the mid-1900
deregulation law to require that utilities no longer divest of
their generating facilities, but hold those facilities at least
through 2004.
Legislation is now pending--it did not pass through the
Senate yesterday, but hopefully by the end of the week--to
permit some bilateral contracting and the auctions that have
been held have resulted in more than two dozen additional
contracts at about $74 a megawatt hour. That is not as low as
was hoped, but my understanding, these contracts vary between 6
months and 10 years. I think there are 39 of them in total.
He goes on to say that I announced the results of the first
Internet-based auction for long-term electricity contracts, and
then he goes on to speak about maintaining the financial
viability of utilities.
I must say this. I think people in California are confused
between the power generation role and the utilities' role of
distributing power, because this morning's newspaper carried an
article about Southern California Edison selling its generation
facilities, which were required under the California law, and
paying off the loans on those facilities, and then taking $4.5
billion and putting it in the holding company.
There is a great deal of criticism emanating because of
that. I am not going to enter into that debate. I am going to
say that it is probably sort of standard practice for privately
owned or investor-owned companies to provide for their
shareholders. I mean, I think almost any company would do this.
The question of whether in an electricity situation this is the
right thing to do remains to be seen, but up to this point,
what has happened is, the utilities have had to buy power at
rates that increased 1,000 percent in this crisis,
extraordinarily volatile purchases.
If you can pass through 64 megawatts per hour, or $64, and
you have to buy megawatts at $1,000, or $3,000, you can see
what happens in terms of the accumulation of debt and, in fact,
these utilities have been acquiring debt at about $3 million a
day. That is inordinate.
Now, let me just make a couple of recommendations. What can
the Federal Government do in this crisis until additional power
generation gets online? The first thing is, provide some
stability in the marketplace. To that end, I have introduced a
bill which I hope the committee will consider.
FERC has the authority to grant, to put on a cap or to do
cost-based rates if the rates are found to be unjust and
unreasonable. FERC has made that finding, but it has refused to
go the next step. My legislation would give the Secretary of
Energy the ability that if FERC finds rates unjust and
unreasonable to, 1) do cost-based rates which allow for costs,
which allow for a margin of profits, or secondly to put forward
a temporary wholesale regional price cap which the Governor of
a State can opt out of if they do not want to be in it, and I
would like just quickly----
The Chairman. Could you summarize the balance of your
statement?
Senator Feinstein. Yes. Could I just indicate and enter
into the record a letter from the Governor of California to the
Governor of Arizona and Nevada, Wyoming, Montana, and Utah
essentially saying that one immediate solution to protect our
customers from skyrocketing prices may be for the FERC to
implement a temporary cost-plus-pricing requirement?
The Chairman. Without objection.
Senator Feinstein. I will terminate now, and thank you.
[The prepared statement of Senator Feinstein follows:]
Prepared Statement of Hon. Dianne Feinstein, U.S. Senator From
California
Thank you, Mr. Chairman.
I appreciate your holding this hearing. There is a lot on today's
agenda, and I will try to be brief.
current status
Today, California is in its 16th straight day of a Stage 3 energy
emergency. This means that California's energy reserves have remained
below 1.5 percent since the middle of January.
Fortunately and miraculously, California has only had two days of
rolling blackouts.
With the help of the President's Emergency Order requiring out-of-
state generators to sell energy into the California market, California
ISO has managed to keep the lights on.
Nevertheless, California cannot maintain the status quo
indefinitely. The fact that there are extremely low reserves places
incredible stress on our electric infrastructure and the financial
underpinnings of that system.
keeping the lights on
California's peak demand during the winter is approximately 30,000
megawatts per day.
The State is meeting this demand through various strategies--
including implementing its interruptible load contracts, purchasing
surplus power from out-of-state suppliers, and even waiving permits for
smog-causing pollutants (such as NOX). The State, however,
cannot keep up this juggling act.
This has been one of the driest years on record in Northern
California and the Northwest. As a result, reservoirs are low. And
because much of our power in the summer comes from Hydro-Power, it is
likely that there will not be sufficient supply to meet the increased
summer demand of approximately 42,000 megawatts.
Unless the State and Federal government take action now, I fear
that we will have widespread and debilitating outages in California
and, possibly, other areas of the west.
financial crisis
Because of the way the electricity market was restructured, this
energy crisis is causing a financial crisis as well. The cost of
constant peak power has ruined the credit ratings of our two largest
investor-owned utilities, PG&E and Southern California Edison and has
them poised on the brink of bankruptcy.
Consequently, the State has had to step in and buy power itself. In
fact, the State has already spent $500 million dollars to secure power
supplies. Furthermore, the State is suffering from lost productivity as
a result of this crisis.
A recent study by the Los Angeles County Economic Development
Corporation has concluded that California's rolling blackouts and
interrupted service have taken an estimated $1.7 billion toll in direct
and indirect costs on the economy. This figure includes costs to big
businesses, small businesses, and institutions. When the lights go out,
we suffer from lost wages, lost sales, and lost productivity.
If nothing is done, the 6th largest economy in the world is put at
risk.
Two questions arise: How did California get into this mess, and how
will we get out of it?
state situation
In 1996, California passed a badly flawed electricity deregulation
bill. It was problematic on several fronts, but the biggest problem
with the bill was that it forced California to rely on the ``spot''
market and ``day ahead'' market for 95 percent of its electricity.
At the time, supplies were high and prices were low, in large part
because the State was still recovering from the 1990-1991 recession.
Legislators assumed that deregulation would spur an increase in new
generation and that demand would stay low and energy efficiency would
improve. All those assumptions turned out to be wrong. In the past four
years, demand has skyrocketed and little has been done to improve
energy efficiency.
Demand for energy increased, but the supply of energy has remained
constant. Inexorably, wholesale prices went up, and now we face
shortages.
solutions to the energy crisis
In theory, the solution to the energy crisis is simple: either
increase supply or decrease demand or do some of both. In the real
world, however, that is much more difficult to accomplish than it
sounds. Power plants take 3-4 years to get sited and built, and people
need energy to run their daily lives.
Nevertheless, California is taking steps to address the crisis.
Already, the State has approved 9 major power plants, which will
generate enough energy to power 6 million households (6,278 Megawatts).
California has also implemented a conservation plan, which cuts
energy use across the State by 7 percent. In addition, the state has
taken steps to fix the market which has caused this crisis. California
has:
Conducted an energy auction to cover up to one-third of the
State's energy demand;
Expedited siting of new generating facilities;
Eliminated environmental obstacles to in-state energy
generation.
Through these efforts, I am hopeful that California will be able to
avoid further blackouts in the next few weeks.
federal role
The most important thing that the Federal government can do is
provide stability and prevent price gouging. To that end, I have
submitted legislation to give the U.S. Secretary of Energy the
authority either to impose an interim Western regional price cap or to
set reasonable cost-of-service-based rates for power generators if the
Federal Energy Regulator Commission (FERC) finds there are ``unjust and
unreasonable'' rates being charged.
You can't have a situation where California is buying power
averaging $300 per megawatt hour, but can only pass it on to consumers
at an average of $75 a megawatt hour. Under the Federal Power Act, FERC
holds the exclusive authority over energy generators and marketers. But
despite this authority and despite FERC's finding that rates in
California are ``unjust and unreasonable,'' the Commission has refused
to take action.
[I would like to enter into the record the November 1, 2000 FERC
Order Proposing Remedies for California Wholesale Electricity Markets.
The yellow tabs indicate where FERC refers to ``Unjust and
Unreasonable'' rates.]
Thus, I have this introduced legislation to provide the Secretary
of Energy the power to impose a temporary regional price cap and
thereby prevent the price gouging or to set cost-of-service-based
rates, allowing a reasonable profit for the power generators. If,
however, a governor does not believe that the rate cap is in his or her
state's best interest, that governor would be able to ``opt out'' of
the cap.
working with other states
For those who say that this is just California's problem, don't kid
yourselves. This crisis will not be confined to California. Ultimately,
it will have an impact on Washington, Oregon, Idaho, and the other
western states--either directly with regard to power supplies or
indirectly through its impact on the regional, national, and
international economy.
I strongly believe that the only way to address this problem is for
our States to work together. Already, nine governors of western states
have indicated that they are open to some sort of rate cap, and I hope
that this Committee will be, as well.
natural gas
In addition to the electricity crisis, natural gas supplies and
prices are presenting another troubling problem for the region. Stocks
of natural gas are low everywhere and because of the cold winter, the
demand has been much greater than usual.
Low stocks and high demand have driven up prices across the
country. It has been especially troubling in California on two fronts.
First, because of the economic uncertainty surrounding PG&E,
California has had to rely on another Emergency Order from the
President requiring natural gas suppliers to sell to PG&E. Without this
order, it is possible that 3.5 million homes in northern California
could be forced to go without heat. And unlike rolling blackouts which
typically end in 60-90 minutes, if there is a natural gas crisis, if
3.5 million pilot lights go out, it would be weeks before PG&E would be
able to turn them all back on.
The second concern lies in Southern California where natural gas
prices have remained at nearly double the national average. Last
Friday's spot prices for natural gas were $12.99 per million British
Thermal Units (BTUs) in San Diego compared to $7.14 in Chicago, $6.88
in Katy, Texas and $6.31 at the Canadian border.
[I want to also submit for the record a copy of a December 20
request I made to FERC asking for an investigation of the natural gas
prices in southern California.]
Mr. Chairman, I know that you held hearings about the natural gas
situation in the last Congress and I urge you to take another look at
this problem.
conclusion
Clearly, the energy crisis is a complex problem. I know the
Governor and the legislature have been working tirelessly to find a
solution to these problems, and I believe that they are on the right
path. But the Federal government has a responsibility as well. I urge
my colleagues to listen to the testimony that you will hear today, and
consider the legislation that I outlined above.
As I said a moment ago, California has the world's sixth biggest
economy. It simply cannot function without reliable sources of energy
at reasonable prices. This crisis may have originated in California,
but I guarantee it won't respect State boundaries. We all have a
crucial stake in working together to resolve it.
The Chairman. Senator Boxer.
STATEMENT OF HON. BARBARA BOXER, U.S. SENATOR
FROM CALIFORNIA
Senator Boxer. Mr. Chairman, if you can tell me when I have
gone 3 minutes, I will wrap it up. Thank you so much, and I
know you would rather do 2 minutes, but Mr. Chairman, thank you
for your graciousness in allowing me this opportunity, and the
same to Senator Bingaman.
My purpose for being here today is really threefold. It is
quite--I think the simple points I want to make, No. 1, I want
to also thank the past Energy Secretary and the current Energy
Secretary for ensuring an adequate supply for California while
we have been in these stage 3 alerts. I cannot tell you what it
means to all of us, and we are very, very grateful.
Second, I want to expose a myth, that environmental laws
are responsible for the electricity crisis in California, and
third, I want to expose the myth that the Federal Government
has no role in this crisis.
So my first point, I have already thanked them, and I think
I would certainly hope that Secretary Abraham would continue to
be vigilant on short-term help to our State.
Now, we have heard that California is in this situation
because of strict Federal and State environmental laws, and the
fact show it is not true. I ask unanimous consent that a New
York Times editorial from January 16 be placed in the record at
this time.
The Chairman. Without objection.
Senator Boxer. Let me quote from it. ``Some politicians
blame the State strict air rules which they say deterred
construction of new powerplants and shut older ones down, but
the real reason for the energy shortfall is that no new plants
were built in the nineties because prices were low, supplies
were plentiful, and producers wanted to wait.''
Mr. Chairman, this editorial is right on target. It is not
the fault of the environmentalists that California lacks
generating facilities. Let me give you the facts. The history
of the crisis demonstrates this. Before deregulation the
public, California PUC ordered the utilities to build more
generating facilities. The utilities did not want to.
In fact, the utilities, not the environmentalists, actively
worked to halt powerplant-building in California, and the
utilities argued that no new capacity would be needed until
2005. They were wrong, but the California PUC kept on pushing
the utilities and they took them to court, and the utilities
said to the State administrative law judge, do not force us to
build these plants. We do not need them. The court ruled
against them.
However, they took that turn-down and they went to FERC,
and FERC sided with the utilities, and no plants were built,
and so as a result we do not have enough in-State generation.
If the construction had gone forward as the PUC wanted, the
State would have an additional 1,000 to 2,000 megawatts of
power, enough to prevent the almost daily stage 3 alerts and
the rolling blackouts.
I will not get into the shielding of billions of dollars. I
think Senator Feinstein is right, there is going to be a lot of
analysis of that, and I will leave it up to you and many
others, and myself I will look at these, but today I do not
think it helps to raise that question.
The Chairman. Your 3 minutes are up.
Senator Boxer. I will conclude in 1 minute. FERC says in
its own words, its responsibility is to regulate the
transmission and wholesale sales of electricity in interstate
commerce. That is its mission, and so for us to say that they
have no role does not even make sense. In fact, last November
FERC found the electricity rates in California were, quote,
``unjust and unreasonable.'' That is why I support Senator
Feinstein's bill. I have my own bill with Bob Felner on the
same subject in terms of wholesale prices.
My final point, you are right, Mr. Chairman, when you say
that deregulation that was pushed in California by Pete Wilson
and the legislature, Democrats and Republicans together, did
not fully deregulate. It said, you cannot pass the cost on to
consumers. However, Mr. Chairman, I would say to you, if, in
fact, they could, prices could go up 1,000 percent, 600
percent, so I ask you whether in the real world consumers would
accept that kind of increase.
So I hope we learn from California. I hope we can work
together, Mr. Chairman. I know you and I do not see eye to eye
on a lot of things, but I am ever so grateful to you for
focusing attention on our problem. Thank you.
The Chairman. Thank you, Senator Boxer. We now move to the
panel, and we have got a lot of witnesses and we are going to
try something that I am going to kind of insist on, and that is
the colors of the clock here. I know you do not have one in
front of you, but the green means you are running, the yellow
means to wind up, and the red suggests stop.
The first panel, we are going to try to give you about 7
minutes each, and then the second and third panel we are going
to try 5 minutes. That way we might be through about 5 or 6
o'clock tonight.
With that, let me introduce Larry Makovich, senior director
of research, North American Electric Power, Cambridge Energy
Research Associates, Cambridge, Massachusetts, for an overview,
followed by Peter Fox-Penner, principal of the Brattle Group,
Washington, D.C., and Mr. Kit Konolige, managing director,
Morgan Stanley Dean Witter, New York, and we trust you will
call them as you see them. That is what we want to hear. We do
not want any pussy-footing around here.
All right, Dr. Makovich.
STATEMENT OF LAWRENCE J. MAKOVICH, PH.D., SENIOR DIRECTOR OF
RESEARCH, NORTH AMERICAN ELECTRIC POWER, CAMBRIDGE ENERGY
RESEARCH ASSOCIATES, CAMBRIDGE, MA
Dr. Makovich. Good morning, Mr. Chairman and members of the
committee. I will try to summarize my prepared testimony in 7
minutes.
When California started its deregulation in 1996, it did so
because it had some of the highest electricity prices in the
country. There was a lot of optimism that what they were doing
in California would provide a model for the rest of the West to
follow, as well as other electricity markets around the world.
Well, what has happened today is, we have a severe shortage of
electric supply in California, and that has caused skyrocketing
prices, rolling blackouts, financial distress, and political
turmoil.
In fact, right now I think the biggest problem with
California is, no one can agree on what went wrong and, of
course, we are trying to formulate a solution. That is a big
problem. Although it is tempting, it would be incorrect to
blame this problem on deregulation itself. California has set
up a market with serious flaws, and these flaws prevented
supply from keeping up with demand. 5 years ago, when
California passed its legislation to restructure this industry,
it had a surplus of electric generating capacity. The economy
grew 32 percent over those 5 years, and electric energy
consumption grew 24 percent, so even with increased electric
efficiency in the California economy, we reached a point in
1998 when supply and demand was in balance. We went passed that
in 1999 and 2000 into a period now where we have a shortage.
Urgent action is needed right now to address this shortage
crisis in the short run to avert an even more serious problem
this summer, and we also need to fix the problem in the
California market that created this shortage in the first
place.
Now, the crisis in California arose because people believed
that an electric energy market was just like any commodity
market. When supply and demand would tighten up, prices would
gradually rise, stimulate investment, and supply and demand
would stay in balance. This assumption was wrong. Power markets
are not like other commodity markets. They are complex and have
unique characteristics, and the real lesson in California is
that there is a right way and a wrong way to set up power
markets.
California's restructuring law involves sweeping changes
that did many but not all of the things that were necessary to
set a market up properly. Customers could choose among
alternative suppliers. Divestiture created a large number of
independent rival generators. There was a formal power
exchange. The ISO provided a traffic cop on the transmission
system that hooks buyers and sellers together.
They had a plan to deal with their stranded costs, but the
structural flaws in this plan were that the market was set up
to make it impossible nor profitable to build new powerplants.
These flaws were right there from the start of deregulation,
which has made this shortage both inevitable and, sadly,
preventable.
Now, the first problem is, the State does have an approval
process for new powerplants that creates significant obstacles
to building new power supplies. These hurdles have made
California one of the toughest places on earth to build a new
powerplant. Year after year, the State has failed to approve
the amount of new capacity that has to be brought on to keep
supply and demand in balance.
Now, even without these siting obstacles, California also
set up a market that was guaranteed to deliver prices that were
too low to provide a timely signal for the amount of capacity
that was needed to keep this market in balance.
Now, setting up a power market properly means you have to
pay for two things, capacity and energy. California set up a
market that only paid for energy, the utilization of
powerplants. When you turn on a 100-watt bulb, you have to have
a capacity in an electric system to meet that demand, and then
you also have to pay someone to utilize that capacity to burn
the fuel over time to produce the watt hours.
Now, unlike other commodities, electric energy is not
stored in inventory. It thus requires this capacity to be
there. Unlike other nonstorable commodities like
telecommunications services, there is no equivalent of a busy
signal in the power business, unless you consider a blackout a
busy signal.
Now, most of the time in the power business there is plenty
of capacity to meet customer demand, so the typical problem in
a power system is to figure out which power units ought to be
running, and that is what the energy market that was set up in
California did so well. But to figure out the best plants to
run want an energy market that clears on short-run costs only.
You want the cheapest plants from a short-run basis to be
running at any point in time.
So as we look at the record, whether the California market
had a surplus of capacity, a balance, whether we look at the
years when it was in shortage, the California energy market was
doing its job of clearing on the basis of short-run costs.
Now, of course, the problem is no one is going to move
forward and build powerplants on the basis of short-run cost
recovery alone, and in fact when the market dipped into a
severe shortage, of course, any short market of any type, price
runs up dramatically. The price run-ups that we have seen right
now are far higher than what is needed to bring forth new
supply, and they are too late. If it takes 2 or 3 years to site
new powerplants, the price signal had to occur years ago to
avert this kind of shortage.
What California lacked was a requirement that if you are
going to sell people electric energy you also have to have
enough capacity, either owned or under contract by the
suppliers, to meet their needs, plus a reserve to cover for the
variances that we see from weather and hydro availability and
so forth.
Now, if this requirement were in place, there are
mechanisms, the right type of long-term contract, or a formal
capacity market that could create the payment mechanism that
would provide the timely price signal to show that it is
profitable to invest in powerplants at the right time in a
market like California.
Now, when we look around other deregulated power markets
like Texas, New England, Pennsylvania, New Jersey, Maryland,
they have these capacity requirements. Texas is a great
example. It is a fairly isolated power market, so it has energy
independence. Texas is roughly the same size as the California
power market. It started its deregulation after California. It
had less of a surplus capacity cushion to work with, but
because it set up both the capacity requirement and energy
market, and it sited enough powerplants to keep supply and
demand in balance, Texas added 5,000 megawatts of new supply
last year, and it's got another 8,000 coming over this year.
California is about 5,000 megawatts short. Had they done
what Texas did there would be no shortage right now. Was this
an honest mistake in California? The problem in California
comes down to this. There was a belief that you could set up
the rules for the power market with a stakeholder democracy.
Instead of an expert independent governance structure for the
power exchange and the ISO, there were large committees of
stakeholders. It is no surprise that when they organized this
market with a surplus, the majority opinion was, why pay for
capacity when the liability is free, and so today we need to
embark on emergency actions to create lower demand and greater
supply, and the West, being so interconnected with California,
the citizens and businesses throughout the West now have an
enormous bill that reflects the cost of this costly mistake in
the power market setup.
Thank you.
[The prepared statement of Dr. Makovich follows:]
Prepared Statement of Lawrence J. Makovich, Ph.D., Senior Director of
Research, North American Electric Power, Cambridge Energy Research
Associates, Cambridge, MA
california power crisis: what are the real lessons?
When California passed its electric power restructuring law in
1996, it prided itself with being on the leading edge of deregulation
in the United States. when the state passed its power restructuring
laws in 1996. At that time, the state took on the daunting task of
power deregulation for good reasons. The state's power prices were
among the highest in the country, and the industry was mired in a
complex regulatory system that promised to lead to still higher prices
because the inefficiencies of traditional regulation made California's
power prices among the highest in the country. The hopes were that
deregulation would deliver lower prices and that California would be a
model for other power markets to follow. That's not what happened. The
results, instead, are today's power crisis: stand in stark contrast to
the shortages, skyrocketing prices, induced prices run-ups rolling
blackouts, financial distress and political turmoil.
Today, one of the biggest problems in California is that no one can
agree on what went wrong. Customers, regulators, politicians and power
producers are all pointing a finger at each other to assign blame.
Although tempting, it would be incorrect to blame the problems in
California on deregulation itself. Indeed, there is a grave danger of
drawing the wrong lessons. If this crisis drives California back to the
heavy-handed regulation and control that launched power restructuring
in the first place then the state is likely to find its electric sector
becoming increasingly inefficient and expensive--and very much
disadvantaged compared to regions with properly structured power
markets. California is now at a critical juncture--the state can go
backwards by reregulating--or even taking outright ownership--or the
state can fix the flaws in its power market. The latter is the way to
go.
Urgent action is needed not only to meet the current crisis but
swift and dramatic steps are needed to avert an ever more severe
shortage in the coming summer.
the real lessons
The real lesson of the California power crisis is that there is a
right way and a wrong way to set up and run a power market.
California's electricity crisis is the result of three critical
failures:
1. California set up its power market with serious structural flaws
that made timely investment in new power supply neither possible nor
profitable. These flaws were part of the California market design right
from the start of deregulation. Consequently, the current power crisis
was both inevitable and yet could have been prevented.
2. It has been enormously difficult to site and build new plants in
the state. California has perhaps the most daunting power plant
approval process in the nation. This process and the inability to site
have thwarted efforts by companies to build the new power plant
facilities that could have averted the supply shortfall.
3. Although described as ``deregulation,'' the California system is
only a partial deregulation. Customers remain under controlled prices
(retail) that are well below the prices paid by utilities to generators
(wholesale). This is a fundamental misalignment between the two parts
of the market that creates a liquidity problem for utilities and
disconnects the demand side from the market.
The crisis in California arose because people believed that
electric energy markets were just like other commodity markets--when
demand and supply tightened up then prices would gradually rise,
stimulate investment and keep supply and demand in balance. That
assumption, however, is wrong. Power markets are not like other
commodity markets. The power business is complex and has unique
characteristics. Research over several decades pointed out that power
markets are far more challenging to set up properly than most other
markets. The system that was set up in California could have taken
these realities into account--and come out with a good result. The
system that was set up did not take these realities into account--with
the results that we now see.
what triggered the crisis
The flaws of the market design prevented supply from keeping up
with demand. Five years ago, when California passed its power
restructuring legislation, the state had a surplus of power generating
capability. Since that time, the California economy grew a phenomenal
32 percent, fueled by a 24 percent increase in electricity consumption.
The fact that electricity use increased less than overall economic
growth meant that the state was becoming more efficient in its use of
power. Yet conservation and greater efficiency could not stem the need
for additional supply. By 1998, demand growth had ended California's
power surplus. The record of the past five years is clear--California
failed to approve the siting and permitting of anything near the 1,200
Mw needed each year to keep demand and supply in balance. As a result,
far too few new power plants were added to California's power sector
over the past five years. Moreover--and this point needs to be faced--
not enough power plants are currently under construction to end this
shortage in the near term.
Why was new generation not added? That is the heart of the matter.
The California power market was simply not designed to add enough
generating capacity at the right time.
the market design
California's restructuring law involved sweeping changes that did
many--but not all--of the things necessary to make a power market work
properly. The legislation unleashed competitive forces: customers could
choose electric service providers (ESPs); utilities were required to
divest at least 50 percent and by requiring divestiture of at least 50
percent of their generating capacity owned by incumbent utilitiesto set
upto create a large number of independent rival generators. The
legislation replaced the existing decentralized wholesale power market
with a centralized energy market called the California Power Exchange
(PX). Another institution called the Independent System Operator (ISO)
became the traffic cop in the transmission grid that physically
interconnected the electric consumers and producers. The ISO also ran a
market for other services power plants provide (for example, voltage
control) to manage power flows on the grid.
The California restructuring plan faced a particular complication--
``stranded costs.'' The traditional utilities had billions of dollars
of costs that could not be recovered at expected market prices. Thus,
California included a transition plan to move to a market while
recovering these above market costs. To do this, the state backed
utility bonds to finance a rate reduction of 10 percent along with the
establishment of a retail price cap with a competitive transition
charge--otherwise known as the ``CTC.'' The CTC was the difference
between the retail rate cap and sum of all power costs, including the
wholesale power price. The retail price cap and its associated CTC
expired once a utility recovered enough revenues to cover stranded
costs. At this point, utilities remained obligated to serve customers
by buying power from the power exchange and passing along this cost.
The California crisis exploded when stranded cost recovery began to end
and thousands of customers were released to the market just in time for
the shortage to hit with far too little additional power supply in the
works. As an emergency measure, the state returned to price caps to
counter the shortage driven price shocks.
too few new plants: obstacles to siting
The state's approval process creates significant obstacles to
building new plants. These include an open-ended environmental review
process, tough siting and permitting procedures and well-organized
community opposition. These hurdles make California one of the most
difficult places on earth to build a power plant. As a result, year
after year, the state failed to approve anything near its annual
requirement for new supply to keep up with its growing demand.
too few power plants: insufficient incentive to add '"capacity"
Even without these obstacles to siting and building, no barriers to
entry, California set up a power market guaranteed power prices that
were too low to support enough timely investment in new supply.
California set up an energy market that paid power generators to run
their power plants but did not set up any market mechanism to pay
generators for capacity--in other words, no capacity price signal to
create an incentive to bring on new capacity. This meant that prices
were lower in the short run, but it also meant that prices would
eventually explode in a future shortage.
Setting up a power market with the right price signals requires
payments for two electric commodities--energy and capacity. For
example, when someone turns on a 100-watt light bulb, the power system
needs to have a power plant with the capacity to produce an additional
100 watts of power. If capacity is available to meet this demand then
utilization of the capacity through time can produce the watt-hours of
energy. Unlike other commodities, electric energy is not stored in an
inventory and thus requires capacity as well as utilization of that
capacity to meet customer needs. Unlike other non-storable commodities
like telecom, a busy signal (a blackout) is not an acceptable way to
get around this capacity requirement--because, when you're talking
about electric power, a ``busy signal'' takes the form of a blackout.
California needs enough capacity at any point in time to meet the
sum of customer demands for example, ten 100 watt bulbs add up to a
kilowatt of demand and 1000 kilowatts add up to a megawatt. During the
summer time when air conditioners are humming, California reaches a
peak demand of about 53,000 megawatts. Since generating capacity can
break down or hydroelectric capacity can vary depending on how much
snow there was the previous winter,conditions can vary, California like
any other power market needs a capacity reserve an additional 15
percent or so of capacity to insure that supply meets demand at all
times. This margin provides the cushion that can absorb shocks caused
by shortfalls in supply or surges in demand. In California, that
cushion was eliminated by the growth in demand, on the one side, and
lack of new capacity on the other.
Although compelling evidence of a developing shortage was apparent,
most industry observers were complacent due to the belief that when new
supply was needed the energy price would rise and bring forth new power
plant in time. This faith in the energy market was ill founded. The
California energy market alone was incapable of providing a timely
investment signal because it was successful in doing the job of
providing a price signal to efficiently utilize existing power plants.
Most of the time the amount of generating capacity available to
meet customer needs exceeds the sum of customer demands. Thus the
typical problem for a power market is to figure out which plants ought
to be running to minimize production costs at any hour. To do this,
sunk costs are irrelevant and competition should drive energy prices to
reflect the short run costs of rival producers even at time of peak.
The evidence in California is compelling--as long as a surplus existed,
the wholesale energy market cleared on the basis of short run
production costs with a level and volatility that was half of what was
needed to support new investment. Similarly, when demand and supply
were in balance, energy prices continued to reflect production costs.
Even in a slight shortage during 1999, competitive forces were so
strong that the energy market did not break significantly from
production costs.
When the market tipped to a severe shortage in 2000, energy prices
soared and volatility exploded to levels that were multiples of what
was needed to support new investment. Besides being higher than needed
to support investment, these price increases were also too late. The
price signal for new investment needed to come several years before
demand and supply reached balance to account for the lead time needed
to site, permit and construct new power plants.
Clearly, a properly structured power market can not rely on
periodic shortages and reliability crises to provide timely investment
incentives. Instead, a properly structured power market needs a
capacity payment mechanism. This begins with the simple requirement
that anyone selling electric energy to customers must also buy enough
capacity to cover these customers capacity needs plus a reserve. A
capacity requirement met by the right type of bilateral contract or
through a formal capacity market can provide the timely price signal
needed to avert shortages and keep power markets in balance in the long
run.
how other states have solved the problem
California's lack of a capacity payment mechanism stands in stark
contrast to other restructured power markets such as Texas, New England
and the Middle Atlantic region. For example, Texas had a market rule
that required anyone supplying electric energy to customers to also
have enough capacity (either owned or under contract) to meet demand
plus a reserve. As a result, power developers in Texas expected to sell
both the capacity and energy from power plants. Besides looking more
profitable due to two revenue streams instead of just one, building new
electric supply in Texas was also possible. Texas approved the siting
and permitting of more than enough new supply to keep the market in
balance. Texas implemented its restructuring program after California
and with less of an initial capacity surplus. The Texas power market is
about the same size as the California market, yet last year Texas added
over 5,000 Mw of new supply and expects to add 8,000 Mw more this year.
short term action
California is currently about 5,000 Mw short of supply.
Unfortunately, there is no quick fix. Nevertheless, there are many
short run actions that can reduce demand and add supply. These measures
include:
Find more conservation and interruptible load on the demand
side.
Add greater flexibility in legal and environmental limits on
the power supply side. For example, the back-up and emergency
generating systems at hospitals, hotels and office buildings in
addition to barge mounted and mobile emergency power sources
could provide a critical amount of additional supply in short
order.
Reactivate mothballed generating units.
Expedite permitting and construction of power development
already underway in California.
Unfortunately, actions taken so far do not address the underlying
problem and in some cases are making matters worse. The retail price-
freeze solved the price shock problem of this shortage but created a
grave a serious liquidity problem. The state's utilities are trapped in
a sort of no-man's land, between high wholesale prices and regulated,
frozen retail prices. Forcing California's utilities to buy power at
levels many times greater than the level they can charge customers
caused major utilities to accumulate over twelve billion dollars of
uncollected power expenses in just the past six months. Besides
bringing these utilities to the brink of bankruptcy, the liquidity
problem makes power sellers very nervous about selling their power
creates a disincentive to power sellers and never being paid.
The long run solution is clear--California needs a mechanism to pay
for capacity and needs to approve development plans each year for
enough capacity to close the current gap and keep up with demand. These
reforms are not simple--instead of using the appropriate type of
bilateral contract or making the proper rules for a capacity market,
California could mistake long term energy contracts for the needed
capacity payment mechanism and create massive take-or-pay obligations
in the future. In addition, the politics of ``not in my backyard'' may
subvert real attempts to site and permit needed supply.
flawed decision-making
The problem in California is not deregulation itself. The system
was only partially and not properly deregulated. The flaws in
California's power markets resulted from a flawed process of
deregulation based on an idea riddled with uncertainties--stakeholder
democracy. Stakeholder democracy is the belief that if all of the
stakeholders of a problem are brought together, the correct policy will
emerge through negotiation and compromise. Instead of independent,
expert oversight, California intentionally designed large committees of
stakeholders for the governance boards of the California Power Exchange
and the Independent System Operator. When California formulated its
deregulation policy with plenty of power plants already in place, it
was no surprise that the majority of stakeholders voted not to pay for
capacity as long as the reliability was free. Citizens and businesses
throughout the West, as well as the utilities, are now stuck with the
bill for what has turned out to be a huge and costly failure in
deregulation policy formulation.
The Chairman. Thank you for staying within your time limit.
We appreciate that very comprehensive statement.
Mr. Peter Fox-Penner of the Brattle Group. Please proceed.
We would encourage those of you on the following panel, if you
are interested in learning new things, so do not repeat what
somebody else said, which I do not have to remind you we have a
little problem with that here on this side of the dais. We do
not practice what we preach.
Senator Domenici. Some of us have not even had a chance to
preach.
[Laughter.]
STATEMENT OF DR. PETER S. FOX-PENNER, PRINCIPAL,
THE BRATTLE GROUP, INC.
Dr. Fox-Penner. Thank you, Mr. Chairman. Thank you, members
of the committee. Thank you for the opportunity to share my
views on the state of the electric utility industry and recent
events in California. I am speaking to you today not for my
company or its clients, but, rather, as an expert involved in
the industry for many years.
In fact, Mr. Chairman, believe it or not, 14 years ago I
was a student doing a doctoral thesis on this very topic. I
sought help from this committee and Mr. Useem gave me very
generous assistance way back then. It is a pleasure to have
this chance to thank him before the committee today and,
Howard, after today, I sincerely hope you have no regrets.
[Laughter.]
Dr. Fox-Penner. Mr. Chairman, there is no question that
what is happening in Western power markets is a tragedy of
immense proportion. As a student of energy history, I believe
that there is really no parallel for this episode in the
history of the developed world.
Now, there are two main schools of thought on this crisis.
One group claims this episode shows that deregulation has been
a total failure and reregulation is the way to go. A second
group argues that the problem is that California failed because
its deregulation was incomplete, and that a more complete
deregulation, along with more supply, is the only answer.
Mr. Chairman, neither of these views is correct. The
solution to California's problems and to our electric supply
nationally is a combination of Federal, and yes, there is a
Federal role, State and regional policies that allow the power
sector to evolve smoothly towards greater competition,
recognizing the diversity of supply arrangements and public
protections that are lasting features of our system.
California's problems were caused by a host of factors, and
I will try not to repeat Mr. Makovich. The State's robust
economy spurred a substantial increase in demand, energy
efficiency programs were cut, net capacity additions were
inadequate, California did grow dependent on imports, we have
had extraordinarily cold winter weather, depleted Western hydro
reserves, the lowest gas storage levels since 1976, and the
highest gas prices in a long, long time, and all of these
factors exposed and amplified design flaws in an overly complex
deregulatory scheme that Mr. Makovich did a good job
discussing.
I would note to the committee that some of these factors
are present to varying degrees in other deregulated markets
across the United States. The Midwest and Atlantic coasts have
experienced several episodes of price spikes and reliability
threats. Demand has outstripped supply nationally across the
country by a substantial margin, but here, as in California,
the marketplace is rapidly adding plant. The private sector I
think is doing its job.
I also note that every State that has implemented
deregulation has required the utilities to continue to offer a
price-regulated default service for customers who do not choose
to shop, and that in every such State 90 percent or more of all
customers have opted to stay with this regulated service, and
this leaves other utilities vulnerable to the tragic
undercollections that have nearly bankrupted two of the
California utilities here today.
What is the committee to learn from this experience? Mr.
Chairman, I have five recommendations for Federal action, and I
will not discuss State or other actions that I think are also
important.
First and foremost, one of the things that makes electric
restructuring uniquely difficult in the United States is our
overlapping State and Federal regulatory system. No other
Nation in the world has such a diverse regulatory framework.
Recognizing that we can change this only by degree, Congress
must be prepared to engage on the issue of the jurisdictional
structure of utility regulation if it intends competition to
work in the power business.
Gas and electric markets are regional, reliability is
regional, and there is no avoiding this. Federal legislation is
necessary, though not sufficient. In my opinion, legislation
should include--and this is not a complete list--FERC authority
over all transmission lines and reliability procedures. I think
PUHCA and PURPA need to be addressed. FERC's authority to
police market power needs to be clarified. I will have more to
say about that in a moment.
Of course, we need to continue to provide for public
interest programs. Beyond this, we must face the explosive
question of how to license and expand our energy
infrastructure. I suggest that this Congress or the
administration take the lead in creating a real dialogue
between Governors, local authorities, the environmental
community, and all segments of industry directed towards
procedures that will enhance our energy infrastructure, and
when I say energy infrastructure, Mr. Chairman, I am referring
to the full vertical supply chain that brings us electricity,
but it is not true that all segments of that supply chain have
that same degree of scarcity or problems in them.
I think that starting at the end of the chain, transmission
lines are by far our biggest problem. After that, gas storage,
which I mentioned, and perhaps gas production is next and is I
think on the way to being fixed, and least scarce and of least
concern--in other words, the market is doing the best job in
this area--is the powerplants themselves and gas pipeline
additions.
Personally, I believe that any procedures adopted to
address the infrastructure needs will have to demonstrate a
maximum reliance on decentralized sources and minimum
environmental impacts before the public will accept new large-
scale facilities, but until a forum exists for balancing our
infrastructure needs the rest of the Nation will slowly reach
the same throughput limits California has reached, to
disastrous ends.
Second, I implore we all recognize electric markets will
never work properly, never, without demand-side responses that
so far are largely missing. In this area, the Federal
Government can take a leading policy and technology diffusion
role.
My third point concerns the environment. While
environmental regulations certainly impose costs on power
developers, there is no evidence that the Federal Clean Air Act
is the cause of today's generation shortage in California. The
plant construction boom in New England, where many States also
impose very strict environmental controls, illustrates that
robust development is possible under Federal environmental
rules.
California does impose stricter environmental quality
standards than are mandated under the Clean Air Act and I
believe this has limited powerplant development to a degree.
However, since the State itself has begun to address these
issues, I do not believe that weakening the Clean Air Act is
necessary, or even necessarily an effective way to encourage
new capacity in California.
My fourth point concerns the difficulty of balancing energy
price volatility supply adequacy and protections against market
power. Deregulated gas and power markets are uniquely prone to
extreme price variabilities, and will go through boom-bust
cycles. We must carefully craft an alternative to the
admittedly expensive supply buffer regulation gave us, or
endure the consequences, and the acceptable outcome must not
insulate consumers from all price signals, for this eviscerates
not only deregulation but some regulated markets as well.
A final point, Mr. Chairman. Let me briefly mention the
important topic of market power. It is inordinately difficult
for economists to separate illegal market power from natural
industry variability in this highly volatile industry and
inadvertent or even intentional market design flaws. I know I
have discussed this with Senator Feinstein.
The California markets illustrate this vividly. Whereas we
have a near-unanimous verdict from economists that market power
is present, we have a vast range of opinion on what to do about
it. For this region, I urge Congress or the administration to
convene an independent panel to examine this topic and
recommend better Federal policies regarding these complex
issues.
To summarize, Mr. Chairman, California's crisis calls for
immediate and concerted efforts in that State and region.
However, we will only multiply the tragedy if we fail to use
this opportunity to enact policies critical to the long-term
success of our energy infrastructure and to our economy as a
whole.
Thank you.
[The prepared statement of Dr. Fox-Penner follows:]
Prepared Statement of Dr. Peter Fox-Penner, Principal, The Brattle
Group, Inc., Washington, D.C.
Mr. Chairman, and Members of the Committee, thank you for the
opportunity to share my views on the state of the electric utility
industry and particularly on recent events in California. I speak to
you today not for my company or its clients, but rather as an expert
involved in industry restructuring for many years.
Mr. Chairman, there is no question that what is happening in
California today is a tragedy of immense proportions. Families in San
Diego and many other parts of the western U.S. face double-digit rate
increases, businesses are laying off workers, two of the nation's
largest utilities are on the edge of bankruptcy, and an entire state
faces repeated rolling blackouts. These unprecedented problems threaten
to spill over to weaken the U.S. economy. As a student of energy
history, I believe that there is arguably no parallel for this episode
in modern times in the developed world.
If you follow the press on this crisis--and who can avoid it?--you
know there are two main schools of thought. One group claims that this
episode shows that electric deregulation has been a total failure, and
re-regulation or public power is the answer. A second group argues that
California failed because its deregulation was incomplete, and that a
rapid, more complete deregulation (along with more supply) is needed.
Mr. Chairman, the most important thing I have to say to you today
is that neither of these views is correct, and neither represents a
viable course of action for federal and state policymakers. The
solution to California's problems and to our electric supply needs
nationally is a combination of federal, state and regional policies
that allow the power sector to evolve smoothly towards greater
competition, recognizing the diversity of supply arrangements and
public protections that are lasting features of our system.
the california market problem
There is a fair degree of consensus concerning the proximate causes
of California's problems. First, the State's robust economy spurred a
substantial increase in electricity demand, rising between 2% and 3%
per year between 1995 and 2000. Average peak loads rose substantially
during the early summer months of 2000 compared to the levels
experienced in 1999, driven by unusually hot weather. Some of the peak
load and energy demand increases could have been averted through more
aggressive energy efficiency programs, but California utilities reduced
spending on demand-side measures by over 50% between 1994 and 1998. In
addition, during the period between 1996 and 1999, when peak loads rose
5,522 MW, net capacity additions only grew by 672 MW, and thus
California grew increasingly dependent on power imports from the
surrounding region. Cold winter weather, depleted western hydro
reservoirs, and a natural gas price increase across the country all
further contributed to the sustained level of high prices we see today.
All these long-term or external factors served to expose and
amplify design flaws in an overly complex deregulatory scheme. The
design flaws, notably a massive over-reliance on spot markets and
capped retail prices, are often cited as the main reasons for
California's problems, but all of the ingredients listed above
contributed to creating today's crisis.
national implications
While these long-term and market design factors have produced a
calamity in the western U.S., it is critical to understand that many of
these factors are present to varying degrees in other deregulated
markets in the U.S., and that these markets are not invulnerable to
California-like problems, albeit at a smaller scale. The Midwest and
Atlantic Coast have experienced several episodes of price spikes and
reliability threats. Between 1995 and 1999, U.S. electric demand
increased by 9.5%, while total electric generation additions rose only
1.6% and investment in transmission lines actually declined. To make
matters worse, deregulation reduced utilities' energy-efficiency
spending by 50%. The result is a power sector in many regions
critically short of new generation, needed transmission lines and/or
effective conservation measures. Less than a year ago, an Electric
Power Research Institute seminar concluded that, ``North America is
closer to the edge, in terms of the frequency and duration of severe
power outages, than at any time in the last 35 years.''
The Committee should also note that every state that has
implemented electricity deregulation has required utilities to continue
to offer a frozen, reduced ``transition'' rate or a price-regulated
``default'' electric service for customers who do not choose
competitive suppliers. While some states have done better than others,
no state has removed retail price protection from anywhere near all
customers. In every deregulated state 90% of consumers or more have so
far opted to stay with this regulated service, leaving many utilities
vulnerable to the under collections that have nearly bankrupted Pacific
Gas and Electric and Southern California Edison. Having said this,
however, it is clear that deregulation is working better in most states
than it is in California, and deregulation at the wholesale level has
made great progress as well.
appropriate policy response
What is the Committee to learn from this experience, and what
policy response is appropriate at the federal level?
Perhaps the first item to mention is that electric restructuring is
uniquely difficult in the U.S. because of our overlapping state and
federal regulatory authorities. No other nation in the world has such a
diverse and complex regulatory system, and the reality is that we can
change this only by degree. Electric markets will work only with
cooperation between, and improvements in, state and federal regulation,
including the creation of regional regulatory or quasi-regulatory
entities. In short, Mr. Chairman, Congress must be prepared to engage
the issue of the jurisdictional structure of utility regulation if it
intends competition to work in the electricity business. Electricity
markets are regional, and reliability rules are also most appropriately
enforced at the regional level. There is just plain no avoiding this.
Federal legislation will unquestionably be necessary, though not
nearly sufficient. In my opinion, legislation should:
Give the FERC authority over all transmission lines and
reliability organizations and procedures;
Facilitate but not require state retail choice and enable
municipal and co-op utilities to participate without
penalization;
Clarify FERC's authority to police market power; and
Provide for continued public interest programs for low-
income customers, environmental protections, and energy
efficiency and R&D programs.
Beyond this you must face the explosive question of how to license
and expand our energy infrastructure. I suggest that Congress or the
new Administration take the lead in creating a real dialog between
governors, state regulators, local authorities, the environmental
community, and the industry, all directed towards procedures that will
enhance our energy infrastructure. I believe that these procedures will
have to demonstrate a maximum reliance on decentralized sources and
minimum environmental impacts before the public will accept new large-
scale facilities. In any case, until a forum exists for improving our
demand and supply infrastructure, the rest of the nation will slowly
reach the same limits of energy service throughput that California has
reached to disastrous ends.
Second, I implore that we all recognize that electric markets will
never work properly without demand-side responses that so far are
largely missing. Allow me to explain. In every competitive market you
can think of, consumers not only know the prices they pay, they are
able to change their consumption almost immediately in response to
price changes. So far, electricity is an unhappy exception to this
rule. Electric markets do produce price signals, but most consumers do
not see them; and even if they do, it is very hard with today's
technology to reduce demand in relevant timeframes when prices go up.
Imagine, Mr. Chairman, if Americans had to choose their gas station and
fill up at the pump each week without knowing what they were paying
until they received a bill at the end of the month. With recent
advancements in information technology, it is not merely unfortunate
that electric consumers can't adjust immediately to high prices, it is
fatal for electric competition in the long run.
In this area, Mr. Chairman, the federal government can take a
leading policy and technology diffusion role. No state has the budget
or the expertise to implement demand-responsive technology nationwide.
This is a uniquely national mission and it is a vital one. And on a
similar note, federal leadership on more general energy efficiency and
demand management technology diffusion is equally valuable to the
nation, and also has fallen back due to the forces of unleashed
restructuring.
Third, while environmental requirements certainly impose costs on
powerplant developers, there is no evidence that the federal Clean Air
Act is a cause of today's generation shortage in California. The
substantial new plant construction boom in New England (where many
states also impose strict environmental controls) illustrates that new
development is entirely possible under federal environmental statutes.
California does impose stricter air quality standards and emission
offset requirements than mandated by the Clean Air Act, and this has
limited powerplant development in certain areas. However, since the
state has begun to address these issues, I do not believe that
weakening the Clean Air Act would be an effective way to encourage new
capacity in California.
My final point concerns the difficulty of balancing energy price
volatility, supply adequacy, and protections against market power.
Deregulated electricity markets are uniquely prone to extreme price
variability, particularly in times of shortage. Under such conditions,
it is extremely difficult for even a well-functioning market to prevent
a degree of volatility and supply uncertainty that elected officials
must judge for its political acceptability. And regardless of this
outcome, we cannot insulate consumers from all price signals, for this
eviscerates not only deregulation but sound regulated markets as well.
I believe that an under-appreciated and inevitable feature of
deregulated energy markets is the sort of ``boom-bust'' cycles that we
have often decried in oil and gas production in the past. Deregulation
of electricity does imply that shortages may occur if only by accident
and that the admittedly expensive supply buffer that regulation gave us
for 50 years will no longer be there. In my opinion, either the economy
will develop better ways to adjust to gas and electric price volatility
or the public will lose patience with the concept, regardless of the
many benefits of electric competition.
Relatedly, it is a fact that deregulated utility markets are
subject to the antitrust laws and to specific utility statutes as well.
It is inordinately difficult for experts such as myself to separate out
illegal sources of market power from natural industry variability and
inadvertent or even intentional market design flaws. The California
crisis illustrates this point vividly. Whereas we have a near-unanimous
verdict from economic experts that market power is present in these
markets, we have a vast diversity of opinion on what to do about it.
Buyers are asking the federal government and the courts for action,
sellers are asserting that they are doing nothing whatsoever illegal,
and the agencies and courts are unable to respond with much certitude.
Ambiguity over this issue also can erode suppliers' willingness to
enter and expand, thereby compounding our problems. For these reasons,
I urge Congress or the Administration to convene an independent panel
or commission to carefully examine the topic and recommend federal
policies to address these issues.
summary
To summarize, Mr. Chairman, the California crisis gives us the
perfect opportunity to address much-needed policy reforms in the
electricity sector. Federal legislation should provide for regional
reliability protections, public benefits, market power clarification,
public power participation or opt-out, and other federal needs.
Beyond this, this Committee and the nation face a challenge that is
more fundamental than deregulation, and which ultimately will determine
deregulation's fate: how to reconcile a deep-rooted, but obsolete
state-federal division of regulatory authority with energy markets and
infrastructure additions that are inherently regional. Regional energy
issues need a concrete forum for resolution and action, while fully
respecting the views of state and local leaders and other stakeholders.
Similarly, we must develop a combination of policies and patience that
allow us to achieve supply security without crippling competition
itself.
Solving these problems will be difficult, but we must remember that
the hard problems take time. The policies that help create the world's
most economical and reliable utility system were not built overnight.
More than thirty years elapsed between the birth of the utility
industry and state utility regulation, and it took another decade and
the Great Depression to pass the Federal Power Act.
California's crisis calls for immediate and concerted efforts in
that state and region. However, we will only amplify the tragedy if we
neglect this opportunity to enact policies critical to the long-term
success of our energy infrastructure and our economy as a whole.
The Chairman. Thank you.
Our last witness on this panel would be Mr. Kit Konolige
from Morgan Stanley.
STATEMENT OF KIT KONOLIGE, MANAGING DIRECTOR, MORGAN STANLEY
DEAN WITTER, NEW YORK, NY
Mr. Konolige. Thank you, Mr. Chairman, members of the
committee. Good morning. I am aware I am the designated Wall
Street analyst here, and so let me avoid emphasizing some of
the points made already and instead start by giving what I
would say is the short answer from Wall Street for how the
finance community views this situation and, more importantly,
how, from a Wall Street perspective, the situation could most
efficiently be solved.
I would start by saying that a true supply and demand
market would be most important for those who would invest in
powerplants in California or other States. In particular, price
caps are a negative for investors. Long-term contracts are a
positive for investors.
Certainly long delays in the approval of proposed
powerplants are a negative for investors and, overall, I think
clarity in the laws and the ability to have a firm belief that
when you are going to build a powerplant that is going to last
for 20 or 30 years, that the laws are going to remain the same
over that time period and, for example, caps on prices and so
on will not change in those period, is a very significant help
to people making that investment decision.
I will not go through the crises. Everybody knows what they
are, blackouts, very high prices. Let me just add to what the
chairman mentioned. He mentioned Tacoma and Idaho. My favorite
neighboring site is Seattle, where the city utility already
raised electricity prices 10 percent this year and now is
talking about needing another 18 percent. All these rate
increases, by the way, are higher than California has imposed
on itself.
I would also point out that the emergency help given to
California this winter, in particular from the hydro resources,
is that much less hydro electricity that is available for the
even higher peaks that are coming this summer, and so I think
many people are reasonably concerned that the crisis can get
worse this summer before it gets better.
What was the nature of this dysfunction in the market that
we can all agree on? I would say again from the perspective of
investors and Wall Street, I would say it is pretty simple, and
it has been mentioned before. There was a very strong and a
kind of mandated disconnection between supply and demand.
California has not allowed, as has been mentioned, any new
powerplants to be built for 10 years and at the same time it
mandated lower prices to customers, so you had customers using
electricity with no signals that it was in short supply, and
powerplant builders who would have been happy to respond to the
high wholesale power prices were not able to do so because of
the extremely long period in which there was no ability to
actually put the powerplant on the ground.
Senator Boxer mentioned before that high prices, if passed
through to the consumer if the market were freed, would result
in runaway prices and, of course, there is a certain concern
about that. If the prices to consumers were freed but the
supply response is not freed, then you will continue to have a
dysfunction.
I think the central point of my testimony would be that we
need to move towards a system in which both supply and demand
of electricity are as open to the market as possible and in
particular I think that means that we need to move towards a
system where we let consumers pay the true market price of
electricity. That will send signals to builders of powerplants
that there is a need for new powerplants, and we need to allow
powerplants to be built in a reasonable period of time in order
to respond to that.
As has been mentioned here, for more than 10 years
California has built no new powerplants. That is unlikely to be
just a coincidence. In that time, with the lower prices in
California since the 1996 law, Californians are now using 6,000
megawatts more than they did at the beginning of the period of
the law. That is about 12 big powerplants' worth, so you need
some more power to be generated in California.
I think it has been mentioned already, the now sort of
internally famous story of the Metcalf plant in San Jose, where
the Calpine Corporation was willing and anxious to spend many
millions, maybe millions of dollars to build one of the newest
cleanest powerplants in the world, and yet the big company,
Cisco, and the city of San Jose tooth and nail opposed this
plant, and continue to oppose this plant, even though the
Silicon Valley area there is most subject of all areas of
California to blackouts and, in fact, has had the blackouts.
Let me mention a couple of specific other points on the
free market and then wrap up. California interfered with the
free market in a couple of kind of unique ways that were
troublesome. First of all, it prevented the market from signing
long-term contracts in the market for electricity. In most
countries and other States long-term contracts are considered
the fundamental way in which both buyers and sellers levelize
and hedge the price of electricity over a long period of time.
This effective prohibition on long-term contracts drove up spot
prices in California and throughout the West.
As conditions got tighter in the year 2000, the State
sought what I would consider a quick fix in the form of price
caps. Four separate times last year price caps were lowered.
California now has the lowest price cap in the country, at $150
per megawatt hour, versus the next lowest price cap of $750.
What has the result been? California is the only State that
has produced the highest electricity prices and the only
blackouts in the country. Maybe just a coincidence. Probably
some negative impact in which the market gets around the price
caps. I think clearly, from the point of view of Wall Street,
you get a perverse incentive where, in a price cap situation,
people will only sell into that market if they get what might
otherwise be considered very high returns, because they
consider that their long-term prospects are very suspect in a
situation like that. If you leave the market alone, they are
happy enough to build a plant and take their chances on the
long term.
I would say the good news is that this is a crisis that was
created by political decisions, can be fixed by political
decisions, and I think if it is fixed, I personally know dozens
of energy companies that are willing to invest billions of
dollars in new power in California. Of course power companies
would want to build in California. There are not enough
powerplants in California. In theory, it is an excellent place
to build.
But I would say two key things need to be done before that
happens. One is, again on the supply side, the process for
siting powerplants simply has to be made more transparent and
much quicker. We could see not just gas, but clean coal, wind,
solar projects would be lining up to build in California, but
if it takes 5 years to get a decision you are eliminating a lot
of the people who would be most interested.
Finally, as I think others have mentioned, I think it is
unrealistic, and it will not produce a functioning market, if
you even for a period of years attempt to insulate customers
from the high prices of electricity. If they do not see prices
rise in times of shortage, customers will simply continue to
run the air conditioning and that will just compound and add to
the crisis.
So I would end by saying simply, it may take some time and
effort to put an effective market system into place, but it
would be very much worth it to California and all its
neighbors, because an effective marketplace with good supply
and demand signals would bring down long-term prices, and it
would certainly prevent the kind of devastating blackouts we
have seen in California.
[The prepared statement of Mr. Konolige follows:]
Prepared Statement of Kit Konolige, Managing Director, Morgan Stanley
Dean Witter, New York, NY
Good morning, Mr. Chairman and members of the committee. Thank you
for the opportunity to address this committee hearing on an issue of
such national importance.
My name is Kit Konolige. I am a managing director at Morgan Stanley
Dean Witter. My job is equity research analyst in charge of our
coverage of electric utilities and unregulated power companies.
Basically, my team and I advise investors--such as pension funds,
mutual funds, and small private individuals--on which power companies'
stocks are likely to provide a good return on their capital, and what
are the risks involved.
In more than 11 years doing this job, I have never seen large
electric companies in a more dangerous financial position than Edison
International and PG&E Corporation over the past two months.
Some people think that the possible bankruptcy of these companies
is a matter of concern only to investors in the stocks and bonds of two
utilities. I believe that is a very wrong and dangerous idea.
The utilities' financial crunch is one symptom of a broken system--
other symptoms include blackouts and the likelihood of much higher
electricity prices throughout the West. This is a crisis that has
already caused severe problems for all electricity consumers in
California, throughout the West, and even throughout the country.
It has produced much higher than necessary electricity prices,
which lead to higher costs throughout the economy, and thus overall
lower economic performance. California caused the problem, and
Californians are suffering blackouts and high prices as a result--but
the rest of the West, and the country, are also paying the high price,
probably for years to come.
So fixing this crisis is a matter of some national urgency.
The good news is that this is not a natural calamity. It is largely
a politically created crisis and it can be fixed, though I think its
effects will linger.
This is not a crisis caused by deregulation. There was never real
deregulation in California. This is a crisis caused by not enough
deregulation. It was caused by California's unique, disruptive new form
of re-regulation. These high electricity prices, which inevitably will
be passed through to residential customers and businesses throughout
California and the West, were mostly the predictable result of
political meddling that disrupted the marketplace for electricity.
And for those who now pine for the golden days of regulation, let
me remind them that this 1996 law in California was meant precisely to
bring down the high prices caused by regulation. Regulation was blamed,
I think correctly, for encouraging utilities to overbuild expensive
capital investments and for providing no incentive to keep down
operating costs.
The authors of the so-called deregulation plan, passed in 1996 in
California, claimed to want a market system, yet they prevented both
supply and demand from working. What they really wanted was permanently
low electricity prices with no limits on consumption. No system can
produce that, as the Soviet planners proved for decades--and this
attempt at overriding basic economic rules had spectacularly perverse
effects that we must now all deal with.
California's system allowed neither supply nor demand to work
properly to produce lower electricity prices. Preventing new power
plant construction stifled supply, while fixing consumer prices
artificially low encouraged excess demand.
At the most basic level, this is a crisis of supply. There is not
enough electricity--for a simple reason--there aren't enough power
plants. In the last 10 years, demand in California has grown at 3 or 4
percent in some years, while no new plants of any size have been built
in the state.
So eventually, the shortage of power in California was bound to
produce high prices. In a well-constructed market system, the high
prices would have called forth new supply of the commodity--and thus
high prices would have solved their own problem. But since California
requires generally five years of hearings before new plants can begin
construction, there is no new supply in any reasonable time to compete
down high prices.
Even today, in the middle of this crisis, the hostility to power
plants remains. The classic story involves the Metcalf plant proposed
for San Jose's Coyote Valley. Among the major victims of last summer's
blackouts were the citizens of San Jose and the stakeholders of Cisco--
one of the most important companies of California and of the entire New
Economy. The blackouts produced inconvenience and, more important, many
millions in economic losses.
These blackouts were hardly a surprise, as the Silicon Valley area
imports more than 80% of its electricity from outside the region--so it
has few electrical resources when supplies get tight. And yet, offered
a solution to their problems in the form of one of the newest, cleanest
power plants in the world, both the city government and Cisco have both
fought this power plant tooth and nail. Cisco apparently just didn't
like a power plant next door to its proposed new headquarters.
Everybody says they want cheap power, and plenty of it--just not a
power plant to produce it. You don't need a Ph.D. in physics to figure
out that, at least for now, you need big machines to produce
electricity--and if you don't build them, you're going to run out. The
Silicon Valley area imports 83 percent of its power from outside the
area. We've seen this ``not in my backyard'' syndrome lots of other
places--but seldom so obviously, and seldom with such disastrous
consequences.
California flunked another Economics 101 test as its desperation
move to lower price caps--four separate times in one year--proved as
predictably misguided as it had for all those decades in the Soviet
Union. California now has the lowest price cap in the country at $150
per megawatt-hour--the next lowest cap is $750. No special prize for
guessing which state produced the highest electricity prices and the
only blackouts. And yet there are still people arguing for yet lower
price caps.
The California ``market'' system also had a unique feature that
seemed almost perversely designed to produce high prices. This was the
requirement that the great bulk of power be bought and sold only in the
spot market. Again, the open market was circumvented--an open market
would have produced mostly long-term contracts to stabilize prices, as
it has in other states and countries. This spot market reliance is now
recognized as a big mistake and is on its way to being changed--but the
effects linger.
What about the demand side? Demand also wasn't allowed to work in
the supposedly deregulated market of California electricity. Under the
1996 law, high prices were deliberately not passed through to
consumers. This shielding of consumers from high prices has put the
utilities some $12 billion in debt--and eventually the customers will
have to pay off much of that debt anyway.
But artificially low fixed prices create an economic problem that
is more important than the fate of the utilities. High prices are
supposed to cause consumers to use less of a scarce commodity, and thus
bring prices down. This is how gasoline and airline tickets and
Disneyland passes work. But the politicians didn't allow it to work
that way in California electricity. Encouraged by artificially low
prices, California consumers naturally continued to increase their use
of electricity, even as the wholesale price indicated the commodity was
getting scarcer and scarcer.
Higher prices are the simple, direct way to conservation.
how it hurts the west--and the rest
Californians themselves are the main victims of this failed project
to install a sort of market-manipulating system for permanently cheap
electricity.
But the West as a whole, and in fact the entire country, are also
suffering from the after-effects.
First of all, by damaging its own economy through blackouts and
needlessly high energy prices, a California that is one-eighth of the
entire U.S. economy inevitably has hurt every other business and
consumer in the country.
More specifically to the West, high electricity prices in
California drive prices higher everywhere else that is interconnected,
from Seattle to Las Vegas to Phoenix and beyond. In effect, by not
building their own power plants, Californians are putting upward
pressure on prices by soaking up electricity from regions that have
built their own plants. Seattle City Light is now considering an 18%
rate hike, on top of a 10% increase on January 1--more responsible
pricing than California, a big part of the high-price problem, is
willing to impose on itself.
Citizens of neighboring states might also ask whether they want to
dedicate their equally treasured land and water to siting plants to
serve San Jose--the city that wants more electricity but no more power
plants..
The chaos of the California markets generally has spilled over into
the entire West, producing higher prices throughout the region. The
uncertainties of payment and of the emergency federal orders have
raised the cost of energy for all California's neighbors--and those
prices are indicated in the market to be substantially higher for the
next five years.
At best, all the residents of neighboring states are facing higher
prices for electricity because of the policy failures in California.
But in addition, the regional economy is disrupted when aluminum plants
shut down to resell their electricity at much higher prices.
Perhaps most pernicious, the political demand by California to be
bailed out of a crisis of its own making has led to federal orders
that, for example, have used scarce hydro resources in the Northwest,
driving up prices now and setting up potentially dangerous shortages
for this coming summer. Water used to generate electricity in the
winter, when it normally isn't needed, is water that's unavailable next
summer when the demand will be much higher.
Thus, a continued federal policy of forcing out-of-state providers
to subsidize California creates a moral hazard, allowing California to
avoid building unwanted power plants and to keep its consumers
subsidized at artificially low prices. The more responsible political
systems nearby are paying the price.
Finally, because some people tend to believe California's leaders
when they blame ``deregulation'' for their political and market
failures--even though deregulation never really existed in California--
this has set back the cause of true deregulation elsewhere in the
country. Over time, this means higher prices than necessary in other
states, as the inefficiencies of regulation are extended to avoid the
mess that California called deregulation.
so what is the solution?
But deregulation, real deregulation, is the solution, not the
problem.
Just as with telephone service, airlines, and other previously
regulated industries, we can have every confidence that a true open
market in electricity will produce lower prices over time than the
regulated system could. The market is more efficient than the
regulators and politicians, as the California electricity fiasco has
proved once again.
In fact, deregulation is working well almost everywhere in the
United States but California.
Other states including New York, Massachusetts, and Rhode Island
have recently allowed rate increases of 10% or more to be passed
through to their customers. Western states like Oregon and Washington
are also recognizing the need for rate hikes when energy prices rise.
Freeing prices to rise (and fall) helps control excess demand. It
recognizes the reality of higher natural gas prices, and prevents the
expensive financial disruption we've seen in California.
In return for these modest price hikes--the first increases in 10
years or more--the open market in New England is now producing a great
infusion of new power plant construction. Though well known for their
conservation principles, the New England states allow construction of
power plants within a reasonable period of a few years after the first
proposal. The resulting construction of billions of dollars worth of
clean, efficient new power plants, now coming on line, should assure
abundant electricity at reasonable prices for many years to come.
Utilities and individual customers are signing long-term contracts to
lock in those prices. Meanwhile, dirty old oil plants are being crowded
out of the New England marketplace.
In my view, California's way out is straightforward--since
deregulation is already working so well in many other states. If
California will move towards a reasonable approximation of the free
market by letting customers' prices rise to reflect true wholesale
prices, and by stopping its excessive opposition to entrepreneurial
companies who want to spend billions of their own dollars to provide a
commodity California needs--then Californians can regain the simple
pleasure of on-demand electricity at a stable and reasonable price.
The Chairman. Thank you very much. Now, you are aware of
the progress being made and the manner in which the California
legislature and the Governor and others are trying to address
the problem. The question for us is, is this going to be
adequate for Wall Street to come in and finance the expansion
of energy-producing facilities in California?
Mr. Konolige. I think two answers to that, Mr. Chairman,
would be----
The Chairman. Give me the straight answer first.
Mr. Konolige. How about two straight answers, two aspects
of it?
The Chairman. If I get that lucky, that is fine.
Mr. Konolige. I guess I would start by saying the first
thing Wall Street wants is certainty. Wall Street can deal with
a lot of intricate laws if those are the laws and they stay in
place, so write the laws and say, these are going to be the
laws for the next 5, 10, 15 years.
The Chairman. You are talking to us or to California?
Mr. Konolige. I am talking to the California folks who are
working on this. If they put in position--if they were to say,
for example, it will now take 4 years to site, to go through
the process of siting a powerplant, well, that would be far
from ideal, but there would be companies who would say, okay,
I'll take my chances on 4 years. It is this possibility that it
will not be 4 years, it will be 6 years, that really throws
them for a loop.
So having transparency and clarity on, first of all, how
long it takes to build the powerplants, and secondly, on what
market for the power is going to be when the powerplant is
finished. Specifically there I'm talking about, are there going
to be attempts at price caps or not? Is there going to be an
open market where, when you build a powerplant, you can go out,
solicit customers, make an arm's length agreement and sell the
power, take your chances on what the market conditions are?
After all, as the builder you are putting billions at risk and
if somebody wants to buy the power from you, you should be
allowed to sell the power under a contractual arrangement.
The Chairman. I want to get at whether this is adequate.
What California is doing now, is it going to be adequate? Is it
going to meet the criteria of Wall Street?
Mr. Konolige. Well, I do not think I have seen enough
detail. I do not know that there are----
The Chairman. Do you have a copy of this letter the
Governor sent?
Mr. Konolige. The letter?
The Chairman. That was outlined by the Governor from
California.
Senator Feinstein. Mr. Chairman, I do not believe anyone
has that letter. It was just brought in this morning.
The Chairman. Well, we will keep the record open, and we
would like to have your analysis, because to go through this
exercise and then find that it is inadequate from the
standpoint of Wall Street's point of view, you have got to go
back to the drawing board again, is that not correct?
Mr. Konolige. Well, if the Governor listened to me and Wall
Street, then that might be correct.
The Chairman. Well, you are either going to invest or you
are not. You are looking for the highest return and the least
risk.
Mr. Konolige. No question about it.
The Chairman. What is your second point?
Mr. Konolige. Those were the two points.
The Chairman. What we are doing here is, we are on a 5-
minute time, and I think my time is running down, but all
members will have 5 minutes. I want to reflect on something
that Senator Bingaman brought to our attention relative to the
role of the administration and the implication of all they seem
to be doing is promoting ANWR as some kind of, I guess, support
for California's energy crisis.
I think that is incorrect, and I would point out for the
record what the administration has done and the liability that
the administration has passed on potentially to taxpayers
throughout this country. On natural gas there was an order on
January 19 to mandate an energy sale of natural gas. That can
only be initiated by the President of the United States, I
might add, and it is implemented by the Secretary of Energy,
and that original order was initiated January 19. There was one
extension on it to February 7, on electricity.
The original order, a sales order which is under the
authority of the Secretary of Energy, was initiated on December
14. There have been five extensions to February 7, so to
suggest that the administration has not done much I think is a
gross inaccuracy of reality.
What the administration has done is, basically, in the
event that California cannot repay the generators of this
power, the Federal Government is going to have to meet that
obligation, because this was an order of the Federal
Government. I am sure it will be a full employment act for the
lawyers on the theory of taking, if, indeed, California could
not pay for it.
Now, how can California pay for it? Why, there are a number
of options. Floating the bonds, guaranteeing the debt,
financing and so forth, but I just want to make the record
clear that this administration has basically passed on to the
taxpayers of the entire United States the contingent liability
associated with billions of dollars of power that has been
ordered by this administration to give California time to work
out of this problem.
Now, the only thing that is somewhat conclusive is the
statement that they are not going to give them any more time
beyond the 2-week period, which I believe ends February 7. I
think what the administration may be trying to communicate to
the American public and some of my colleagues is that when you
become so dependent on outside sources, as California has, for
electricity and energy, you risk your ability, if you will, to
control your destiny, and there is a parallel here in oil, and
I do not think anybody is unaware of it, and that is the
reality that we are becoming more and more dependent on
imported oil, 56 percent, so there is a parallel there and I
think that is the point the administration is making.
Oil and ANWR is not going to bail out California's energy
problem, but this administration is, I think, going certainly a
long way by basically underwriting payment when California
cannot pay it. It will not be billed for 2 months.
So with that, I would turn to Senator Bingaman.
Senator Bingaman. Thank you very much. One issue that is
foremost in discussions here in Washington is whether any
effort should be made at the Federal level to restrict the
price of wholesale electricity going into California. Mr.
Makovich, I do not think you had a chance to comment on that,
and also Peter Fox-Penner, I did not hear your comment on that.
Dr. Makovich. Well, the question of price caps,
particularly price caps that will be set for the entire Western
power market, I think it is important to realize price caps are
not something you want to be a permanent feature of any market,
but as I mentioned, this is a market that was flawed and, of
course, is in crisis, so I think we have to realize price caps
are a very limited tool available to deal with this crisis.
The first danger is if you set price caps you will cause a
severe distortion. For example, if you set these on the basis
of what historic prices have been in the past, you run the
danger of setting them far too low. Gas prices have doubled or
tripled since a year ago.
The cost of NOX allowances, the emission credits
out there have increased substantially, and so it is very easy
to take a typical powerplant right now, a 10,000 Btu powerplant
at the prices for gas that were available just last Monday,
with $10 per pound on NOX you can get to $165 per
megawatt hour on variable costs, so you have to be very careful
you are not putting a cap at $150 and giving them the incentive
not to run.
If used, they should be temporary. They should not look
indefinite, because that could discourage supply additions, and
I would suggest if used you should tie it to reform and force
California to fix the flaws of not approving enough powerplants
and not paying for capacity.
Senator Bingaman. You still have not answered the question,
should they be used? You said, if used. If you were advising
FERC, would you recommend that they step up to that issue and
try to do something in the way of controlling prices?
Dr. Makovich. Well, I think, given how short it looks like
this market is going to be for next summer, we are going to be
in a crisis next summer as well and, as I said, in a crisis
situation the temporary use of price caps may be an appropriate
thing to get us through this crisis, because otherwise the
burden of this big mistake just gets passed right on to
customers.
Senator Bingaman. Peter, did you have a point of view you
wanted to express?
Dr. Fox-Penner. Yes, Senator. First of all, I would note
that I think Kit mentioned that there are already caps on all
of the deregulated markets, but they are at levels that are
much higher than most of the markets are trading at, with the
exception of California. California had a cap for most of last
summer and the market traded right at that cap for almost the
whole summer, particularly the second half of the summer
I think I would echo what Mr. Makovich said, that it is I
think extremely hard to set caps that are at a fair level and
that do not sort of hamper or squelch investment, which is key
to solving the problems in the long term, and you have to set
them high enough to give people selling under the cap fair
return on their investment, and that means you are essentially
going back to the same determination you make in cost-based
rates.
I think it is very difficult to transition to that for
short period of time, Senator, and to transition off of it, and
yet you do not want to be on it for a very long period of time,
so I think they are a last resort. Realistically they are
probably going to be necessary for next summer and I think the
FERC has all the authority it needs, and has used it time and
again when it has felt the need to, but I want to say, Senator,
most importantly, that in California and elsewhere a much
better approach than caps is long-term contracts.
Economically they do almost the same thing. You fix a price
for a long period of time. It is a locked-in price, but as we
just heard from Kit, Wall Street likes them. Powerplant
developers are willing to sell under long-term contracts. The
auction that California is holding now that Senator Feinstein
mentioned is the best development to come along in California I
have seen since the problem started. I think it is the path out
of this. The utilities have to be able to cover the cost of
those long-term contracts. They have to be at fair levels for
sellers to sell and you will see, as Mr. Konolige mentioned,
dozens of powerplant developers willing to sell under long-term
contracts, willing to build plants, in my opinion.
Senator Bingaman. My time is up. I want to introduce into
the record an article * that Paul Joskow and Edward Kahn have
written on this general issue, and I will ask a question about
it during the next opportunity.
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* The article has been retained in committee files.
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Senator Campbell, you are next.
STATEMENT OF HON. BEN NIGHTHORSE CAMPBELL,
U.S. SENATOR FROM COLORADO
Senator Campbell. Thank you, Mr. Chairman, and I thank the
panel for the articulate, concise, and educational
presentation.
I think there is some misconception about what the
administration is doing now. I know I have read in the paper
some quote that was attributed to President Bush that there
would be Federal help for California but, as you probably know,
one of your suggestions, Mr. Fox-Penner, is probably already in
the process, because the President did convene a panel that is
going to try to study not only the problem but the Federal
involvement and what it should be.
Vice President Cheney is the chairman of that panel, and
Andrew Lundquist, who was the staff director of this committee,
just went over. In fact, I think yesterday was his last day
with the committee, and so there is going to be some
involvement, and hopefully we will find how to prevent future
mistakes and help.
But I have to tell you, I do not have any questions, but I
have a very strong affection for California, as my colleagues
from California, Senator Boxer and Senator Feinstein, know.
They have always been able to count on me when it is an issue
with the State in which I was born and went to high school in
and went to college in, and was a policeman and a teacher and
on the Olympic team, all from California, and I still go out
regularly. I have lots of relatives.
So I think that in some cases there may be some distasteful
decisions we have to make, and some of us may hold our nose a
little bit when you talk about what it is going to cost the
American taxpayer to help, but I think we have to, and not only
because of my affection for that State, but fully half of this
committee, at least to my knowledge, comes from States and
represents States that are in the same power grid.
Certainly my colleagues from Idaho and Wyoming and Montana
and Oregon and so on, we are all on the same power grid, and I
think some of us are convinced that the economy of California
that relies so much on energy, and now energy from our States,
if that economy takes a nose-dive and gets into a downward
spiral we are all going to be pulled into it, so we all have a
vested interest in trying to do what we can to stem that
downward spiral.
I think most of us recognize that and we are going to be
involved in it, but we also recognize that California cannot
have it both ways. When I lived out there I lived in a little
town called Wilton and one called Elk Grove, and I was right in
the shadows of what was called Rancho Seco. It was a nuclear
power-producing facility built by Sacramento--SMUD, I guess it
was, Sacramento Municipal Utilities District, I think it was
called, and I can still remember the regulatory problems they
had getting that built in the late fifties, early sixties, when
they were starting.
I left there in the early seventies, and up until that time
it had never been turned on except to test. There was so much
opposition, regulatory opposition, and I can still remember on
the main road--I could see the towers right from our ranch--
there was almost a daily stream of protestors going out there
from the environmental community with placards, and all this
stuff to prevent it from being fired up.
So I kind of reject the attitude, the notion that the
energy-producing companies did not do it because the profits
were not right. There were a number of reasons why they could
not expand, in my view, and certainly opposition from
regulatory agencies that was driven by environmental concerns
was part of the deal, too.
I understand that that sat idle for a number of years, and
another $600 million was put into Rancho Seco to upgrade it,
retrofit it and all that, and it still has not been turned on.
It still does not produce power. I might be wrong in that,
because I left there a number of years ago, but that is what I
have heard, but clearly you cannot have it both ways. You
cannot have a growing economy, a growing number of people, a
growing reliance, as the Silicon Valley is, on energy, as
manufacturing is on energy, and then at the same time not be
willing to build the very apparatus that produces the energy.
I mean, I am not a nuclear scientist, but any damn fool
ought to be able to figure that one out. You cannot have it
both ways, and I think until the lawmakers of California come
to that realization, that they are not going to have it both
ways, then they are going to stay in this predicament ad
infinitum, whether the Federal Government helps or not, because
we cannot just support the State when the will to produce
power-generating mechanisms is not there.
In fact, some people in California are advocating tearing
down the very dams that produce some of the hydro electric
power. You cannot have it that way. So I would hope, when we
get through all of this and we do find a solution, that it is
going to also help all of our States that are some of the
power-producing States that are in that same grid, that the
legislature of California will take the lead in trying to
prevent a recurrence of what is happening now.
But just as one Senator, I wanted to just tell you and the
other witnesses that I am absolutely committed to doing what
ever I can, as one Senator, to try and resolve the problem, and
I thank all of you for your testimony.
Thank you, Mr. Chairman.
Senator Bingaman. Senator Craig.
STATEMENT OF HON. LARRY E. CRAIG, U.S. SENATOR
FROM IDAHO
Senator Craig. Thank you very much, Senator Bingaman.
Gentlemen, I think we all agree that your testimony was
insightful and certainly led to the kind of record that has to
be established both for the Congress and for the American
public to understand that what is going on out in California
just did not happen by accident.
It either happened by failure to make the right decisions,
or wrong decisions made. I am not sure how you cast it, but I
do know there is a problem that goes beyond California, and my
full statement will become a part of the record, but I did want
to reflect on some of that problem as a Senator from the State
of Idaho and part of that Pacific Northwest hydro base out
there that is being dramatically affected at this moment by
California.
I recognize that power flows both ways. There were times
when California could produce surplus power, and that power
flowed into the Pacific Northwest. There are times when we
produce surplus power and it flowed to California, but that was
a positive relationship when both sides of that flow were
trying to keep relative balance with growth and recognize it
and have those capacities and margins to offset. Obviously, in
the last few years that's changed dramatically.
Let me give you some facts for the record that are a very
real concern to me. This last week I was informed by the
Bonneville Power Administration that it is raising power rates
60 percent over the next 5 years. Implementing this increase
will require a 90-percent raise in rates for Northwest
consumers over the next couple of years. I am suggesting to my
consumers in Idaho that they send the bill to California. This
will likely cause job losses. Our high-lift irrigation pump
system may well have to shut down some of its operations.
Hardships on the average consumer in the Pacific Northwest
isn't because of the Pacific Northwest. It may well be because
of California.
California's energy needs have already exhausted Coolee
Dam's water supply for power production. Now, that is one of
the largest hydro systems in the world, and it has been drained
down dramatically in the last month because of a Federal order
that I am very cautious ought to ever be implemented again, and
I have suggested to the President and the Vice President that
one time was too much, twice is way too much, and a third time
would be a major error on the part of the Federal Government to
force the Pacific Northwest to solve California's needs.
Yesterday, Mr. Chairman, I spoke with the new district
commander of the Corps, the Army Corps of Engineers of the
Walla Walla District and learned that orders were given to
operators of the Federal Dvorjak project in Idaho to draft that
reservoir 1 foot per day for the next 6 days in order to
generate enough power for the current demand. Dvorjak happens
to be in my State of Idaho.
Now, that is a reservoir that is 4 or 5 miles in length. To
draft it down a foot a day is a very dramatic thing to do. Most
importantly, that reservoir's water has been used over the last
several years intermittently to provide water cooling
temperatures to the whole of the Snake-Columbia system for the
purpose of moving fish downstream, fish that are endangered in
the Snake and the Columbia system that many friends of the
environmental community are extremely worried about, and yet at
the same time the consequences of California is that we may
lose capacity to augment an environment to make it more
positive for the endangered fish of the Snake and Columbia
system.
Well, that story goes on and on, and if we have exhausted
Grand Coolee and have exhausted Dvorjak, then we turn to Libby
and to Hungry Horse. I am afraid that my colleague from Montana
will get extremely exercised over that.
Yes, the virus in California is affecting the Pacific
Northwest dramatically, and for the reason you have all
expressed. The grid system that is interlocked is not an
isolated situation. If it were, my guess is we would be less
sympathetic to California, because it truly would be a crisis
of their own making. Today they are able to spread that crisis
into the rest of the Pacific Northwest at a time when we are
experiencing 62 percent of snow pack within the region. That is
the water for next year's generating capacity, next summer's
generating capacity, and that is a fairly average rate of
moisture for the entire watershed region that provides moisture
to the Snake and the Columbia River systems.
I will conclude, Mr. Chairman. The brown-outs of California
now could well be the brown-outs of Idaho and Oregon and
Washington next summer, and I am afraid that my consumers and
my voters are not very sympathetic to California. Now, we will
work in the short term to solve their problems, but if their
solutions for the short term do not address the things you have
talked about for their long-term needs, we will grow less
sympathetic and a good deal more angry.
The Chairman. And you are happy this morning?
[Laughter.]
Senator Craig. Mr. Chairman, one last example. 2 cents per
kilowatt hour versus $500, to the average consumer out there
that is $2 a gallon going to $500 a gallon milk. Now, in Idaho
my folks could quit drinking milk for the short term. They
cannot quit using power.
[The prepared statement of Senator Craig follows:]
Prepared Statement of Hon. Larry E. Craig, U.S. Senator From Idaho
Mr. Chairman, the California energy crisis is now the Western
United States energy crisis, and perhaps soon, will be a national
energy crisis.
Late last week, I was informed by the Bonneville Power
Administration that it is raising power rates 60% over the next 5
years. Implementing this increase will require a 90% rise in rates for
Northwest consumers over the next year. This will likely cause many job
losses, farm foreclosures, and hardships for the most vulnerable
citizens of the Pacific Northwest.
California's energy needs are rapidly exhausting Grand Coulee's
water supply for power production. Yesterday, Mr. Chairman, I spoke
with the new District Commander in the Corps of Engineer's Walla Walla
District and learned that orders were given to the operators of the
federal Dworshak project in Idaho to draft the reservoir one foot per
day for the next six days in order to generate enough power to satisfy
current demand. That is an incredible volume of water being depleted
when you consider that the Dworshak reservoir is currently over forty-
five miles in length.
Ironically, Mr. Chairman, the water drained from Dworshak will be
used by downstream federal dams on the lower Snake and Columbia Rivers
to produce power to serve BPA customers. As you may recall, Mr.
Chairman, those dams on the lower Snake River have been, and continue
to be, the target of environmental groups who claim the power produced
at those dams is not needed. Perhaps, now, more rational views will
prevail in the dam breaching debate, and we can concentrate on recovery
measures for fish that will work.
It appears, Mr. Chairman, that the volume of water in Dworshak will
be exhausted soon and that the Corps will be forced to turn to Libby
Dam and Hungry Horse Dam to serve the power demand. There is little or
no water reserve left for power after those options are used. Add to
that the condition of the snow pack which is only 62% of normal, and
you begin to appreciate the growing concerns of the citizens in the
Pacific Northwest.
Mr. Chairman, we need answers. Many of us on this Committee knew
last Fall that there was something seriously wrong with the California
deregulation experiment. Indeed, I went to the Floor of the Senate last
October expressing concern about the problem in California and made a
plea for a quick and honest assessment of the circumstances that were
leading to failure there.
Some assessments are emerging and perhaps today, Mr. Chairman, we
will supplement those assessments with important facts.
Clearly, editorial boards for major newspapers throughout the
country are expressing their views on the California crisis.
In the past decade, according to the Census 2000 figures released
last month, California added more residents than any other state in the
nation--4.1 million. Unfortunately, that same decade, the state
sacrificed intelligent growth on the altar of environmental extremism.
Those are not my words, Mr. Chairman. Those are the words of the
editorial board of the Atlanta Constitution Newspaper written on
Tuesday, January 16, 2001.
The editorial entitled ``Balance Essential on Environment'' goes on
to say:
At the root of the problem is California's environmental regulation
minefield, a primary reason that not one major power plant has come on
line since the early '90s. In an over-the-top crusade for clean air and
water, federal and state agencies have been manipulated by unelected
vocal environmental groups determined to banish fossil fuels from
California. As a result, the state mandates the toughest environmental
regulations in the nation, cramping residents' choices and snowballing
the cost of living and doing business in California. It's difficult to
feel sympathy for people who gripe about high utility bills and outages
when they meekly swallowed--indeed encouraged--the power grab by not-
in-my-backyard ``consumer'' groups and environmental zealots touting
wind farms and solar power.
Mr. Chairman, although environmental zealotry has contributed
greatly to the energy crisis in the West, failure to ensure adequate
fuel supply reserves are clearly complicating a quick and safe response
to the pressing demand for reliable power.
During the past decade, we have heard a chorus of energy marketers
and environmentalists sing the praises of natural gas as a cost
effective and environmentally sensitive energy source. The past
Administration has hailed natural gas as the cleanest fuel for home
heating and has aggressively pushed utility companies to convert oil
and coal-fired electric plants to gas.
The irony, Mr. Chairman, is that all this aggressive promotion has
not been backed by commensurate efforts to ensure supply. Indeed, Mr.
Chairman, what appears to be the case in the United States is that we
lack a readily available and sufficient supply of natural gas to
satisfy current demand, let alone the increasing demand that we expect
in the immediate future. Consequently, natural gas prices are high and
will continue to go up in the future.
This will not change until we reverse government policies that have
foreclosed opportunities for choice of fuels. The policies of the past
Administration contributed greatly to fuel shortages in the Northeast
by preventing additional pipelines from being built thereby depriving
hard hit consumers in the Northeast the option of lower cost natural
gas.
Not only is this my opinion, Mr. Chairman, but also the opinion of
many energy experts such as the well respected economist Daniel Yergin,
and Federal Reserve Chairman, Alan Greenspan. Both have testified as to
the lack of American investment in our energy infrastructure and have
warned us of the economic consequences of failure to garner adequate
supply.
Moreover, Mr. Chairman, the past Administration has complicated our
ability to retrieve adequate supply by locking-up federal land deposits
of this valuable energy source and increasing federal red-tape and
bureaucratic inefficiencies that on the one hand runs up costs to our
citizens and on the other denies consumers the choice they have been
promised. Both of these results are unacceptable, Mr. Chairman.
I thank you for giving the Committee this opportunity to delve into
the facts of California's energy crisis and I look forward to working
with you and my colleagues on this Committee to successfully and
quickly respond to this problem.
The Chairman. Thank you, Senator Craig. We will not pursue
the milkman any more.
Senator Burns, from the great State of Montana.
Senator Burns. I will not take a lot of time, Mr. Chairman.
I want to thank you and I want to thank----
The Chairman. You have only got 5 minutes.
Senator Burns. I would like unanimous consent that I may
put my statement in the record.
The Chairman. Without objection.
[The prepared statement of Senator Burns follows:]
Prepared Statement of Hon. Conrad Burns, U.S. Senator From Montana
Mr. Chairman, thank you for calling this very important, and well-
timed hearing on ``California's Electricity Crisis and Implications for
the West.'' My constituents in Montana are watching us very closely
today because they need to see leadership. They need to see that
California is taking a responsible role in leading us out of this
crisis. They need to see leadership from the Bush Administration. They
need to see leadership by this Committee. And they need to see
leadership within the energy industry.
First, we need leadership out of our new administration. The Bush
Administration, to their credit, is following up on their campaign
promise to structure a national energy policy that takes into account
everyone in America. They are sensitive to environmental concerns,
while making sure that production and generation increases so that we
do not handcuff the United States' economy to such a degree as to
minimize our role in the world's economy. The United States should take
an active role in our world's energy policy, and our role should
encompass the needs and desires of all facets of the U.S. economy. In
short, I am confident that the Bush Administration will lead us towards
a regulatory regime in the energy industry that allows all of America
to take part in economic revitalization.
Second, America needs to see this Committee take an active role in
our nation's energy problems. Many critiques of deregulation want to
say that deregulation is solely to blame for our current energy
problems. I want to make it clear that in determining what to do about
our energy problems we must know the difference between correlation and
causation. Because two related events happened at nearly the same time,
it does not necessarily mean that one caused the other. Critics say
deregulation caused our current energy problems. I find that hard to
believe after analyzing some basic statistics. In the Northwest, demand
for electricity is up at least 24 percent over the last 10 years. At
the same time, generating capacity is only up around 3-4 percent. I am
not an economist, but I can tell you that balance within our
electricity industry is skewed towards higher price. Therefore, when we
look at our role in solving the energy shortage, I want this committee
to take an active role in seeing that we lessen some of the impediments
to electricity generation and transmission. Let's make sure that the
federal agencies that oversee the energy industry are streamlining
their processes to help ensure that supply meets demand.
In Montana, we have the resources and we have the ability to bring
more power plants on line. However, even if we were producing more
power, we do not have the ability to bring this power to market because
I am told that all of the transmission lines are at maximum load. The
American people are looking for leadership from this Committee. Let's
take an active role in ensuring we streamline government so that it
enhances industry's ability to generate and transmit electricity.
Last, the energy industry itself must provide leadership. Many
people say that industry is making today's energy shortages even worse.
I think that there are some legitimate concerns revolving around
today's energy producers. If it is true that energy producers are
taking enormous profits at the expense of the American economy, then
they need to analyze their practices and show restraint. I understand
that publicly-held companies have a fiduciary duty to maximize profits.
However, consumers also have a right to fair market prices that are not
the result of market manipulation and industry collusion. While I
continue to maintain that our largest problem is lack of supply, I will
keep my eye on our energy producers to make sure they are not
exacerbating our problems. I remain confident that our producers will
realize they have a duty to consumers as well as to shareholders. I
believe they will help lead America back to stable energy prices.
Mr. Chairman, again I thank you for calling this hearing today, and
I look forward to the testimony of our panelists.
Senator Burns. I happen to look at the California situation
maybe a little bit different, because I still think they are
part of this union, and we have to do something to help our
folks in California, although I will tell you this is a good
time to run a good commercial for Montana. Those folks that
want to do business and need a lot of power, we produce about
3,900 megawatts a year, and we use less than that. We would
like to move more into the California market, but I am told
that the transmission lines and our ability to transmit that
power is limited and almost at capacity now, so those of you
who want to look to Montana, why, you may do so. You can call
my commercial office downtown. They will set you up.
I do believe that that is one way that we can solve some of
our problem on the Western grid. I think the whole thing needs
to be looked at in totality. We look to the BPA for part of our
power. We look also to WAPPA, to the East, and of course our
own ability to produce in Montana. I think mine-mouth using
coal, clean coal technology, and mine-mouth generation, and
moving it in transmission lines, is probably the best way we
have to addressing the problems we have in California. That may
not be the cheapest way, but it is a reliable way in order to
address that.
Curves should have told us something, Mr. Makovich, as near
as 5 years ago if we look at everything, we looked at Economics
101 as we watched curves, and we could see where the demand for
electricity was going up, yet our curve for production was just
barely going up. Like, 24 percent increase in the last 10 years
and only a 3 percent increase in our generating capacity tells
us that that curve had to start at least 5, 6 years ago, and
someone did not pick up on that.
You made the comment that the overlapping of
jurisdictions--I think, Peter, maybe you made that, of
jurisdictions of FERC and State, lends a lot of confusion on
where are we to go. We have had applications in for small dams,
the recertifications of FERC, and that takes forever for some
reason or another, 4 or 5 years on recertification. That should
not take that long. Do we pass legislation that gives our
regulatory people a time line in which to complete
recertification, or to do something that is required, and would
any of you want to comment on that?
Dr. Makovich. I think that each State has its own unique
set of requirements. In order to site and permit powerplants I
think a time line requirement is a good idea, but I think more
importantly, I think States have to have a minimum target of
approvals regardless of how long this process is going to take,
or what time line they have got.
For example, in California's case, if they are not
approving 1,200 megawatts a year then they are not keeping up
with demand, and so I think you have to force them to meet some
targets.
Senator Burns. Peter, what is the increase in demand in
California? What is the growth? I am told it is around 3,000
megawatts a year. Is it increasing that much?
Senator Feinstein. Demand went up 14 percent last year. I
cannot translate that into megawatts.
Dr. Fox-Penner. I think demand went up, I believe, 4
percent last year, which was extraordinary, off of 50,000
megawatts. I am not good at doing that in my head, but 3,000
sounds a little too high.
Dr. Makovich. Actually, the peak demand this last summer
was a little bit below where it was the summer before. If you
look at peak demand, the maximum demand in California, it is
growing, if you correct for weather and the business cycle,
about 2 percent a year.
Dr. Fox-Penner. I got about 2,000 megawatts
Senator Burns. In other words, we were at least close, but
it is hard, it seems like in the investment world--as our man
from Morgan Stanley will tell you, it is hard in this business
to build a church for the Easter crowd, it seems like, but
nevertheless it looks like we are going to have to do some of
those activities, is that correct?
Dr. Makovich. Yes.
The Chairman. Your time has expired.
Senator Burns. And I will yield, and I have got something
else to do, but I will be back in time to talk to the industry.
Thank you for your testimony today. I appreciate that very
much.
The Chairman. Thank you, Senator Burns.
Senator Akaka.
Senator Akaka. Thank you very much, Mr. Chairman, and thank
you for having this hearing.
Mr. Makovich, you stated that what has happened is that
there is a severe shortage of power in California, and Mr. Fox-
Penner said it is a tragedy of immense proportion, and the
Senators from California have indicated that it is so severe
that Congress has to act immediately on this.
Mr. Makovich pointed out that part of the problem is that
consumption has grown 24 percent and there are structural flaws
creating the problem. You also mentioned, Mr. Makovich, that we
need to create lower demand as well as increase power
production, and my question to you on those two, on creating
lower demand and increasing power production, is whether you
have any suggestions or any ideas as to how this can be done.
Dr. Makovich. Well, when we look at the magnitude of this
shortage, as I mentioned, 5,000 megawatts, we are at least
5,000 megawatts short, I think it is important to recognize
conservation and efficiency gains which have been occurring in
California over the past 5 to 10 years. They can help on this
problem but they cannot even be a major solution here. What you
can get in the short run on conservation and additional
interruptible load will help, but you have to do--this is not a
question of just shutting off all of the swimming pool pumps in
California. This is a major shortage that conservation and
efficiency cannot meet alone, and so what it means on the
supply side is do everything you can on the demand side, but on
the supply side you need emergency generation. You need to
bring barges in where possible to California with generating
capability.
I think if you could put some flexibility in environmental
regulations to allow backup systems at hospitals and
universities and hotels, the diesel gen sets they have for
emergency purposes to be able to run this coming summer, that
is another thing that would help. I think you have to scramble
right now on both the demand side and the supply side, because
we have a looming crisis again this summer.
Senator Akaka. Mr. Fox-Penner.
Dr. Fox-Penner. Senator, there are many conservation and
pricing measures that I think should be looked at. I do agree
that many of them take a while to implement and will not be
ready for this summer, just as it is going to be hard to build
any permanent powerplants for the summer, I would say
impossible, but I hope that this episode teaches us that we
must continue those efforts. There is a whole variety of
efficiency options and we are going to need lots of power for
the long run here, and we cannot take our eye off that ball.
There are a few, though, short-term demand-related measures
that I feel are extremely important, and one of them is to
accelerate the implementation of technologies that make
buildings demand-responsive price-responsive themselves.
Buildings can actually reduce their energy use dramatically
with no humans involved in response to price signals, and
research has shown, as I mentioned in my testimony, that until
we get technologies like this and more demand response, we will
never have fully working electric markets, so we have to do
this. We should do it as quickly as we possibly can, and this
sort of thing does not take a terribly long time to implement.
Mr. Konolige. If I might mention one suggestion, the
standard, most straightforward conservation measure is to raise
prices to customers, and since California has already raised
prices 10 percent, I think that will have some impact on
lowering demand.
If it were to go ahead with some of these suggestions that
have been raised in the political process so far and increase
prices further, they would have to be increased for the summer,
perhaps an emergency surcharge of some kind would be a
reasonable way to really dampen demand. In fact, last summer,
when San Diego radically raised prices, there was an immediate
sharp decrease in the usage in San Diego, as you would expect.
So while that may sound like shock therapy, if the problem
is bad enough, namely blackouts, it might be something that the
State may want to consider.
The Chairman. Senator Akaka, your time is up.
Senator Akaka. Thank you very much, Mr. Chairman.
The Chairman. Thank you, Senator Akaka.
Senator Wyden.
Senator Wyden. Thank you, Mr. Chairman. What is especially
troubling to me is that the same California utilities that
engaged in the questionable transfer of billions of dollars to
their shareholders and others cannot provide iron-clad
guarantees that we are going to be paid back for the power we
have already given, so I am not going to support another
megawatt of power to California unless we have real reforms
that truly protect everybody in the West.
My sense is, and this is my question for our witnesses,
that a critical first step in terms of real reform is to lift
this veil of secrecy that surrounds the energy markets. It
seems to me it is time to make information available about
market power and transmission capability and outages, and I
would like to ask, perhaps Mr. Makovich and Dr. Penner, do you
agree that California, the California ISO and the regional
transmission organizations, ought to provide more information
so that the public is in a position, and investors and others,
to make intelligent choices?
Dr. Penner.
Dr. Fox-Penner. Senator, I would only agree a little bit. I
think the information available about the electric industry,
although it has declined significantly as deregulation came in,
is still pretty good and probably more, I would say from the
industry's standpoint, burdensome than in almost any other
industry, and it is not the greatest barrier that we analysts
see to figuring out what is going on.
Now, having said that, I think there are some minor
improvements between EIA and the FERC in their information
collection. I would be glad to discus them off-line, and though
they are small, I think quite small, they would be quite useful
in making studies, but it is generally not a major issue.
Senator Wyden. I am going to give you a copy of the letter
from the Oregon Public Utility Commission, because they say
they are basically in the dark about these issues. I mean, just
the debate that is going on right now with respect to
deregulation, it is very hard to get accurate objective facts
about how these markets work.
Mr. Makovich, did you want to take a crack at it?
Dr. Makovich. Sure. Good information flows are the life
blood of markets that work well. I think the evidence in the
California energy market was that having set up a formal power
exchange to replace the informal wholesale market that had
existed in the California area did a lot to improve information
flows about supply, demand, and price at any point in time.
In fact, what the information said was, unless this
California market is in a shortage, prices are too low to
support investment, so the information flow to investors was
pretty good. Do not build a powerplant in California because it
is not profitable.
Now, there are some information flaws, and one in
particular is, I think it would help if planned outages of
powerplants----
Senator Wyden. That is one of the first things I want to
see in a California bill, is outages. What about transmission
capability?
Dr. Makovich. Well, if outages were reported I think we
would have much better coordination, and we would avoid the
problem of everybody being down at the same time because they
didn't know everyone else was going to be down, but on the
transmission end, transmission network is very, very
complicated.
If you think this wholesale market restructuring is a mess,
well, if you dig into the transmission restructuring right now,
we think the transmission system in the United States right now
can be described as being in a state of gridlock. People do not
know how to price transmission. They do not know how to manage
the congestion. We have got all sorts of schemes at work right
now to try to figure this out, other grand experiments here,
and yes, there are many economic investments that could create
better power flows, higher integration in the West that are
currently not being done because of this tremendous state of
flux.
Senator Wyden. I guess my concern is that if we are
entering this era of electric power competition, electricity is
traded as a commodity, but there is not open access to the
information that is necessary for a commodities market to
function properly, it is going to be hard to make real
progress.
So I would just say to our friends from California that we
have been more than a good neighbor here. We are going to need
to see some reforms that benefit everybody in the region, and
it seems to me right at the heart of that discussion is getting
good information rather than keeping the public in the dark,
and that is what my constituents are troubled by at a time when
we have got a lot of economic hurt in our region and we are
forced to send more power to California without any guarantees.
Thank you, Mr. Chairman.
The Chairman. Thank you, Senator Wyden.
Senator Thomas.
Senator Thomas. Thank you, Mr. Chairman. I also have a
statement that I would like to have entered into the record.
The Chairman. It will be entered into the record without
objection.
[The prepared statement of Senator Thomas follows:]
Prepared Statement of Hon. Craig Thomas, U.S. Senator From Wyoming
Thank you, Mr. Chairman, for holding this hearing today. We are all
very concerned about the electricity crisis that is occurring in and
around California, especially those of us from the West. California's
version of deregulation has not worked well to date. In fact, it is
putting distorted market pressures on electric power rates in
neighboring states and we, in Wyoming, are beginning to see signs of
the increasing price pressures. This is not good news for my
constituents--on top of high prices for natural gas this winter,
electricity power rates will rise as well.
For the last eight years we have seen a flurry of stringent
environmental regulations combined with a campaign against off-shore
drilling, coal fired power plants, nuclear power plants, developing
minerals on public lands, and hydro relicensing--all contributing to an
overall supply problem. California led this march. And now, they, along
with the rest of the country, are feeling the affects of having no
energy policy in place.
Even so, to a large extent, the problems facing California are
unique to that state:
No major new generation facilities have been built in
California in more than a decade, and in the meantime, demand
has soared;
Inadequate natural gas transportation capacity into the
state, coupled with increasing reliance on natural gas for
power generation, has helped drive up natural gas prices to the
highest levels in the country, thus further increasing the
price of electricity;
Environmental and facility siting restrictions that are the
toughest in the nation make it difficult to build new
generation or even operate existing facilities for the entire
year;
Abnormally dry weather has reduced the amount of available
hydropower generation by nearly 40% this winter;
A critical shortage of transmission capacity in some regions
of the state makes it difficult to efficiently transmit power
to where it is needed;
An almost total reliance on volatile day-ahead and hour-
ahead electricity markets by prohibiting effective hedging and
long-term contracting by incumbent utilities has driven up
prices.
The shortage of generation in the State of California has had a
ripple effect throughout the entire interconnected West, where
wholesale prices have been driven upward. In general, the electric
power market is fraught with uncertainty with about half of the states
moving toward electric industry restructuring and deregulation and
about half the states still served under regulated monopoly
provisioning of electricity to customers. This uncertain environment
has resulted in a lack of capital investment in electric power
generating facilities and in electric power transmission facilities. We
now have a market situation where growth in demand for electric power
has been much faster than growth in supply.
I have always been a supporter of electric industry restructuring.
Having been involved in the electric power industry, I understand the
unique characteristics of each state. I have supported legislation that
empowers the states to restructure their electric industries at the
rate and in the way they decide. Legislation should not impose a
``retail choice mandate'' or deadline on the states so as to fully
allow the best market ideas and approaches to occur. A federal mandate
on the states requiring retail competition by a date certain is not in
the best interest of all classes of consumers.
Despite the problems in California, states are in the best position
to deal with this complex issue. Although the cost of electricity
varies across the country, electric industry restructuring can result
in lower consumer prices for everyday goods and services, the
development of innovative new products and services, and a growing,
more productive economy. Throughout the country, wholesale markets are
not functioning as efficiently as they should. In addition, the
situation in California has made it clear that we should be seeking to
encourage, not discourage, the building of new generation and
transmission facilities that are needed to meet the demands of growing
economy.
That is why I believe Congress can help make wholesale markets work
more efficiently, while deferring to the states on the question of
retail markets, including whether to restructure the electric industry
in their respective states. I plan to introduce legislation that would
help wholesale markets function better, would encourage the building of
new generation and transmission facilities, would enhance system
reliability and that would provide the regulatory certainly necessary
for investment in this critical industry.
Thank you to all the witnesses and I look forward to hearing your
testimony.
Senator Thomas. We talk about transmission. We ought to
take some information from Senator Akaka from Hawaii. They have
dealt with the interstate transmission very well.
[Laughter.]
Senator Thomas. I think certainly we have a crisis in
California, and one we need to deal with, but I have been
around this business quite a while, and it seems to me we ought
to be looking at where we want to be over time with this whole
reregulation thing, and we ought not to ignore that as we deal
with this particular problem.
I think some of you agreed with the idea that FERC ought to
control, set some limits on the wholesale prices. What about if
California does not change the retail price? Is that going to
be workable?
Dr. Makovich. Well, obviously, in a well-functioning market
you do not want to have customer prices capped. You want them
to be linked to what is going on in the wholesale markets, so
this tremendous misalignment we have now, where utilities are
forced to buy wholesale power in multiples of what they can
pass along to customers, is completely unsustainable and, of
course, it has brought the major utilities to the brink of
bankruptcy, and it has contributed to the shortage problem.
Senator Thomas. My question is, should FERC set a price
limit on wholesale power if California is going to continue to
have a limit on retail?
Dr. Makovich. As I said, if they are not aligned properly,
as I mentioned----
Senator Thomas. Are they aligned properly?
Dr. Makovich. Now, no, they are not.
Mr. Konolige. I guess my feeling would be a little
different from the other panelists, which is, I think that
price caps at the wholesale level have no good use. They
inevitable distort the market, and I think we can see very
clearly in California that the lower they made the price cap,
the higher the actual prices occurred.
Now, how could that happen? Well, what happened was that
the out-of-State suppliers would not sell below their cost into
California so the ISO and the PX would have to go around and
around their own price caps, and so the actual prices were
significantly higher.
Senator Thomas. So what is your suggestion for the short-
term remedy?
Mr. Konolige. I think for the short-term remedy, say for
this summer----
Senator Thomas. Well, it is going to be several years, a
couple of years before you get more generation.
Mr. Konolige. I think the solution is that the State of
California should pay the market price. The market price can be
significantly lower by this summer if the authorities move
ahead with their initiative to sign long-term contracts with
the suppliers of power. The long-term contracts are a much,
much better solution than price caps. Long-term contracts are
the market solution to the problem that the price caps attempt
to address, and we know they are the right price because those
are the prices that both sides can agree to.
Senator Thomas. They would have to be pretty low if you are
going to continue to have retail limits.
Mr. Konolige. Well, I think it is clear that long-term or
short-term price caps in California, because of higher gas
prices, because of low hydro conditions, because of the
NOX credits problem, the actual cost of energy in
California of electricity is significantly higher than was
embedded in the rates of the utilities.
I mean, there is a significant discount that the people in
California are getting on the actual price of electricity
today. I would say that sooner rather than later the end
customers have to start paying the freight, but I think the way
that you make that an acceptable transition is, you go to the
generating companies and you sign long-term contracts with
them. You say, what is your best price for 10 years, if we
levelize it, so that they will give up the high near-term spot
prices in return for some assurance that they will get paid
good prices out 3, 4, 5, 8 years from now.
Senator Thomas. That is fine for the generators, but the
distributors are then caught in the middle.
Mr. Fox-Penner.
Dr. Fox-Penner. Well, I largely agree with Mr. Konolige. I
think long-term contracts are far preferable to price caps, and
the States are moving in that direction. They can set a true
competitive market price for power starting this summer and
moving forward, and I do think that over time that retail
prices, or the prices that distributors collect to pay for that
wholesale power, have to come into alignment with fair
competitive wholesale prices. That is sound economics, and I
just think it is the only possible solution in the long run.
Now, you have to take care of special cases and we have to
take care of low income customers, and I am sure that is true
in your State, too, Senator, and we have to align the time path
of these things, and maybe do a phase-in and so on, but they
have to reach alignment.
The Chairman. Senator Thomas, your time is up. Thank you.
Senator Feinstein.
Senator Feinstein. Thank you, Mr. Chairman. I just want to
put something out for these three gentlemen.
Senator Landrieu. I am sorry, Mr. Chairman, are we speaking
in order of attendance?
The Chairman. Yes. Senator Feinstein.
Senator Feinstein. I would just like to correct the record.
California ISO has said that the State will be short 2,000 to
5,000 megawatts every day this summer, and so the bilateral
contracts alone, gentlemen, are not going to take care of it,
and that has to be realized. That is the reason why something
needs to be done in the short term to stabilize the generation
market.
Let me read to you, if I might--Senator Bingaman has put
together, put in the record a study out of MIT titled, ``A
Quantitative Analysis of Pricing Behavior in California's
Wholesale Electricity Market During Summer 2000.'' Let me quote
from that report. Paul Joskow and Edward Kahn are the authors.
``There is considerable empirical evidence to support a
presumption that the high prices experienced in the summer of
2000 reflect the withholding of supplies from the market by
suppliers, generators, or marketers. We base these conclusions
on results of the two analyses described herein. One analysis
is a competitive benchmark price analysis and the other is a
capacity withholding analysis. There was price-gouging in this
market.''
Now, that raises the problem, because the FERC found that
prices in this market were unjust and unreasonable, but the
FERC decided not to do anything about it, so my point is, while
everybody blames California, remember this. California is
bigger than 21 other States put together. California is the
fourth most energy efficient State in the Union, and I will put
documentation in the record to support that. There is a huge
problem out there. California is moving--it will build new
generation facilities. It needs time to do that.
California today is not receiving anybody's power
allotment. This is surplus power that is coming in. California
generates 2,000 to 5,000 megawatts of power a year that go
outside of the State by bilateral contracts. We have honored
those contracts, and will continue to honor those contracts.
There is a real problem in just blaming the State. You
know, there are huge water shortages affecting hydroelectric
power up in the Bonneville area. That is subsidized power, I
agree, the rates have to go up. There is legislation being
considered by the legislature to raise rates, as a matter of
fact, if consumers exceed a baseline consumption level. What
they are talking about is setting rates higher for those that
exceed the baseline, which is about 75 percent of the people in
the State, so I think there will be at least some attempt to
fix the brokenness in the market on that end.
But the point I want to make is, there is not enough power.
Now, this means the common carrier lines for jet fuel will be
clogged. We will not get jet fuel from, say, Chevron to
airports on time. You are going to continue to have business
closures. It is going to impact communication between the
States. It is a very serious issue.
Now, what I am asking you gentlemen, assume for a moment
what I have said is right, and I believe it is, but assume it
is right. What controls the market from charging $3,000 per
megawatt in this summer? Unless you have some mechanism--the
FERC has tried under an administrative law judge for over a
month to bring some long-term contracts and was unable to
succeed. They could not come to terms, so you have a ribald
market out there.
What do you suggest would get us through the summer, short
of somebody being able to make a decision as to how much profit
and how much cost should be passed through, and some control?
If utilities can only pass through $64 a megawatt hour and they
are buying at $3,000 a megawatt hour, what is going to solve
the problem?
Mr. Konolige. Well, I would first suggest, Senator, that if
your problem is a shortage of supply, standard economic theory
would be that if you put a price cap on the supply you will get
less of the supply and not more.
Senator Feinstein. But what is your solution?
Mr. Konolige. The solution is twofold. One is, sign all the
long-term contracts you can.
Senator Feinstein. It will not be enough. It will be 2,000
to 5,000 megawatts short. If I am wrong, I will buy you lunch.
Mr. Konolige. That is fine. Unfortunately, that is such a
hard thing to prove. It is in the future as well.
Senator Feinstein. This is the ISO. This is not my
statement. No matter what they do, they are going to be short
this summer.
Mr. Konolige. I would say if you put a price cap you will
never fill that gap. In other words, if you do not allow
yourself to pay a lot of money for that 2,000 to 5,000
megawatts, you will never get it.
If you put the price up enough, then there would be 2,000
to 5,000 megawatts that, for example that people in Idaho or
the State of Washington might decide at the right price they
will be happy to send to California, but putting a price cap I
think has the exact opposite effect of what you are trying to
achieve. A price cap will not increase supply.
Senator Feinstein. Well, there was a cap, one of $250. All
of this happened when the price cap was taken off. Now, what we
are talking about is just something to get us through the time
when supply and demand can meet, and once you have got the
supply, then you do not have to worry about taking the cap off
then.
Mr. Konolige. Well, I think what might work, and not that I
would necessarily agree that it is a good idea, is if you had
some sort of FERC order that required people from outside the
State to sell into California at some kind of fixed price, but
as I think you have heard on the panel today, there are
probably a number of Senators who would not feel that that was
an appropriate way to deal with the problem.
Another approach, obviously, is if you are 2,000 or 5,000
megawatts short, do not use the 2,000 to 5,000 megawatts. I
mean, California is well-known for its conservation programs.
Perhaps there can be a crash program to improve them so that
there is even less use.
Senator Feinstein. Do you know what this would do to the
economy?
Senator Bingaman. I am sorry, we are going to have to go to
the next questioner.
Senator Dorgan.
Senator Dorgan. Thank you very much. Let me thank the
panelists, and I want to pledge to be helpful, Senator
Feinstein and others who are interested in this issue. This is
a terribly difficult issue, but let me also say, just as a
matter of course, that the energy issues are complicated, not
just this issue. In many ways this is not just about
California, and it is not just about electricity.
I had a hearing in North Dakota 2 days ago talking about
natural gas prices propane prices, heating fuel prices, and so
we have a lot of energy issues. Our country has studiously
managed to avoid a comprehensive energy policy for some decades
now, and we continue to let much of our energy future depend up
on decisions made by OPEC ministers, which in my judgment is a
thoughtless policy, and we have to change it.
The method of deregulating electricity in California,
however, is a giant billboard for failure, in my judgment. They
constructed something that could not possibly work. I am a
skeptic of deregulation in any event, but clearly the construct
of the California experience was unworkable. Deregulation, we
have got a lot of experience with it I would say to Senator
Feinstein.
In the next panel we will have Californians testify, and to
the extent that they flew here commercially, they paid half as
much to fly from Los Angeles to Washington as they would have
paid to fly half as far from Bismarck to Washington. That is
gratis of deregulation, a so-called ``market system,'' when you
have several large participants deciding how they are going to
price a product that is essential to us, and if I might just
for therapy purposes say, another part of the market system is
a short stop that gets $256 million a year and a short teacher
in Fargo that gets $35,000 a year. $256 million over 10 years
is the short stop's contract. That is a market system.
Or the short-tempered Judge Judy paid $7 million a year and
Justice Rehnquist $180,000 a year, so the market system is a
very interesting place, but the market system itself, I would
say to Mr. Makovich, you talked about this. You said that the
general assumption that the electricity markets are just like
other commodity markets is wrong, and I welcomed that, because
it is a very different set of circumstances, to talk about
electricity versus chewing gum, and you point to the unique
characteristics, including capacity versus generation.
You said California has set up an energy market that paid
power generators to run their powerplants but did not set up
any market mechanism to pay generators for capacity. In other
words, no capacity price signal to create an incentive to bring
on new capacity.
Given that flaw in the construct which I heard in your
testimony, these high wholesale prices then are not an
incentive to construct new capacity, are they? In fact, they
would be an incentive to generate a windfall for the current
owners of capacity. Do you agree or disagree with that?
Dr. Makovich. Well, as I said, there is a right way and a
wrong way to set up a power market. I think that power markets
can be set up properly, but relying on this energy market alone
to provide an investment signal is a mistake.
The price signal we have got right now is far higher than
it needs to be, but the most important thing, it is far too
late. This was a signal that needed to be there a few years ago
when we started deregulation. Put any market of any kind of
commodity in the shortage we are in right now, prices will go
up, and it is also due to the fact that electric use, as
someone mentioned, is very critical to our every-day lives.
What uses a lot of electricity are refrigerators and air
conditioners and so when we see a shortage like this and prices
run up, this is a shortage, and all markets will do that.
Now, the question of price-gauging, if that is meant to
imply, then, that people are manipulating this market, the
generators that bought generating assets out there were not the
ones that prevented anybody from building powerplants. They
were not the ones that set the rules up for how this market
will be flawed in its operations, and so if we look at these
high prices that we have got now and coming up for the summer,
we have to remember, the flawed markets, it was not too long
ago that the Western power markets cleared at zero, and so you
know, the flaw in these markets created prices that were too
low in the past and not prices that are too high, and if you
fix the market you can get it right.
Senator Dorgan. Mr. Makovich, thank you for that. Lest
anyone misunderstand my statements, I have studied economics
and taught economics in college. I am a fan of the free market
system, but the free market system exists and works when you
have robust competition with easy entry and easy exit, and
sellers willing to compete with each other.
I must say, in my judgment, as I have watched some
essential services be deregulated, airlines being one,
railroads another, and some others, that there are many in this
country that have suffered dramatically, dramatic injury as a
result of that, and that is why I assume that California
created a construct that would try to protect the consumer, but
that construct was, in my judgment, at its outset unworkable,
and this may be a billboard for the failure of the California
system. It may be a billboard for a much broader failure in my
judgment, as well, with respect to deregulation.
Mr. Chairman, thank you very much.
Senator Bingaman. Senator Cantwell.
Senator Cantwell. Thank you, Mr. Chairman.
Senator Bingaman. Let me just give people the order that I
was given here, Senator Hagel, who is not here, Senator
Cantwell, Senator Kyl, who is not here right now, Senator
Smith, Senator Landrieu, and Senator Nickles. So, Senator
Cantwell.
Senator Cantwell. Thank you, Mr. Chairman. As the newest
member, I always appreciate that opportunity, and I will submit
testimony for the record, but I did want to make a few points.
[The prepared statement of Senator Cantwell follows:]
Prepared Statement of Hon. Maria Cantwell, U.S. Senator From Washington
Thank you, Mr. Chairman. I want to thank you for agreeing to have
this hearing to address the larger implications of the California
crisis, especially for Washington state. One significant consequence
for my constituents is the loss of a paycheck as their employers are
closing their doors. We hope temporarily.
These closures are not limited to our aluminum industry but include
timber products, refineries, steel foundries and many other
manufacturers, soon to be followed by companies that make a living
supporting or using the by-products of these same companies. At the
Georgia-Pacific mill in Bellingham, management made the tough decision
that Christmas would feature the layoff of 850 employees. Public
agencies are faced with the prospect of curtailing services to meet
unexpected costs, such as the waste water treatment facility in King
County which already needs an additional $8 million to cover energy
costs.
Let me be clear that the people of the Northwest respect the long-
standing power-sharing relationship with California and we support its
continuation over the long term. We appreciate Senator Feinstein's and
Governor Davis's letters of thanks to BPA for its role in helping to
avert rolling blackouts in California and we stand ready to be partners
in resolving this western crisis. However, let me be equally clear that
I cannot support ``solutions'' which require more pain for Northwest
consumers in order to maintain current rates or increase supply in
California.
The continuation of the Secretary's order that forces the sale of
excess power further erodes the financial stability of Northwest
utilities. This, combined with the continued volatility of the entire
western marketplace, only guarantees more drastic rate increases in
order to cover costs, including the Treasury payment by BPA. While you
will hear later more details of Northwest utilities' actions, BPA most
recently announced a 60% rate increase over 5 years, with a 95%
increase in the first year. These increases, which have been put in
motion but not yet fully felt by many industrial and residential
customers, will have further negative effects on our economy, and on
the family paycheck.
Again, I appreciate having the Northwest's voice heard today and I
look forward to working with my colleagues and our witnesses to help
resolve this crisis in the West. Washington State's concerns cannot
remain an afterthought. Our people, our cities, our rural communities
and our industries are reeling from the impact already.
As some of you may remember from an earlier economic crisis in
Washington state, the Boeing downturn of the 1970's, there was a
billboard that asked, ``Will the last person out of Seattle please turn
off the lights?'' Through dramatic rate hikes and shuttered businesses,
the billboard this time may well read, ``Will the last person out of
Seattle please blow out the candle?''
My question for the panel focuses on the terms ``dysfunctional and
irrational'' which have increasingly been used to describe our shared
marketplace. As a result, a number of important figures in the energy
industry have been calling for temporary price caps in the western
market--many of whom are incredulous that they would ever have found
themselves advocating for market controls. As a further example, the
Attorney General of Washington state, Christine Gregoire, yesterday
announced an investigation of price manipulation and unfair business
practices.
Have we reached a point in the market where some form of temporary
price caps would help restore us to a rational marketplace? How is this
answer affected by the requirements of the Federal Power Act that
wholesale rates be just and reasonable?
Senator Cantwell. This is a very important hearing this
morning not only for the State of Washington but for California
and the Northwest, so I appreciate your comments in referring
to the larger region and the challenges we face.
Obviously, the impact on the Northwest is that employers
are closing the doors, and I hope that is only temporarily, and
this is not just limited to the aluminum industry but the
timber products refineries, steel foundries, and many other
manufacturers I think are all impacted by this.
At Georgia Pacific a mill in Bellingham made a decision
this Christmas to lay off about 850 employees, so let me be
clear that the people of the Northwest understand the
longstanding power-sharing relationship we have with
California, and we support that continuation over the long
term, and I certainly appreciate Senator Feinstein's leadership
on this and Governor Davis in working with the region's
Governors, but obviously I just want to make a point, too,
about the Northwest Power.
BPA is a cost-based power and operates with ratepayers'
revenues. The ratepayers repay the debt to the Federal
Treasury. They pay the interest on it, and they also repay non-
Federal debt, so I very much want to work on a regional
solution, but obviously very concerned that the Northwest in
the Secretary's continued force of the sale of excess power, it
also erodes the financial stability of those utilities within
the Northwest.
I will not go on with my further comments about the rate
increases that we are seeing in the Northwest, not solely
because of California, but the complexity of the issue, but
that gives some impact. What is your sense of the economic
impact to the Northwest and the urgency in resolving this as
the executive order continues?
Mr. Konolige. Well, I guess you are referring to the
Department of Energy order, which I guess is scheduled to not
continue for very much longer from what I understand that the
administration has said. I think they have said February 7 was
going to be the end of that, so that may be a self-solving
situation, but we will see.
To the extent that that continues, but regardless of
whether there is an order like that, I think the high prices in
California, I mean, California has a market that imports
electricity. Its wholesale prices, whatever the situation with
the price caps, the price caps can only affect inside
California, so there has been anomaly all along, where
California is willing to pay higher prices for Northwestern
Power and much lower prices for electricity inside California,
so the fact that California is in a very massive short supply
situation sucks in power from the rest of the region and forces
prices higher.
In other words, any seller in the Northwest such as an
aluminum plant who did not even used to be a seller will feel
the very strong economic pressure of very high market prices,
so directly and indirectly high prices in California cannot
help but have a significant effect in raising the price level
of electricity throughout the Northwest.
Senator Cantwell. Yet you still have resistance to the
temporary price cap as a concept?
Mr. Konolige. Simply because I think it does not work. I
mean, that temporary price cap, I think it is a practical
impossibility to extend it to the West. Outside of California
there is no organized marketplace. The issues of exactly who
you would impose it upon, under what circumstances--could you
take, for example, private contracts between a buyer and a
seller and say, this buyer and seller cannot contract for a
different price? I mean, that seems like an elaborate system
you would have to put into place to try to enforce that.
So our feeling all along has been as a practical matter
price caps do not work. I mean, that is the opposition, is that
they do not really hold down prices.
Senator Cantwell. So do you think, then, that in thinking
out this from a regulatory perspective, that UTC's or others,
or even the concept of, in the banking industry at least you
have, if there is a run on a bank you have FDIC insurance. They
are mandated to have some coverage, some plan as a backup, so
what is the backup plan?
Mr. Konolige. The backup plan here is, for example,
Bonneville Power hopefully will not run out of water this
summer. There will be enough electricity for everyone as long
as, look, if we literally do not have enough water and do not
have enough gas, then there would be blackouts for everybody.
Short of that, there will be a price at which the market
clears, so the issue ultimately comes down to who pays that
price, and if you set the price too low I think what is going
to happen is you have a lot of generators who will simply go
out of business, or at least temporarily go out of business,
and they will say--so the perverse effect of price caps is, if
you are short power, setting a low price cap represses the
amount of power available. I think that is the practical issue
with setting price caps.
Senator Bingaman. Senator Smith.
Senator Smith. Gentlemen, I appreciate very much your
testimony. I wonder if you can give me a one-word answer to the
following question. From all that you have heard proposed and
likely to be passed in Sacramento, is it apt to fix
California's short-term problem? If each of you could take a
shot at that.
Dr. Makovich. No.
Dr. Fox-Penner. I would say mostly.
Senator Smith. And the financial man?
Mr. Konolige. I take the Fifth.
[Laughter.]
Senator Smith. From all you have heard proposed and likely
to be passed in Sacramento, will what California is doing, will
it solve their long-term problem? A one-word answer, if you
can.
Dr. Makovich. No.
Dr. Fox-Penner. Senator, did you mean proposed and likely
to be passed?
Senator Smith. What Governor Davis is proposing, is it
going to be sufficient to fix this problem?
Dr. Fox-Penner. Well, I am not quite sure who exactly has
proposed what at this point, Senator, but of the total----
Senator Smith. You are not alone in that, by the way.
Dr. Fox-Penner. Of the total legislative package, the most
recent understanding I have of the total legislative package, I
believe it is most of what is needed but not all.
Mr. Konolige. I would agree with that. I think there is
enough good ideas in there, and if they all got implemented and
in the right combination I think we would be well on our way to
fixing the long-term problem. Short term is harder.
Senator Smith. But you have disputed with Senator Cantwell
the idea of price caps, and that is one of the proposals that I
understand is out there, at least short term.
Mr. Konolige. That is what I said, if the right things go
in and the wrong things stay out.
Dr. Fox-Penner. May I comment on that, Senator?
Senator Smith. Yes.
Dr. Fox-Penner. I agree with Mr. Konolige's point that the
danger with price caps, the overwhelming danger is that they
will not work and will be counterproductive.
If we are in a true shortage situation this summer, where
prices are rising to a level where it is clear that--and we
kind of say pure rent, that the prices regardless of how high
they rise are not bringing forth any more supply, price rises
above that point we economists say do not have social or
efficiency-enhancing values and at that point they become just
a fairness and a hardship issue, and for this summer, if we
could find that spot, that point where it no longer brought
forth any supply and was just a pure transfer of wealth, it
would be fair and even efficient to cap prices at that level. I
wish I had that answer for you.
Senator Smith. Well, let me tell you what steams me. right
now, Oregonians are being notified, and many Washingtonians
with even higher rates, that their rates will be going up 20,
30, 40, and in one Washington utility 50 percent. Now, I do not
think that is fair while California is capped at 10 percent. I
have to tell you that. I think that stinks.
What really has me steamed this morning is a cartoon in an
Oregon paper that says, our view from California. It is a
diagram of my State with a couple of energy sockets in it, and
I got a laugh at first, until I realized in real human terms
there is a lot of people about to go out of work, and I do not
like it.
In addition to that, for the last 8 years we have had an
administration at war with energy, when it could not pass its
Btu tax, to the point that serious people are trying to destroy
hydroelectric power in the Pacific Northwest. Now, even with
conservative estimates, our region is 3,000 megawatts short of
power needed, and these supposedly four small dams they want to
pull out on the Snake River produce enough power to run Seattle
every day. I wonder if you could comment on the wisdom of
destroying those four dams right now.
Dr. Makovich. Well, as I mentioned, I think we have to do
everything we can to close this gap that we have talked about
and, as far as the existing solutions, I would just add the
caution that long-term contracts have been mentioned as a
solution here. The right type of long-term contract may solve
this problem. I think the danger is, we enter into the wrong
type of long-term contract.
Do not forget, half of the stranded cost in California came
from long-term contracts that obligated utilities to buy
volumes of energy at expected competitive power prices, the
PURPA contracts.
Senator Smith. You cannot do that when you are tearing out
the power sources, can you?
Dr. Makovich. Right.
Senator Smith. My time is up, but I just wanted to say,
Senator Boxer mentioned we should not lower environmental
standards to produce power. I do not think we should lower
environmental standards to produce more power. I think we ought
to live with our environmental standards, but I did want to
point out to her and the whole world that right now we have an
environmental disaster, because we are paying hundreds of
thousands of dollars every year to save salmon and right now
they are getting flushed at a time when we are not going to
have the ability to save them in the spring nor produce the
power to keep the air conditioners on in California this
summer.
I just think everyone needs to connect with reality here,
that we do not produce power by hitting a light switch, and
that has been the fiction that has been foisted upon the
American people for the last 8 years, and it needs to change.
The Chairman. I thank the Senator from Oregon. We will move
from Oregon to Louisiana.
STATEMENT OF HON. MARY L. LANDRIEU, U.S. SENATOR
FROM LOUISIANA
Senator Landrieu. Thank you, Mr. Chairman, and thank you
for calling this hearing. I have a full statement to submit for
the record, but I do want to follow up with my good colleague
from Oregon to say he is absolutely correct. I would just
disagree that maybe it has only been the focus of the last 8
years.
I think perhaps for a long time in this Nation we have not
been realistic when it comes to what it takes to produce and
consume energy. Our present capacity is not sufficient to meet
the demands of this Nation, growing at its present rate. While
we are grateful for the growth, this is a good time for a
reality check.
No. 2, I would like to say to my colleagues from California
that I do want to be helpful, and I appreciate and can
understand the tremendous pressures that have been brought to
bear on them representing this great State of 30-million-plus
people. However, I am also very sensitive to my colleagues
representing Western States that are directly negatively
impacted, based on the testimony we have heard today, not only
from the panelists but also from other Senators about high
prices as well as the effect on jobs, businesses and consumers.
So, let me make just three brief points, and then I have
two questions for the panel. One, ANWR may or may not be part
of the solution, but this Senator is convinced that increased
domestic production of natural gas, laying of pipelines and
flow of transmission from the sources of power to the consumers
of power are absolutely essential.
As a State that is a producer, we are happy to continue
producing while maintaining high environmental standards.
However, all of the production in the world that we can and are
willing to do in Louisiana on and off of our shore is not going
to mean a hill of beans unless we can get that power to places
like California that need it.
Let me say that I think every State should assume some
responsibilities for producing the sources of power that they
can. We are blessed with available natural gas. We all have an
obligation, every State, to produce our respective sources of
energy in an environmentally sensitive manner. It is a mistake
for this Nation to believe that you can, as the Senator said,
just flip a light switch and create energy. We need to produce
the nuclear energy, or hydro, or clean coal, or oil, or gas or
renewable energy or some alternative. While some States resist
the production of those power sources we now see it can be to
the disadvantage of not only the producing State but to other
States as well.
My second point is that while we do not want to lower
environmental standards, we also do not want to add on top of
Federal standards State standards that are perhaps overly
bureaucratic or overly regulatory and then find ourselves in a
situation where we cannot construct a powerplant in less than
10 years, and then the rest of us have to pick up the cost for
the delay.
I am not talking about lowering environmental standards,
but I think this raises the question of what rights do States
have to implement even higher standards when the result is
other States are either effected in some way by a decision or
have to pick up that tab themselves.
Third, whatever the solution is--and I had a question that
the Senator from Oregon answered. I was going to ask you what
are the three things that we can do immediately to address the
situation in California. In all of your testimony, you
indicated many things, but is there something we could do to
help California and the Western region immediately? I hope the
administration and the members of Congress realize that there
is a huge price to pay for what has happened, which falls on
the shoulders of the low income and the small businesses. This
is the worst result we could find ourselves with and we need to
all start focusing on this possibility.
Thank you, Mr. Chairman. I will wrap up by recognizing that
there is going to be a monetary cost to any comprehensive
resolution, but not allow those that have the least seats at
the table in all of these discussions to pick up the price for
mistakes we have made is not fair.
Finally, I will ask my question, and if you cannot answer
it right now, if you could get it to me in writing I would
appreciate it. In our State, where we are doing our job in
terms of producing for ourselves and other States, we are faced
with a question raging about the need for a water source to
feed merchant powerplants.
Now, we have a lot of water in Louisiana. We have it coming
every which way but loose. However, there is a tremendous
amount of concern among farmers, business people and consumers
about the need for groundwater to run these plants.
Could you just give a brief comment, in writing, about
whether this should be a concern for this committee as we
encourage the development of plants to generate sources of
energy? Are there some water policies that need to be reviewed
to make sure that we have adequate sources of water necessary
to run these plants?
I thank you, Mr. Chairman, and look forward to continue
working with you and the committee on this issue.
The Chairman. Thank you, Senator Landrieu, and you will
respond in writing?
Dr. Fox-Penner. Yes, sir.
The Chairman. Senator Nickles.
STATEMENT OF HON. DON NICKLES, U.S. SENATOR
FROM OKLAHOMA
Senator Nickles. Mr. Chairman, thank you very much, and I
want to thank our panelists and apologize maybe to the next
group of panelists. You have assembled a great group of
experts, I think, that can contribute a lot to our education on
this issue, and so thank you all for your participation.
Mr. Chairman, I will just make a couple of comments. When
we debated electric regulation over the last Congress I
complimented you then because you had a lot of hearings and I,
for one, wanted to do a national bill. I still want to do a
national bill, and some people have indicated, well, wait a
minute, the California result of deregulation proves that we
cannot do one. I think they have proved that you can do one
wrong and make a serious mistake.
Some people said, we do not need to do a bill because a lot
of States are doing it on their own, and we have this chance to
see this progress work, and I think you have seen that. I think
you are seeing a lot of States doing it and do it well and do
it right, and you have ample supplies. You do not have the
shortages.
In California, I think you do not have so much a power
failure as you have a political failure. The politicians
goofed, Democrats and Republicans. A lot of people wanted to
superimpose their wisdom and replace the laws of supply and
demand, and they have really messed up, and they are asking
other States to bail them out, and maybe they want the Federal
Government to bail them out. I hope and think that that will
not be the case. I think it will be a serious mistake.
Most of the solutions of the panelists I have heard, I have
heard people say, wait a minute, price caps are a failure. It
is the politicians that put price caps on, and it is a serious
failure. It has not allowed the marketplace to work.
I have heard the panelists say, we need more long-term
contracts. California is the only State that has--and correct
me if I am wrong--a significant percentage of the contracts or
their buying power on the spot market. Most States have a very
large percentage of their power purchased contracted on a long-
term basis. California has a very significant percentage on a
short-term basis, on spot market, much more fluctuating, much
more volatile, and much more expensive at this particular time.
California has now embarked on a situation where their
regulatory requirements, the NOX standards, the
emission standards have gone up substantially in this year, not
a freeze to 2000, but an increase in 2001.
It will be interesting to hear from panelists, maybe not
this panel but the next panel, how much power is idle because
of the increasing emissions standards. Could, or should there
be a moratoria, or should there be a waiver from those emission
standards? Could we help alleviate the shortage?
You have a situation caused by politicians that because of
the price caps that now you have bankrupt utilities, really as
a direct result of the political action that was taken by
politicians. People do not want to sell to the utilities
because they are bankrupt, or they are heading to bankruptcy,
or they are not too far from bankruptcy, or they are behind on
their payments. Therefore, people do not want to enter into
long-term contracts.
Again, that is a political failure caused by legislation,
caused by politicians, and now I am afraid that part of the
Governor's solution--and you all may have been more
complimentary. From what I understand you are now talking about
Governor Davis and the politicians and saying, well, we want
the Government to make contracts, long-term contracts, and in
exchange for that we will buy equity, we will get equity in the
utilities.
In other words, drive them down to bankruptcy, but oh yes,
we want to be stockholders, and then they will come out when it
comes up. I think that is a serious mistake, and we have to be
careful, when you have problems or crises you have to be
careful you do not compound the mistakes, and I look at that
as--again, I am all for States having a lot of flexibility, but
I think that avenue, if that is what they still pursuing, and I
have not seen what they have done in the last day or so, is a
serious problem.
Also, you have politicians that have intervened and made it
very difficult to license and build new plants. California has
not built any new plants. The majority of California's plants
are 30 years old, and so we have significant problems. The sale
of credits for a lot of those old plants, it makes it difficult
for them to operate. It makes it expensive to even bring in a
new plant because they have to purchase credits to do so.
To compare State-by-State, other States have been building
a lot of plants for the last 10 years or 12 years, so
politicians again, I think maybe in some cases county level,
State level have made it difficult to have additional power
supplies, again somewhat intervening and intervening in the
laws of supply and demand and in the process really creating a
major problem.
So my point is, and this is really more comments than
questions, I think you have not so much a power failure but a
political failure, and it is important that we have steps taken
in the right direction, and from what I am reading in the
papers, I am afraid that a lot of what California is talking
about, more long-term contracts and so on, will be helpful,
some of what they are talking about doing, having the State be
primary purchasers, or purchasing a significant amount, having
the State government picking up the pieces for these utilities,
I think is absurd, and I wanted to make that editorial comment.
Mr. Fox-Penner, did you want to comment?
Dr. Fox-Penner. If I may just answer one point, Senator,
and thank you for the time, my information is that there are no
powerplants now in California failing to generate for
environmental reasons. They are all on, with the possible
exception of a 100-megawatt plant in Glendale, which ironically
may not be generating because it did not participate in the
pollution-trading scheme they have there.
Senator Nickles. We will ask the next panel, because I do
not think that is accurate, but we will find out, and I am not
sure, I may be incorrect, but I think there are plants that are
idle because of the increased NOX standards, and we
will find out. We will ask the panel.
Mr. Chairman, I apologize. This panel is--timewise, I am
going to have to leave, but I am very interested in what the
next panel has to say, and I will be reviewing those comments
extensively, so thank you.
The Chairman. Thank you very much. It is appropriate now
that I think we go to the next panel and combine panel 2 and
panel 3, and I apologize, I would hope we could conclude after
Senator Schumer has asked his questions that have not already
been answered by you or proposed by a previous member, is that
fair enough?
At the conclusion we will bring the entire two panels
together, it would be my intention, and I have talked to
Senator Bingaman that we allow them to make their statements,
all of them, before we begin any questioning, and Senator
Feinstein has a question.
Senator Feinstein. Do you intend to take a break?
The Chairman. No, I do not intend to take a break. I am
fearful we will drag this thing out beyond reasonableness, but
I concur, somebody has got to call the shots.
Senator Schumer.
STATEMENT OF HON. CHARLES E. SCHUMER, U.S. SENATOR
FROM NEW YORK
Senator Schumer. Thank you, Mr. Chairman. I want to thank
you for holding this hearing, and our witnesses, all of our
witnesses, particularly those from New York, being here, and my
questions actually relate not so much directly to the
California crisis, but to the lessons it has for New York and
the rest of the country. Fundamentally, anyone in America who
thinks, well, you can isolate California and say they made a
bunch of mistakes and it will not happen anywhere else I think
is sadly mistaken. There is a fundamental problem.
California may be ahead of other parts of the country, but
the fundamental problem is the same, and that is demand
increases, supply stays flat, and there is not much you can do.
When that happens you will have probably, higher prices, much
higher prices, and shortages, and we ought to be thinking in
terms of national policy.
I am a new member of the committee and probably know less
about this issue than anybody else here, but from my 10,000-
feet-up-view, as opposed to knowing all the trees, the bottom
line is very simple, that here in Washington one side of the
aisle says supply, increase supply, increase supply. The other
side of the aisle says, decrease demand, decrease demand,
decrease demand, and the twain never meet, and hence not much
has happened.
I hope one of the things that the California crisis can do
is importune all of us to sort of come together in the middle.
There are merits on both sides. There are merits about
increasing supply, there are merits about decreasing demand,
and frankly we are not going to get anywhere unless somehow,
led hopefully by this committee, we meet on both of those
issues.
But for me the implications in California, which I think
have relevance to my State of New York and to the whole
country, are that demand increased rather dramatically and
supply stayed rather flat.
I think the second problem which also has relevance,
particularly to New York but other places as well, is that
California sort of assumed it could regulate the wholesale
market independent of other regional supply systems. They sort
of felt--and they are pretty big, bigger than us, but they sort
of felt they could just sort of wall off California and deal
with the problem that way, and that is not true.
FERC really recognized for the States tried to work
together to build regional transmission organizations which
lead to seamless energy across borders and create incentives of
building new transmission lines to adapt to that situation, and
it did not happen.
Again, I think New York is similar. We have large parts of
our State, particularly New York City and Long Island, which
even if they build a powerplant up-State cannot very easily get
that power down-State, so the fundamental questions I have for
you are based on the two biggest lessons that we learned from
California, and my question is, are those correct lessons to
extrapolate not only to New York but the whole country, and
what other lessons can we learn from California as we apply it
to the whole country?
I would open that up to any of the three panelists who wish
to take a stab at it.
Dr. Makovich. As you look at supply and demand fundamentals
in regional power markets, New York, if we have normal summer
weather and the economy holds up, New York is very likely to
have an electricity crisis this summer, and it is down-State
New York, it is New York City, Long Island.
As you mentioned, demand has grown, supply has not. There
are bottlenecks in the transmission system that will not allow
enough surplus capacity from New England and up-State New York
to solve this problem, and yes, this summer in New York it
looks very tight.
Dr. Fox-Penner. Thank you, Senator. I would agree with
that, but let us be careful to draw the correct lesson from
this. The correct lesson is not that we do not know how to
build powerplants in the eastern part of the United States,
because we have as much capacity as New England demands today,
and not all of it could even be absorbed, so the primary
problem in New York, the poster child for this is transmission
capacity, and that is a lesson that this Congress and this
country must learn, and it is very, very challenging, Senator.
It is challenging in urban areas most of all, but every urban
area almost in the country is facing transmission constraints,
so in that sense it is very definitely national.
Senator Schumer. Would you name some other ares that are in
as tight----
Dr. Fox-Penner. The city of San Francisco is in what is
called a load pocket with not enough transmission. Boston is a
load pocket. Chicago had transmission constraints a few summers
ago. They had to bring in power on flatbed trucks because they
could not get enough transmission, and there are other load
pockets. I think Louisiana has one, Senator Landrieu has one,
and I cannot even name all of them.
Senator Schumer. But there are lots of them around the
country?
The Chairman. Senator Schumer, your time is up.
Senator Schumer. Thank you, Mr. Chairman. Could I just ask
one quick other question? It will require a yes or no answer.
The Chairman. We will see.
Senator Schumer. I just heard the following statistic,
which I found astounding, and can you just tell me if it is
right or wrong? Someone told me that 3 or 4 years ago computers
and other sort of new economy devices consumed about 7 percent
of the energy in California and today they consume 18 percent
of the energy in California, and in 10 or 15 years from now
they will come close to consuming half of the electricity needs
of California. Is that crazy, or is that fairly accurate, and
you have to answer yes or no.
Dr. Makovich. False.
Dr. Fox-Penner. False.
Mr. Konolige. False.
Senator Schumer. Thank you, Mr. Chairman.
The Chairman. Thank you, Senator Schumer. We still do not
know what the percentage is.
Senator Schumer. I could ask that next question if you
like.
[Laughter.]
The Chairman. We are not going to let you off that easy. I
want to thank you, gentlemen, very much. You have contributed
to the record and identified some of the inconsistencies and
called them as you saw them, and we may have some questions for
the record. It will remain open, and I wish you a good day and
invite you, since others sat through your presentations, that
you sit through theirs.
We are going to call panels 2 and 3, who are going to get a
little chummy up here because we will probably have to bring in
some hard seats. The first is Mr. Steve Frank, president and
CEO of Southern California Edison, Rosemead, California, Mr.
Steven Kline, vice president, Federal Governmental & Regulatory
Relations, PG&E Corporation, Washington, D.C., Mr. Fred John,
senior vice president, External Affairs, of Sempra Energy--that
is San Diego Gas & Electric, San Diego, California--Mr. Keith
Bailey, president and CEO, the Williams Companies, Oklahoma,
Mr. Steve Kean, executive vice president and chief of staff,
Enron, Houston, Texas, Mr. Joe Bob Perkins, president and chief
operating officer, Reliant Wholesale Group, Houston, Texas, Mr.
Curt Hildebrand, vice president, Business Development, Calpine
Corporation, Pleasanton, California, Mr. Richard Ferreira,
executive advisor, Sacramento Municipal Utility District,
Sacramento, California, Mr. Tom Karier, council member,
Northwest Power Planning Council, Spokane, Washington, Mr. John
Gale, general manager, Pricing and Regulatory Services, Idaho
Power Company, Boise, Idaho, Mr. Brett Wilcox, chief executive
officer, Golden Northwest Aluminum Incorporated, The Dalles,
Oregon, Mr. Mark Crisson, director of utilities, Tacoma Public
Utilities, Tacoma, Washington, and Judi Johansen, executive
vice president, Regulation and External Affairs, PacifiCorp,
Portland, Oregon.
Have we been able to accommodate everybody somehow? All
right. Lady and gentlemen, I would encourage you to submit your
statements as written, summarize your statements, and
highlight, if you will, the points you want to make, and
please, you have sat through the other presentations with a
great deal of patience, and hopefully you have either learned
something or have something to point out relative to the points
that were overlooked, or points that you take exception to, so
I would encourage you not to be repetitive.
We all know the problem, so we do not have to address it
any more. The question is, of course, how do we get out of the
problem and what the workability is, and the impact in the
future of what we are concerned with, and if anybody is really
hungry or has something immediate, we would allow them to go
first. Otherwise, we will go on the basis of the panel as I
announce them.
I see nobody seeking relief, so--although Steve Frank of
Southern California Edison and Steve Kline of PG&E might be
seeking relief, we will start with them.
STATEMENT OF STEPHEN E. FRANK, CHAIRMAN, PRESIDENT & CEO,
SOUTHERN CALIFORNIA EDISON, ROSEMEAD, CA
Mr. Frank. Thank you, Mr. Chairman. I will stay brief. In
fact, a good deal of my best material has already been used
this morning, and everybody has had a chance to read about us
in the newspapers probably ad infinitum, but it is clear that
our market is broken. It has been broken for sometime.
Last year, we paid $28 billion for electricity, four times
as much as was paid the year before. In December and January of
last year, average prices were about $30 a megawatt hour. This
December and January, average prices were $270 a megawatt hour.
Now, from my company's standpoint, what that has meant is
that we have now paid about $5 billion more for electricity
than we have recovered from our customers. Our credit ratings
have been reduced to junk. Our access to the credit markets are
closed. We have suspended about $800 million in payments in
debt and power purchases. We have eliminated our dividend, the
first time in 100 years that that has happened.
We have reduced costs sharply, reducing and impacting over
2,000 jobs, and put our ability to run our system out into the
future into jeopardy, and I think the worst thing here for all
Californians is that with all of the money that has been
flowing out of the State over this period of time the people in
our State do not have a clue as to whether they are going to
have electricity tomorrow or they are not going to have it.
We are in the sixteenth or eighteenth day, depending on how
you count it, of stage 3 emergencies this year. We have had
rolling blackouts twice in San Francisco in this month of
January. We have interrupted our interruptible customers 12
times already in the month of January, and clearly businesses
cannot run being interrupted 12 times, and in fact businesses
are very clearly reluctant to locate or expand anything in
California, and Senator Burns, I believe, was making a pitch
for some of our businesses already this morning. He would not
be the first one to do that.
The darndest thing about it is, all of this is happening
when usage is really running about 65 percent of peak. This is
not the time when you would expect shortages. It is not the
time when you would expect high prices. We in our company have
done about all of the self-help things we think we can find,
and there are not a lot more rabbits to pull out of these
particular hats.
Now, we have gone through a lot of the reasons this
morning, and they are pretty familiar, the over-reliance on the
spot market, the lack of long-term contracting authority for
sales generation, the one-price auction, which we have not
talked about too much, but I think is a clear issue, the lack
of new supply and, maybe most importantly, the fact that there
has been absolutely no price signal to our customers.
The blackouts that have occurred in San Francisco have not
been experienced by Southern California Edison customers,
albeit we have come very, very close a couple of times, so in
effect our customers have felt absolutely nothing, either from
a cost standpoint or from a usage standpoint, throughout all of
this crisis.
Now, there is not any lack of blame, and I think it is easy
to find ways to point fingers at a lot of people, but I, for
one, do not believe that is a particularly worthy exercise any
further. We need at this point strong and decisive leadership
to deal with this issue. After too long a period of indecision
in our State I think we are seeing leadership exercised in the
legislature of the State today. There are discussions going on
now that I hope will bear some fruit, but the situation I guess
I would say is still very, very fluid.
I know it is tempting to just say, California, you guys
screwed it up, so you guys fix it, but this clearly has
regional and national implications, and I believe it requires
action at the Federal level as well. Only the Federal
Government has the authority over wholesale rates, and
wholesale rates have to be moderated, at least in the short-
term, as part of this fix.
Now, FERC, as has been pointed out many times this morning,
has found wholesale rates to be unjust and unreasonable, but
they have declined to remove market-based pricing authority in
reaction to that finding. Now, I believe in markets, too, but
where they have already been deemed to be not workably
competitive, some action is required until they are workably
competitive.
We believe that a temporary return to a cost-based
approached, not caps necessarily, but a cost-based approach
until the market is workably competitive is fair to both buyers
and to sellers, and when we talk about a cost-based approach we
are talking about reasonable rates of return as part of that
cost.
We are not asking sellers, or suggesting that sellers
should sell into the marketplace at a loss, and therefore we
support S. 26 that Senator Feinstein introduced last week as an
effective approach to bringing immediate relief from the
excessive wholesale prices that we see in the marketplace.
I will save the rest of my remarks for questions, but I do
appreciate your having this hearing so early in the session,
Mr. Chairman, and I also appreciate very much the leadership of
Senator Feinstein in introducing this bill last week. Thank
you.
[The prepared statement of Mr. Frank follows:]
Prepared Statement of Stephen E. Frank, Chairman, President and CEO,
Southern California Edison, Rosemead, CA
Good morning. I am Stephen E. Frank, Chairman, President, and CEO
of Southern California Edison. I appreciate the opportunity to testify
before you today on the problems which threaten not only California's
electric system, but the economic well-being of the state and
potentially the entire country.
Eight months ago, my company was financially healthy. Our credit
rating was A+ and our market capitalization was approximately $6.5
billion, based on a share price of $20. Today, our credit rating is
deeply speculative grade or ``junk.'' We have temporarily suspended
payments for borrowed funds totaling $480 million. In addition, we also
deferred making power purchase payments totaling approximately $360
million. Our stock price dropped to a low of $6.25, but has risen in
the recent week to approximately $13. We have eliminated common
dividend payments to our shareholders for the first time in our 100-
year history. Not by coincidence, as I sit before you today, California
is enduring the 16th day this month of Stage 3 Emergency alerts, the
most serious level leading to rolling blackouts.
Southern California Edison has found itself in a precarious
situation where we had to buy wholesale electricity at artificially
high prices and resell at artificially low prices. As a result, we
incurred $4.5 billion in under-collections as of the end of 2000.
We initially financed this massive revenue shortfall by borrowing
in unprecedented amounts. However, we have now exhausted our credit,
and have limited cash reserves. As a result, we have suspended payment
for power and some of our outstanding debts. We are implementing major
cost reduction measures totaling nearly half a billion dollars
annually, which will reduce our workforce by approximately 1,850
positions and limit critical investments in the electric system. If
sustained, these reductions in staff and operating budget will
certainly jeopardize the reliability of our system and our ability to
adequately serve our customers. In addition, as I mentioned earlier, we
have suspended dividend payments to our shareholders for the first time
in our 100-year history.
These measures are not enough, however. With the widening gap
between wholesale and retail prices, even the most drastic cutbacks we
could possibly make would only generate enough cash to buy another few
weeks' worth of wholesale electricity. Earlier this month, in response
to seller concerns about the creditworthiness of the state's major
utilities, the California Department of Water Resources began buying
power in the wholesale markets in an effort to avoid massive blackouts.
During this past year, California has seen wholesale electricity
prices skyrocket. In 2000, California paid nearly $21 billion more for
wholesale electricity than it paid the year before--a nearly four-fold
increase. In 1999, the bill for areas served by the Independent System
Operator (ISO) was $7.4 billion; in 2000, it rose to $28 billion.
As staggering as this increase is, it does not reflect the true
cost of the electricity crisis to California. The high prices we have
been paying have not ensured adequacy of supply. Power emergencies have
become an everyday occurrence. There are several power plants under
construction or in the permitting stages in California, but not nearly
enough for the state to pull ahead of the current supply shortage--not
to mention the substantially higher demand anticipated next summer.
Neither is there sufficient power to sustain the state's economic
growth. Without dramatic action to accelerate the provision of new
supply to the market, the problem has the potential of continuing for
years.
However, the problem is not entirely one of supply shortage.
Ironically this winter, during a time of relatively low load, we
experienced the well publicized rotating blackouts in Northern
California on January 17 and 18. In addition, both we and PG&E have
been forced to repeatedly curtail ``interruptible'' customers--those
who agreed during a supply crisis to a limited number of interruptions
in exchange for lower rates. These customers include schools, small
businesses and larger manufacturers. While the California Public
Utilities Commission (CPUC) last week decided to suspend the fines for
this program and make it purely voluntary, this has increased the
likelihood of rotating blackouts. The uncertainty about the state's
power supply has led some businesses such as Intel to announce they
will avoid further expansion in the state and consider relocating
outside of California entirely, while other businesses, such as Miller
Brewing Company, have announced layoffs and curtailed operations due to
lost productivity.
The shortfall this winter has been caused both by problems in the
California market structure, and worries about the creditworthiness of
the California utilities. As a result, generators have decided to
either not run their plants or send their supply elsewhere, creating
artificial shortages and the constant threat of more rotating
blackouts, even when there is no shortage of supply.
How did we get here? What has gone wrong? No participant in this
crisis is free of blame: Everyone can now see that the market structure
adopted in California's electricity restructuring is terribly flawed,
even though the intent was to introduce competition and ultimately
lower prices for consumers. The Federal Energy Regulatory Commission
(FERC) over-relied on competitive markets to control consumer prices,
even when it became obvious that California's market was not
competitive and that prices consumers will inevitably pay were
rocketing out of control. The CPUC only reluctantly gave the utilities
limited authority to hedge and refused to declare an end to the retail
rate freeze. All of us, including the utilities, were not as insightful
as we should have been about the way the market would work and the way
demand and supply would get out of balance in the California economy.
Generators and other suppliers took advantage of a situation that
obviously gave them significant economic gains.
Everyone involved, private companies and public agencies,
undoubtedly believed they had good reasons for what they did.
Predictably, there has been a lot of finger pointing and casting of
blame. None of this fixes the problem, however; and the longer it goes
on, the deeper the crisis becomes. What is needed now is strong and
decisive leadership directed to solving the problem.
What needs to be done? At the state level, California officials
need to take a combination of actions including raising rates, finding
ways to finance both the past and future utility undercollections, and
other actions to reestablish the creditworthiness of California's
utilities. This is critical, because the reality is that the electric
grid requires substantial capital investment for modernization and
expansion. Financially crippled utilities will not be in a position to
make the required investment that is critical to the health of this
vital infrastructure industry. Furthermore, increased rates similar to
those implemented in neighboring states will send the appropriate price
signals to consumers and encourage conservation.
California officials, working in cooperation with federal
regulators, need to implement market structure reforms, including
reduced reliance on the spot market by encouraging long-term contracts.
New methods of compensating peaking units, through bilateral contracts
with buyers or the ISO, are needed so these plants can recover their
costs without inflating the overall cost of generation. The state also
needs to consider ways to streamline the siting of new plants.
While there is much that California can and should do, there is
also a clear need for immediate federal action. Under the Federal Power
Act, only the federal government has authority over wholesale rates.
Clearly something must be done about the current wholesale rates. The
FERC found the rates in the California market to be unjust and
unreasonable on November 1, 2000, and prices have only gone up since
then. The law unequivocally requires that FERC set just and reasonable
rates; the courts have made clear that FERC may depart from cost-based
pricing and permit market-based pricing only where it finds that the
markets will restrain prices to just and reasonable levels. The FERC
cannot continue to rely on an overly doctrinaire approach to
competitive markets when the markets are not sufficiently competitive
to control prices and ensure fair rates.
We believe that the imposition of temporary cost-based price caps
or load-differentiated price caps is fair to both consumers and
sellers. Those sellers who truly have high costs will be allowed to
recover those costs, including a reasonable return on their investment,
but only when their high priced power is needed to keep the lights on.
We recognize that price caps may be only a temporary solution. However,
longer term solutions take time, and immediate relief is needed now.
Therefore, we support Senator Feinstein's S. 26, introduced last week,
as an effective approach to bringing immediate relief from the
excessive wholesale rates throughout the West.
In conclusion, I would like to thank the Committee and you,
Chairman Murkowski, for holding this hearing so early in the new
Congress. I also would like to thank Senator Feinstein for the
tremendous leadership she has demonstrated throughout this crisis and
in introducing S. 26, an effective vehicle to address the problems in
the California wholesale electricity market.
The Chairman. Thank you, Mr. Frank. Our next witness is Mr.
Steve Kline, PG&E.
STATEMENT OF STEVEN L. KLINE, VICE PRESIDENT, FEDERAL
GOVERNMENTAL & REGULATORY RELATIONS, PG&E CORPORATION
Mr. Kline. Thank you, Chairman Murkowski, Senator Bingaman.
This is truly an opportune time to be having a hearing on
California and the Western issues related to electricity
crises. I am going to stipulate to a lot of what Mr. Frank said
about our current financial situations. Our situation in terms
of financials is identical, with the exception, I think our
exposure number is $1 billion more, but at this phase in the
game I would say we are all generally in the same situation.
I am also going to not belabor some of the points that were
made earlier by Mr. Frank on the cause of this problem, but I
would like to make a couple of comments that I think have not
been fully developed earlier this morning.
I would like to just focus for a moment on the fact of
higher gas prices across the Nation in terms of higher
electricity prices across the Nation and in California. I asked
our folks to do an analysis of, assuming deregulation or
restructuring, whatever California's process is called, had not
occurred, what would the cost impacts that would be running
through traditional regulation with fuel cost adjustments that
were routinely made in the context of rate-making through the
eighties and nineties?
Our folks came up with an estimate that the power produced
by PG&E's plants that are now divested would be about 23
percent higher than the embedded cost component that exists in
our rates today, so it is clear a large component of what is
going on is gas price impacts that we are seeing in the
marketplace.
I also want to stress that the problems here are not the
result of the overall concept of opening markets, and this is
clearly, as you have heard, not a deregulation problem. Basic
economics tells us that under any regulatory system, under the
conditions that have been described today, higher prices would
prevail. That said, it is true that California's approach to
restructuring, combined with short supplies, have had a huge
effect in terms of producing these extraordinarily high prices.
I would just second the notion that frozen rates are
causing us several problems, financial problem for some, but
they are also causing a huge problem in terms of sending price
signals to customers and sending them signals to make the
necessary investments in energy efficiency and conservation,
which further reduce demand.
Clearly, this problem cannot be solved until supply and
demand are back in balance. In order to increase supply we
clearly need to invest in clean and efficient new powerplants,
together with natural gas pipelines and infrastructure, and I
would really stress the impact of natural gas as a way to solve
this problem, and we need clearly to construct new high voltage
transmission power lines, and that is not easy politically, but
it needs to be done.
What I would like to conclude with, there are a few things
that we have identified that the Federal Government can clearly
do as the State works around the clock to resolve this problem.
We believe that the Federal Government needs to do everything
it can to continue to encourage regional transmission
organizations and open access to the transmission systems. It
needs to:
Accelerate permitting of natural gas pipeline
infrastructure. This is a big issue, and can have a big impact.
Encourage the efficient use of energy through research and
processing standards. That process is underway.
Encourage continued development of renewables by
maintaining the existing renewables production tax credit.
And finally, increase funding for low income energy
assistance to assure that those least able to pay are not left
out in terms of access to reliable energy.
Thank you.
[The prepared statement of Mr. Kline follows:]
Prepared Statement of Steven L. Kline, Vice President, Federal
Governmental & Regulatory Relations, PG&E Corporation
introduction
Good morning Chairman Murkowski, Senator Bingaman, and members of
the Committee. I'm Steven Kline, Vice President for Federal
Governmental & Regulatory Relations of PG&E Corporation. Thank you for
the opportunity to testify before you today. This is truly an opportune
moment to be having a hearing on California and the Western Region's
energy crisis.
where are we?
As widely reported, California's electricity distribution
companies, including Pacific Gas and Electric Company, teeter on the
brink of bankruptcy, because we are unable to recover the
extraordinarily high prices for the power we must purchase in the
wholesale market, to fulfill our public utility obligation to serve.
how did we get here?
California's problem is fundamentally one of supply and demand:
statewide, between 1996 and 1999 electricity demand grew by 5,500 MW,
while supply grew by only 672 MW. The effects of this extreme imbalance
between supply and demand have been exacerbated by reduced hydropower
supplies and rapid economic and population growth across the West.
In addition, higher natural gas prices across the nation are
contributing to higher electricity prices. As a comparison, suppose we
were to turn back the clock for a moment to pre-restructuring times.
Under traditional regulation with fuel cost adjustments, power costs
from Pacific Gas and Electric's now divested gas-fired plants would be
23 per cent higher than the frozen commodity cost included in today's
rate, simply due to gas price increases alone.
The problems in California are not the result of the overall
concept of opening electricity markets to competition. Basic economics
tells us that under any regulatory system, wholesale power costs would
be substantially higher under the conditions I have just described.
That said, it is true that California's approach to electricity
restructuring, combined with short power supplies, have undoubtedly led
to the unexpected 500 to 1,000 percent wholesale power cost increases
experienced over the last eight months and to the resulting financial
crisis for the utilities.
California's restructuring approach required utilities to divest
their power plants and to purchase all of the power needed to serve
their customers on the volatile spot market. Further, until recently,
the use of long-term bilateral contracts or other price hedges were
also precluded. Designed to work in an environment of abundant power
supplies, California's market structure has not served customers well
under short supply conditions.
In addition, frozen retail customer prices have shielded consumers
from the real costs of electricity, nearly eliminating price signals to
make energy efficiency investments or to conserve, and thus reduce
demand.
where do we go from here?
California's energy crisis cannot be resolved until supply and
demand are back in balance. In order to increase supply, new clean and
efficient power plants must be sited and built, together with natural
gas transmission and distribution pipelines and high voltage power
transmission lines. In order to reduce demand, energy efficiency
investments need to be made and customers need to see accurate price
signals. In the short-term, efforts to squeeze additional power from
existing power plants and greatly expanded demand-side management need
to be encouraged for better or worse, summer, which is California's
peak season for energy demand, is only months away.
As we speak today, California's Governor and legislature are
working round the clock to craft a satisfactory resolution that assures
reliability and public safety, stabilizes retail rates to customers,
addresses the longer-term infrastructure needs while protecting
California's environment, and returns the State's utilities to
financial health.
Both the Clinton and Bush Administrations have been very helpful:
continuation of the Emergency Orders created a window for the State to
act. We recognize that the Orders are not without cost, and we
therefore appreciate even more the efforts that our neighboring states
have made to assist California during this critical and unprecedented
time.
Beyond the necessary State actions, the Federal government should
do everything it can to:
encourage Regional Transmission Organizations and truly open
access transmission systems;
accelerate permitting of natural gas pipeline
infrastructure;
encourage efficient use of electricity through research and
efficiency standards;
encourage continued development of renewable energy
resources by maintaining the existing renewables production tax
credit; and
increase funding for low-income energy assistance to help
assure that those least able to pay are not left without access
to reliable energy.
Thank you for the opportunity to appear before you. I would be
happy to answer any questions you might have.
The Chairman. Thank you.
Mr. Fred John.
STATEMENT OF FREDERICK E. JOHN, SENIOR VICE PRESIDENT, EXTERNAL
AFFAIRS, SEMPRA ENERGY, SAN DIEGO, CA
Mr. John. Mr. Chairman, Senator Bingaman, Senator
Feinstein, thank you for the opportunity to speak this morning.
SDG&E, which is a subsidiary of Sempra Energy, is in a somewhat
different situation than PG&E and Edison, but it is not that
dissimilar. We came out of our rate freeze in 1999, when we
sold off our powerplants and eliminated our stranded assets,
and then in June 2000, when rates increased dramatically in our
service territory, the State legislature imposed a new rate
freeze, but did give us the opportunity to recover those costs
over time through a bill called AB 265.
The problem is, at this point the California commission has
not yet taken any action on that legislation in order to manage
the balancing account that is growing rather dramatically in
our area. The same issue, you are capped at 6.5 cents per
kilowatt hour, and you are paying wholesale prices approaching
22 to 25 cents per kilowatt hour, and no business on a
sustained basis can charge customers far less than what it pays
for the product.
To add to this, SDG&E is now subject to what we call the
zip code effect when it attempts to borrow money to finance the
cost of buying wholesale electricity. Our ability to obtain
financing is being negatively affected by the poor financial
health of both PG&E and Edison.
If rate relief is not granted soon, the financial community
will start to doubt SDG&E's ability to amortize its under-
collection, which could put us at the financial crossroad that
the State's other investor-owned utilities face today. What we
basically have is a promissory note from the State of
California, and what we are trying to do is collect on that
note without having to go to court to litigate it.
We support the positions that Steve Frank and Steve Kline
have said on a variety of issues. Our view is there is a four-
pronged approach to this issue. One is, you need long-term
contracts, but as Mr. Makovich said on the prior panel, those
contracts have to be the right kinds of contracts, and they
have to be reasonably priced.
The problem right now is, whether you are a utility
negotiating with the suppliers or the State of California
negotiating with the suppliers, we have absolutely no leverage,
because nobody in the Federal Government is willing to step up
to the plate and say, if you do not come to the table with just
and reasonable prices, we are going to either impose cost-based
rates, or we are going to require refunds, or a combination of
both.
So that is one part that needs to be done, and by the way,
do not take this lightly. We are not a company that
historically has liked any kind of price caps, but you reach a
point where enough is enough.
Second is, the State of California has to be willing to
bite the bullet and allow increased retail rates, otherwise the
utilities are not going to be able to stay solvent.
Third, there has to be an expedited siting process in the
State dealing with generation, with electric transmission, and
with gas transmission, and that also involves, especially with
respect to transmission facilities, cooperation between the
Federal agencies and the State agencies as you are going
through the SEPA process or the NEPA process.
Finally, there has got to be a much more aggressive effort
on the demand-side management, energy efficiency, something
equivalent to a Marshall Plan, in order to capture those 2,000
to 5,000 megawatts that Senator Feinstein referred to earlier,
if you are going to get any handle on the short-term problems
facing the State.
With that, I will end my comments.
[The prepared statement of Mr. John follows:]
Prepared Statement of Frederick E. John, Senior Vice President,
External Affairs, Sempra Energy, San Diego, CA
Good morning. I am Fred John, Senior Vice President of External
Affairs at Sempra Energy. Sempra Energy is a Fortune 500 energy
services holding company whose subsidiaries provide electricity and
natural gas services. Sempra Energy's two California regulated
subsidiaries are San Diego Gas & Electric Co. (SDG&E) and Southern
California Gas Company (SoCalGas). Together, these utilities serve a
population of 21 million in southern California.
Mr. Chairman, I commend you for holding this hearing today to
enable the Committee to hear first hand of the scope and enormity of
the energy crisis in California. I also appreciate your insightful
comments in the Congressional Record regarding this issue.
In short, California's energy crisis is the culmination of serious
supply and demand imbalances and flaws in the market structure created
by state legislation and regulation. These imbalances have contributed
to the skyrocketing wholesale price of the electric commodity that
Californians are being asked to pay by suppliers who presently have no
incentive to negotiate to bring costs in line with those in the rest of
the country. While the high electric rates are the immediate issue that
must be addressed for us to fix the system, they are but one symptom of
a system that is badly broken. Today in California we face a
dysfunctional electric market that needs immediate repair by both state
and federal regulators and legislators. A solution to the existing
electric crisis involves four areas:
1. The need for long-term contracts for wholesale electricity at
reasonable prices.
2. State approval of appropriate retail rate relief to help the
state's investor-owned utilities manage their growing balancing account
under-collections caused by the differential between the wholesale
prices charged to the utilities and the retail rates that the two
utilities are permitted to charge their customers.
3. An expedited siting process for new electric generation,
electric transmission and gas transmission facilities.
4. An aggressive energy efficiency program that provides real
incentives for customers who conserve energy and penalties for those
who don't conserve energy.
These solutions must take place on an integrated basis. All of them
are necessary if California is to overcome the present crisis.
Some in Washington have characterized the issue simply as a
California problem, created by California, for California to solve.
However, as recognized by Federal Reserve Chairman Alan Greenspan in
testimony last week before the Senate Banking Committee, this is an
issue of national importance and one that must be addressed by federal
and state government officials working together. As Chairman Greenspan
stated: ``it is scarcely credible that a problem can exist in
California which does not feed to the rest of the 49 states. The energy
crisis in California threatens the economic well-being of the nation.''
overview of deregulation in california
In hindsight, it's clear that the market created by AB 1890, (the
state legislation deregulating the electric industry) and the CPUC's
orders implementing AB 1890 were flawed. They imposed a retail price
cap but not a wholesale price cap, required that utilities bid for
power exclusively through a state-created Power Exchange, federalized
the state's transmission system, removed electricity providers from
state oversight, and severely restricted the ability of the investor
owned utilities to enter into long term contracts. These restrictions
exacerbated the flaws in the fledgling market as problems with supply
and demand imbalances in the western region surfaced over the past
year.
This is not a purely California problem. While California's demand
growth over the 1999-2000 period (when price spikes began) was
relatively flat, demand growth throughout the interconnected grid of
the western region has been strong. In fact, it has been estimated that
nearly 85 percent of the growth in electricity demand over the past
five years in the western region has occurred outside of California.
While it has been widely noted that no major power plants have been
built in California over the past 10 years, that is generally true
throughout the region. And the reason is simple. In 1992, Congress
initiated the move toward deregulation with the Energy Policy Act.
Until decisions were made regarding market structure and the ownership
of generation, investment was frozen. Once California completed its
legislative and regulatory shift to the new market, many proposals for
power plant construction were submitted to the state. While the state's
process for siting of plants is long and burdensome, the delay in
proposed investment in powerplants over the prior decade should not be
treated simply as a bureaucratic problem in one state. Rather, the
problem is a symptom of the investment community's reaction to a
significant change in regulation affecting the entire western region.
The now obvious flaws in AB 1890 and the regulatory orders
implementing it did not surface until after July 1999, when SDG&E was
the first utility in the state to pay off the debt on its stranded
assets (as required by AB 1890 to enter the competitive market). Once
SDG&E opened its market to competition, the utility passed through to
its ratepayers the market cost of the electric commodity. Initially,
retail prices were in alignment with wholesale costs. However, during
the summer of 2000, electric wholesale commodity prices skyrocketed and
SDG&E's ratepayers were subjected to the highest and most volatile
prices in the nation--prices that were 500 percent higher than at the
same time in 1999.
The extraordinarily high prices being paid by San Diego customers
created a politically untenable situation. In an effort to ``fix'' the
problem, for SDG&E the Legislature's cure became worse than the
disease. In short, AB 265 was passed and capped at 6.5 cents per kwh
the amount that ratepayers would be charged for the electric commodity.
Yet, SDG&E continued to pay upwards of 22 cents per kwh to its
suppliers. SDG&E was required by AB 265 to place the difference, or
under-collection, in a balancing account to be repaid in 2002 or 2003.
How the under-collection would be repaid was not outlined in the bill.
The immediate problem facing SDG&E today is that the balancing account,
which exceeds $450 million (far beyond the original projections of the
AB 265 proponents), and there is no end in sight. While AB 265
guarantees the utility recovery of its prudently incurred costs, the
growing balancing account under-collection has become a balloon payment
that must be paid in the future by our customers.
SDG&E has sought rate relief from the CPUC in order to help manage
the balancing account under-collections. This relief is similar to that
proposed by the other two investor owned utilities--PG&E and Southern
California Edison--whose balancing account under-collections have
reached levels proportionately equivalent to SDG&E based on each
utility's sales of electricity.
At the present time SDG&E is subject to the ``zip code'' effect
when it attempts to borrow money to finance the cost of buying
wholesale electricity. SDG&E's ability to obtain financing is being
affected negatively by the poor financial health of PG&E and
SoCalEdison.
Whatever views one holds regarding the current crisis and who may
be responsible for it, the reality is that neither PG&E, nor Edison nor
SDG&E can continue indefinitely to provide electricity to consumers at
a loss. What business could operate in that manner? We have argued
before the CPUC that if rate relief is not guaranteed soon, the
financial community will doubt SDG&E's ability to amortize the under-
collection. We are trying to work with decisionmakers at every level of
government to avoid a point in the not too distant future when SDG&E
will face the financial crossroads the state's other utilities are
facing today.
Let me be clear--we have reluctantly come to the federal government
to participate in solving this crisis at the wholesale level. In fact,
we continue to seek commercial solutions with the parties directly
involved in the issue, including the generators and marketers. While
some issues can and must be solved by California, the issue is clearly
larger than the state's ability to solve on its own.
california actions
The Legislature has continued its efforts to solve the energy
crisis during a special session devoted entirely to the issue. The
State has appropriated $400 million (which has almost been exhausted)
to the Department of Water Resources (DWR) for short term purchases of
power. The Legislature is also considering how the DWR can act as the
procurement agent for the utilities' customers for long term power. The
DWR recently conducted an on-line auction to buy power to see if lower
priced energy was available. However, it is not clear how much long
term power will be available to DWR as a result of the auction or the
actual price of the power or the duration of the contracts. While these
efforts are an initial attempt to solve the problem, it is not certain
that the State of California will be able to execute long term
contracts with suppliers that provide sufficient amounts of electricity
at reasonable prices to assure Californians affordable and reliable
power until new generation and transmission capacity is built in the
state.
That is why Sempra Energy is proposing the following actions that
must be taken to solve California's energy crisis.
proposed actions
1. Long Term Contracts
As part of implementing AB 1890, the CPUC refused to allow
utilities to enter into long term contracts as a hedge against price
spikes. The Legislature directed electricity to be bought and sold on
the spot market. We now know that the bidding process into the state
Power Exchange drove up prices for last minute energy demands, and
helped to create the high rates we are experiencing today. Long term
contracts represent a critical tool in helping to control price
volatility and ensure reliability.
The problem that exists under the current structure is that there
is little incentive for suppliers to negotiate reasonable prices to
stabilize the system. The state has taken actions to ensure the
financial ability to continue to purchase needed power as two of the
investor owned utilities have been driven to the point where they are
unable to purchase power. If the pricing problem is not addressed, this
situation will quickly exceed even the state's ability to provide
financing. As Standard and Poor's recently stated, ``the failure to
find a long term cure to this energy crisis could put the state's long
term credit at risk.''
We need a sanctioned ``time-out'' so that market participants can
work together to reach agreement on a reasonable price for the electric
commodity. The solution is to provide an incentive structure for the
supply side of the market to negotiate in good faith with the demand
side to get the state through the current crisis. For that we need
federal action.
The suppliers must be required to enter into long term contracts
for a reasonably priced electric commodity, or face federal sanctions:
either a federally-imposed fixed hard cap on the wholesale price of
electricity or cost based rates. Simply put, neither the state of
California nor its investor owned utilities have the ability to control
the actions of the suppliers or the leverage to bring them to the
negotiating table.
Sempra Energy has reluctantly supported the imposition of fixed
hard price caps on the wholesale price because it has become apparent,
newspaper reports to the contrary, that there is no incentive for the
suppliers to negotiate with either the utilities or the state on long
term contracts. While long term contracts won't allow the generators to
continue to reap the profits of the past seven months, these contracts
can provide profits that are higher than the projected future market
value for the electric commodity. Although imperfect, long term
contracts provide all market participants with something while the
dysfunctional market is corrected. If the Federal Energy Regulatory
Commission (FERC) continues its unwillingness to impose hard caps on
the wholesale price, we believe Congress must intervene and direct FERC
or the Secretary of Energy to take such action immediately.
A more stringent measure to reduce rates would impose cost based
rates on the generators. Through this process, the generators would be
subject to FERC proceedings that would establish ``just and
reasonable'' rates for serving California. The problem with this
solution is that while it might ultimately establish reasonable rates,
it would be a slow process and would prevent more immediate action from
occurring.
II. Retail Rate Relief
California's investor owned utilities must be permitted to pass
through the costs of procuring electricity for their customers.
As described above, the utilities have sought rate relief from the
CPUC. However, to date the CPUC has either granted a very limited rate
increase in the case of PG&E and SoCalEdison, or no rate increase in
the case of SDG&E.
The lack of trust by the financial community of California's
willingness to do what is necessary to maintain the financial integrity
of the state's investor owned utilities grows each day that neither the
CPUC nor the Legislature nor the Governor are willing to step to the
plate and take the actions necessary to manage the huge and growing
balancing account under-collections caused by the mismatch between
wholesale prices and retail rates.
PG&E and Edison are at the financial precipice and SDG&E is trying
to make sure that it doesn't get there.
III. Expedited Siting Procedures
Immediate action must be taken to expedite the siting of electric
generation, electric transmission and gas transmission facilities in
California. Although virtually no new power plants have been built in
the past ten years, steps are underway to immediately increase
generation. Since April 1999, six power plants (representing 4,700 MW
of new generation) have been approved; five of the plants are under
construction and the sixth is scheduled to begin construction by April
2001. Twenty more plant applications are being reviewed by the state
Energy Commission. These developments and the creation of the
Governor's Green Team (charged with accelerating the siting and
permitting of generation and coordinating local, state and federal
government agency review and action) represent important steps to
increasing much needed supply. However, even with these changes, it
takes the State of California much longer to site new generating plants
than many other states. Also, when it comes to new electric or gas
transmission facilities there must be greater coordination between
state and federal agencies as they process permits to comply with the
California Environmental Quality Act and the National Environmental
Protection Act. In addition federal, state and local air quality
requirements pose challenges to the siting process. Finally, often
local opposition to a generating plant or transmission line can either
block or substantially slow down approval of a project. State and
federal regulators must work together to develop creative solutions to
increase electric supply and the capacity to transport this supply.
IV. Conservation
Successful management of the demand side of the market must include
conservation efforts. Historically, utilities have played a critical
role in helping customers to reduce usage through the use of
fluorescent light bulbs, new appliances, weather-stripping and other
incentive programs. However, recent efforts to diminish the role of the
utilities in conservation efforts has resulted in a decrease in actual
conservation. While it makes sense to devise new and better ways to
encourage conservation, the fact is that energy is going to cost more,
at least in the short term. Utilities can and should play an integral
role in managing conservation programs.
In California, the state government has agreed to reduce energy use
during Stage 2 alerts. The federal government is taking similar action.
We believe that the state and federal government should continue to set
an example for load reduction efforts and should work with the business
community to develop voluntary demand reduction programs. In the Energy
Policy Act of 1992, Congress created mechanisms to enable the federal
government (the nation's largest energy consumer) to tap private
capital to upgrade outmoded facilities and reap energy and cost
savings. However, federal facilities have been slow to take advantage
of this law and should be held accountable by Congress for inaction.
Also an increase in the retail price of electricity will provide
appropriate incentives to reduce energy consumption. This is especially
true if rate designs are developed to charge more for increased usage
of electricity and if customers, especially the larger customers, had
energy meters that allowed them to see on a real time basis the impact
of higher usage on the price they will pay for electricity.
conclusion
The energy crisis in California is real. The Governor and state
legislators are working around the clock to devise a solution. However,
until more plants are built, the supply and demand imbalance will
continue. Until the market is fixed and the utilities are financially
stable, the skyrocketing energy prices will continue to wreak financial
havoc on California and, in time, the nation.
Federal intervention is necessary to give the suppliers an
incentive to negotiate reasonably priced long-term contracts. To
develop a truly workable market, the suppliers must be part of the
solution. The utilities cannot continue to negotiate among themselves
and with state policy makers. For the system to work, a fair and
workable market must be created.
We need an immediate mid-course correction to maintain the solvency
of the state's utilities, protect customers, and create a market that
truly is competitive. The federal government is in the unique position
to bring together these seemingly disparate interests to forge a
consensus on how to best more forward. I think we can all agree that an
electric market in California that works well into the future is in all
of our interests. Thank you. I am pleased to answer your questions.
Senator Bingaman. Thank you very much. Why don't we just
keep going down the line.
Steve Kean.
STATEMENT OF STEVEN J. KEAN, EXECUTIVE VICE PRESIDENT & CHIEF
OF STAFF, ENRON, HOUSTON, TX
Mr. Kean. Thank you. I appreciate the opportunity to speak
to you today about California's problem and the potential
solutions. I think it is interesting to note a lot of this
ground has already been covered. You keep hearing the same four
things, we need to increase supply, we need to get demand to
respond, we need to have more long-term contracting and less
reliance on the spot market, and we need to make sure that the
State's institutions are financially sound.
I am just going to hit on a couple of subtleties to those
that I do not think have been covered yet. First, on the supply
side, California has to expedite its siting process. It takes 5
to 7 years to build new powerplants in California. It takes us
10 months in other States. Now, the process is insane. An
outside observer cannot look at this and reach the conclusion
that this is a sane process. It may have been developed for
good reasons, it may be administered by people acting in good
faith, but the results that it produces are insane. It takes
too long, and that is a California problem, and it needs to be
addressed by California.
On the demand side, California has to enable demand to
respond when supplies are tight, and that means the best way to
do that is real competition and real choice. When buyers and
sellers get together in a marketplace they will look for ways
not only to reduce the cost of supply but also to reduce
demand, because what matters to those customers is the overall
bill. If you allow buyers and sellers to meet you can work on
that problem. Today in California, 99 percent of the customers
are still served under utility service. That is not
competition. That is not deregulation. That has to change.
On the long-term contracting, one more thing on demand, and
this I think goes to your question, Senator, you are right, we
cannot get additional powerplants online by this summer, but
one thing that could be done is, we could have whoever the
buyer of power is, whether it is the utility or another State
institution, be willing to pay as much for a demand reduction
as for a supply increase.
In other words, if you are willing to pay $150 for a
megawatt, if you also offered $150 for every megawatt of
reduced consumption, you could start to work down the demand
side. That creeps the price down, and you could get that done
in the time that we have between now and this summer.
Long-term contracting, I think California is putting itself
on the right track. It excessively relied on spot markets. It
is beginning to focus on long-term contracting, and it is the
right thing to do. There is an important sequencing issue here,
though. We need to have credit-worthy entities in the State.
Really, all solutions depend on that. You have to have
financially solvent entities. Nothing is gained by allowing
utilities to go bankrupt.
Secondly, we need to have real progress on the siting
front. There has to be credible steps taken so that the market
believes that in fact additional generation is going to be
coming online. You can see real progress. You can see real
expedition in the way permits are processed. That will push
forward prices down so long-term contracting, as you do it in
later periods, will produce even better pricing, so there is an
important sequencing issue there that I do not think has been
touched on yet.
Just as importantly, there are a number of things that do
not work. Price caps do not work. They simply--they have been
tried in California. They do not work. Hard ones, soft ones,
they simply have not worked. What happens with price caps is,
the market ends up being bifurcated, because unless you are
willing to say, I am going to turn lights off, you still have
to go out into the market to buy the supply you need, and that
is what has happened.
You have had the institutions of the State forced into the
market at the last minute to buy the supplies you need, so the
price caps have not worked, and extending them around the West
would simply extend that problem, or export that problem to the
rest of the West.
It has also resulted in the cancellation of some peaking
power facilities in California which could have come online as
early as this summer but were unable to because of the way
price caps were set. The caps have not worked. They have not
worked really in any context, and if they did work, I would
tell you so, and I would say, let us go do it right away, but
it simply will not work, and it will just extend the problem to
the rest of the region.
A second solution that has been discussed that also will
not work is State control of the power business. There is no
reason to believe, and there is every reason to doubt, that
Governments would do a better job than private firms in rapidly
constructing and efficiently operating new facilities. State
takeover of the power system is simply a bad idea.
My final point is, and particularly for this committee, the
problems we are now seeing in California are not limited to
California. Can California happen again? The answer is, yes, it
can. It can happen in regulated States. It can happen in States
which have restructured their power business.
What we need to do to prevent local emergencies from
proliferating and becoming national disasters is build new
generation and interconnect it. Get the interstate transmission
system open and expanded to enable power to move from where it
is to where it is needed, and give customers the freedom to
choose. We cannot stand still. We cannot go backwards. We have
to go forward.
Thank you.
[The prepared statement of Mr. Kean follows:]
Prepared Statement of Steven J. Kean, Executive Vice President & Chief
of Staff, Enron, Houston, TX
i. enron
Enron develops and operates networks around the world, primarily in
energy and communications. We combine physical assets and contract
access to the physical assets of others to make markets in, among other
things, energy commodities, pulp and paper, steel and other metals, and
broadband capacity. Our primary products are contracts which protect
end users and producers from price volatility.
Enron is the largest buyer and seller of electric power in North
America and participates in power markets around the world. As a market
maker in power markets, we post prices at which we will buy and prices
at which we will sell.
Enron's role as a market maker gives us a uniquely objective
perspective on the problems in California.
With the exception of a few megawatts of wind facilities, Enron is
not a generator in the state of California.
We sell protection from price volatility to both producers and end
users. Consequently our interest in California's power market (and the
rest of the markets we operate in) is to ensure that the market works
effectively. That's what enables us to do business.
We post both purchase and sales prices. To the extent a market
participant thinks our price is too high, they can sell to us.
Contrary to what you may hear or read, our success is linked to
efficient markets, not higher prices in California, or anywhere else
for that matter. What we are interested in is competitive and well
functioning markets. Our financial success is not built on California's
back. Our business grew dramatically around the world and across
commodities in part because we migrated our market making activity to
an online platform and because there is increased demand for risk
management in many markets. Our volumes have grown and so have our
earnings. We do not have uncommitted generation to profit from in
California. But, for the first time, many market participants have
begun to see the benefits of hedging against their commodity price
risk. Many people purchased our products--both producers and customers.
These distinctions are important ones because they uniquely
position us to identify the facts and the solutions objectively.
ii. california
A. The problem. California's current crisis has very
straightforward causes:
Economic growth spurred growth in the demand for
electricity.
New supply additions did not keep pace with this growth in
demand.
The state placed excessive reliance on a state-created spot
market, which meant that utility buyers were exposed to price
fluctuations across their entire portfolio.
The state did not deregulate; that is, the state did not
enable new entry into the supply (generation) business and did
not in fact give customers choices.
The combination of these factors squeezed utilities between a
volatile spot market and regulated customer rates, leading at first to
rapid recoveries for utilities (when wholesale prices were low) and
later to gigantic deficits and near bankruptcy (when wholesale prices
moved up).
B. The Solutions
Just as the problems in California are straight forward, so are the
solutions.
Supply
California must allow supply to catch up with demand. It generally
takes 5-7 years to build new generation facilities in California. Enron
and other companies have done it as quickly as 10 months in other
states. California's process must be streamlined. California needs more
power now. It must become a state priority to rapidly site and
interconnect new generation. Another way of getting at this same
problem is approving and siting new and expanded transmission
facilities.
Demand
California must enable demand to respond when supplies are tight.
In a true competitive market, buyers and seller are free to set
mutually beneficial terms. In California's regulated retail environment
less than 1% of customers are served by competing suppliers (the rest
are still regulated utility customers). A market place where buyers and
sellers meet would change the demand picture in the following ways:
--real time price signals would encourage conservation or shifting
of demand to off peak times.
--suppliers would offer products to encourage conservation (energy
efficient equipment for example). Demand reductions at key times drive
market prices down for everyone. To get a demand response, however,
customers must see price signals from the marketplace. In the long run,
prices must be allowed to reflect the market. In the near term, such
prices would have to be introduced gradually and combined with
``purchased demand reductions.'' Paying for demand reductions makes
sense. If utilities, the ISO, or the state, are willing to pay $500 for
a megawatt, they ought to be willing to pay the same for a
``negawatt.'' New capacity cannot be brought on in time for this
summer's peaks. But, demand reductions could be purchased with a
minimum of disruption to businesses, workers and the economy.
Long term contracting: California has recognized the importance of
reducing reliance on the spot market and has started an auction process
designed to shift more of the state's demand to long term contracts.
This is sensible. Forward power prices are ``backwardated,'' meaning
that power prices are lower for future deliveries than they are for
current deliveries. This means that longer term contracts will produce
average prices lower than today's spot price levels, immediately
reducing utilities' costs. However, these markets are shallow and
skittish today. Price caps and active government intervention in
California's power markets combined with financial uncertainty about
the utilities' ability to pay has built large risk premiums into bids
in those markets. If California entered into forward contracts after an
active program to site new transmission and generation, forward prices
would be lower and more bidders would bid in greater supplies. The
sequence of the reforms needed in California is therefore critically
important: the institutions of the state must be financially stabilized
and clear, credible steps must be taken to give the market confidence
that new supplies will be brought on line. Forward contracting in that
environment will produce better results.
Financial stability: The creditworthiness of the state's
institutions must be reestablished. Without credit worthy buyers of
power, it will be difficult to attract new generation and long term
supply commitments. The sobering fact is this: unless the state is
willing to cut off significant load in the state, it has only two
``choices''--it can buy the power the state needs in the short term, or
it can let the utilities become insolvent and then buy the power the
state needs. Nothing is gained by letting the utilities in the state
become insolvent. The state appears to be on the right track with
recently introduced legislation designed to ensure collection of past
amounts and provide support for future purchases.
The introduction of real price signals to bring supply and demand
into balance can and should be tempered by phasing in rate increases
and market pricing and by insuring that low income customers are
protected through continuing subsidies.
Just as importantly, there are a number of proposed ``solutions''
which will not help the situation in California or the rest of the
West.
Price caps: price caps are bad for consumers, the economy and the
environment. Price caps in the West have not worked and will not work.
Price caps have led to the cancellation of peaking power projects which
could have brought additional supply to California in the near term.
[Attachment 1] * Price caps have succeeded only in disrupting and
bifurcating the market for power, sending the states' institutions into
the real time market to buy the power needed beyond the amounts
purchased at or below the caps. Price caps merely export California's
problems to neighboring states, discourage investors from developing
needed supply resources, disrupt the market, and force a last minute
scramble for power which endangers reliability.
---------------------------------------------------------------------------
* The attachments have been retained in committee files.
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State control of the power business: There is no reason to believe
(and every reason to doubt) that governments will do a better job than
private firms in rapidly constructing new facilities and operating
those facilities efficiently. Competition in the generation sector has
produced faster construction, more efficient facilities and has placed
the risk of those facilities on investors not taxpayers or consumers.
Government resources would be best focused on streamlining siting and
interconnection rather than building and operating facilities with
taxpayer funds.
Repeal Choice: Consumers are never better off with fewer choices.
The only consumers that were protected in San Diego were those who
chose alternative suppliers. It would be a mistake to repeal choice.
iii. implications for the west and the rest of the u.s.: the need
for federal involvement
California's problems have already spilled over into neighboring
states. California is a significant importer of power. As demand has
grown so has its need for imported power, particularly from the
Northwest. [Attachments 2 and 3] In past years, abnormally high
hydroelectric capacity has masked some of the underlying supply/demand
imbalance. [Attachments 4 and 5] Normal or even lower than normal hydro
conditions mean that California's demand is taxing Northwest resources.
Moreover, California is just the latest of several disruptions in
U.S. power markets and, unless we act quickly, it will not be the last.
Reliability problems and price spikes have occurred with increasing
frequency across the country. Some of the underlying causes are the
same (e.g. higher demand spurred by economic expansion throughout the
country).
To prevent reliability and pricing of power from becoming a problem
throughout the nation, policymakers must act now. Power plants are not
built in a day.
The solutions which will prevent local emergencies from becoming a
national disaster are straightforward:
New generation must be built and interconnected.
The interstate transmission system must be opened to enable
power to move from where it is to where it is needed, reducing
the need for new supplies.
Customers must be free to choose. Choices mean not only
lower prices but greater innovation in products and services
which can reduce demand at critical times.
Policymakers need to remove the barriers which inhibit these
solutions. Federal lawmakers should enact legislation to enable all
Americans to have better access to reliable, affordable supplies of
power, which can best be achieved by providing them with access to the
nation's interstate grid. In addition, the Federal Energy Regulatory
Commission (FERC) should act. It should fully unbundle transmission
service and provide for nondiscriminatory access to that service. It
should ensure open access transmission through the ``seams'' (the
administrative borders separating parts of the grid). It should also
expedite the interconnection of new generation with clear rules and
deadlines to prevent foot dragging by utilities who don't want to
connect with competitors' generation. FERC should also require the
nation's transmission owning utilities to join Regional Transmission
Organizations (RTO) which will ensure that this access and
interconnection continue to occur on a nondiscriminatory basis.
The answer to the question: Can California happen again? is ``yes
it can,'' though perhaps not in precisely the same way. What began as
an effort to increase competition, customer choice and innovation ended
as a heavily compromised and half-baked new regulatory regime. (This
has happened in other states and jurisdictions as well.) California did
not deregulate its power market. The FERC has not deregulated wholesale
markets. Instead, policy makers have chosen (or are forced by political
realities) to negotiate with incumbent monopolies over the terms of
restructuring. The result is the worst of both worlds.
What is required is a rededication to introducing real competition
into power markets. Access to transmission and customer choice should
be a top priority. It must be swift and complete. The nation cannot
afford to stand still on this issue. Electricity is too important. The
needs of customers--particularly in the high tech sector--have outpaced
the existing regulated monopoly model. Regulation in the old style does
not work and California demonstrates that heavily compromised
restructuring does not work. What is needed now, more than ever, is an
unwavering commitment to an open and competitive power market.
The Chairman. Thank you very much, Mr. Kean.
Mr. Joe Bob Perkins.
STATEMENT OF JOE BOB PERKINS, PRESIDENT AND CHIEF OPERATING
OFFICER, RELIANT ENERGY WHOLESALE GROUP, HOUSTON, TX
Mr. Perkins. Mr. Chairman, Senator, thank you very much.
The panel and the previous panel have described much of the
supply and demand situation. I will try to just provide
additive comments while echoing that my analyses and the
analyses of my firm is very similar to theirs.
The Chairman. You might comment on the supposition by some
that there has been unfair pricing within the wholesale market
and that there should not be, if you want to take that on in
your presentation.
Mr. Perkins. I will put that in my comments. Am I starting
my 5 minutes now?
The Chairman. You are starting now. Go ahead.
Mr. Perkins. Reliant Energy entered California in 1998,
when we purchased five plants, 3,800 megawatts. Now, that is
one of the larger positions. The largest positions are in the
hands of the utilities. Some 55 percent of the market of
generation is still held by the utilities. That position is 9
percent of the California market and 3 percent of the Western
interconnect market.
Our role since that time has been an active market
participant, and I am proud of that role, working closely with
the ISO, the PX, and FERC to try to improve a market situation
that we inherited. We went into AB 1890 with purchasing after
it had already been written. We thought it was a reasonable
model, but even in 1998 we were working on long-term contracts
and offering long-term contracts to the market.
I am also proud of our record, particularly our record of
performance in plant operations over the last couple of years.
In the year 2000 we produced 10,900 million megawatt hours, and
in the summer of 2000 we ran at rates that were 200 percent
that of the average of the previous 5 years, 35-year-old plants
that we had figured out how to run twice as much as they had
run over the last 5 years, and that helped keep the lights on
in California. The in-State generation was leaned on very
heavily in the summer of 2000, and we are proud of our
performance.
The supply-demand picture has been described very well
here, and I am just going to add a few supply clarifications,
and I heard some questions asked. First of all, the statements
of intent of California legislators and the administration in
California were right on target, and they need to achieve those
goals. However, if we start working on generation in California
today, a new development project, it will be 2004 until we have
it on the ground for any project of significant size.
Secondly, the president of the GE Turbine Division was
recently quoted as saying, some 868 turbines are ordered to
bring supply to this wholesale market, and 21 of them are
pointed to California. I think that is a very dramatic
statement about the industry's evaluation of regulatory and
political risk associated with California, even though supply
and demand are very tight.
There was a question about whether we were using up
generation for next summer. As an industry, we are using up
generation for next summer. Hydro will not be replaced by then
because it is so very low, and the emissions caps on emissions-
limited facilities are being limited, or being run up right
now, so that they may not be available in the summer.
An example would be our Coolwater plant, which has an
overall capacity utilization restriction of some 56 percent,
and it is running flat out now. If we keep running it between
now and summer, there will not be anything left by the time we
get to the middle of the summer. I know other producers have a
similar situation.
One solution to that is to run it right up until we are out
and then get emergency relief, but we should be thoughtful
about that and we should recognize that as the rules currently
state, both hydro and emissions credits are being used.
Now, this is a big problem. The FERC December order
established a framework for market reform and for solutions. It
was a well-thought-out framework. Do we agree with every single
element of it? No, but it was a well-thought-out framework.
However, the State of California has been slow to act against
the recommendations that FERC could act on.
Worse, we still have, and it has been referred to often,
the retail subsidy issue in California. I am not going to
elaborate on that, but I would like those members of the
committee and the people looking at my testimony to turn to the
second-to-last page in the testimony. It will be easy to find,
Exhibit A-4, which very sort of graphically states increases
over 2000 rates for a number of utilities across the country,
including many of the Western States represented on this
committee. It shows utilities in California with a 9-percent
rate increase.
I would remind people that that is a 9-percent rate
increase on top of a 10-percent rate decrease that was put in
place in 1998, and so we are talking about a flat rate since
1996, when gas prices have increased incredibly, and most of
the generation out here on the margin is fired by natural gas.
Secondly, there is a range of 15 to 50 percent rate
increases in those other States, many of them Western States,
and you could characterize that as helping to pay for the rate
subsidy in California.
Now, since I have got you looking at page A-4, I am going
to get you to turn to page A-5 as well, please, because there
is some inaccurate perceptions about market price behaviors,
and I hope this is responsive to your direction, Mr. Chairman.
In fact, our testimony, written testimony includes a detailed
explanation of June 29 supply and demand, comparing 2000 and
1999. That particular period of time, Mr. Chairman, is used by
the California PUC, used by the oversight board to say, look,
supply and demand is about the same, but something has changed
in pricing, $50 to $500.
This morning, I saw a copy of a fax that I know was sent to
many of your offices. That fax had a handwritten comment on it,
probably by one of the staffers, that said, how can this be
when supply and demand have been about the same, but it is not
a complete analysis. It is missing part of the facts, and those
facts are on page 5. Supply and demand in the California ISO
was about the same. Demand was about the same in the California
ISO, but imports from other States was not showing up in 2000
to the same extent it did in 1999.
What you can see on this chart is that 4 p.m., peak time on
that date, and the situation occurred for most of the summer,
and it is all documented in public by the ISO, 4,500 megawatts
short of imported net supply, on top of a peak demand at the
time of about 41,500. Supply and demand was not the same.
If you add those two together, it was essentially a demand
on California generation of some 46,500 megawatts, or the
equivalent of the highest peak demand they have seen. What you
had is demand competing for supply, and running the price up
during that period of time.
Those are my additive comments, Mr. Chairman. Thank you.
[The prepared statement of Mr. Perkins follows:]
Prepared Statement of Joe Bob Perkins, President and Chief Operating
Officer, Reliant Energy Wholesale Group, Houston, TX
Summary
I. Reliant Energy is the owner of approximately 3,800 megawatts
(MW) of California generation and is an active participant in the
Western power markets. We also own an additional 5,600 MW of generation
across the country (including approximately 4,200 MW in the Mid-
Atlantic (PJM) region), have 6,500 MW of generation in construction or
advanced development, control 2,000 MW through multi-year contracts,
and participate in most domestic gas and power markets. Additionally,
Reliant Energy's regulated subsidiaries own and operate 14,000 MW of
generation in Texas, and its European subsidiary owns and operates
3,500 MW in Western Europe.
II. Reliant Energy has been working diligently to be a part of the
California solution since entering this market in 1998; our efforts
have included attempting to improve flawed market structures through a
leadership role with the California Independent System Operator (CAISO)
and Power Exchange (PX), working with the Federal Energy Regulatory
Commission (FERC) to establish market rules that will attract new
capital investment, providing an unprecedented amount of power from an
aged fleet of units in 2000 to help meet California's demand, and
cooperating with all investigations attempting to address market
solutions.
III. Our market perspective, which is that of a participant who has
invested heavily in learning this and other mature power markets, can
be summarized as follows: a) the current crisis in California is a
product of supply/demand fundamentals; b) responses to the market
situation have yet to address the underlying supply/demand problem; and
c) the risk of supply shortages and outages will become more severe as
hotter Summer temperatures significantly increase the demand for
electricity in the Summer 2001.
California supply/demand fundamentals. The supply shortages
experienced in California have been brought on by years of neglecting
supply/demand fundamentals. No significant generation has been built in
California in more than a decade while California's economy, and hence
its electric demand, has surged dramatically. This fragile supply/
demand balance became evident in the Summer of 2000 due to increased
temperatures and reduced hydro electric capacity. In addition, high
natural gas prices along with flawed market rules have exacerbated the
extent of the crisis.
Responses to the current market situation. The FERC's December 15
Order established a framework for needed market reform; however, the
State of California has been slow to adopt measures that would
alleviate the supply/demand problem (particularly by increasing retail
rates to better reflect market costs). Instead, the state has focused
on an inaccurate perception of market manipulation. This reluctance to
raise retail rates has lessened consumer incentives to reduce
electricity consumption and has intensified the IOU credit crisis,
which in turn worsens the supply crisis.
The California market outlook for Summer 2001. In a worst case
scenario, California could face power generation emergencies this
Summer with far more serious consequences than those experienced to
date. Unfortunately, there is no ``silver bullet'' for the near-term
supply shortage; demand reduction initiatives are required across the
entire Western region to mitigate the high risk of forced blackouts.
However, because many of these demand reduction initiatives will
require extended lead times to implement, immediate action is required.
IV. Market-based solutions and competition will provide the
fastest, most effective relief and remedies to California's supply/
demand problems--if state, local and federal laws and regulations are
adopted that remove existing impediments to siting new generation
facilities and facilitate the development of regional market-based
solutions.
Testimony
I. Reliant Energy is the owner of approximately 3,800 megawatts
(MW) of California generation and is an active participant in the
Western power markets. We also own an additional 5,600 MW of generation
across the country (including approximately 4,200 MW in the Mid-
Atlantic (PJM) region), have 6,500 MW of generation in construction or
advanced development, control 2,000 MW through multi-year contracts,
and participate in most domestic gas and power markets. Additionally,
Reliant Energy's regulated subsidiaries own and operate 14,000 MW of
generation in Texas, and its European subsidiary owns and operates
3,500 MW in Western Europe.
An established energy provider. Reliant Energy, based in Houston,
Texas, is an international energy services and energy delivery company
with approximately $20 billion in annual revenue and assets totaling
more than $28 billion. The company also has a wholesale energy trading
and marketing business that ranks among the top five in the U.S. in
combined electricity and natural gas volumes. It also has wholesale
trading and marketing operations in Western Europe. The company has
nearly 27,000 MW of regulated and unregulated power generation in
operation in the U.S. and Western Europe and has announced acquisitions
and development projects that will add nearly 6,500 MW.
Reliant's presence in the Western region, including California.
Reliant Energy entered the California market in 1998 acquiring 3,800 MW
of generation, consisting of 5 plants in Southern California, in three
transactions from Southern California Edison. We also have an
additional 1,400 MW of generation in construction or advanced
development in the Western region. Using an often quoted rule of thumb,
Reliant's generation fleet could provide power for approximately 4
million homes in California.
A fragmented market in California. Although we are one of the
larger merchant generators in California and across the country, our
share of the market is only 3% of the WSCC (the Western System
Coordinating Council)--which is the market that includes California,
most of the other Western states, and western Canada--and we have no
more than a 10% share in any other market. We make this point to show
the fragmented nature of supply ownership in WSCC and most markets.
Additionally, the ownership of generation in California still resides
largely in the hands of the regulated electric utilities, which are the
three utilities represented on the left side of the following chart.*
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* The exhibits and appendix have been retained in committee files.
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II. Reliant Energy has been working diligently to be a part of the
California solution since entering this market in 1998; our efforts
have included attempting to improve flawed market structures through a
leadership role with the ISO and PX, working at the FERC to establish
market rules that will attract new capital investment, providing an
unprecedented amount of power from an aged fleet of units in 2000 to
help meet California's demand, and cooperating with all investigations
attempting to address market solutions.
Attempting to improve flawed market structures. While multi-year
contracts have existed in California since 1998, the IOUs in California
were largely precluded by legislative and regulatory restrictions from
participating in these markets. Reliant has been a proponent of
expanded forward contracting by the IOUs to mitigate exposure to the
price volatility associated with the spot market. We have also been an
active participant and contributor to the processes for improving the
CAISO and PX, working closely and communicating well with both
agencies, as well as gaining the respect of staff and management at
both agencies.
Working with FERC to establish market rules. With respect to FERC
proceedings governing the evolution of the wholesale markets, we have
been very active, frequently assuming a leadership role in terms of
addressing and improving market structures. We were very active in the
recent efforts including 1) the DOE/Treasury Department ``Energy
Summits,'' 2) FERC's forward contract proceeding with the California
utilities, and 3) workshops to lay out the facts and to try to develop
solutions.
Providing an unprecedented amount of power from a 35-year-old
fleet. The average age of Reliant's generating units in California is
more than 35 years. The average heat rate of our California generating
units is more than 10,000 British thermal units per kilowatt hour (Btu/
kWh). This is an older and relatively inefficient fleet of generating
units compared to the efficiencies associated with new generating
technologies, which have heat rates as low as 7,000 Btu/kWh. In fact,
at the time Reliant acquired its California units it anticipated
retiring a number of these units. But with electric demand soaring
Reliant has had to pour millions of dollars in new capital into these
units to keep them operating and extend their operating lives.
We are proud of our contributions to keep generation running to try
to meet the demand for power in California. Reliant Energy's plant and
technical staffs have worked hard to maximize the performance of our
generation. During the Summer of 2000 for example, we ran this fleet at
double the rate of the prior 5-year average--despite the age of the
fleet and the fact that necessary maintenance had been deferred on a
number of these units prior to their sale by SCE. To achieve this
result, maintenance on many of these units has now been deferred to the
point that more serious availability problems may result in upcoming
months unless the units are taken down soon for needed maintenance.
While the existing supply problems in California are serious, the
potential for even greater problems exists for this Summer, especially
if required maintenance is not performed soon.
We went to extraordinary efforts in overtime, innovation, and
assumed risk to achieve these results. Unfortunately, many parties do
not understand that these generation units are being run far harder and
for more extended periods of time than historically. The total energy
production from Reliant Energy's California generation fleet was 10.9
million MWh in 2000 compared with 6.1 in 1999 and 3.6 in 1998 (see
Chart A-1 in the appendix). We are confident that the results of the
various investigations into the so-called withholding issue will verify
the above statements. We welcome such investigations to the extent that
they can disabuse people of flawed notions and get everyone focused on
the real problem at hand--a serious lack of capacity in California.
Our energy production could be further increased were it not for
the most restrictive emission limitations in the country imposed by
local California air boards, which limit the operating hours of some
units:
At our current higher-than-normal operating rate, these
restrictions will idle significant capacity (approximately 900
MW of Reliant Energy's portfolio) this Summer when really
needed for peak demand.
There have been some allowances made by local California air
boards to date. Broader temporary relief of these most
restrictive emissions limitations could increase overall energy
production by up to 20% for our portfolio and potentially even
more for some of the other generation owners in California.
Temporarily lifting emissions restrictions may be necessary
given the supply shortage California faces this Summer
(discussed further in Section III).
III. Our market perspective, which is that of a participant who has
invested heavily in learning this and other mature power markets, can
be summarized as follows: a) the current crisis in California is a
product of supply/demand fundamentals; b) responses to the market
situation have yet to address the underlying supply/demand problem; and
c) the risk of supply shortages and outages will become more severe as
hotter Summer temperatures significantly increase the demand for
electricity in the Summer of 2001.
California supply/demand fundamentals. The supply shortages
experienced in California have been brought on by years of neglecting
supply/demand fundamentals. No significant generation has been built in
California in more than a decade while California's economy, and hence
its electric demand, have surged dramatically. This fragile supply/
demand balance became evident in the Summer of 2000 due to increased
temperatures and reduced hydro electric capacity. In addition, high
natural gas prices along with flawed market rules have exacerbated the
extent of the crisis.
Note: Our perceptions of supply/demand tightness in the California
energy environment are consistent with similar conclusions from the
recent FERC investigation (in connection with the Staff Report issued
in November) and the Treasury Department analyses (in connection with
the early January ``Energy Summits'').
The current situation in California results from years of
neglecting supply and demand fundamentals, which have dramatically
increased the risk for power shortages in California. As the demand for
electricity has increased, California has relied increasingly on power
from volatile sources (e.g., imports and hydro electric), rather than
developing internal power generation to support the state's needs.
Reserve margins before imports in California have shrunk
from 15% in the early 1990's to near zero today.
California rules for siting and permitting plants have
curtailed the development of necessary internal supply.
The percentage of California's power supplied by imports has
doubled from 13% to 26% since 1990.
Heavy dependence on hydro power (24% of capacity) increases
the uncertainty of supply given the dependency of this resource
on precipitation levels.
Limitations caused by the transmission infrastructure can
significantly limit importing supplies from other Western
states (import transmission was congested 36% of peak time in
Summer 1999).
The limitations of the existing system became transparent when the
high risk of power shortages finally hit California full force during
the Summer of 2000:
Summer energy demand increased by 13% due to high
temperatures, while imports were reduced by 53% versus 1999.
Hydro electric output was reduced by 28% versus 1999 as a
result of lower precipitation.
Forced outages on generation plants more than doubled as a
result of higher operating hours (run times almost doubled for
Reliant plants from 1999 to 2000). In the Fall of 2000, outages
remained high primarily due to nuclear refueling and
retrofitting of plants with better emissions reduction
technology.
Acute supply shortfalls combined with a fly-up in natural gas
prices and flawed market rules have exacerbated the extent of the
crisis.
California gas prices have increased from $2.37 (January
2000) to $14.33 per million British thermal units (MMBtu)
(January 2001), and have exceeded $50.00/MMBtu at times (see
Chart A-2 in the appendix).
The Competitive Transition Charge (CTC) design discouraged
retail competition and long term risk management.
IOUs were required to buy almost all power from the more
volatile spot market.
Retail rate freeze prevented California IOUs from passing on
energy purchase costs.
The current credit crisis, which has had an additional
impact on supply, is a direct result of flawed market rules.
Responses to the current market situation. The FERC's December 15
Order established a framework for needed market reform; however, the
State of California has been slow to adopt measures that would
alleviate the supply/demand problem (particularly by increasing retail
rates to better reflect market costs). Instead, the state has focused
on an inaccurate perception of market manipulation. This reluctance to
raise retail rates has lessened consumer incentives to reduce
electricity consumption and has intensified the utility credit crisis,
which in turn worsens the supply crisis.
FERC's December 15th Order attempts to address many market defects,
such as, elimination of ``hard'' price caps and facilitating more
forward contracting. In addition, the Order clearly identifies certain
actions that the State of California must take to implement the market
reforms identified by FERC.
The State of California has created a retail consumer subsidy by
failing to raise rates to reflect market conditions and pass on the
increased costs of energy generation to consumers. In the year 2000,
natural gas costs increased significantly, but the California utilities
could not recoup these costs from the consumers that they are obligated
to serve.
Gas-fired generation constitutes 51.5% of California's
energy production (see Chart A-3 in the appendix).
The high cost of natural gas underlies much of the current
price increase issue.
The $14.33/MMBtu price compares to $1.63/MMBtu price in 1996
when retail rates were frozen by California's deregulation
legislation.
Many states (e.g., Texas) with better access to fuel and no
supply shortage have raised retail rates more than 20% in
recent months to address increases in natural gas costs while
California only recently raised rates approximately 10% (after
a 10% decrease in 1996) (see Chart A-4 in the appendix).
Filed rate doctrine supports the flow through of wholesale
power costs approved by FERC to reflect increases in fuel and
emission costs. The California Public Utility Commission (PUC)
has so far refused to recognize this judicially approved
doctrine.
Unfortunately, attention has been diverted from the supply problem
by the incorrect perception of market manipulation. The PUC, along with
the California Electricity Oversight Committee, has compared prices
from June 29, 1999 to June 29, 2000 in an effort to demonstrate the
dysfunctional market. The PUC's analysis shows that under similar
demand conditions of approximately 41,500 MW, PX prices for power
during peak hours averaged $50/MWh on June 29, 1999 and $500/MWh on
June 29, 2000. However, upon closer analysis, this example does not
support market manipulation charges and demonstrates a failure to
properly analyze and understand three key factors: 1) the balance of
supply and demand in the Western region (not just California), 2)
increases in natural gas and emissions credits prices, and 3) bidding
behavior on the part of the buyer (not the supplier).
Regional supply and demand balance. The June 29 example illustrates
how, in similar demand situations, the availability of imports can have
a tremendous impact on California supply. In the given scenario, the
net imports on June 29, 2000 at 4 p.m. were 4,500 MW (see Chart A-5 in
appendix) lower than on June 29, 1999, which was over 11% of the 41,500
MW demand. This reduction in net imports, resulting in a leftward shift
in the supply curve (see Exhibit 2: CAL-PX Aggregate Supply/Demand Bid
Curves at 4 p.m. on June 29), put upward pressure on PX prices as local
generation capacity struggled to meet demand.
Increases in natural gas/emissions credit prices. Gas prices on
June 29, 2000 were $5.11 per MMBTU versus $2.37 on June 29, 1999.
Emissions credits prices were $23.00/lb on June 29, 2000 versus $2.00/
lb on June 29, 1999. These higher operating costs result in a further
steepening of the supply curve (Exhibit 2).
Buyer bidding behavior. Faced with a tight supply/demand balance,
buyers dramatically altered their bidding behavior in 2000. The demand
bidding curve jumped by 300-500% (see Exhibit 2) from June 29, 1999 to
June 29, 2000. This is a clear example of how buyer behavior can have a
major impact on market price during periods of scarcity of supply.
The California market outlook for Summer 2001. In a worst case
scenario, California could face power shortages this Summer with far
more serious consequences than those experienced to date.
Unfortunately, there is no ``silver bullet'' for the near-term supply
shortage; demand reduction initiatives are required across the entire
Western region to mitigate the high risk of forced blackouts. However,
because many of these demand reductions initiatives will require
extended lead times to implement, immediate action is required.
Worst case scenario. The potential for shortages and blackouts is
very real for the Summer of 2001. A downside scenario includes 1) low
hydroelectric availability (Bonneville Power Administration estimates
are currently 68% of average--one of the worst hydro years on record);
2) loss of imports due to credit concerns (with the California
Department of Water Resources or other purchaser); 3) warmer than
normal weather (current long-term weather view); 4) continued high
demand (strong economic outlook for California and the entire West); 5)
plant outage rates at 2000 levels (although the hard running 2000
levels may cause additional outages in 2001); and 6) continued strict
local environmental constraints (recent news stories show that despite
the crisis, ``NIMBY'' and ``BANANA'' activity is still at very high
levels). The combined impact of these factors could mean as much as
1,100 hours of blackouts for the rest of the year.
Our analysis shows that even in the case of normal weather, the low
hydro generation availability and base/optimistic assumptions for other
factors could still result in approximately 50 hours of blackouts.
Essentially, California will have to be incredibly fortunate with
respect to cool weather, high hydro generation availability, and
unprecedented conservation offsetting demand growth to avoid blackouts
this Summer.
Potential consequences. Recent blackouts, which were only the
result of a 500 MW shortfall, have demonstrated the potential for
serious economic and social disruptions. Events include the loss of
power to 500,000 California residents. Businesses were forced to send
thousands of employees home. Schools had to close or hold classes
without power. Power shortages led to traffic light outages and the
shutdown of ATMs. Dairy farmers had to dispose of milk, while citrus
farmers feared the power losses would lead to a failure to protect the
crops from freezing. Power shortages during the Summer of 2001 could
lead to more serious repercussions:
Blackouts could be ten times worse, at up to 5,000 MW;
Outage duration could be up to 6 hours per day;
The blackouts could affect as many as 20-30 million people;
and
Economic cost of outages can be estimated in the multiple
billions of dollars.
Need for immediate action. There is little time left to take
action, and very little new generation is coming on line before we hit
the Summer peak in approximately 90 days. Historically, Summer peak
demand increases by approximately 40% over current levels. Current
actions are severely exacerbating the potential Summer supply
shortfall:
Generators with run time limits which are typically
allocated to the Summer are running now and will exceed their
limits by the Summer peak season;
PG&E and SCE are utilizing limited load curtailment rights
normally reserved for peak Summer loads--essentially
eliminating interruptible load as a source of future relief for
the rest of the year; and
PG&E has had to access natural gas from its storage
inventory which reduces available volume for the remainder of
the year--reportedly now at critical levels.
Emergency solutions for the short term. Given the short time until
Summer 2001, major supply additions are not likely to be forthcoming.
Potential solutions must focus on region-wide demand reduction
programs. A set of solutions limited only to California, not
encompassing the West region, is very likely to be inadequate.
Significant construction of new generation by this Summer is
not likely given the 2-4 years permitting and construction
cycle.
Averting high risk of supply shortages and forced blackouts
will require unprecedented demand reduction programs throughout
the West region.
--Continued exercise of involuntary interruptions of
industrial customers in California under interruptible
tariffs could add approximately 2,800 MW. Rights under
these tariffs need to be extended by creating economic
incentives to continue to allow interruptions.
--Voluntary curtailments of new interruptible customers
in the West region, outside California, could add
approximately 1,800 MW.
--Buying back power from industrial customers across
the West region at prices they voluntarily accept could
add approximately 3,000 MW.
--Buying back power from aluminum smelters in the
Pacific Northwest could add 3,100 MW.
--Very aggressive conservation by California
residential customers has the potential to add
approximately 600 MW in the near term; however, the
lack of accurate retail price signals prevents consumer
incentives to conserve energy.
In addition, California must fix the credit problems in the
state in order to incent neighboring states to sell their
excess power which could add 4,800 MW.
Local air board environmental restrictions should be relaxed
temporarily to add approximately 1,900 MW.
IV. Market solutions and competition will provide the fastest, most
effective relief and remedies to the supply/demand problem--if state,
local and federal laws and regulations are adopted that remove
impediments and facilitate regional solutions.
Remedies must address supply/demand issue. The supply/demand
problem California is currently experiencing is rooted in a variety of
interrelated factors, several of which have been driven by shortsighted
desires to artificially depress prices below market levels:
A decade of resource planning neglect has resulted in demand
rapidly overtaking supply and reducing reserve margins to near
zero with little advance notice.
Market intervention, both in terms of California's failure
to allow retail rates to increase to reflect increases in
energy and emission costs and in the CAISO's misguided use of
price caps, has resulted in flawed pricing signals on both the
demand and supply side.
--Retail consumers receiving artificially low retail
price signals have not been encouraged, and have had no
incentive, to conserve usage contributing to higher
demand levels than would otherwise have been the case.
--Suppliers have looked at California skeptically in
terms of additional capital investment in new
facilities given numerous efforts to intervene in the
market. These efforts have created a level of
uncertainty that makes suppliers reluctant to invest
significant amounts of incremental capital in
California.
The lack of statewide siting criteria has created a ``not in
my backyard'' attitude when it comes to siting new generation
facilities, making California one of the most difficult and
time consuming states in which to site and permit a new
generation facility in the United States.
Addressing demand issues. From the demand side, increasing retail
rates to reflect the true cost of supply will encourage necessary
conservation and the development of demand side management tools to
mitigate the need for additional generation capacity.
Addressing supply issues. From the supply side, assuming the siting
and permitting impediments described above are addressed by the State
of California, market forces, without heavy handed price cap
intervention, will result in new capacity being built in California. As
additional capacity is built, prices will inevitability fall. For this
to happen, however, suppliers must perceive California as a stable
market for incremental investment--not a state whose policies are
driven by short-term considerations.
Removing impediments to regional solutions. To accomplish the
foregoing there will also need to be a greater emphasis on dealing with
energy issues in the West on a regional basis. As the present situation
demonstrates, California's failure to address its energy problem has
regional implications. The energy interdependence of the region is
undeniable and solutions need to be crafted that take regional
implications into account, especially in the near term.
The Chairman. Thank you very much. We appreciate your
statement, and we will review your written statement in its
entirety.
Mr. Keith Bailey, president and chief executive officer,
the Williams Companies, Tulsa, Oklahoma.
STATEMENT OF KEITH BAILEY, CHAIRMAN, THE WILLIAMS COMPANIES,
INC., TULSA, OK
Mr. Bailey. Thank you, Mr. Chairman. I will attempt to be
brief, and I appreciate you putting my filed testimony in the
record.
As you saw from the filed testimony, what we have attempted
to do as we participated actively in the dialogue with the
State leaders as well as the Federal participants is to focus
not on how we got to where we are, but rather how we get from
where we are to where we would like to be, and so the comments
I will make will be in that context. Where do we go, really,
from here?
We acknowledge that where we are is at a point, with
California having a significant shortfall of available
capacity, when it looks at all of the sources that it can draw
on and that is a function of--why we are here has been I think
pretty well documented by the prior panel, and the prior
panelists on this panel, but in the short term we think the
most important thing that can be accomplished--by short term I
mean immediately, is that the State needs to step in and become
the credit-worthy buyer of the net short position, and it needs
to do that in unambiguous way, not trying to do just enough, or
using half measures. It has to do it clearly and decisively.
The reason is, as you pointed out in your opening comments,
California is a major importer of power and people that sell to
import nations or import States will simply not sell to
uncredit-worthy buyers. There is also a practical benefit to
that, because the forward price curves for power today, and the
current cost of power today, carry with them a credit risk, and
the elimination of that credit risk in a decisive way will
immediately, in our judgment, reduce both the current cost and
the forward cost of power.
In the medium term, and by this I mean between now and
summer, we think it is absolutely essential that there be a
lifting of the air quality regulations that are preventing the
installation of new facilities, or the running of existing
facilities, and panelists to my right have described some of
those impacts.
We look at it in the aggregate, and it is our belief that
that act alone, and it will probably take a combination of
Federal and State action, would add 4,000 megawatts to the
available capacity during the summer months that otherwise
might not be there and, as Senator Feinstein pointed out, that
is as significant amount of power at the margin that can make a
difference.
Finally, in the long term, we need to have an investing
climate in California that is not built from the standpoint of
bankrupting utilities, retroactive rule changes, price caps, or
expropriation of private assets. That sounds a whole lot more
like a third world country than it does our most prosperous
State, and the practical impact of that kind of rhetoric,
whether it is ultimately where we end up or not, and I do not
believe it is where we will end up, but the practical impact of
that rhetoric is increased risk perception and that, in turn,
translates very directly into the pricing curves that people
trade around.
So again, a clear road map that the utilities' financial
strength is going to be restored, that California is going to
do the kinds of things that make it a place that people want to
invest, will also have a short-term benefit of making the power
markets more reasonably priced and that will also then ensure
that private investors continue to put capital into the State.
Hopefully I have given you a little time back, Mr.
Chairman.
[The prepared statement of Mr. Bailey follows:]
Prepared Statement of Keith Bailey, Chairman, The Williams Companies,
Inc., Tulsa, OK
I am Keith Bailey, President, CEO and Chairman of The Williams
Companies. Williams is a Tulsa based energy and communications company
with some $33 billion in assets and about 22,000 employees. We entered
the competitive communications market some 16 years ago with the
breakup of AT&T and have seen first hand the benefits that competition
has brought to that market. We recently completed a major expansion of
our national fiber optic network which now spans some 33,000 miles in
the continental United States and is considered by many industry
observers to be the most innovative and leading edge fiber network in
the world.
Of course I am here today before the Committee because of our
energy business. On the energy side we operate across the spectrum of
businesses that exist from the wellhead to the end user. We are a top
25 independent exploration and production company. We are one of the
largest natural gas pipeline companies with five wholly owned systems,
which literally span the country in all directions. We also have
minority interests in two major import pipelines serving the United
States with Canadian gas. On any given day our systems transport some
17% of the nation''s demand for natural gas. We are among the very
largest North American natural gas gathering and processing companies
and are a market leader in the natural gas liquids area. We have two
refineries and a series of retail gasoline outlets. Williams owns a
major petroleum pipeline company and owns and operates the largest
independent petroleum storage operation in the country.
More recently, we have entered the power business and currently own
or dispatch in excess of 9000MW of power generation facilities spread
across the United States, including nearly 4000MW in the Los Angeles
basin. In addition, we are a major marketer and trader of a full range
of energy commodities, including power. Finally, as an asset intensive
company, we are also a major consumer of energy. We believe this range
of activities and experience in the energy business gives us a good
platform from which to understand both the current problems in the
California power markets and the best pathway to correcting those
problems.
From a broad perspective, the factors that have contributed to the
current situation in California appear clear and many press articles
and media reports have discussed them extensively. In the attempt to
deregulate power markets and reduce prices, policies were adopted that
at the time offered some short-term appeal but which have proved over
the longer term to have actually driven the outcome in the opposite
direction of what the policies were intended to produce. The fatal flaw
was to attempt to mix artificial pricing constraints with a partially
deregulated market. The fundamental problem was a system that did
little or nothing to provide true market based price signals to the end
user. This essentially allowed demand to grow in an artificial and
unconstrained way that likely would not have occurred to the same
degree had market forces been allowed to work fully.
But while understanding the past is instructive, as a participant
in the California market, our focus is on helping to chart a path that
takes us from where we are today to where the State believed it was
going when it set out down the path of deregulation. Obviously,
overarching all of this is an ongoing emphasis on intelligent power
consumption through aggressive conservation measures. In addition, we
believe there are three elements operating in different time frames
that must ultimately be part of that solution.
Short Term:
First, there must be a creditworthy buyer in California to purchase
the power necessary to meet demand. At present the utilities in the
State are unable to do so, given their financial constraints. At this
point the only creditworthy buyer is the State of California or one of
its agencies.
Second, everything possible must be done to enable the dispatching
of the maximum amount of generating capacity, which can be made
available each and every day. That may, and probably will, involve a
temporary waiver of some of the environmental limitations that prevent
that from happening today.
Finally, the purchasers of power must be able to use the full range
of contracting options available in today's market both from the
standpoint of duration of purchases (long, intermediate and short-term)
and the type of power being purchased (base load, standby, peaking).
Medium Term:
All barriers to installing new power generating capacity must be
re-examined with the objective of expediting the permitting process and
bringing as much new capacity on line as early as possible. We recently
brought a plant online in another part of the country that went from
concept to operation in 9 months. It can be done if everyone involved
is committed to the task.
In addition, the short term environmental waivers discussed above
may need to be extended on existing facilities. Deadlines to retrofit
these facilities with more stringent emission controls may also need to
be deferred to preserve the maximum possible generating capacity
availability until new units can be brought on stream.
Long Term:
The financial viability of the state's utilities must be restored.
Failure to do so would create an environment that would deter needed
private investment. The competitive market and the private sector can
and will work to bring demand and supply back into balance, but only as
long as California remains an attractive place to invest.
Williams appreciates the opportunity to share its views in this
matter with the Committee and looks forward to being a constructive
part of finding the solutions that we all seek.
The Chairman. Thank you very much for that very concise
statement and specific recommendations relative to the
immediate, intermediate, and long term.
Next, we will call on Mr. Richard Ferreira. Mr. Ferreira is
the executive advisor for the Sacramento Municipal Utility
District, Sacramento. Please proceed.
STATEMENT OF RICHARD FERREIRA, EXECUTIVE ADVISOR, SACRAMENTO
MUNICIPAL UTILITY DISTRICT, SACRAMENTO, CA
Mr. Ferreira. Thank you, Mr. Chairman, for the invitation
to speak here today. I would also like to say a special hello
to Senator Feinstein of California and to thank her and her
staff for all the time and effort they put in trying to solve
this problem.
I would like to begin by just making a couple of brief
comments about the Sacramento Municipal Utility District, or
SMUD. SMUD serves about 1.2 million citizens in the county of
Sacramento, and it is a community-owned or municipal-owned
system. During the State restructuring debate, community
utilities argued that we should be allowed to retain local
control and make their own decisions about retail access. All
of the California municipal utilities, including SMUD,
determined that it was in the best interests of the consumers
to keep the obligation to serve and retain ownership of
generation and transmission.
The California restructuring law respected our right to
local control and allowed us to maintain ownership and to
mitigate risk by buying power in the forward markets to reduce
our exposure to spot prices. This is not to say that SMUD and
its customers were not hurt by the market. Runaway wholesale
prices have caused us to spend more than $60 million more than
what we had budgeted during last year. We have no financial
reserve left, and we are facing higher prices in the market.
We believe the problem is a regional issue not limited to
the borders of California. Neither California nor any of the
surrounding States can be considered a gated community in the
electrical market. We already know that it is affecting all the
Western markets, including Canada. We are beginning to see
signs in other parts of the States, such as New York, in which
we have a critical imbalance between supply and demand. We
think California is not an isolated incident, but rather is the
proverbial canary-in-the-coal-mine warning that we need changes
in our national energy policy.
We believe there are actions that Congress can and should
take in both the short and the long term to address the
immediate crisis and lead to a workably competitive market.
Clearly, there are steps that California should take on its
own, and you have heard some of those comments this morning,
including lessening demand, building more generation and
transmission, and stabilizing rates. My written testimony
describes these steps in more detail.
While these are important measures, they are only part of
the solution. We also think there is a need for Federal action
to get California, the West, and the Nation back on track.
Specifically, first, we suggest a temporary regional price cap
on wholesale prices until there is an adequate supply in the
region. A price cap is necessary to stabilize market conditions
and to allow time for generation and transmission investment
and market improvements to bear fruit.
SMUD would be the first to admit that price caps are not an
ideal solution. However, we must face facts. You cannot have
competition without an adequate supply. The alternative is
runaway high prices for a significant period of time, which
causes tremendous social and economic disruption.
While additional generation is planned for California and
the region, only a small percentage will come online this year.
The majority of the new supply will not be available to
consumers over the next 2 or 3 years. SMUD is concerned that if
prices do not stabilize, political leaders of, in our case
California, or the voters, will simply pull the plug on
electric competition.
We recognize that there are valid objections to price caps.
For example, some argue that price caps will inhibit new supply
or not fully compensate suppliers. SMUD believes a price cap
can be fashioned to address this objection by ensuring that the
cap is high enough to allow the generator to recover its
capital cost and to earn a reasonable profit.
I would also like to make a few comments on market power.
Both as a short-term remedy and long-term solution we need
Federal action to deal with market power abuses. Independent
studies conducted by the California ISO and others show
evidence of market manipulation. SMUD believes FERC has the
authority and needs other resources to identify potential
market power abuses and impose sanctions and penalties if, in
fact, that occurs.
I can assure the committee that you would not see prices in
California every hour of every day, including 3 o'clock in the
morning, if we truly had a competitive market. To provide a
longer term solution we desperately need a national energy
policy that promotes fuel diversity, energy efficiency,
conservation, and new supply technologies. Currently, the
United States is betting its entire energy future on natural
gas. We have been a leader in Sacramento----
The Chairman. I would ask you to summarize the balance of
your statement, please. Your time has expired.
Mr. Ferreira. Thank you, Mr. Chairman. I would like to just
finally urge the committee to continue its efforts in reforming
the existing hydro relicensing process. Relicensing currently
results in higher cost and some degradation, as we have heard
earlier. We think this can be done and still respect our
environmental commitments.
In conclusion, the California energy crisis has already
caused significant economic dislocation in the entire West.
Certain solutions are within California's grasp and
responsibility. Long term and more effective remedies require
Federal action, and in the long term we can use the attention
generated by the crisis in California to increase emphasis on
energy efficiency and diversity and promote alternative
sources.
Thank you.
[The prepared statement of Mr. Ferreira follows:]
Prepared Statement of Richard Ferreira, Executive Advisor, Sacramento
Municipal Utility District, Sacramento, CA
introduction and summary
Mr. Chairman and Members of the Committee, thank you very much for
the opportunity to appear before you today. The fact that you have
convened this hearing shows that you understand how important
resolution of the current energy crisis is for California, and the
entire Western United States.
Frankly, the current situation is bleak. We are experiencing
outages in the middle of January. Utility operators are dreading what
might happen in a few months when we near our summer peak. We face
razor-thin reserve margins on a daily basis, and routine plant or
transmission line failures can trigger rotating outages. In the
wholesale power markets, the apparent floor for spot market energy
prices is higher than peak prices of the not-so-distant past.
Manufacturers have already postponed planned expansions due to energy
price and reliability concerns, adding to fears of an economic
downturn. And there are no easy solutions. Based on our best estimates,
it will take years to get the needed transmission and generation
facilities built to support a competitive market.
The current situation in California has national import as well, as
Federal Reserve Chairman Greenspan has already recognized. I was
pleased to hear this week that President Bush has formed a Task Force
under the leadership of Vice President Cheney to tackle what has become
a regional problem. California will take certain steps to ameliorate
the current crisis, but many of the problems must be addressed on a
regional basis. Only the federal government can accomplish regional
solutions.
By way of introduction, let me tell you a little about the
Sacramento Municipal Utility District, or SMUD, on whose behalf I
appear before you today. SMUD is a consumer-owned municipal utility
that serves approximately 1.5 million persons in the greater Sacramento
area. During debates on AB 1890, California's restructuring law, SMUD
and other municipal utilities fought for and retained local control
over our energy choices in the competitive market.
This local control has significant practical manifestations.
Because of local control, SMUD retained its obligation to plan for and
serve the electricity needs of our consumer-owners. It has never been
SMUD's belief that competition relieved SMUD of its responsibility to
ensure that its customers had sufficient electric supply at stable
prices. As a consequence, SMUD and other municipal utilities retained
their power plants dedicated to serve native load customers. This is in
direct contrast to our investor-owned colleagues in California who,
because of regulatory orders and business decisions, sold a high
percentage of their generation assets and declined to build new
generation. We have also not transferred away rights to use regional
transmission facilities, built at great expense, to deliver economic
energy from other parts of the Western region to our customers. This
has given us further ability to mitigate market risk for our customer-
owners.
All things considered, SMUD has been able to weather the market
volatility and high prices relatively well as compared to our investor-
owned neighbors. However, there is no escaping the market forces that
have been unleashed. SMUD, like most businesses and consumers in
California, is exposed to high market prices. Today, SMUD is about to
commence a rate proceeding due to high market prices for both
electricity, and the natural gas that powers our local power plants.
As I will discuss in more detail later in my remarks, there are
steps California can take to help itself. A series of well-chronicled
events, exacerbated by well intentioned but mistaken market experiments
in California, have contributed to the current situation. However, the
solution will not arrive overnight, just as the problem did not arise
overnight. Needed investments and market improvements will take some
time to bear fruit. Further, the one overarching lesson from the
California experiment is that a piecemeal, state-by-state approach to
market development and market oversight will simply not work. A
regional approach to markets is required, and only the federal
government can make this happen. Therefore, SMUD believes that the
federal government does have a role to:
help stabilize the current regional wholesale market until
needed investment in generation and transmission is made;
act as the steward for regional market reforms that have the
best chance to make the promise of competition a reality; and
encourage investment in energy efficiency and supply through
a reinvigorated national energy policy.
background--a road paved with good intentions
As I stated above, we have a regional energy crisis on our hands.
Actions taken by California have exacerbated the situation. You have no
doubt read and heard much about California's failure to build new
generation and transmission in the face of growing demand. This is
certainly true. What is also true is that investment in generation and
transmission has not kept pace with demand throughout the West. Lack of
facility investment is not a uniquely California phenomenon. What we
did in California, however, is adopt market structures that laid the
infrastructure inadequacies bare for market participants to exploit. I
would make the following additional observations regarding the road to
competition in California.
First, California opened up its markets at a time when reserve
margins throughout the Western United States were dropping. It has been
well chronicled that increased demand in the growing West has caused
surpluses in regions such as the Pacific Northwest and Desert Southwest
to diminish. California was already a net importer of electricity, and
it saw its traditional suppliers with less power to export to
California during peak summer periods. At the same time, as California
demand grew, less power could be returned from California to the
Pacific Northwest during California's off-peak winter periods, as had
been the traditional practice. Therefore, tighter reserve margins
affected the entire Western region. On occasion this year, prices
outside California have exceeded prices inside California, due to
several factors. In a regional market, if the highest price in the West
is in California, buyers in Portland and Phoenix will be forced to pay
close to the California price. Likewise, if the price in the Northwest
is the highest, that price is likely to prevail throughout the West.
The difference is that California adopted a market design that paid
all bidders the highest, or marginal, price paid for electricity. This
raised the overall amount paid for energy exponentially. Elsewhere in
the region, markets worked the ``old fashioned'' way, and the highest
price was only paid for that last increment of energy needed. Thus, the
overall affect on consumers in California was much greater. The lesson
that was reinforced over the past year is that California is not a
``gated community'' when it comes to electrical supply. What we have
also learned is that no other individual state is likely to succeed in
building a fence at its borders due to West-wide supply tightening and
overall market forces. Price is a regional matter, and remedies for
high prices must be regional in scope.
Second, California's road to restructuring can be characterized as
a ``Wait, Then Hurry Up'' approach. This had an adverse affect on
utility infrastructure investment. Serious restructuring discussions
began in California in the early 1990's. Over a period of years,
California regulators issued Yellow Books and then Blue Books after
entertaining endless comments from stakeholders. The state legislature
then joined the fray, and AB 1890 was signed into law in 1996. Already
California had endured several years of regulatory uncertainty,
contributing to the lack of investment in both needed generation and
transmission facilities.
Once AB 1890 was enacted, however, it seemed things could not be
done fast enough. The law directed that the entire industry, from
trading of power to operation of transmission, be radically altered in
less than eighteen months. Since the March 1998 start-up of the
markets, there have been over forty filings at the Federal Energy
Regulatory Commission making major or minor changes to market rules.
Uncertainty due to regulatory inaction was, therefore, followed by
instability of market rules, further dampening investment in a capital-
intensive industry. Thus, California managed to combine the worst of
regulatory delay and inaction, with the worst of hasty implementation.
This approach exacerbated already poor market fundamentals of short
supply.
Third, California implemented radical changes to the rules of
wholesale power trading that ignored prevailing regional practices.
Instead of the old model of an industry based on relatively predictable
behavior by buyers, sellers, and operators of the Grid, California
implemented a system that encouraged last minute trading of electricity
in an effort to extract efficiencies from the market. Attractive on the
chalkboard, it did not work when put into practice. The inability of
customers to say ``no'' when prices were too high gave more leverage to
suppliers in an already tight market, because buyers were looking to
meet their needs in real time, rather than locking in supply months or
years in advance, as had traditionally been done. The rest of the
Western region also resisted California's approach. The result is that
rules governing trading and grid operation vary greatly between
California and the rest of the West. In hindsight, this could have been
easily avoided. It also points to the need for regional solutions.
Thus, California made several errors that contributed to the market
dysfunction witnessed today. We not only have a crisis brought on by a
supply/demand imbalance, but we unintentionally aided and abetted this
fundamental imbalance by the manner in which we implemented
restructuring, despite the best intentions of California stakeholders.
Avoiding California's Mistakes--Lessons Learned
Other states can try to avoid the mistakes of California. I would
make the following observations on lessons learned from our painful
experience.
First, competition in the electric utility industry will not just
happen with a wave of the so-called ``invisible hand.'' Workable
competition requires certain preconditions be met before markets can be
relied on to reach competitive outcomes. There must be sufficient, and
probably a surplus, reserve margin of supply in order to discipline
price. In a tight market, because of the essential nature of the
commodity and the inability to effectively store electricity, demand
behavior is predictable and sellers can essentially name their price.
Without adequate reserve margins, it may be virtually impossible to
discipline prices charged by suppliers. Lesson Number One from
California may be that, in a competitive era, we need much more
generation on line ready to serve consumers than we built in a
vertically integrated, regulated industry, in order to maintain price
discipline in markets. This lesson must work its way into how we
examine regional markets when determining the potential for the
exercise of market power by suppliers.
Second, markets will not work if, no matter what the price level
is, demand remains almost the same. Demand responsiveness is taken for
granted in most other markets. Implementation of demand responsiveness
in electricity markets presents a greater challenge. I have not seen
great strides in this area in California or elsewhere. While
regulators, including FERC, talk about customers bidding their demand
into markets just like suppliers bid their output, these programs are
in their infancy and are far from fruition. The California ISO
continues to try to implement such programs, with limited success. We
are a little closer to making demand responsiveness a reality today
than before our troubles began. Yet everyone agrees that demand
responsiveness is necessary to control prices, especially during
periods of tight supply. Common sense would indicate that other regions
contemplating a market approach should carefully consider whether they
have meaningful demand-side approaches in place before they move
forward.
Third, someone must be responsible for serving customers, and that
responsibility must be well defined. I mentioned earlier that SMUD and
other California municipals never wavered from the obligation to serve
their customers, and they planned accordingly. We can argue about
whether our investor-owned utilities were relieved of the legal
obligation to serve; it was certainly hinted at. Many expected that new
Energy Service Providers would be climbing over each other fighting for
IOU customers. At a minimum, the existing IOUs were not given clear
direction about whether or not their obligation to serve remained in
full force. This mistake simply cannot be repeated.
Fourth, it is important to take the time necessary to ensure the
fundamental components of a workable market, like those cited above,
are in place before proceeding with full-fledged competition. Progress
should be made in measured steps. In California, we turned operation of
the utilities and wholesale markets inside out in less than eighteen
(18) months. In retrospect, it should not come as a surprise that it
did not work precisely as planned. We have spent the last three (3)
years in a vain attempt to correct flaws in the system exposed by
market participants. We learned that regulators and market makers
couldn't keep pace with power marketers and brokers when it comes to
closing loopholes in system design. Given the importance of the
electricity industry to the well being of the nation, the final lesson
to be learned from California is that a measured pace of change may be
preferable to an overnight overhaul.
``California Only'' Solutions Will Be Band-Aids
There are immediate steps that can be taken in California, without
federal assistance. However, these will merely be band-aids until
regional solutions are forthcoming.
First, California must take all practicable measures to lessen
demand for the coming summers. The most promising means to ensure
reliability and mitigate high prices in the immediate future is to
reduce the demand for electricity. Frankly, it is our only option,
because generation planned to come on line in the next two years will
allow California to keep up with demand growth, and little more. At
SMUD, this week our elected Board will consider augmenting our demand-
management efforts, including a more flexible and aggressive air
conditioning cycling program that allow us to cut demand from our
summer peak usage. We are also discussing how our largest industrial
and commercial customers can change manufacturing process and work
schedules to allow energy conservation during peak periods. In the very
near term, demand side efforts such as these hold the most promise of
reducing the threat of outages due to insufficient supply, as well as
mitigating price spikes during periods of high usage.
Second, we must overcome the NIMBY (Not in My Back Yard) and NOPE
(Not on Planet Earth) syndromes so that both generation and
transmission can be built. I am hopeful this can be accomplished
without abandoning environmental goals. New generation facilities have
much smaller footprints than old units currently in place. Physically
they are much smaller. They are more efficient, and their affect on air
quality is much less than existing units that they would replace. New
generating units would not only bring more supply to electricity
markets, they would also improve air quality, and their relative
efficiency would lessen demands on natural gas supply caused by older,
less efficient units.
Transmission system improvements may be more difficult, but are no
less necessary. The current transmission system was built to be part of
a vertically integrated utility run as a cohesive whole. It was not
built to support a disaggregated competitive industry, a so-called
``interstate highway'' approach to transmission access and competition.
Not only is more transmission necessary to ensure reliability, but it
is also necessary to ensure suppliers cannot exercise market power, or
charge rates above competitive levels for sustained periods, because
inadequate transmission limits access to supplies from competitors in
localized areas.
One factor overlooked when examining siting reforms is that fellow
competitors are often the most vocal opponents of siting new generation
or transmission projects. A new generator may cut into profits of
existing facilities, and will therefore be ardently opposed. Likewise,
a new transmission line can reduce the monopoly power a generator has
on serving customers in a constrained area of the grid, and therefore
will also be opposed. We have seen both examples in California. It is
simply not fair or accurate to lay frustrations of siting delays solely
at the feet of environmentalists or intransigent residents.
Third, we must stabilize wholesale rates. As has been much
publicized, suppliers and buyers, with the help of the State of
California, are currently in the process of attempting to negotiate
long-term contracts. If successful, these contracts have the promise of
being able to avoid immediate rate shock for California consumers by
locking in lower-than-spot-market prices through contracts with longer
terms. I would caution, however, that long-term contracts and low
prices for electricity are not necessarily synonymous.
Long-term contracts for electricity can ensure stable prices, but
they cannot ensure low prices. In fact, the ability to enter into long-
term contracts at reasonable rates is predicated on functioning short-
term wholesale markets. One cannot be accomplished without the other.
You can be sure that a supplier will only enter into a contract if it
believes the return on the contract will be favorable as compared with
spot market outcomes for the length of the contract. I cannot emphasize
strongly enough that long-term contracts are not a substitute for
properly functioning wholesale energy markets. They are a merely a
``deodorant'' to mask dramatic retail rate hikes.
regional and national solutions are essential
While California has received the bulk of the attention, it is
merely the ``canary in the coal mine.'' California has its own unique
set of problems, but California may be the first indicator of a broader
national energy crisis. As your hearing indicates, California market
problems have already contributed to high prices and economic
dislocation in the rest of the West. Other energy markets, such as
those in New York, appear to be on the brink of supply inadequacy and
price volatility, perhaps this coming summer. Thus, the energy crisis
is a federal concern. Moreover, some things, such as regulation of
wholesale energy markets, are exclusively federal. Here are things the
federal government can do.
An Interim Regional Price Cap
First, and for the shorter term, the federal government, through
FERC or Congress if necessary, can stabilize markets in the West with
an interim regional price cap.
A regional price cap is necessary to stabilize market conditions
and allow time for generation and transmission investment, and market
improvements, to bear fruit. Today, prices in wholesale markets are
persistently at levels that are 3-5 times what retail customers are
used to paying for energy. A crisis mentality has developed, and this
mentality does not allow constructive discussion on meaningful market
reforms. SMUD is concerned that if prices don't stabilize, political
leaders in the West will simply end the move to competitive markets. We
need help from leaders in Washington, D.C. to implement a regional
approach to bring order to wholesale markets.
SMUD would be the first to admit that price caps are not an ideal
solution. Managing competitive markets is exceedingly difficult.
However, we must face facts; the alternative is run away high prices
for a significant period of time. While additional generation is
planned, only a small percentage will come on line this year. There
continue to be barriers to entry for new supply and transmission.
Indeed, the entire planning process for the Western United States has
eroded due to competitive pressures. Suppliers are much less willing to
share information regarding planned generation that they regard as
commercially sensitive, as compared to the close voluntary coordination
that characterized the regulated industry. Meanwhile, demand continues
to grow at a considerable rate.
Transmission additions are also needed, not only in regional
transmission corridors that have been identified as bottlenecks, but
also in highly populated areas to deliver the electricity to consumers.
Even if permitting and related concerns were solved tomorrow, it will
literally take years to build the necessary transmission. Until then,
the ability of new supply to get to consumers will be thwarted.
Finally, we have learned that the ability of the consumer to say
``no'' to high prices is a prerequisite to a functioning competitive
market. Facilitating demand responsiveness will take federal investment
in technologies such as real-time metering and pricing, as well as
changes in consumer behavior to become more attuned to when energy is
consumed. These three things, new supply, new transmission, and demand
responsiveness, are necessary for workably competitive markets. Yet
they are not on the near-term horizon. The consequences of allowing
unfettered price levels without meaningful competitive discipline are
unconscionable consumer hardship, and economic dislocation to small and
large consumers alike.
There are valid objections to price caps. For example, it is argued
that caps will inhibit new supply, or will not fully compensate
suppliers. SMUD believes a price cap can be fashioned to address this
objection by allowing exemptions for certain higher priced suppliers
that are necessary for reliability, and by implementing a flexible cap
that allows for changes in input prices, such as increases and
decreases in the price of natural gas.
Further, the cap can be designed so that marginal costs of new
efficient units fall well below the cap, thus providing additional
incentives for new generation to replace old. SMUD has advocated such a
price cap before the Federal Energy Regulatory Commission. A more
detailed description of the SMUD proposal is attached to my remarks.*
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* The proposal has been retained in committee files.
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Again, remedies such as price caps are not the ideal solution.
However, we are long past ideal solutions. Interim price caps can be
made consistent with the goal of continuing to move the industry
forward on the path toward real competition, while ameliorating the
certain consumer hardship that will be felt if no action is taken and
prices remain at record high levels.
A New Look at Policing Market Behavior and Identifying Market Power
Competitive markets still need policing. For the past decade, the
electric utility industry, at the urging of regulators, has developed
increasingly complex markets. With a market the size of California,
tens of millions of dollars are now won or lost in hourly trading. A
billion dollars can change hands in a week when market participants
exploit market rules during periods of tight supply.
Complex markets require active monitoring and a vigilant policing.
The old regulatory structure of months-long proceedings followed by
after-the-fact refunds is not well suited for the new market.
Traditional measures of market power may not suffice to protect
consumers from the exercise of market power in product markets that
were never contemplated as part of integrated utility operation.
Markets must be examined for the potential exercise of market power
before they are implemented. FERC and other regulators must have the
expert staff necessary to monitor energy markets and identify abuses,
and regulators must have the authority to impose penalties if
anticompetitive practices are uncovered. These reforms may or may not
require changes to current law, but they certainly require increased
attention from responsible regulators. Competitive markets cannot be
relied upon to police themselves.
Reform the Existing Hydroelectric Licensing Process
Hydropower is critical to the entire West. SMUD strongly supports
the efforts of the Committee to streamline the licensing process for
hydroelectric facilities. SMUD recommends, at a minimum, the following
legislative reforms in the relicensing process to ensure protection of
existing, reasonably priced hydroelectric generating resources.
First, federal and state agencies should adopt least cost
alternatives to meet environmental objectives identified in
relicensing. Recognizing the value of existing hydro resources, federal
and state agencies should avoid, where possible, imposing operating
conditions through relicensing that would result in reductions of
capacity. Second, environmental review of federal and state agencies
under various statutory authorities should be coordinated and
streamlined. Third, there should be a statutory requirement that all
license conditions be supported by sound science and subject to
appropriate administrative review.
National Energy Policy Emphasizing Energy Efficiency, Diversity, and
Supply
There is a desperate need for a national energy policy. The nation
has enjoyed a long period of relative energy surplus. During that
period, we lost focus on investment in energy efficiency, conservation,
and new supply technologies. SMUD is a leader in this area, investing
considerably more than the national average. Yet, even at SMUD the fear
of competitive pressures in California resulted in reductions in the
level of funding for these activities. Aggressive financing programs
for efficient appliances have been scaled back. Appliance standards
have stagnated while technologies are available to improve energy
efficiency. While high market prices have allowed certain existing
renewable technologies such as wind energy to look more competitive,
investment in other technologies such as fuel cells and solar has
lagged.
Federal energy policy must provide incentives for investment in
energy efficiency and new supply. We are losing fuel diversity. In
California and elsewhere, natural gas is virtually the only fuel choice
for new generation. As we saw in California, electricity prices have
become dependent on the price of one commodity, natural gas. The lack
of fuel diversity also jeopardizes reliability due to an over
dependence on the delivery of natural gas to fuel electric generators.
Right now in California, there are threats of disruption of gas supply
to electric generators, due to a lack of pipeline capacity, or to the
inability of the utility to buy enough gas to keep pipelines full.
Electric generators are near the front of the line when gas
curtailments are necessary, which means the electric supply shortage
will be exacerbated.
These are matters of national concern. Scattered state or local
programs cannot generate enough momentum to move new technologies
forward, or to make significant strides in energy efficiency. A
cohesive national energy policy is the best way to make meaningful
improvements in these areas.
conclusions
California's energy crisis has already caused significant economic
dislocation in California, and has affected the entire Western region.
Certain solutions are within California's grasp and responsibility.
Long-term and more effective remedies require Federal action. In the
short-term, SMUD advocates adoption of a regional price cap on an
interim basis in order to stabilize regional wholesale markets. A
regional price cap will provide the breathing room necessary in order
for new generation and transmission to come on-line, so that the goal
of a workably competitive market can be realized. In the longer-term,
Congress can use the attention generated by the current crisis in
California to highlight the need for a national energy policy, with
increased emphasis on energy efficiency, conservation, and development
of alternative energy sources to ensure greater fuel diversity.
If we take the opportunity to learn from mistakes made in
California, we can emerge from the current crisis in a stronger
position than when we entered.
The Chairman. Thank you.
Mr. Tom Karier. We look forward to your statement, and he
comes as council member of the Northwest Power Planning
Council, Spokane, Washington, and I would encourage you to add
any reference to what Canada may provide, assuming the price is
right, BC Power, specifically.
STATEMENT OF DR. TOM KARIER, COUNCIL MEMBER, NORTHWEST POWER
PLANNING COUNCIL, SPOKANE, WA
Dr. Karier. Thank you, Mr. Chairman, members of the
committee. I am testifying today on behalf of the Northwest
Power Planning Council. My name is Tom Karier, and I am one of
two Washington members on the council appointed by Governor
Gary Locke. I also chair the council's Power Committee. The
council is an agency of the States of Idaho, Montana, Oregon,
and Washington, and under the Northwest Power Act of 1980 the
council conducts long-range electric planning and analysis. We
also prepare a program to protect, mitigate, and enhance fish
and wildlife for the Columbia River Basin that have been
affected by hydropower dams.
Clearly, what started out as a California crisis has
quickly expanded into the entire West Coast, and I know we have
a very distinguished number of panel members from the Northwest
who will address the specifics, but last year the council
reviewed the West Coast electricity supply and high market
prices at the request of Northwest Governors and identified the
key events that were contributing to the crisis, many of which
have been mentioned in more detail, but obviously high on the
list was the California electricity restructuring.
Second was the lack of new plants and new conservation and
renewable resources. We also had below-average rainfall and
snow pack in 2000. There is the price of natural gas rising,
and clearly the unplanned and scheduled maintenance of a large
amount of capacity in California.
Currently, we are most concerned about the present
conditions of the Federal Columbia River power system, a
system, as you know, largely fueled by water. Precipitation so
far this winter is 63 percent of normal, and Columbia River
run-off between January and July is predicted to be only 68
percent of normal, and the elevation of Lake Roosevelt in my
State, behind Grand Coolee Dam, is the lowest in 25 years. The
weather forecast, in a word, is dry. Without normal or above-
normal rainfall for the remainder of the winter and spring, our
power supply will be stressed even more than it is already.
This winter, poor hydro conditions in the region, combined
with California's supply crisis, are exacerbating the imbalance
between supply and demand and causing significant hardship. The
power crisis is affecting Northwest utilities and ratepayers as
well as those in California, and particularly businesses and
industries. Northwest utilities are raising their rates
dramatically in some cases. 30 to 60 percent increases are not
uncommon. Businesses and industries are shutting down or
cutting back. Aluminum smelters can make more money selling
their power back to Bonneville than selling aluminum.
I would like to comment briefly on our recommendations for
alleviating the problem. First, we need to treat electricity
like the commodity it has become and encourage market
mechanisms that manage risk of exposure to high prices.
Certainly the long-term contracts would be part of that.
Second, we need to evaluate the shortage of generating
plants in the competitive marketplace. Can we rely on the
market to provide sufficient capacity to keep the power system
reliable? The council plans to investigate this question.
Third, we need to develop a robust market on the demand
side of the meter. We see great opportunities in price-
responsive demand management, such as reducing or shifting
loads during periods of high prices.
Fourth, California obviously needs to fix its deregulation
law. This attempt, in our view, at retail competition was a
failure and needs to be corrected.
Fifth, we need better information on which to base regional
power decisions. Better, more timely information about loads
and resources will improve decisionmaking and reduce the sense
of panic in the market.
Sixth, Western utilities need a workable procedure for
dealing with emergencies when they develop. I am pleased to say
that the Power Planning Council, along with Northwest
utilities, Western Systems Coordinating Council, Bonneville and
others, have been working on creating an emergency response
team since last December that has functioned very well in the
last few weeks.
Seventh, while there is no consensus among Northwest
Governors on the need for price caps, my Governor, Gary Locke,
supports interim price caps as a means of cooling the
superheated power market. We think that this offers the best
chance of avoiding even more serious problems in the near
future.
We do not support the Department of Energy's emergency
order to sell to California. There is a significant credit risk
in selling to California, and correcting that problem would do
much to improve the trade between our two regions. The
Northwest also needs to protect its ability to meet future
loads.
Finally, we all need to continue our efforts to use energy
more efficiently. From our studies in the Northwest,
conservation is cost-effective, and it works.
In summary, the council recommendations amount to a call
for the West to fix their current problems while investing in
the future. We must ensure that utilities and consumers remain
financially solvent until new sources of generation and demand
reduction moderate prices.
The Chairman. I would ask you to wind up your statement,
please.
Dr. Karier. Thank you, Mr. Chairman. That does complete my
testimony.
[The prepared statement of Dr. Karier follows:]
Prepared Statement of Dr. Tom Karier, Council Member, Northwest Power
Planning Council, Spokane, WA
introduction
Good morning, Chairman Murkowski and members of the Committee, and
thank you for the opportunity to testify today on behalf of the
Northwest Power Planning Council. My name is Tom Karier and I am one of
Washington State Governor Gary Locke's two appointees to the Northwest
Power Planning Council.
The Council is an agency of the states of Idaho, Montana, Oregon
and Washington. Under the Northwest Power Act of 1980, the Council
conducts long-range electric energy planning and analysis, and also
prepares a program to protect, mitigate and enhance fish and wildlife
of the Columbia River Basin that have been affected by hydropower dams.
In my testimony, I will briefly recount the results of the
Council's October 2000 analysis of the reasons behind the high
electricity prices in the West, discuss the current condition of the
Federal Columbia River Power System, which provides about 40 percent of
the Pacific Northwest region's electricity, describe some of the
impacts of the current crisis on Northwest electric utilities and their
customers, and offer our recommendations for how to address the
problem.
To begin, we believe six key events are contributing to the current
power crisis in the West. These are:
1. The wholesale power market created by California's electricity
restructuring is dysfunctional, needs fixing and has affected other
western states. The remedies ordered by the Federal Energy Regulatory
Commission have yet to have a significant effect.
2. Construction of new power plants and new conservation and
renewable resources during the last decade did not keep pace with
growing demand for electricity. In the Northwest, for example, demand
for electricity has grown 24 percent in the past decade while
generating capacity has grown by only 4 percent. When California is
factored in, the gap between demand and supply is even greater.
3. Below-average rainfall and snowpack in 2000 contributed to poor
hydropower conditions in the Northwest. Snowpack runoff is predicted to
be 68 percent of normal this year; the elevation of Lake Roosevelt
behind Grand Coulee Dam is the lowest in 25 years.
4. The price of natural gas, the fuel of choice for thermal power
plants in the Northwest, had doubled last summer and now is over three
times the price it was last year at this time. .
5. Some California power plants had to shut down for unplanned or
scheduled maintenance or because they violated air quality regulations.
6. The loss of flexibility in the operation of the hydroelectric
system due to Endangered Species Act requirements has derated the
system by more than 1,000 megawatts.
I will explain these in more detail later in my testimony, but for
now let me say that each of these events would cause problems in
isolation, but in combination they have created ``The Perfect Storm''
for western utilities and their customers. Of these key events, we are
most concerned at the moment about the outlook for hydropower
generation.
In a normal year, the volume of the Columbia River runoff between
January and July is 106 million acre feet, measured at The Dalles Dam.
In early January, the forecast for January through July 2001 was 80
million acre feet, or 75 percent of normal. Last week, the forecast was
revised downward to 72 million acre feet, or just 68 percent of normal.
By way of comparison, the worst January-July period on record was 50
percent of normal.
Obviously, this is a dry winter in most of the Northwest.
Precipitation in the Columbia River Basin so far is 63 percent of
normal, and the weather forecast for the next two weeks is, in a word,
dry. Reservoirs behind dams in the Columbia River system currently are
about 49 percent full; typically in January, the reservoirs would be
about 65 percent full.
As for hydropower generation, in a normal year the Federal Columbia
River Power System will produce about 15,500 average megawatts. This
year, with current predictions of runoff, the system is expected to
produce much less. To put that in perspective, given the driest
conditions on record, which are 50 percent of normal, the current
system would produce about 11,500 average megawatts. We may be
dangerously close to that this year.
We can hope for above-average precipitation for the remainder of
the winter and no unusually cold weather that would boost electricity
consumption. But clearly, the outlook is not good.
Meanwhile, many electric utilities in the Northwest recently
announced substantial rate increases in response to high market
prices.\1\ In fact, several utilities have raised rates to their retail
customers as much or more than utilities in California. Businesses and
industries that use large amounts of power are suffering. To better
understand the impacts, the Council recently convened a panel
representing four Northwest utilities that have been affected
differently by the current crisis.
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\1\ Market prices for the last year at the Mid-Columbia trading hub
are displayed in the figure attached as the last page of this document.
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Briefly, here is what we learned:
Tacoma Public Utilities implemented a 50-percent rate
surcharge, which amounts to a 43-percent increase to
residential customers and 75 percent to industrial customers.
Dry weather is impacting Tacoma's hydropower operations,
forcing the utility to make purchases in the spot market.
Tacoma spent $60 million for power in December and is facing
continuing high prices with cash reserves of only $130 million.
The utility has secured diesel generators with 50 megawatts of
capacity, called for conservation, imposed the rate surcharge,
and is also planning to take on $100 million in debt to get
through the rest of the winter.
Tillamook Public Utility District in rural western Oregon is
facing market exposure of $20 million, while the utility's
total annual budget is about $11 million. Tillamook joined with
several other rural utilities to buy a portion of its load on
the market several years ago, and today the utilities' combined
power bill has ballooned to $117 million. While Tillamook
recently announced a new agreement with Bonneville, Tillamook
has asked its large customers to discuss cutting back
electricity consumption. But these customers have orders to
fill and are reluctant to jeopardize their production.
Puget Sound Energy of Bellevue, an investor-owned utility
with some 900,000 customers, reported it is in a precarious
stage of load/resource balance. Rising prices for natural gas
are squeezing the utility's finances while Puget is operating
with a five-year residential rate freeze. The utility may ask
the state Utilities and Transportation Commission for emergency
rate relief. High prices have caused some of Puget's industrial
customers who are on market-indexed rates to shut down or
curtail production.
Clark Public Utilities, which serves about 130,000 customers
in the Portland suburb of Vancouver, Washington, recently
raised its rates 20 percent to meet the increased price of
natural gas and power from its generating plant, which supplies
about half its load. Currently, the remainder comes from
investor-owned utilities under long-term contracts, but those
expire in July and Clark anticipates another rate increase in
the fall when it goes back on the Bonneville system.
Last week the Bonneville Power Administration announced that
a vastly increased demand for its products, beginning in
October, will force the agency to make significant market
purchases to augment the federal system. As a result,
Bonneville is proposing an average 60-percent rate increase
over the next five-year rate period, beginning October 1, 2001.
Bonneville acknowledged that the first year could be
significantly higher than 60 percent, and some Bonneville
customers are anticipating rates as much as 100 percent higher.
Given the current market situation and the projected spring
runoff, Bonneville believes it needs revenues that average
annually about $1.3 billion more than its estimates made just
last May.
There is other bad news, as well. Idaho Power Company recently
announced its power purchases are $121 million above expectations and
may require a 24-percent rate increase. Utah Power & Light is proposing
a 19-percent rate increase. Moody's Investor Service recently changed
the credit rating of Seattle City Light to negative because of concerns
that low water levels will impact the utility's hydropower generation
and force more power purchases on the spot market.
Industries are hurting, too. Recent news stories report on
smelters, paper mills, chemical makers and mines in the Northwest that
either are shutting down or curtailing production in response to high
electricity prices. These include six aluminum smelters in Oregon,
Washington and Montana, and also other major industries in Tacoma,
Seattle, Bellingham, Butte, Portland, and elsewhere. Ironically, some
can make more money selling their contracted power back to the supplier
than they can by operating. In turn, this allows the supplier to avoid
purchasing more expensive power on the market.
Not all the news is bad, however. Bonneville has been able to
exchange surplus power with California on a two-for-one basis, and
California has already returned significant amounts of that power. This
has helped Bonneville avoid running the hydrosystem harder to meet its
load. However, other utilities in the Northwest, which have been
ordered to sell surplus power to California, remain concerned that they
will not be paid for their power.
Mr. Chairman, as I noted earlier in my testimony, there are
multiple reasons for the current power crisis on the West Coast. Two
years ago, the Northwest Power Planning Council initiated a study of
the adequacy of the Northwest's power supply. This study was motivated
by the observation that while the region had enjoyed several years of
robust economic growth and, consequently growth in the demand for
electricity, there had been very little in the way of new generation
development. At the same time, efforts to improve the efficiency of
electricity use in the region had been reduced dramatically because of
the uncertainty of utility restructuring. This raised the concern that
under conditions of high stress, the system might not be able to fully
meet the region's power needs to serve load and to maintain the
reserves essential to a reliable system. Conditions of high stress
involve combinations of high weather-driven loads, poor hydropower
conditions and forced outages of thermal and hydropower generating
units.
The study, which we completed in early 2000, concluded that:
There is an increasing possibility of power supply problems
over each of the next few winters (December, January,
February), reaching a probability of 24 percent by 2003. This
takes into account both regional resources and the availability
of imports. The level and duration of the possible shortfalls
could be relatively small--a few hundred megawatts for a few
hours--or quite large--a few thousand megawatts for extended
periods.
The region would need the equivalent of 3,000 megawatts of
new capacity to reduce the probability to a more acceptable 5-
percent level. That new capacity should take the form of new
generation, conservation and economic load management, i.e.,
reductions or shifts in consumer loads that make economic sense
for the consumer and the power system.
It was unlikely that market prices would be sufficient to
stimulate the development of sufficient new generation in that
time frame. This meant that in the near-term, an even higher
priority needed to be placed on developing economic load
management opportunities.
While this study generated a good deal of interest, it is difficult
for people to get too excited about probabilities generated by arcane
computer models. However, last summer, and again this winter,
developments in the power system captured the attention of the industry
and the public. Those developments resulted in unprecedented high
prices in Western power markets, including the Northwest. Average
prices for power were well over $200 per megawatt-hour, occasionally
reached $700 per megawatt-hour or more, and peaked on December 11 at
$5,000 per megawatt-hour on the Mid-Columbia trading hub. At the low
end, that is more than 10 times the previous high, and at the high end
more than 100 times. In short, prices are phenomenally higher than in
past years.
The Council believes that high spot-market prices are a tangible
manifestation of the fundamental problems identified in the Council's
power supply adequacy study of last winter. That is, the prices are an
indicator of current scarcity. Last summer, the system, which already
was facing tight supplies, was further stressed by combinations of
unusually high loads, poor hydropower conditions and forced outages of
thermal units. There is little in the way of price-responsive demand to
mitigate these prices. Those who had available supply were able to ask
for and receive high prices. This combination of factors is precisely
what led to the power supply adequacy problems identified in the
Council's study. These factors apply not only to the Northwest but also
to the entire Western Interconnection. There are some additional
factors related to the design of the California electricity market, but
they should not obscure the basic underlying problem. Absent some
action, the next similar event could result in not only high prices but
also a failure of the Northwest system to meet loads.
In the following paragraphs I will summarize the evidence regarding
the factors affecting Western market prices, focusing in some detail on
the last week of June 2000, the period in which the highest prices of
the summer were observed. While prices at times were higher in
December, we believe the reasons for the high prices last summer and so
far this winter are the same. I will also offer our recommendations for
actions to mitigate future price excursions and potential power supply
adequacy problems.
demand growth without similar growth in supply
As noted above, the Council believes the high prices are
symptomatic of an overall tightening of supply, exacerbated by a number
of factors. Some of these factors are physical and economic, others are
related to the relative immaturity of the competitive electricity
market and the uncertainties involved in the transition from a
regulated structure. The physical and economic factors include
unusually high weather-driven demands throughout the West, an unusual
pattern of hydropower generation, a high level of planned and forced
outages of thermal generating units, and high natural gas prices. The
factors related to market immaturity and transitional uncertainties
include the lack of a demand-side price response in the market,
inadequate utilization of risk mitigation strategies, insufficient
investment in new generation, and other factors related to the design
and operation of the California market.
Between 1995 and 1999, peak loads in the Western Systems
Coordinating Council area increased by nearly 12,000 megawatts, or by
about 10 percent. The increase would have been even more if 1999 hadn't
been a relatively mild weather year. Generating capacity available
during peak load months did not keep pace with peak load growth,
increasing only 4,600 megawatts.
When growth in demand outpaces growth in power resources, the
result is a narrowing of reserve margins. This implies more efficient
utilization of existing capacity and was an anticipated benefit of
moving to a competitive generation market. However, if it proceeds to
the point of putting reliability at risk and destabilizing prices, it
is a problem. The period of the highest prices in the summer of 2000
coincided with a period in which loads in the Northwest, California and
the Desert Southwest were at high levels as a result of high
temperatures throughout the West. In the Northwest last June, peak
loads were approximately 3,400 megawatts greater than one year earlier
while in California loads were approximately 1,400 megawatts higher. As
we moved into the winter, high heating loads, poor hydro conditions and
an extraordinary amount of generating capacity out of service in
California drove prices even higher.
lack of new energy conservation
We also know that efforts to improve the efficiency of electricity
use, that is, conservation, have fallen off considerably in recent
years. This is largely the result of the uncertainty created by the
restructuring of the electricity industry. Utilities, which were the
primary vehicle for conservation development, generally reduced their
efforts because of concerns about creating potentially stranded
investment. They also expressed concerns about the need to raise rates
to cover conservation costs and the revenues lost as a result of
conservation. Council staff has estimated that if the Northwest had
maintained its level of investment in conservation at its 1995 level
through the last three years of the decade, we would now be using the
equivalent of the total output of a combined cycle combustion turbine
less electricity. The average cost of saving that electricity is a
fraction of the current market price of power.
unusual snowpack and runoff
An unusual pattern of Columbia River runoff last summer also
contributed to the power problem. While runoff was expected to be
normal, in fact the spring runoff came somewhat earlier and higher than
normal. By May and June, runoff and hydropower generation were less
than normal. Hydropower generation in late June was approximately 6,000
megawatts less than the previous year. As I noted earlier, runoff this
spring is expected to be far below normal.
thermal plant outages
Outages at thermal plants also contributed to the problems last
summer. Maintenance at thermal plants frequently is planned for the
May-June period when abundant hydropower typically is available. In
addition, plants do break down, sometimes when it is least desirable to
do so. We have attempted to identify Northwest thermal units that were
either on planned outages or forced outage status during the last week
of June. This was done by examining the generation data reported to the
Western Systems Coordinating Council and supplemental data that was
provided by Northwest generators. These combined data sets represent
about 85 percent of the thermal capacity in the Northwest. From these
data it appears that approximately 1,500 megawatts of capacity were out
on a long-term basis, either planned or extended forced outages, and
another 2,400 to 2,700 megawatts were on short-term forced outage
status in late June, when temperatures--and power prices--peaked. As
noted earlier, power plant outages in California this winter have
exacerbated an already tight supply picture.
rising natural gas prices
Rising prices for natural gas, a primary fuel for thermal power
plants, also contributed to the high power prices. Between the summer
of 1998 and the summer of 2000, natural gas prices at Sumas on the
Washington/British Columbia border increased from about $1.50 per
million Btu to $3.30. Prices in Southern California increased over the
same period from about $2.40 to $4.18. Prices moved substantially
higher during late August and September. During mid-September, prices
at Sumas were $4.60 and prices in Southern California were over $6.00,
although the California prices were affected by a serious pipeline
explosion. Prices have stayed approximately at those levels, or
slightly higher, since then. Current prices at Sumas exceed $6 per
million Btu.
Depending on the gas-fired generating technology used, for every $2
increase in natural gas prices the cost of generating electricity
increases between $15 per megawatt-hour and $22 per megawatt-hour.
However, the increase in natural gas prices, while contributing
significantly to higher electricity prices, cannot come close to
explaining the increase in peak electricity prices.
the lack of a market for demand reduction
Our analysis of the western market also disclosed a systemic
problem associated with the immaturity of the competitive electricity
market, which is the lack of a demand side to that market. Demand
responsiveness to price is important to an efficiently operating
market. Demand responsiveness is an essential mechanism to balance
supply and demand. Without some degree of demand responsiveness, there
is no check on the prices that can be charged when supplies are tight,
except for artificial caps. This is particularly critical when supplies
are stretched to their limits. Under those circumstances, a relatively
small degree of price responsiveness can have a relatively large
reducing effect on prices, and could also mean the difference between
maintaining service and curtailing it.
Currently, at any given hour, the amount of electricity demand is
virtually independent of wholesale price. This is because the vast
majority of electricity consumers do not see market prices in anything
approaching real time and, for the most part, have done little if any
thinking about how they could reduce their demand if power were very
expensive. The Council is not advocating retail access as a means of
achieving price responsiveness. The states are making their decisions
about when and how much to open their retail markets to competition.
But developing price-responsive demand does not require passing real
time market prices on to all consumers. It does mean, however, that
those suppliers who see wholesale prices should act as intermediaries
between the market and consumers to effect load reduction or shifting
that is in the mutual economic interest of the consumer and the power
system. We believe this will develop in time, and that the current high
prices will help motivate that development. In the past several months
several hundred megawatts of price responsive load reduction have been
put under contract by Northwest utilities. However, given the tight
supplies and high prices now affecting the market, the Council believes
that continued effort should be devoted to encouraging and facilitating
the demand side of the market.
the california effect
Among the Western states, California's electricity industry is
farthest down the restructuring path. California's path is, in many
ways, quite different than most other examples. California created a
market structure that is quite centralized and complex. For most of its
life, the California market has yielded competitive power prices.
However, under periods of stress, we believe that the sheer size of the
California market, in combination with the characteristics of its
structure and the incentives it creates, clearly have resulted in
prices that are higher than they might be otherwise.
The problems associated with the California market have been the
subject of intense scrutiny in recent months. We generally believe that
the steps ordered by FERC to shift California investor-owned utilities
out of reliance on a spot market for the majority of their supplies and
into longer-term contracts for supply is the right direction. As you
know, however, implementation of such steps is clouded by the potential
insolvency of these utilities. Quick resolution of these problems is
essential.
recommendations
Mr. Chairman, based on our analysis of the West Coast market, we
offer the following recommendations:
1. Encourage Greater Use of Risk Mitigation Mechanisms
One of the characteristics of a commodity market is the emergence
of mechanisms to manage risk, and electricity is rapidly becoming a
commodity market. These mechanisms include actual physical forward
contracts for supply, futures contracts, financial hedging mechanisms,
and so on. These mechanisms can limit exposure to high prices. At the
same time, however, there is always the risk that they will prove more
costly than the spot market. As noted earlier, we believe the
limitations on forward contracting by California utilities was a
contributing factor to the price extremes of this summer and fall.
We believe the same is true of other market participants in the
Northwest and elsewhere. While opportunities to enter into forward
contracts and other hedging arrangements have existed, it may be that
the protracted period of low market prices for electricity lulled some
market participants into believing they had no need for such
mechanisms. The extreme volatility of the market has been revealed. We
believe this will spur the development and use of risk mitigation
tools. Every effort should be made to encourage their development and
use.
Had more market participants been able to take steps to protect
against risk, it is likely that the price volatility impacts would have
been moderated. Forward contracting is also a vehicle by which new
entrants in the generation market can limit their downside risk,
thereby facilitating the development of new generation.
2. Monitor the Market for its Ability to Provide Sufficient Capacity
and Fuel for Reliability Purposes
The Council's analysis of power supply adequacy indicated that
market prices would not be sufficient to support the development of
``merchant'' power plants, which sell into the spot market exclusively,
until 2004. Current prices have changed that situation. The Council has
also done analyses looking at actual market prices over the past year
to see if they would be sufficient for a new entrant to cover its
variable operating costs and its fixed costs and earn a reasonable rate
of return. Until last summer, the answer was ``no.''
Since then, however, given the electricity and gas prices
experienced over the past year, the answer has become ``yes.'' With
higher prices, a couple of plants not considered in the Council's
adequacy study have begun construction. In the Northwest, there are now
1,276 megawatts of capacity under construction that should come on line
in 2001 through 2002. There are another 2,977 megawatts that already
have site certificates, 1,291 megawatts of which we judge to be
``active'' projects, and another 3,060 megawatts that are in or have
begun the siting process. The major factor that will determine how many
of these plants go forward will be the developers' assessments of
future market prices and the willingness of potential purchasers to
enter into longer term contracts.
Almost all of these plants are natural-gas-fired combustion
turbines, although the developer of a 24-megawatt wind farm in
northeastern Oregon recently announced plans for a 300-megawatt
expansion of that site. Nearly all of the proposed thermal plants are
located within reasonable proximity to natural gas pipelines. There is
a similar story to be told elsewhere in the West.
The degree of developer activity is encouraging. However, if we
were to experience a few years of relatively warm, wet winters and cool
summers, market prices probably would fall, and many of the active
projects might become inactive. If followed by a dry spell and a hot
summer or a cold winter, we would be up against the supply limits
again. Similarly, we are concerned about this hydro-induced volatility
on the market for development of new gas pipeline capacity. New
pipeline capacity is needed to fuel most new generation. We must ensure
that mechanisms in both electricity and gas markets can signal pipeline
expansions when needed.
The question this possibility raises is whether we can rely on the
market, and various risk-mitigation mechanisms, to provide sufficient
capacity for reliability purposes. And if not, what are the options for
ensuring that there is capacity and fuel available to ensure
reliability and mitigate excessive price spikes. The Council intends to
pursue this question.
3. Initiate Efforts to Develop the Demand Side of the Market
While the lead time for the development of new combined-cycle
generation is relatively short, there will be a period during which the
region and the West are vulnerable to further price spikes and possible
reliability problems. Developing the demand side of the market has the
potential for somewhat shorter lead times. Price-responsive demand can
help mitigate price spikes and potentially avert reliability problems.
The Northwest has a great deal of successful experience in
increasing the efficiency of electricity end-use as a resource. The
region needs to reinvigorate those efforts in light of the market
prices we are experiencing. However, the region in particular needs to
move aggressively to implement price-responsive demand management--
reducing loads during periods of high prices or shifting the loads to
periods of the day when prices are lower. The bad news is that this
region has relatively little experience with these approaches. The good
news is that there should be significant untapped potential.
As noted earlier, the Council is not advocating retail access as
means of achieving price responsiveness. The states are making their
decisions about when and how much to open their retail markets to
competition. However, the Council believes that market-like mechanisms
in which the consumer receives a significant part of the benefit will
be most effective. Pilot programs were initiated last year in the
region in which the serving utility and the load-reducing consumer
share the cost savings of avoided power purchases (or the revenues from
selling the freed-up power on the market). These programs appear to
have been successful, although limited in scope. The greatest potential
for such partnerships probably exists within industry and large
commercial buildings. What can be done will vary from building to
building and process to process. Nevertheless, if provided the
incentive, the Council believes people will rise to the challenge.
Creating these incentives should be a priority for the utilities of the
region.
4. California Should Correct the Incentives in Its Market Structure
That Contribute to Excessive Prices and Volatility
Quick implementation of the FERC's order for reforming the
California market is essential.
5. Until the Market Stabilizes, Data for Monitoring and Evaluating the
Performance of the Market Should Be Available on a Timely Basis
One thing we learned last summer was that it is difficult to obtain
the data necessary to monitor and evaluate the performance of the
market. Despite the fact that utilities in the Northwest were extremely
cooperative, there was a delay of many weeks before the relevant data
could be obtained. We understand the possible commercial sensitivity of
this information. We believe, however, that there should be
arrangements possible that both protect the commercial value of the
information and make it possible for independent parties to evaluate
market performance on a timely basis. Until the market has stabilized
and the public has greater confidence in its operation, this should be
a high priority for market participants and organizations like the
Western Systems Coordinating Council, California authorities and
regional transmission organizations as they are formed.
6. Electricity Emergency Processes and Procedures Need To Be in Place
The Council determined in its October report that getting the
processes and procedures in place that would be used in the event of an
actual supply emergency should be a priority. Until new generation
comes on line and demand-side programs can be implemented, there is
significant probability that our emergency readiness will be tested.
Necessary elements include an inventory of the actions that could be
taken, the trigger points for taking these actions, clear definition of
roles and responsibilities, and a communications plan to inform the
public. We are pleased that efforts to accomplish this were
established--and successfully utilized--this winter involving the
Pacific Northwest Utilities Conference Committee, the Northwest Power
Pool, Bonneville, the Power Planning Council, the Northwest states, and
the region's utilities.
7. Conserve Energy
We all can do our part by conserving energy. In recent months,
electric utilities and the news media have bombarded us with energy-
saving ideas--insulate your attic, caulk around your windows, install a
programmable thermostat and replace incandescent light bulbs with
compact fluorescents. Each of these will save energy. On a larger
scale, the Power Planning Council, Bonneville and others have developed
an exhaustive list of more than 1,000 energy-saving techniques and
applications that could be implemented in homes, businesses and
industries. The list was developed by an association of energy
conservation experts known as the Regional Technical Forum and will be
utilized by Bonneville to calculate energy savings under the
conservation discount proposed for the 2002-2006 rate period. The
measures and information about their energy savings are posted on the
Council's website, along with their estimated cost.
In summary, our recommendations amount to a call for the West to
fix the current problems while investing in the future. We must ensure
that utilities and consumers remain financially solvent until new
sources of generation and demand reduction moderate prices. Perhaps the
only good thing that can be said for the current crisis is that it
offers the West an opportunity to think carefully about our future
power supplies and take steps to ensure adequate investments in
conservation, renewable energy and new base-load generation. These
developments would be aided by a coordinated effort to streamline
siting processes throughout the West so that we retain the essential
environmental and community safeguards while avoiding unnecessary
delays.
Mr. Chairman, that completes my testimony, and I would be pleased
to answer any questions.
The Chairman. Thank you very much.
Mr. John Gale. Mr. Gale comes to us as general manager of
pricing and regulatory services of Idaho Power in Boise, Idaho.
STATEMENT OF JOHN R. GALE, GENERAL MANAGER, PRICING AND
REGULATORY SERVICES, IDAHO POWER COMPANY, BOISE, ID
Mr. Gale. Thank you, Mr. Chairman and Senators. I am
speaking today from the Idaho Power Company's perspective, a
small utility operating in the Pacific Northwest. Idaho Power
is generally known for two things. It is predominantly
hydroelectric, probably relying the most on hydro facilities of
any investor-owned utility, and consequently it supplies
service to its retail customers at the lowest rates of all
investor-owned utilities.
Hydro is a mixed blessing, however. Hydro availability for
production varies from season to season and year to year.
Managing the supply situation is a challenge for a
hydroelectric company. We try to address this challenge through
adding to our portfolio thermal plants and purchasing from the
Northwest market. The Northwest market has proven to be a very
good tool for both public and private utilities for a number of
years, going back as many as 20. It helps the utilities in the
Northwest optimize their resources and provides a market for
them to sell into when they are in surplus situations.
Another way we try to manage our power supply situation is,
we have a rate-making mechanism within the State where we flow
through both the benefits and the cost of supplying power to
our customers. This benefit is flowed through on a sharing
basis so the shareholders of the company are responsible for a
portion, but we are able to let our customers see the price as
costs are imposed upon us.
We see this as an advantage in our rate-making process over
that in California, because our customers are able to see the
price, act on the price, make business decisions, decide crops
and so forth, based upon their power supply cost, and it also
provides a good signal for conservation efforts that they would
want to make.
Another advantage of having the rate-making mechanism is
that our creditors also know that we have that behind us, and
as they sell power to us, they know that they stand to be paid.
A last comment on the mechanism is the sharing mechanism
between the customers and the company provides an economic
alignment so all decisions about power supply are made for
everyone's best interest.
I talked about earlier this year. It could be the biggest
challenge for power supply in the Northwest. It is a bad
situation, and we are looking at a dry year with high prices.
For my company we are at 60 percent snow pack expected stream
flows in our Snake River Basin.
As far as prices are concerned, looking for the balance of
year of prices we could obtain today, we are looking at $350 a
megawatt hour for the balance of 2001. That is 35 cents a
kilowatt hour, to put it in a retail customer's perspective,
and we typically sell at 3 to 6 cents an hour. Excuse me, 3 to
6 cents per kilowatt hour.
What does that mean? As Senator Craig said earlier today,
we are already looking at a 24-percent increase going into the
spring. That will only get worse with the drier year, and could
easily double. The forecast, as we have said, is dry, and
typically in the Northwest once you get into a dry year you
stay in a dry year. Assumptions about returning to normal have
not been proven historically.
That leads me to some observations about California, and
specifically to the executive orders from the Secretary of
Energy. What is distasteful for other Northwest utilities is
that it prioritizes California in the market above other
States. We are in the same market. We are facing the same
problems and the same high prices.
A second problem with the executive order is that it makes
it uncertain on how to treat reservoirs as far as the drawdowns
to produce power. The reservoirs become our energy source for
next summer.
Lastly, as we approach spring we will hit a time when we
should have generation surplus. We would love to sell to
California at that time, love to sell into the best market we
possibly could. The reason is, at that time that is our chance
to offset our high cost we have incurred all winter, a chance
to reduce our customers' rates.
I will conclude on that remark.
[The prepared statement of Mr. Gale follows:]
Prepared Statement of John R. Gale, General Manager, Pricing and
Regulatory Services, Idaho Power Company, Boise, ID
Mr. Chairman and Members of the Committee, thank you for the
opportunity to address the Committee today on behalf of the Idaho Power
Company. Idaho Power's comments are based upon our perspective as a
hydro-based, investor-owned utility operating in the WSCC grid and
serving retail customers in Idaho, Oregon, and Nevada. We intend to
provide a northwest regional perspective on the California energy
situation and its impact to other states operating in the west. I am
John R. Gale, General Manager of Pricing and Regulatory Services for
the Idaho Power Company.
background
The Idaho Power Company, established in 1916, is an investor-owned
electric utility currently serving more than 380,000 customers in a
20,000 square-mile area including parts of southern Idaho, eastern
Oregon, and northern Nevada.
The Company presently operates seventeen hydroelectric plants,
including the 1,167-megawatt Hells Canyon Project and shares ownership
in three coal-fired plants located in Oregon, Nevada, and Wyoming.
During a normal water year, approximately 60% of the total power
generated by the Company is hydroelectric. This substantial commitment
to and investment in renewable hydroelectric resources allows Idaho
Power to provide its customers with electricity at some of the lowest
rates in the nation. In fact, among investor-owned utilities, the
Company has the lowest combined rates (residential, commercial, and
industrial) in the country.
characteristics of the california market at the beginning of
deregulation
At the outset of electric industry restructuring in California,
wholesale prices were well below retail prices. Excellent water
conditions in the Pacific Northwest further enhanced a substantial
regional surplus. At that time, California was dependent on imports for
approximately 20% of the load.
Demand for electricity was growing by 1,500 MW per year, however
new generating capacity and meaningful transmission were lagging
behind. Increased demands without additional generation within the
state or new transmission pathways for importing generation into the
state led to California's steadily declining reserve margins.
the new market structure proved to be flawed
As part of the restructuring, the California investor-owned
utilities divested of up to 50% of their generation without ``buy-
back'' provisions from the new owners. In addition, the new market
formed without the stabilizing effect of long-term energy contracts.
Consequently, 85% of the retail supply was necessarily acquired from
the spot market. Residential retail rates were reduced by 10% and all
rates were frozen through 2002, or until stranded generation costs
could be paid.
The expectation was that wholesale prices would continue to stay
below the retail prices with the net difference directed towards paying
off the above-market (or stranded) utility generation costs. What was
not contemplated, however, was the possibility that wholesale prices
for purchased power could increase in magnitudes and for sustained time
periods threatening the very structure of the new California market.
``California Travails, A Chronology of Events in California's
Energy Crisis'', a draft document prepared by the Edison Electric
Institute is included for reference purposes as Attachment 1 * to these
comments.
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* The attachments have been retained in committee files.
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what happened in 2000?
A combination of factors led to demand overtaking supply during
2000. Weather became more severe in the west with both a hotter summer
and a colder winter. In addition, the Pacific Northwest was confronted
with the first low hydro year since 1992. Excessive thermal plant
outages combined with decreased hydro generation capabilities further
reduced regional supply. To make matters worse, natural gas prices hit
record highs at $60 per MMBtu. Since most new electric generation
utilizes natural gas as its fuel, the two energy prices began to move
in parallel. Electric prices also hit record highs reading as much as
$5,000 per MWh and averaging $300 per MWh for the year.
Attachment 2 and Attachment 3 are graphs indicating fourth quarter
2000 market price changes for natural gas and electricity respectively.
the california electric system gets stretched to the breaking point
In order to continue serving their respective retail customers, the
California utilities continued buying power at expensive spot market
rates although their retail prices were fixed. After eight months the
combined debt reached $12 billion. The debt, in turn, caused counter-
parties to be concerned about the ability of the California utilities
to pay for their purchased power. As suppliers became reluctant to sell
into the California market, the Secretary of Energy began to issue
executive orders applicable to most western generators and marketers
requiring sales to continue.
In early January 2001, the CPUC authorized some interim rate relief
to the utilities through increased retail rates. Ultimately the
increased rates proved insufficient as the utilities' stock prices
plunged, their credit rating devalued, and bankruptcy looms.
is there a solution?
Idaho Power realizes that no state enjoys hearing advice from other
states on how to fix its problems. Our comments are given as
observations from an entity somewhat removed from the immediate crisis.
In our view, there appears to be certain actions that, if taken, could
begin addressing some of the structural problems in the California
market.
First, it is our belief that showing customers the true cost of
electric energy will help to reduce the demand for electricity. When
retail rates accurately reflect cost, then customers can make
appropriate economic decisions regarding energy usage, conservation
measures, load control programs, alternative energy sources, and new
sources of supply. When retail prices do not cover costs, the utilities
are left with a shortfall that cannot be made up on volume. In
addition, existing suppliers and new generation developers will respond
favorably when the retail prices rise to a level that allows for
recovery of wholesale costs because they have more confidence in the
utilities ability to pay for their product.
Second, the California market would function more efficiently with
some reforms such as credit support for the existing debt from either
the state or federal government. Additionally, the settlement process
could be shortened to time periods that are more typically prevalent in
the industry. Faster settlement would ease some liquidity pressure on
suppliers. The introduction of forward contracts would also provide
some risk management tools for those buying on behalf of retail
customers.
The third recommendation is to incorporate a long-term view to the
supply of power. For instance, generation siting needs to be more
flexible and expeditious. Grid expansions also would facilitate a more
fluid electric market with potentially additional participants. A
diversified fuel mix, including renewables, will contribute to the
stabilization of price volatility. Finally, increased applications of
customer and utility distributed generation will provide further supply
options for the future.
impact to idaho
Idaho Power's strong reliance on hydro generation produces both
benefits and detriments to the Company and its customers. Under normal
water conditions and markets, Idaho Power is the least cost provider
among all investor-owned utilities. The abundant supply of inexpensive
energy consequently has contributed to the growth of an industrial and
agricultural base across southern Idaho.
On the other hand, hydro generation causes both supply and cost
management problems for Idaho Power due to the variability of stream
flows and their corresponding effect on hydro generation output. The
management challenge is further contingent on additional demands for
river operations such as recreation, flood control, and fish
restoration.
In order to respond to wide fluctuations in hydro generation, Idaho
Power supplemented its hydroelectric production with coal-fired
generation plants that supply reliable resources from an availability
aspect but tend generally to be more expensive to operate relative to
hydro due to the addition of fuel costs. Furthermore, both seasonal and
annual fluctuations in stream flow conditions led Idaho Power to early
and active participation in the northwest wholesale power market. The
active northwest energy market benefited Idaho Power and its customers
for a number of years because our peak energy loads and surplus
generating opportunities came at different time periods than our
neighboring utilities.
As power purchases and fuel costs became increasingly more
important to Idaho Power's financial well being, the Company, along
with its customers and regulators, developed a ratemaking mechanism
that allowed for the transfer of most, but not all, of the power supply
costs and revenues to the Idaho retail customers. By leaving a portion
of the costs and benefits for absorption by the Company's shareholders,
the mechanism aligned the customer's and the Company's economic
interests at all times. Therefore, whenever Idaho Power is in the
market, either to buy for its system requirements or to sell its
surplus generation, its customers have the major interest in optimizing
the transactions that is, receiving the lowest price when buying and
the highest price when selling.
The California energy situation impacts Idaho Power in multiple
ways. To begin with, Idaho Power, along with many other western
utilities, frequently accesses the same energy markets as California.
Current California demands ripple throughout the whole western grid.
The increased prices we pay for power reflects the effect of the
California situation on the market. Idaho Power Company's power supply
costs during the last eight months have hit levels previously unheard
of or even contemplated. At this point in time our Idaho retail
customers are looking at a 24% overall rate increase this spring with
possibly even greater increases if our currently dry winter continues.
Attachment 4 shows Idaho Power's actual net power supply expenses over
the last eight months compared to expected expenses and normal
expenses. In December alone, the Company spent $70 million more than
expected. Attachment 5 demonstrates the cumulative effect of increased
power supply expenses over the eight-month period.
The Secretary of Energy's executive orders compound the problem for
us in several ways. First, they create uncertainty in market operations
as western energy suppliers sort through their California obligations
before responding to others in need of power. Second, the executive
orders create additional uncertainty for hydro operators who
contemplate whether to draft reservoirs in the middle of winter to
serve California loads. Drafting reservoirs now could prove to be
extremely detrimental to our native retail customers as the Company
faces its own system deficiencies this summer with below normal water
conditions. Under the direction of our governor and our state
commission, Idaho Power has not drafted its reservoirs to date.
However, as this spring progresses there will be the possibility
that Idaho Power's system generation could exceed our retail customers'
needs. River operations, due in part to flood control considerations,
usually require the Company to draft reservoirs in late February and
March. At these times, Idaho Power will have the opportunity to sell
its surplus power on the market. The Company and its customers would
like to obtain the best possible price at this time because the
revenues from surplus sales offset the high power purchase costs the
Company has been experiencing. Obviously after buying all winter
without the benefit of wholesale price caps, the Company does not
desire to sell into a market where they are imposed. Furthermore,
should Idaho Power generate surplus power to sell in the market, it is
imperative for both its customers and shareholders that it be paid for
those sales.
As stated above, Idaho Power and its customers are looking at a
challenging year from a power supply perspective with significant rate
increases likely for this spring. The Snake River agricultural base
will be hit particularly hard because of their dependence on high load-
factor electric pumps to irrigate fields. Asking these farmers to pay
for power supply costs driven up by the action of others is not an
acceptable solution.
hydro relicensing
Another contributor to supply and reliability problems is the loss
of non-federal hydroelectric power due to the cumbersome and costly
hydroelectric relicensing process. Hydroelectric power plays a critical
role in western energy supply, particularly as it relates to meeting
peak demand. In the Idaho Power system and in other parts of the
Northwest, hydropower contributes to over half of our energy supply. In
a recent government study, it was revealed that hydroelectric plants
are losing on average approximately 8% of their generation capacity due
to conditions placed on the licensee. These are conditions that Federal
natural resource agencies can place on a licensee without regard to how
it effects the loss of generation, economics, recreation, or other
ancillary attributes of a facility. Hydropower is a clean, renewable,
and efficient generation resource and we can ill afford to lose this
valuable asset. I urge you to support legislation, such as that
introduced by Senator Larry Craig (S. 71) that restores balance into
the relicensing process. Three attachments are included in support of
hydroelectric Relicensing reform. Attachment 6 is a copy of testimony
the company recently submitted at informational hearings conducted by
the Federal Energy Regulatory Commission. Attachment 7 and Attachment 8
are two background papers outlining basic facts about hydropower and
examples of some of the problems associated with the current
relicensing process.
summary
Rising natural gas prices, poor streamflow conditions, and a
disintegrating California power market have combined to create a
turbulent year for energy providers and their customers. Utilities seek
to provide essential services while having to purchase shortfalls in an
unforgiving market. In turn, rates must go up to cover the additional
costs while customers and utilities both try to optimize their energy
dollar.
Idaho and Idaho Power are no exceptions as we and our customers
face what may be our most challenging year. Additional burdens created
by federal mandates directing preferential treatment for another
state's energy crisis are not warranted nor welcome.
We would ask that additional federal executive orders not be
extended and that California look to itself first in seeking to resolve
its energy problems.
Finally, as a predominately hydroelectric company, we would endorse
relicensing reform as a means of preserving some of the supply we enjoy
today.
The Chairman. Thank you very much. I think you have pretty
much painted the picture from Idaho Power's point of view.
We will move to Mr. Brett Wilcox. Mr. Wilcox is chief
executive officer of the Golden Northwest Aluminum,
Incorporated, in The Dalles, and I assume you will be prepared
to tell us whether it is better to be in the aluminum business,
or the business of reselling power as opposed to making and
selling aluminum.
STATEMENT OF BRETT E. WILCOX, CHIEF EXECUTIVE OFFICER, GOLDEN
NORTHWEST ALUMINUM INC., THE DALLES, OR
Mr. Wilcox. We operate two primary aluminum smelters in
Goldendale, Washington, and The Dalles, Oregon. We employ 1,225
highly paid workers at full production. Unfortunately, our
primary aluminum production now is almost completely curtailed.
The reason is simple. Power prices in the West are simply too
high to produce aluminum. Some other energy-intensive
manufacturing companies also have had to curtail production.
Soon, many more jobs in industry and agriculture will be lost.
Make no mistake about it, the energy crisis is not just
about electricity bills, it is also about paychecks. So far our
company has been able to mitigate the impact of higher power
cost because we purchase some of our power under long-term
contract with the right to remarket power we did not use.
Through agreements with the Bonneville Power Administration and
our union, we were able to reduce consumption, remarket power,
and use the net financial benefits to protect our workers,
share with BPA, and help pay for new conventional and renewable
power resources.
The electricity crisis in California has adversely affected
the entire West Coast. Some of the causes are obvious, shortage
of generation, low average hydropower, gas and power
transmission bottlenecks, and increases in natural gas prices,
but the most frustrating cause is the rules California adopted
for electricity restructuring have themselves driven up prices
not only in California but in the Northwest.
The sharp drop in demand that usually follows a sharp
increase in the price of any commodity has not yet occurred in
California because most end users there have not yet received
price signals of the crises. Instead of higher prices balancing
the market, Californians have experienced rolling blackouts.
In the short term there are few ways to increase supply. We
need to speed up the permitting process required to develop new
generating resources We can also temporarily relax some
powerplant emission controls, as Governor Locke of Washington
has announced, and we need to remove constraints on hydro
operations, especially spilling water, that significantly
reduces power generation without really helping endangered
salmon.
Near-term responses need to focus on ways to reduce demand.
Demand reductions will occur. The issue is how to ensure that
they do not destroy the economic well-being of the West in the
process. End-use consumers cannot be spared the rate impacts of
high power costs for long, but the way in which we pass those
high costs through to them will determine how they affect the
economy.
If soaring wholesale power costs drive up the average
melded cost of every kilowatt hour of power, then residential
customers will be hit hard not only in their utility bills, but
even harder in their paychecks. This is because any significant
increase in the average cost of all power will shut down large
portions of manufacturing, business, and agriculture. The same
is true of California as the Northwest. In a competitive global
economy, even a small increase in the average cost of a
company's entire power supply could make its entire operation
uneconomic.
The alternative is to make end-use consumers feel the full
impacts of higher wholesale power cost at the margin. This
gives real price signals. Increase in consumption requires
someone to buy very expensive power. The end-use consumer
should feel that cost. Decrease in consumption reduces the need
to buy expensive power, and end-use consumers should experience
that savings, too.
Businesses can conserve energy at the margin, ensuring that
the bulk of their production continues to be competitive. For
example, a farmer can take some marginal acreage out of
production rather than being forced out of business altogether
because of a large increase in the average cost of its entire
irrigation load.
A very practical application of this is possible in the
Northwest through BPA. Until recently, BPA planned to continue
selling power to customers for about $25 per megawatt hour. Now
BPA expects to pay $125 per megawatt hour to buy the power it
needs to meet its load. This will lead to large increases.
Instead of melding high cost purchases with low-cost
supply, BPA should divide each customer's purchases into two
parts. The larger part could be supplied without buying
expensive additional power. The smaller part would represent
the portion that Bonneville has to buy at high cost. Each
customer would be able to turn the higher cost portion back to
BPA, allowing BPA either to remarket it at a higher market
price and credit the proceeds against the customer's bill, or
to reduce the amount that BPA itself must pay. This not only
helps the customer and the economy, but also ensures BPA
repayment.
I know this idea can work, because our company has already
pioneered it with BPA. We curtailed our smelting load, returned
the power to BPA, and are putting the marketing proceeds to
beneficial use. What I am proposing here is an adaptation of
that successful effort. It could apply broadly to all BP
customers. This would significantly reduce BPA's need for power
and cost. Only a broad effort can spare deep pain.
Thank you very much.
[The prepared statement of Mr. Wilcox follows:]
Prepared Statement of Brett E. Wilcox, Chief Executive Officer, Golden
Northwest Aluminum, Inc., The Dalles, OR
Good morning, Chairman Murkowski and Members of the Committee. My
name is Brett Wilcox. I am the CEO of Golden Northwest Aluminum, the
corporate parent of Goldendale Aluminum Company and Northwest Aluminum
Company. We own and operate two primary aluminum smelters and
associated facilities in Goldendale, Washington, and The Dalles,
Oregon. We are by far the largest employer in these beautiful but
economically distressed rural areas. We employ a total of 1,225 highly
paid workers, at full production.
Unfortunately, we are no longer at full production. Our primary
aluminum production is now almost completely curtailed. The reason is
simple: power prices in the West are currently too high to support
aluminum production. Other energy intensive manufacturing companies
that are exposed to the market price for power also have had to curtail
production. Soon, when high market prices for power purchases are
passed through rates charged by the Bonneville Power Administration and
local utilities, other Northwest manufacturing and industrial jobs, as
well as agricultural jobs that depend on irrigation pumping , will be
lost. Make no mistake about it: the crisis in the West is not just
about electricity bills. It is also about paychecks.
So far, our company has been able to mitigate the impact of higher
power costs because we purchased some of our power under long-term
``take-or-pay'' contracts with rights to remarket any power that we
didn't use. Through agreements with BPA and our union, the United
Steelworkers of America, we were able to reduce consumption, remarket
the power made available, and use the net financial benefits in the
Northwest to protect our workers, share with BPA, and help pay for new
conventional and renewable power resources to supply a portion of our
long-term power requirements. I've attached to my testimony our release
explaining our curtailment and remarketing.
The electricity crisis in California has adversely affected the
entire west coast. Some of the causes are obvious: physical shortages
of generating capacity, below normal precipitation and hydro power,
bottlenecks in power transmission and gas pipeline capacity, increases
in the price of natural gas, and resource outages. But the most
frustrating cause is that the ``rules of the game'' California adopted
for electric power restructuring--unlike the rules in other states--
have themselves driven up prices not only in California, but in the
Northwest as well.
The sharp drop in demand that usually follows a sharp increase in
the price of any commodity has not yet occurred in California, where
most end-users have not yet received any ``price signal'' of the
crisis. Instead of higher prices balancing the market, Californians
have had to experience rolling blackouts. In the Northwest, however,
the price impacts are now being felt by end-users. The full force was
felt first by the aluminum smelters, then by the industrial customers
of several large utilities. Now it is about to be felt by almost
everyone in Washington, Oregon, Idaho, and western Montana.
This crisis has few short-term fixes to increase supply. We do need
to speed up the permitting process required to develop new generating
resources and to build new power transmission and gas pipelines. One
short-term way to increase the supplies of power is to the temporary
relaxation of some power plant emission controls, as Governor Locke of
Washington has just announced. We also need to review and remove
constraints on hydro operations--especially spilling water--that
significantly reduce power generation without really helping endangered
salmon.
Near-term responses need to focus on ways to reduce demand. Demand
reductions perhaps massive ones--will occur. The issue is how best to
manage them, and how to ensure that they do not destroy the economic
well being of the West. End-use consumers can't be spared the rate
impacts of high power costs for long. But those high costs can be
passed through in two ways: either by melding costs and raising the
average rate of every kilowatt-hour, or by passing through actual high
market prices just on the marginal kilowatt-hours of consumption.
If soaring wholesale power costs drive up the average cost of
power, then residential customers will be hit hard not only in their
utility bills, but even harder in their paychecks. This is because any
significant increase in the average cost of power will shut down a huge
portion of Northwest manufacturing, industry, and agriculture--and
presumably the same is true in California. In a competitive global
economy, even a small increase in the average cost of its entire power
supply can make a company's entire production uneconomic.
The alternative is to make end-use consumers feel the impact of
higher wholesale power costs at the margin. This gives real price
signals. Increases in consumption require someone to buy very expensive
power: the end-use consumer should feel that cost. Decreases in
consumption reduce the need to buy very expensive power: the end-use
consumer should experience that saving. Businesses can conserve energy
at the margin, ensuring that the bulk of their production continues to
be competitive. In agriculture, for example, a farmer can take some
acreage out of production for a period, rather than not being able to
farm at all because of a large increase in the cost of his entire
irrigation load.
A very practical application of this is possible in the Northwest
through the Bonneville Power Administration (``BPA''). BPA supplies
forty-five percent (45%) of all power in the Northwest. Until recently,
BPA planned to continue selling power to utilities at $20-$25 per
megawatt-hour (``MWh''). Now BPA expects to pay $125/MWh to buy the
power it needs to meet its load growth. As a result, BPA last week
announced a sixty percent (60%) rate increase for its customers for the
entire next five years. This comes on top of very large rate increases
many Northwest utilities have already imposed on their retail
customers.
Dividing each customer's purchases into two parts could mitigate
this situation. The larger and less expensive portion would be power
that BPA can supply without buying expensive additional supplies in the
market. The smaller and much more expensive portion would represent the
portion that BPA must spend huge sums to buy. Each customer should be
able to turn the latter portion back to BPA, allowing BPA either to
remarket it at high market prices and credit the proceeds against that
customer's power bill, or to reduce the amount that BPA itself must buy
to meet its customer's loads. This not only helps the customer and the
economy, but also ensures that BPA can meet its treasury payments no
matter what happens to the wholesale cost of power.
I know this idea is practical and can work. I know because our
company has already pioneered this with BPA. We curtailed our smelting
load, returned the power to BPA for remarketing, and are putting the
remarketing proceeds to beneficial use. Demand for power is temporarily
reduced, BPA is on a sounder financial footing, our workers are still
getting paid, and we are putting money aside to develop new power
sources, including wind generators. What I'm proposing here is an
adaptation of that already-successful effort, but one that could apply
broadly to all BPA customers, reducing overall BPA requirements by
perhaps ten to fifteen percent (10-15%). Only a broad effort can spare
everyone deep pain.
I've attached to my testimony a paper showing how this concept can
work to save aluminum jobs and other jobs throughout the Northwest
until the day when power supplies increase and power prices become more
reasonable. I hope you will review this paper and contact me with any
questions. I hope you will urge BPA to implement this approach.*
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* The paper has been retained in committee files.
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Finally, turning to the long-term, there are many potential
solutions that have been covered by others here today. I would like to
mention one additional solution that deserves more attention. The vast
reserves of natural gas in Alaska, the Beaufort Sea, and northern
Canada are a key to the long-term energy supply and continued economic
prosperity of the United States and Canada alike. Left to their own
devices, market forces will eventually be sufficient to get this gas to
the Lower 48--but the gas will arrive here more slowly, in smaller
volumes, and at higher prices than would be optimal for the North
American economy.
This is an instance where market forces could use some help in the
form of active diplomacy and initiative by the U.S. and Canadian
governments. The obstacles to an optimal timing, volume, and price of
northern gas are primarily economic obstacles within Canada--
particularly the perceived interests of those who benefit from today's
high gas prices and today's constrained limits on available pipeline
capacity. Those interests are legitimate, but they can be reconciled
with the broader interests of the economic health of both nations. If
this happens and the two governments, working together, can bring it
about then the northern gas should be able to get here quickly, in
large volumes, and at prices low enough to spur decades of continued
economic prosperity.
Thank you for your time and consideration.
The Chairman. Thank you very much.
Mr. Mark Crisson, director and CEO of Tacoma Public
Utilities, and again, none of you from the Pacific Northwest
have mentioned the potential availability of power from British
Columbia. Maybe somebody will, but I just wanted to remind you.
I see we have a volunteer, Judi Johansen, who is next in line,
so my question, while you think about it, is, can we not just
go up to British Columbia and pay the price?
Mr. Mark Crisson, please proceed.
STATEMENT OF MARK CRISSON, DIRECTOR/CEO, TACOMA PUBLIC
UTILITIES, TACOMA, WA
Mr. Crisson. I am Mark Crisson, director of Tacoma Public
Utilities in Tacoma, Washington. Our largest division is Tacoma
Power, which serves 150,000 customers and operates 700
megawatts of hydroelectric capacity.
As you have heard from our earlier panelists, the Northwest
is experiencing very dry weather conditions. Mr. Gale from
Idaho said he has 60 percent snow pack. That sounds pretty good
to me. We are looking at about 45 percent. Our inflows are the
lowest of 80 years of historical record right now, and
consequently our hydro facilities are greatly under-performing
their planned levels, and we are having to turn to these West
Coast power markets for about 25 percent of our power needs,
and we have heard about the prices in the power markets.
This is having a drastic effect our financial resources. I
estimate that with continuation of current weather and market
conditions we will exhaust our entire $130 million cash
reserves by April, and that is with our rate surcharge in
place. We put a 50-percent rate surcharge in place in December.
In the meantime, other Northwest utilities have started to
follow suit.
Snohomish Public Utility District in Everett, Washington,
did 35 percent. Seattle City Light has done 28 percent to date.
Yesterday they reported that by October that may have to go up
to a total of 75 percent in order to pass through the full
effect of Bonneville's projected increase of 95 percent that
was mentioned earlier in the panel discussion.
Clearly, this is a regional problem, perhaps even a
national problem, and the impacts of our power surcharge are
already being felt in our community. While our rates have
historically been low, our per capita usage is higher than
average, resulting in bills that are equal or above the
national average for our residential customers, so the increase
in the bills from Tacoma Power will create significant hardship
for many in our community.
Moreover, many energy-intensive industries have located in
the Northwest and in Tacoma in reliance on low power prices.
The recent surcharge, together with steep increases in natural
gas prices, have already forced several of our industries to
curtail their operations or suspend production altogether. For
example, Louisiana Pacific, Pioneer Chemical, who was our
largest customer, Schnitzer Steel, and Atlas Foundry have all
either curtailed or suspended operations. It should be noted
this happened before the full impact of our surcharge is even
reflected in their bills.
We have taken a number of steps on the surcharge in trying
to deal with this crisis. We brought in an additional new power
supply by installing 50 megawatts of temporary diesel
generation with the best available control technology to try to
address our power shortage. These are not cheap, but at current
power prices we are saving $300 to $400,000 a day in purchase
power with these in operation.
We are also promoting conservation in our service area
through advertising, direct customer contact, and product
promotion. Our city council has adopted a resolution that sets
an aggressive conservation target of 20 percent in our
community.
I do believe there is a Federal role in this crisis. The
Federal Energy Regulatory Commission is being called upon by my
utility as well as by a host of others to temporarily
reestablish cost-based rates and, if necessary, firm price caps
in Western energy markets. Unfortunately, a current majority of
the commission appears more concerned with not interfering in
what is clearly a dysfunctional market than they are in
fulfilling their prime directive under the Federal Power Act
that wholesale rates be just and reasonable. In order to avoid
further utility insolvency and to mitigate the rate impact on
all consumers, it is time for FERC to impose cost-based pricing
or caps on a temporary basis.
I want to emphasize that insolvency is a continuing concern
for Tacoma Power. Even with our 50-percent surcharge in place,
we will need to borrow nearly $100 million between now and
October to pay our purchase power bills. We just cannot raise
the rates fast enough to keep up with what we are seeing in
these markets.
Many of the steps we have talked about today are fine, but
they just do not address the short-term problem. In my opinion,
we have a house that definitely needs to be put in order, but
the house is on fire, and we need to put the fire out before we
worry about remodeling.
One panelist earlier was concerned that such steps might
distort the market. In my view, we are ready for some changes.
Distortion in this market might be an improvement.
Mr. Chairman, many concerns along these lines can be
addressed in how the pricing mechanism is structured and
applied. That is why there needs to be a healthy discussion
about the form of the pricing mechanism. The point is that the
debate at the Federal level should be how best to reestablish
the link between cost and price in these markets, not whether
it should be done.
Let me just conclude by saying that our problem in Tacoma
and, I think, in the region can only be remedied in the short
term by a return to cost-based power pricing or more
precipitation in the Northwest, but not even Congress can make
it rain, so Tacoma supports legislation to direct FERC or an
appropriate party to fulfill the mandate of the Federal Power
Act to assure just and reasonable wholesale rates in Western
markets through temporary cost-based pricing, as described
above.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Crisson follows:]
Prepared Statement of Mark Crisson, Director/CEO, Tacoma Public
Utilities, Tacoma, WA
Mr. Chairman and members of the Committee, I am Mark Crisson,
Director/CEO of Tacoma Public Utilities in Tacoma Washington. The
Department provides power, water, and rail services to Tacoma and
vicinity. Our largest division is Tacoma Power, which serves 150,000
customers and has an annual budget of approximately $250 million. The
utility owns and operates four hydroelectric projects comprising a
total electrical capacity of over 700 megawatts.
The Northwest is currently experiencing very dry weather, which is
resulting in record low inflows to our power projects. Consequently,
our hydroelectric facilities are significantly under-performing in
relation to their planned levels, and we must purchase power in the
western wholesale markets to replace this shortfall. Unfortunately,
these markets are experiencing unprecedented price levels that are
presently 10-15 times normal and at times have been as much as one
hundred times last year's levels. This has had a drastic effect on our
financial resources: we estimate that with a continuation of the
current weather and market conditions, we will exhaust our $130 million
cash reserve by the end of April.
With the support of the Public Utility Board and City Council,
Tacoma Power responded decisively by implementing a 50% electric rate
surcharge on December 20. In the meantime other Northwest utilities
have also imposed surcharges or announced rate increases, including
Seattle City Light and Snohomish Public Utility District. Last week
Bonneville Power Administration announced it will require a rate
surcharge of 95% in October and estimates rates will average 63% above
current levels over the next five years. As you can see, the power
supply and price impacts of California's problems extend well beyond
California: the Northwest has been adversely impacted as well. And as
Chairman Greenspan testified last week, and as President Bush noted
this week, this mess could undermine the country's economic expansion,
making this not just a regional problem, but a national one.
The impacts of our power surcharge are already affecting the Tacoma
economy and our community. While our rates have historically been low,
our per capita usage has been higher than average, resulting in bills
that are equal to or above the national average for residential
customers. The increase in these bills will create significant hardship
for many in our community, particularly low-income residential
customers using electric heat and water heat. Moreover, many energy-
intensive industries have located in the Northwest and in Tacoma in
reliance on low power prices to enhance their costs of production. The
recent surcharge, together with steep increases in natural gas prices,
has forced several of our industries to curtail their operations or
suspend production altogether, e.g. Louisiana Pacific, Pioneer
Chemical, Schnitzer Steel, and Atlas Foundry. It should be noted that
this has happened before the full impact of the surcharge is reflected
in customer bills.
In addition to the surcharge, Tacoma Power has taken a number of
other steps in response to this crisis. First, we have tightened our
belt considerably, reducing all unnecessary capital outlays and putting
system expansion plans on hold. Second, we have secured additional new
power supply by installing 50 megawatts of temporary diesel generation
(with best available control technology) in our industrial area. These
units began operation this week, and are saving us $300-400,000 per day
in purchased power expense. Third, we are strongly promoting increased
conservation in our service area through advertising, direct customer
contact, and product promotion. Our City Council has also adopted a
resolution that sets an aggressive conservation target of 20% for our
community. And, finally, we are working with state and federal
government regulators and legislators to address the energy problem.
With regard to this last point, Governor Locke has tackled the
energy problem by introducing a bipartisan package of legislation aimed
at promoting new supply and increased conservation. He also declared a
state-wide energy alert last week to facilitate operation of temporary
additional generating sources and to require conservation on the part
of public sector agencies. Tacoma, other Northwest utilities, and the
State of Washington have all stepped up and taken meaningful, and often
difficult, actions to address this dilemma--it's now time for the
federal government to help.
While the problems in California may be largely self-inflicted,
their effects are regional and national in scope. Moreover, in creating
the Independent System Operator, California essentially federalized the
matter, since the ISO is under jurisdiction of the Federal Energy
Regulatory Commission. FERC has been called upon by my utility, as well
as by a host of others (the states of Washington, Oregon, California,
Seattle City Light, and the California Municipal Utilities, to name a
few) to temporarily re-establish cost-based rates and/or firm price
caps in western energy markets. Unfortunately, a current majority of
the Commission appears more concerned with not interfering in what is
clearly a dysfunctional market than they are in fulfilling their prime
directive under the Federal Power Act that wholesale rates be just and
reasonable. California is taking steps to right its ship, but most of
the steps are aimed at avoiding utility bankruptcy or facilitating the
acquisition of new supply. It's not clear the state's actions will have
any beneficial impact on the near-term price of wholesale power. In
order to avoid further utility insolvency and to mitigate the rate
impact on all consumers, it is time for FERC to impose cost based
pricing and/or price caps on a temporary basis.
FERC should move quickly to take three steps. First, it should
define standards for what comprises a competitive market. Second, it
should then require cost based rates and/or price caps for markets
which do not meet this standard. Third, it then needs to establish some
process for monitoring operation and compliance in the markets.
Most concerns with price caps in this instance are not well
founded, particularly since their implicit premise is a functional
market. Many concerns can be addressed in how the pricing mechanism is
structured and applied. That is why there should be a healthy
discussion about the form of the pricing mechanisms, since this new
territory. For example, one approach would be to use a multiple of the
price of natural gas as the basis for a price cap, with exceptions
allowed only when it can be demonstrated that actual unit-specific
costs exceed that level. The point is that the debate at the federal
level should be how to best re-establish the link between cost and
price in these markets, not whether it should be done.
Our residents, businesses, and industries are all suffering severe
economic impacts due to higher power and energy prices. This situation
can only be remedied in the short term by a return to cost based power
prices or more precipitation in the Northwest. But not even Congress
can make it rain, so Tacoma supports legislation to direct FERC or an
appropriate party to fulfill the mandate of the Federal Power Act to
assure just and reasonable wholesale rates in western markets through
temporary cost based pricing as described above.
That concludes my testimony. Thank you, Mr. Chairman.
The Chairman. You realize, Mr. Crisson, you are challenging
the ability of the lobbyists, who are often referred to as
rain-makers.
Mr. Crisson. We are definitely throwing down the gauntlet
to that group, sir.
[Laughter.]
The Chairman. Well, the proof is in the pudding, and we
have not had either one yet.
Ms. Johansen of Pacific Corp is executive vice president
for regulatory and external affairs.
STATEMENT OF JUDI JOHANSEN, EXECUTIVE VICE PRESIDENT,
REGULATION AND EXTERNAL AFFAIRS, PACIFICORP, PORTLAND, OR
Ms. Johansen. Thank you very much. The nice thing about
batting clean-up is there is not much left to say.
The Chairman. There is one more.
Ms. Johansen. I was speaking on his behalf.
PacifiCorp is the largest private utility outside the State
of California. We have the pleasure of serving in six States in
the Western region, and we serve over 1.5 million customers.
As I sit here today, I think about the context of this
debate. There has been a lot of discussion about price caps and
economic theories. I sit here thinking there is a very high
probability that the West Coast will face blackouts this summer
due to the very events that people have discussed earlier, so
our task is not simply what do we do for the long term, but
what do we do for this summer and for the next few years.
I would like to echo the call that several have made for
the immediate imposition of some sort of cost-based price caps
on wholesale sales. We, like other utilities, are seeking
emergency rate relief today. We are before the Utah commission
seeking emergency relief to keep our utility in good financial
shape, so those price caps can only stem some of the bleeding
that we are all feeling.
There is an urgent need because of the situation for this
summer for Federal and State political leaders to immediately
appropriate funds and create emergency incentives for more
conservation to compliment what is already being done.
Third, the Federal Government must stop extending the DOE
order compelling sales of power from Northwest utilities into
uncredit-worthy parties in California.
One point that has not been mentioned here today, the
California Power Pool, the PX, has a very odd mechanism whereby
if one party defaults the other parties pay their bill. With
Southern Cal Edison defaulting on its payment to the PX, my
company this week received a bill for their debt, and we are
expecting an even larger bill for their debt in addition to the
burden that we currently take on.
That is an untenable position, and Senator Murkowski
appropriately points out that it creates a takings liability
for the Government to compel us to continue to participate in
those markets.
Access to capital is being hindered by the repercussions of
the California situation. Our own utility is facing increasing
cost and limitation on access to capital, and it comes at a
very difficult time, because the very fix we need is
investments in the infrastructure, so we need the Federal and
State leadership to assure the financial markets that you will
take actions to assure that our investments will be sound.
Finally, I will comment on the Canadian situation. There
are two thoughts that come to mind. First of all, while Canada
has significant generation resources, they, too, are a hydro-
based utility, or have a hydro-based system. They, too, are
suffering the same drought conditions, but that being said,
they have been significant participants in this West Coast
market and I would urge that, as we look at price cap
solutions, we also assure that somehow the Canadian
participants in the California markets and in the West Coast
market somehow be caught under the net of that regulation as
well.
Thank you very much for your time.
[The prepared statement of Ms. Johansen follows:]
Prepared Statement of Judi Johansen, Executive Vice President,
Regulation and External Affairs, PacifiCorp, Portland, OR
Mr. Chairman and members of the Committee, my name is Judi
Johansen. I am Executive Vice President for Regulation and External
Affairs at PacifiCorp. My company is an electric utility that provides
retail service to nearly 1.5 million customers in six western states.
We have about 8,000 megawatts of electric generating capacity in nine
states, and approximately 15,000 miles of transmission lines across the
west.
PacifiCorp has not been a major player in California competitive
markets since deregulation was implemented there in 1998. The
California market presented few opportunities and increasing risk over
time, so PacifiCorp has had small exposure in California. We do
continue to provide service to about 45,000 retail customers in the far
northern part of the state.
Coupled with substantial growth in other parts of our own service
territory, PacifiCorp has not had a substantial amount of electricity
to sell to the California Independent System Operator since the forced-
sale emergency orders were issued, beginning more than a month ago.
That is not to say, however, that our company and customers are
immune to the problems in California. The western region is a highly
interconnected grid that has spawned a region-wide wholesale power
market. California represents at least 30 percent of the western
market.
PacifiCorp is in the wholesale market even though our generation
portfolio roughly meets our load requirements. Generally, the company
needs to purchase power to meet peak needs, both seasonally and daily.
Peak power is generally the most volatile market; the cost of this
power can be several multiples of off-peak prices.
As a result, we have filed applications to account for
extraordinary power costs and, in some cases, to begin recovering those
costs from customers. We believe the volatility in peak markets has
largely been driven by a combination of decreasing generation reserves
plus flaws in the California structure that drove so much of that
state's procurement into the spot market.
The company and our customers are also exposed to the California
utilities' defaults on obligations to the California Power Exchange
(PX). This is due to a convoluted, inequitable provision in the PX
system that assigns the obligations of defaulted PX participants to
entities still involved in the PX. When Southern California Edison
defaulted on its payment obligation to the PX two weeks ago, the PX
sent other PX participants bills for shares of this obligation, based
on their proportionate piece of the PX market. In PacifiCorp's case,
this bill represented about $2 million or one percent of the defaulted
obligation.
The volatile, costly wholesale market and collapsing PX are two
significant manifestations of the shock waves California has sent
through the west. Now, California is in the midst of significantly
changing its deregulation statute and policy makers here in Washington
and in every western state capital are considering what needs to be
done to bring demand and supply back into balance and otherwise
stabilize the market.
PacifiCorp is eager to engage in these discussions. In fact, the
company gathered a series of regional stakeholders last October to
discuss the problems that arose last summer and steps to alleviate
future supply shortages. While nobody at that forum predicted the dire
consequences that would befall the west less than two months later, I
do believe we began an important dialogue.
Whatever path federal and state leaders choose, the path must be
one that works for electric consumers. Customers want prices to be
stable and reasonable and they want service to be reliable. PacifiCorp
aspires to remain a low-cost provider of electricity and to provide
world-class customer service. Our new service standards and commitments
will meet these aspirations.
The fundamental requirement on all stakeholders is to take steps to
balance supply and demand. In each case, it is vital to have a
regulatory and investment climate conducive to meeting the following
objectives:
tempering demand growth with price signals and other
opportunities to encourage energy efficiency;
facilitating the reliable, economic delivery of electricity
over the western transmission grid;
providing greater certainty over the terms and conditions
under which generating facilities already in operation may run
over the next 10-20 years;
creating an environment conducive to investments in new
generation resources.
PacifiCorp has been working with state regulators and customers to
enhance energy efficiency and load reduction both immediately and in
the long term. We urge the Congress to give serious consideration to
tax policies that encourage investments in energy efficiency such as
those embodied in S. 2718 from the 106th Congress.
With respect to enhancing transmission, PacifiCorp has been leading
the effort to form RTO West in response to FERC Order 2000. We believe
the current situation makes establishment of RTO West even more
valuable than ever. Creation of RTO West will make grid operations more
efficient and facilitate construction of new generation. While the
company has not taken a position on proposals to provide the FERC with
eminent domain authority to site new transmission facilities, it is
worth noting in the west that significant existing and future
transmission corridors are located on federal lands. Federal agencies
should work constructively to locate facilities expeditiously and
permit their construction and operation in a cost-effective manner.
Maintaining existing generation capacity is vital to upholding the
first rule for getting out of a hole--stop digging. Most of
PacifiCorp's existing generation fleet is comprised of mine-mouth coal
plants in the Intermountain West and hydro generation in Washington,
Oregon and Idaho.
With respect to hydro, we have been actively engaged in relicensing
various projects and find the process frustrating as most agency
participants have no obligation to balance environmental and economic
objectives. This Committee heard testimony from PacifiCorp last year on
Senator Craig's legislation to make modest changes in the Federal Power
Act's licensing procedures. We thank Senator Craig, Senator Gordon
Smith, and others actively engaged in this legislation for their work
and urge the Committee and its members to review the bill now pending
before the Committee, S. 71, in light of current and future electric
resource needs.
Our coal plants are already among the cleanest in the nation for
SO2 emissions. We recognize, however, that a new generation
of air emission standards is possible in the next few years. PacifiCorp
has been working at the regional level for nearly a decade to fashion
an approach to regional haze that achieves environmental objectives
through a flexible framework. Under the leadership of Utah Governor
Mike Leavitt and the Western Governors' Association, great progress has
been made on this front.
It is this type of constructive, cooperative approach to air
quality issues that PacifiCorp hopes will mark the wave of emission
control agreements. The company is prepared to engage in a multi-state,
multi-pollutant strategy that, going forward, will achieve significant
emissions reductions. This is a far better approach than the
adversarial, litigious tactics that have pervaded emissions debates in
other parts of the country.
To stimulate construction of new generation, it is important that
policies and regulations at the state and federal levels properly align
risk and reward. Investing in new generation--which by virtually all
accounts is necessary to solve the west's problems--requires huge
amounts of capital. Sending unclear regulatory signals about the
potential return on investment (or sending clear, discouraging signals
to investors) will thwart investment in new plants.
Conversations with investors and investment analysts confirm not
only the potential for this investment gridlock, but the reality of it
as well. Wall Street equates regulatory uncertainty with a bad
investment climate. This makes the cost of financing new projects
higher. These costs are ultimately borne by consumers.
While this concern is primarily a matter for state policy makers
and regulators, it is relevant to how the Congress addresses supply
policy and how the FERC fulfills its responsibilities.
PacifiCorp has taken the step of proposing a realignment of its
corporate structure in order to make it easier for regulators to
address resource acquisition strategies most appropriate to their
respective states and customers. This realignment will also have the
effect of sending clearer signals to developers about the potential for
fair returns on investment in new generation.
Ultimately, our realignment will require approval from the FERC and
Securities and Exchange Commission. But the consent of state regulators
is essential to putting PacifiCorp in a position in which we may
constructively contribute to solving the regional power supply problem.
On a related matter, PacifiCorp believes one of the more promising
technologies available to increase generation is new wind energy. The
Congress can help facilitate development of new wind generation by
expeditiously extending the renewable energy production tax credit.
And, federal agencies can help by approaching constructively the siting
decisions essential for generation and associated transmission
facilities.
Certainly, other inducements to new generation investment through
the tax code and other instruments should be examined as well.
PacifiCorp is eager to work with this and other relevant Committees of
the Congress to this end.
Mr. Chairman, this concludes my prepared remarks. Thank you for the
opportunity to testify. I would be happy to respond to any questions
you or other Committee members may have.
The Chairman. Thank you very much, Ms. Johansen. I
appreciate your statement.
Our last witness will be Mr. Curt Hildebrand of Calpine,
and we look forward to your statement, and then we will get
into the questions shortly thereafter.
Mr. Hildebrand comes as vice president, project
development, of Calpine Corporation, Pleasanton, California.
STATEMENT OF CURTIS A. HILDEBRAND, VICE PRESIDENT, PROJECT
DEVELOPMENT, CALPINE CORPORATION, PLEASANTON, CA
Mr. Hildebrand. Thank you, Mr. Chairman, members of the
committee. I am actually supposed to be seated down with my
colleagues from California, but being a powerplant developer in
California I am kind of use to this treatment, not in my
backyard, so I am down at this end.
The Chairman. There is more room at that end of the table
than these folks have, so you are lucky.
Mr. Hildebrand. We also believe at Calpine the principal
problem behind the energy crisis in California is insufficient
supply of generating capacity, and we believe that we need to
build more new, efficient powerplants to remedy the problem. We
also believe the Federal Government can play a key role in
helping achieve this goal by streamlining the regulatory
process.
Today, I will describe my company, Calpine, and our plan to
repower America. I will then share with you just two key
examples of permitting problems we have had, specifically on
California projects, and finally I will provide some specific
recommendations on how to help solve these problems.
Calpine Corporation is based in San Jose, California, and
is a leading independent power producer in the United States.
The company's ambitious, 5-year, $20 billion development
program calls for Calpine to install and operate a 44,000
megawatt portfolio of natural gas-fired environmentally
responsible plants. This portfolio will be sufficient to supply
the electrical needs of over 40 million Americans.
The California energy crisis has numerous fundamental
causes, but no simply solutions. Calpine is working at a
furious pace to help address the situation in California.
Calpine currently has 1,300 megawatts of generation capability
in California that has been operating virtually around the
clock during the crisis. Three of the first four new projects
under construction in California are Calpine projects,
including the only two plants coming online this summer.
Mr. Chairman, I believe one of the key reasons the power
supply is not adequate in California has been the slow and
difficult permitting process for new plants. Calpine does not
believe we must roll back environmental projections in order to
increase electricity output. Instead, we want the Federal
Government to take the lead and set an example by ensuring that
new generation approval process proceeds as quickly as
practical while still protecting the public interest.
Let me share briefly with you two recent examples of less-
than-efficient permitting processes. In Sutter County,
California, Calpine is constructing the 545 megawatt Sutter
Power project that was designed to establish a new
environmental benchmark as the cleanest gas powerplant ever
licensed by the California Energy Commission. Over 3 years
ago--in the interests of brevity I will summarize the
testimony. It is in my written testimony.
Three years ago, we filed an initial application for a
prevention of significant deterioration permit at USEPA under
title I of the clean Air Act. 17 months after that original
application was filed, the EPA region 9 solicited comments on
the permit. A person living 100 miles away was the only
commenter, and the agency thoroughly investigated that claim
and found it to be frivolous.
Nevertheless, the same individual filed an appeal to the
U.S. Environmental Appeals Board on the project. We were
already in construction on the project. Even though the claim
had no merits, the EPA's Environmental Appeals Board was forced
to issue a stay of construction, effectively. They were not
able to issue the final PSD.
Finally, after nearly 4 months of our pleading of our case,
the board denied the appeal on December 2, 1999, ruling that
the claim lacked any merit whatsoever. This delay unfortunately
caused Calpine, at great expense, to expedite construction
activities, and it has severely impacted our ability to put
that project online in time for next summer's peak demand.
Let me share another brief example that has already been
mentioned, the Metcalf Energy Center project in California. It
is kind of the poster child, if you will, for projects, the
current state of California.
It is a 600 megawatt facility planned for San Jose. The
Silicon Valley imports over 90 percent of our power from remote
parts of the State. This project is intended to be a showcase
project in our home town. It has been overwhelmingly supported
by a majority of stakeholders, including local
environmentalists, including the Sierra Club, consumer
advocates, the NAACP, and over 26,000 local residents.
However, this seemingly ideal project is being held up on a
number of local, State, and Federal fronts, including local
NIMBY opposition. I will concentrate on the Federal level. One
failure affecting the project is the U.S. Fish & Wildlife
Service and it is expected to issue a biological opinion in a
timely manner. By law they have 135 days to do so. This opinion
was originally due August 2000 on the Metcalf project. All
issues have been settled. However, the opinion has still not
been issued, and we have recently been told that it will not be
issued for a matter of still weeks. This delay has in turn
delayed the ability of EPA to proceed with their air permit
process.
The Chairman. Your time has expired. I would ask you wrap
up, please.
Mr. Hildebrand. Calpine is prepared to invest over $5
billion over the next 5 years to expand power production in
California. I do summarize four suggestions in my written
testimony that I would suggest the Federal Government look at
very strongly in terms of streamlining the overall approval
process.
Thank you.
[The prepared statement of Mr. Hildebrand follows:]
Prepared Statement of Curtis A. Hildebrand, Vice President, Project
Development, Calpine Corporation, Pleasanton, CA
Mr. Chairman, and Members of the Committee, thank you for inviting
me to testify today regarding the California energy crisis. My name is
Curt Hildebrand. I am Vice President of Project Development for Calpine
Corporation. We applaud the Chairman and the Committee for holding this
hearing to better understand the California energy crisis and its
implications for affecting the long-term electricity needs for our
country.
In my testimony, I will address the following issues. First, I will
state briefly what I believe are some of the underlying causes of the
California energy crisis and the ramifications for the future. Second,
I will describe my company Calpine and our very active program to
provide reliable, clean electrical power for our nation. Third, I would
like to share with you today two particular examples of projects that
offer much promise to helping us solve our nation's electricity needs,
but have been significantly delayed as a result of the current
regulatory system. Finally, I will attempt to provide some specific
recommendations for helping to resolve the current electricity crisis
and prevent future crises elsewhere in the country.
I am here today because Calpine believes that the federal
government has a role in helping to generate more electric power in a
timely manner, which in turn will help to resolve the California energy
crisis, reduce the costs to customers, protect the environment, and
avoid other future energy problems. There is no question that Calpine
and other companies possess the technology to produce significant
quantities of electrical power efficiently, at a competitive price, and
in an environmentally-responsible manner. However, while Calpine's
plans show great promise for helping to solve our nation's energy
needs, we are subject to an unnecessarily burdensome regulatory
bureaucracy that hinders our ability to build modern, environmentally-
sound facilities.
In essence, Calpine believes that the construction of badly-needed,
state-of-the-art energy centers must be approved in an efficient
manner. Calpine believes that the federal government review process--
which includes multi-agency action--should be coordinated and
streamlined to allow all permits to be issued, after appropriate notice
and comment, on a timely basis. We cannot afford to be subject to
needless delays arising from the redundant review of the same claims
that already have been thoroughly reviewed by the proper regulatory
bodies. Federal and state agencies should adhere strictly to
established deadlines in order to allow for the orderly construction of
new power plants in a timely manner.
our nation's energy infrastructure and the california energy crisis
Electricity generation, transmission, and distribution is the third
largest industry in the U.S. Only the health care and automotive
industries are larger. There are 750,000 megawatts of generating
capacity in the U.S., and demand for electricity is increasing annually
by three percent. This growth in demand equates to 22,500 megawatts of
new power generation capacity annually plus replacing nuclear,
hydropower, and aging fossil-fuel plants that are retired from service.
As the Committee knows, the electric industry has been restructured
at the wholesale level nationwide, and retail restructuring is
proceeding in many states. Healthy competition, if restructuring is
done correctly, should lead to lower electricity prices, more reliable
service and reduced pollution. Nevertheless, the country's current
population growth, an expanding economy, and the increasing use of
electricity have strained our nation's power infrastructure. In
addition to experiencing power shortages in California and elsewhere,
the nation's current electricity-producing infrastructure is aging: 45
percent of the nation's power plants are over 25 years old. Aging coal-
fired plants also have been a major source of pollution. Obviously,
older plants cannot adequately satisfy our nation's current energy
demands, let alone meet anticipated future demands.
The problems of inadequate supply can be prevented in the future
only by the addition of new, efficient, clean energy centers. Modern
gas-fired, combined-cycle plants are being built that will lower the
cost of electricity and drastically reduce and even eliminate the
impact of power generation on the environment. Calpine believes that
building these new plants is important to the well-being of our
country, and Congress should promote this transition from outdated,
inefficient, and highly-polluting generation plants to the vastly
cleaner and more efficient energy centers such as those that Calpine
and others are building.
Let me review quickly the recent history of electricity generation
in the U.S. During the late 1980s and early 1990s, there was an
abundant supply of relatively inexpensive electricity in this country.
Due to this large supply of available power, electric prices dropped
and utilities stopped constructing new power plants. At the same time,
many utilities chose to implement load management techniques that
helped reduce or manage their customers' electricity needs, thereby
freeing up extra capacity for new users. Independent power producers
sought to develop new projects, only to encounter a maze of regulatory
requirements and uncertainties that raised construction costs and
dissuaded private investment in new power plant projects.
In recent years, the demand for electricity has, however,
dramatically increased. The country's continued economic expansion
during the 1990s, based in large part on growth in the electricity-
consuming high technology and Internet sectors, voraciously consumed
much of the excess reserve capacity in electricity markets.
Unfortunately, despite warnings of a looming electricity shortage
during this time period, many federal, state, and local regulators
continued to raise numerous obstacles to new power projects, and many
promising new energy plants languished in an onerous regulatory review
process. Only recently have many government officials begun to
recognize that new, fuel-efficient electric power-generating
facilities, such as those currently being constructed by Calpine and
others, are desperately needed all across the U.S.
calpine corporation: overview
Calpine Corporation, based in San Jose, California, is a leading
independent power producer in the U.S. and is a recognized leader in
our industry. Our goal is to become the largest U.S. power producer by
being the low-cost base load generator and adding necessary low-cost
peaking capacity. At the same time, the Company currently produces more
renewable ``green power'' than any other company. We are the largest
renewable power generator in the nation.
Calpine has embarked on an ambitious program to help solve our
country's energy needs. To date, the Company has approximately 28,000
megawatts of total electric generation capacity in existing operation,
under construction, and announced development in 27 states and Alberta,
Canada. The Company has the most ambitious development program in the
country with plans to install and operate a 44,000-megawatt portfolio
of natural gas-fired, state-of-the-art, clean, and modern plants by
2005. This development program, which will be sufficient to supply the
electrical needs for 46 million American households, will require a
private capital investment of upwards of $20 billion.
Calpine is working at a furious pace to help address the situation
in California. Calpine currently has plants with 1,300 megawatts of
generation capability in California that have been operating at full
capacity virtually around the clock during the current crisis. Our
California fleet of generators had average plant availabilities in
excess of 95 percent for each of the past two years--well above the
industry average. Four hundred and twenty megawatts of generating
capacity is supplied to utilities through long-term, qualified facility
contracts; virtually the entire balance is sold through bilateral
contract arrangements.
Calpine is a recognized leader in developing new projects in the
State of California. Three of the first four new projects under
construction in California are Calpine projects. As we look forward in
trying to meet the State's current needs, the only plants coming on
line this year in California will be Calpine plants. We anticipate over
1,000 megawatts of new generating capacity to come on line in time to
help meet this summer's peak demand. Ultimately, Calpine plans to have
10,000 megawatts of generating capacity in the State resulting from our
estimated $5 billion private capital investment.
Encouraging electricity generation based upon technology advances
and utilizing cleaner resources, like natural gas, will enable the
American consumer to be able to maintain their current standard of
living at the same or reduced electricity cost, while meeting our clean
air goals. One key to achieving these overall goals of increased
electricity output, reduced cost, and a clean environment, is Congress'
ability to establish an appropriate regulatory process that effectively
and efficiently promotes new electric power plant permitting and
construction.
the federal government must coordinate and streamline the approval
process for constructing new energy centers
Mr. Chairman, the California energy crisis is a national problem,
or at least an indication of future national problems that must be
addressed now. While some experts have pointed to numerous causes of
this electricity crisis, including faster-than-expected increases over
the past several years in consumer and business demand, Calpine
believes that one of the most important causes has been the slow pace
of development and construction of new sources of electric-generating
capacity.
In sum, Calpine asserts that federal regulatory reforms are
necessary to help the nation address the projected electricity
shortages currently facing many regions of the country. Congress must
hold the government regulatory agencies, including EPA and the U.S.
Fish and Wildlife Service, accountable to met specific timelines,
particularly for permit reviews and related responses to stakeholders.
The regulatory process must be streamlined so that the same issues are
not raised repeatedly at numerous stages of the regulatory process.
Mr. Chairman, I would like to state clearly for the record that
Calpine cares about the environment; the Company designs efficient
energy centers and prioritizes ``green'' energy resources. As a result,
Calpine does not believe that the government must roll back
environmental protections in order to increase electricity output.
Instead, the federal government should take the lead and set an example
by ensuring that the construction approval process proceeds in a timely
and orderly manner. Currently, our bureaucratic process provides too
many opportunities for individuals to halt or delay the approval
process for reasons unrelated to local safety, health, and/or welfare,
but rather to publicize and/or promote their other agendas relating to
energy policy. The following are two good examples of projects held
hostage by spurious claims and regulatory delays that have affected our
ability to provide efficient electricity generation capacity that would
help to prevent our current crisis.
sutter power project
Calpine's Sutter Power Plant project is a good example of how the
regulatory process has hindered the construction of new power plants.
In 1997, Calpine committed to build a new, clean-burning natural gas-
fueled power plant in Sutter County, California. This new plant was a
``milestone'' project for California. It became the first new energy
facility licensed in the State's deregulated electricity marketplace.
This plant was intended to serve the electrical needs for over 500,000
households in the greater Sacramento Valley.
The Sutter project was designed to establish a new environmental
benchmark as the cleanest natural gas power plant ever licensed by the
California Energy Commission. This plant also will conserve precious
natural resources by utilizing 40 percent less fuel than the typical
plant in operation today. As discussed below, this project was
unfortunately delayed by one single individual living approximately 100
miles from the plant who was able to abuse the permitting process and
hinder the timely construction of this project.
Early in January 1998, Calpine filed an application with EPA for a
Prevention of Significant Deterioration (``PSD'') permit under Title I
of the Clean Air Act to build the Sutter power plant. As evidence of
its commitment to be a responsible corporate citizen in the communities
where we operate new power plants, Calpine had proposed to partner with
Sutter County to help its citizens enjoy the wide-ranging benefits of
this new plant. For example, Calpine had committed to provide Sutter
County with $2.5 million over ten years to assist the County with its
ongoing efforts to improve levees and provide enhanced protection from
flooding. Calpine also committed to providing funds for much-needed
fire-fighting and emergency response equipment.
Following our action, EPA Region IX eventually solicited comments
in June 1999 on its decision to issue a permit granting approval to
proceed with the construction of the new Sutter plant. During the
comment period, EPA received only one negative comment on the proposed
construction of the plant while hearing numerous comments
overwhelmingly supporting the need for this plant. The Agency
thoroughly investigated this one comment and fully responded in
writing, even though EPA itself recognized that the comment was
frivolous and questioned whether there was a need to respond to it at
all. In fact, many of the concerns alleged by this commenter had no
basis in law and had been thoroughly addressed during prior hearings on
the project by the California Energy Commission and in the Final
Environmental Impact Statement prepared by the Western Area Power
Administration.
EPA Region IX subsequently issued Calpine its final ``PSD Approval
to Construct'' on July 21, 1999, with the Sutter project establishing a
new more stringent benchmark for the ``Best Available Control
Technology'' standard for emissions. In granting this permit, EPA
determined that the emissions from the plant would be well below the
maximum allowable standard as defined by the National Ambient Air
Quality Standards.
Remarkably, despite EPA's (as well as every other necessary local,
state, and federal agency's) approval, construction was again halted
and further threatened by another claim for appeal. Having failed in
several previous attempts to block construction, the same individual
commenter whose arguments had been rejected on several previous
occasions appealed EPA's decision to issue the PSD permit to the U.S.
Environmental Appeals Board. It is important to note that this appeal,
which arrived on the last day of the appeal period, did not focus on
federally-enforceable air permit issues; instead, the comment letter
might be fairly characterized as a general letter of opposition to new
power plants, not an appeal of the specific federal air permit for the
Sutter plant. Nevertheless, under the Board's review procedures, this
appeal, regardless of merit, forced EPA's Environmental Appeals Board
to delay issuance of the final PSD permit, effectively creating a
``stay'' of any construction of the new Sutter plant until the appeal
was heard and reviewed.
Mr. Chairman, in all due respect and despite the Appeals Board's
policy to give priority to PSD petitions for review, working through
the federal bureaucracy is a slow, arduous, and expensive process. The
mere fact that no new claims were presented at all in this appeal and
that EPA and other regulators already had fully considered this claim
several times before should have resulted in an immediate denial of
this appeal. But no such action was forthcoming. Instead, due to its
considerable backlog of cases, it can take the Board many months to
consider an appeal regardless of its merits, causing companies many
millions of dollars and valuable lost time while awaiting a decision to
construct. Further, the Appeals Board's appeal process does not
currently allow for a motion for summary dismissal of frivolous claims.
The inability to engage in construction activities coupled with the
lack of a summary process meant that virtually all construction
planning came to a grinding halt at the Sutter project. Due to this
automatic ``stay'' on construction, Calpine lost millions of dollars
tying up construction equipment and personnel, and a power plant
critically needed in California was unreasonably delayed. Finally,
after nearly another four months of pleading our case, the Board denied
the appeal on December 2, 1999, ruling that the claims in the appeal
lacked any merit whatsoever.
EPA and its independent Appeals Board are not the only federal
entities that can contribute to construction delays; other agencies
also pose procedural obstacles. Calpine has read Senator Pete V.
Domenici's (R-NM) recent letter to President Bush in which he astutely
recognizes that EPA and the Departments of Energy and the Interior
``approach each issue from the perspective defined by their own
specific, narrow agency interests without considering the impact on
energy supply.'' We wholeheartedly agree with your statement, Senator,
and with your conclusion that ``That must change.'' Having shared an
EPA war story relating to our Sutter power plant project, let me share
another war story that helps to prove Senator Domenici's point.
metcalf energy center project
Another prime example of the possible problems caused by the
current regulatory process is the Metcalf Energy Center project in the
Silicon Valley region of California. This project involves a new 600-
megawatt facility in San Jose that will provide enough electricity for
a community of 600,000 people. If constructed, the Metcalf Energy
Center would provide electricity sufficient to serve two-thirds of San
Jose's average power demand and could be operational by early 2003.
The Bay Area has not had a major power plant built since 1972,
while the population has grown by more than 50 percent. In fact, San
Jose currently consumes over 2,500 megawatts of power that is generated
elsewhere while it is capable of producing only 165 megawatts itself,
resulting in less reliable and lower quality electrical service,
ironically for the nation's most high-tech region.
This proposed new energy center is desperately needed. San Jose is
considered the most generation-deficient area in California and,
therefore, it is the most vulnerable area to blackouts. The California
Independent System Operator (``CAL-ISO'') has deemed the Metcalf
project to be one of the top two priority projects in the State. If the
Metcalf project could have been on line last June 14, it would have
prevented the blackouts that took place in the San Francisco area at
that time.
In essence, the Metcalf Energy Center was intended as a
``showcase'' project in our hometown of San Jose to set a new standard
of excellence for air quality and recycled water usage within the power
generation industry and it would be cleaner than any plant its size
ever licensed in California. Unlike many other power plants, this new
plant has been designed so that there will not be a visible water vapor
plume. Further, the Metcalf Energy Center would include more than $10
million in visual enhancements; the main structure would resemble high
tech office towers and over 800 new trees will surround the site. The
site also is shielded from residential neighborhoods by a 350-foot high
hill. The site currently is a junk yard and is undesirable for most
development, and is in fact located directly across the street from the
Pacific Gas and Electric Company's 40-acre Metcalf substation, the main
hub for electricity in the South Bay. This large substation and
associated transmission towers are equipped already with high capacity
lines that have been located there for over 50 years.
With all of these features, this new energy center plant has been
overwhelmingly supported by a majority of stakeholders, including the
local chapters of the American Lung Association and the Sierra Club as
well as other health and environmental groups, the NAACP, major Silicon
Valley corporations, local unions, consumer groups, local businessmen,
and over 26,000 local residents and property owners. The staff of the
California Energy Commission noted that ``the benefits resulting from
the approval of the Metcalf Energy Center would be substantial'' and
recommended approval of the project. This truly is an ideal site and
situation for building a new power generating facility.
To summarize briefly, the Metcalf Energy Center would not create a
health risk to anyone, anywhere, at any time. It has enormous
environmental benefits such as:
Emissions are so small and dispersed so high into the
atmosphere as to render them undetectable at ground level.
The Bay Area Air Quality Management District found that the
project does not pose any threat to public health and
determined that the project uses Best Available Control
Technology (``BACT'') and in many cases significantly improves
upon applicable air quality standards.
The project does not require new transmission towers,
routinely one of the most expensive and environmentally
detrimental aspects of new power projects.
The Metcalf Energy Center will use and evaporate an average
of three million gallons per day of recycled waste water and
will greatly assist the City of San Jose in meeting strict
discharge restrictions into the San Francisco Bay and improve
the South Bay salt water habitat for two endangered species.
The project will reduce local high tech companies' reliance
on diesel fuel to run back-up generators, few of which have any
pollution controls.
Calpine also helped to purchase 116 acres of adjacent land
that will remain as open space by collaborating with The Santa
Clara County Land Trust (and another 15 acres on Coyote Ridge
nearby).
Traffic and housing impacts from the project are minimal,
due to a small work force averaging 24 people per day.
However, this seemingly ideal location and decision to build the
Metcalf Energy Center is currently being held up on a number of local,
state, and federal fronts--two of which involve federal regulatory
approvals. The first is a ``Biological Opinion'' that must be issued by
the U.S. Fish and Wildlife Service under the Department of the
Interior. By statute, the Fish and Wildlife Service must provide a
biological opinion granting or disapproving of the project within 135
days of the date it receives the application. If the Fish and Wildlife
Service adhered to this schedule, it would have rendered its opinion by
August 2000. Even though all of the issues raised initially by the Fish
and Wildlife Service have now been settled--at the latest by September
2000, an opinion still has not been rendered over four months later. In
fact, Calpine has been informed that no opinion will be provided for
many weeks to come. Calpine understands that our submission is not
atypical and that the Fish and Wildlife Service routinely exceeds its
statutory deadline.
Second, because of the Fish and Wildlife Service delays, the
Metcalf project has also been seriously hurt by EPA's inability to move
forward on the required PSD permit. We are unclear as to why the
analyses required under these permitting procedures could not be
managed simultaneously.
Federal delays also tend to foster local delays by providing
additional time for project opponents to mobilize and encourage other
``Not In My Back Yard'' or NIMBY complaints. Calpine and our
development partner, Bechtel Enterprises, have been embroiled in a
well-publicized debate with one of the world's largest high-tech
companies and a vocal neighborhood activist group, which played a role
in the ultimate denial of the Metcalf Energy Center project by the
local City Council. These intervenors have taken every opportunity to
impede and derail our progress on the project. Since early 1999,
Calpine has participated in over 50 public meetings or hearings
addressing the Metcalf Energy Center project in order to respond to
questions and reassure local communities; over one dozen additional
hearings are still planned. The Company has responded to over 300
written data requests to date.
Due to the inordinate amount of obstruction in this case, the
Metcalf project is not scheduled to receive a ruling until this summer,
more than two years after the application was originally submitted to
the State. Without the regulatory challenges and other complicating
factors encountered to date, Calpine would likely have been actively
constructing this vital power generating facility today. In its
editorial last Friday, the Mercury News in San Jose characterized the
initial failure to approve the Metcalf Energy Center as ``dumb'' and
the continued failure to approve the project as ``dumber.'' Special
interest opposition is further characterized as ``short sighted and
parochial.''
benefits of new generation of electrical power
Calpine is prepared to invest in excess of $5 billion over the next
five years to expand power production in California, adding over 10,000
new megawatts of power for 10 million households. We are committed to
spending our investors' money productively toward achieving beneficial
goals that include reliable, low cost, and environmentally-responsible
power. In essence, Calpine believes that the development of a modern
fleet of power generation facilities will yield important benefits for
our nation in four principle areas:
(1) Reduced Costs to Our Consumers
Technological advances in the power generation industry now make it
possible to generate power using 40 percent less fuel than the typical
utility-style plants that were built in the 1960s and 1970s. Because
fuel comprises over 85 percent of the variable operating cost of a
plant, the reduced fuel use translates into lower overall costs.
Calpine's plants also use highly efficient systems that require less
heat than traditional plants to produce the same amount of electricity.
(2) Conservation of Resources
By burning 40 percent less fuel while generating the same amount of
electricity, modern power plants will significantly reduce our nation's
consumption of fossil fuels. These important resources can then be
conserved for future generations of Americans.
(3) Enhanced System Reliability
The explosion of the digital economy has sparked an increase in
growth for electric power as well as the need to ensure that our
electrical system can provide reliable sources of power. Unfortunately,
the nation's lagging development of new power generation and
transmission facilities has put us in our current crisis and prevented
the development of a highly-reliable and efficient electrical power
service.
According to past industry norms, a typical utility standard would
provide electrical service with an average reliability rating of 99.9
percent. This level of performance would translate into customers
facing average outages of approximately eight hours each year. However,
new, high-technology operations demand a much higher level of
electrical service; typical internet and high-technology businesses now
require service with a reliability rating of 99.9999 percent, the
equivalent of having power outages for only a matter of seconds each
year.
Power shortages and blackouts have dramatic impacts on our economy.
However, modern technology and power capabilities can allow us to
greatly enhance the reliability of electrical service.
(4) Reduced Environmental Impacts
Technological innovation has led to dramatic environmental
improvements in electric power generation. Modern natural gas-fueled
plants now typically emit air pollutants at a fraction of what were
emitted into the environment by older plants. Our new modern projects
can provide the following benefits compared to emissions from the
typical fossil-fueled power plants built in the 1970s:
------------------------------------------------------------------------
Reduction in emissions,
Pollutant pounds per megawatt-hour
------------------------------------------------------------------------
Nitrogen Oxides (NOX)..................... 90+% reduction
Carbon Dioxide (CO2, greenhouse gas)...... 40% reduction
Sulphur Dioxide (SO2)..................... 99% reduction
------------------------------------------------------------------------
calpine's recommendations
To help achieve our nation's overall energy goals, Calpine offers
the following suggestions to the Committee. These suggestions are aimed
specifically at improving the current burdensome regulatory procedures
and not at the substantive environmental requirements themselves.
First, Congress should take steps to ensure that the PSD program
under Title I of the Clean Air Act is revised to eliminate the long
delays--sometimes in the form of an ``automatic stay''--triggered by
permit challenges by various allegedly ``interested'' parties where all
of the key issues already have been thoroughly and extensively reviewed
several times before by the appropriate governmental agencies. The PSD
program is a detailed pre-construction regulatory review program under
the federal Clean Air Act that applies to proposed new facilities such
as electric-generating facilities that will be located in areas of the
country that have good air quality (i.e., areas that ``attain''
applicable federal air quality standards). The PSD review process often
can take more than a year, and in many instances, several years to
complete. The public is allowed to comment at numerous points in the
regulatory review process.
For the past eight years, EPA has talked about streamlining the PSD
and the related New Source Review (``NSR'') programs. The Agency has
yet to finalize any revisions to its PSD rules, and the fate of the
Agency's proposed reforms is uncertain. In fact, the directors of 12
state environmental agencies (Alaska, Idaho, Illinois, Kansas,
Louisiana, Michigan, Montana, New Mexico, North Dakota, Oklahoma, Ohio
and West Virginia) recently notified EPA that they are dissatisfied
with the Agency's recent PSD reform efforts, and have urged EPA to
implement ``major reform'' so that a simplified PSD and NSR regulatory
program can be established that provides affected parties with
timeliness, certainty, and flexibility, while still protecting human
health and the environment. We echo these states' concerns,
particularly with respect to the need for increased timeliness and
certainty in the PSD permitting process.
Calpine believes that EPA's proposed reforms to the Title V air
permit program may provide a useful example of the types of reforms
that should be implemented in the Agency's PSD program. For example,
over the past several years EPA has been working to provide facility
owners with increased flexibility in complying with their Title V
permit terms and conditions, defining set timeframes for agency review
and completion of proposed permits, and eliminating unnecessary or
extraneous permit conditions.
Second, in general we must have clearly defined, standardized, and
set deadlines for all federal and state agencies to complete their
review of permit applications. We would recommend that all permit
reviews be conducted concurrently whenever possible. In order to
benefit from new power plants, Congress must help to establish a
permitting process that fairly, yet efficiently, allows public input
but does not delay or halt deserving projects. Calpine applauds the
fact that the Fish and Wildlife Service is subject to a specific 135-
day review period, but this and other timelines need to be adhered to
by the agencies. If these agencies fail to act within the prescribed
timelines, they should then be precluded from further involvement.
Calpine also recommends that specific deadlines be established for
agency action denying or approving private party challenges to proposed
permits. Once a decision is reached on any claim, Calpine believes that
it should not be necessary to revisit the same issue again at another
stage of the regulatory process.
Finally, EPA should not automatically stay construction of new
power plants merely because an appeal of a permit has been filed. EPA
should consider issuing a stay only when a challenge presents clear and
substantiated evidence that EPA may wrongly have approved a permit.
conclusion
If our nation is to meet the increased demand for electricity at
affordable rates, while still meeting our ambitious environmental
goals, we must foster the construction of new, clean power plants.
Companies, such as Calpine, understand that in order to construct a new
plant, the Company must be prepared to implement some of the most
stringent pollution control technologies in the world. We are fully
prepared to meet these challenges. However, we are at a loss trying to
cope with a permitting process that works against new plant
construction and allows individuals to stall construction even after
their concerns have been duly considered. Calpine supports public
participation and input, but we cannot and should not be forced to
delay our projects while we fight meritless claims that already have
been thoroughly reviewed and are designed to prevent new construction.
Mr. Chairman and Members of the Committee, I thank you for your
time, attention, and the opportunity to share Calpine's insights with
you. I would be happy to provide any additional information you may
request. Thank you.
The Chairman. Thank you, Mr. Hildebrand. I want to thank
the panel for their statements. They have been very
informative.
I would like you to provide us with any specifics such as
you indicated, Mr. Hildebrand, with the delay on behalf of the
U.S. Department of Fish & Wildlife in expediting permits within
the time frame that they say they were going to do it, and I
would defer to all panelists to give us some specifics on the
role of the Federal Government as a hindrance to expediting the
regulatory process under the existing law, and any comments
relative to your feeling on the adequacy of regulations to
protect the health and welfare and environment and so forth.
Obviously, we must maintain that balance.
I would also ask that you provide us with any specific
emergency action that you feel the Federal Government should
take beyond the energy sales order, which is certainly underway
now.
Now, I am going to give myself and the others 5 minutes
here, and we are going to try and run through, and
unfortunately I cannot go into the depth that I would want to,
but we have had many of you suggest that part of the answer is
cost-based price caps.
Now, I am here in the role, I think appropriately that we
all have of what is the Federal role. I think the States have
got plenty of expertise to address what their roles are, but do
you agree that FERC should proceed with cost-based price caps,
recognizing that FERC's authority is wholesale, and that FERC
has already indicated a reluctance because of fear that it will
foil, if you will, the competitive market?
Also the concern is, if you put cost-based price caps, will
it be sufficient to attract investment to put in the needed
facilities, because if you go through this process and come
full circle and you do not achieve that, why, you are nowhere.
Do you all agree that cost-based price caps by FERC are in
order?
Mr. Bailey.
Mr. Bailey. Mr. Chairman, I think this also goes to the
notion that many have talked about, about just and reasonable
rates. Let me describe FERC's traditional role in the cost-of-
service model, and that typically is a model that is built
around broad averages and determining prices, and it is built
around an ability of the regulator over time to ensure that a
supplier or provider of service gets an appropriate return on
their investment.
If you look at the powerplants that have been sold, if you
look at spot markets generally, sport markets and these plants
tend to operate at the margin, and it is really more of a
value-of-service pricing model that works at the margin. There
will be times when they are worth nothing, and an earlier
commenter pointed out power at the margin is dispatched at
zero, and just not that long ago.
There will be times when it is the most valuable of the
supply, which is what we are seeing intermittently today, and
to attempt to apply that traditional cost-of-service model in
that marginal pricing environment I think leads very easily to
the wrong answers. It is very difficult to do and, frankly, I
take significant offense to the notion of price gouging and
those sorts of things, because I do not believe that has
happened. I think the market at the margin is operating the way
the value-of-service or spot market typically operates.
The Chairman. You do not support FERC coming in with price-
based caps?
Mr. Bailey. I think defining cost-based is difficult. There
are times as a supplier when you have no assurance of any
recovery. In fact, you have absolute assurance you will not get
any recovery. On the other hand, when the power is most in
demand and the value of that power is the highest, if you
attenuate the pricing at that time, then what you have done is
changed the return model for that investor fairly dramatically.
But one thing that I found helpful as we have had our
discussions with the legislative leaders in the State and the
people at the Federal level, it is simple enough to model what
the world would have looked like had these generating
facilities, which again are the least efficient, the oldest and
the peak dispatch units, had not been sold, if they had simply
been there, and what the cost would have been under those
circumstances.
What people will find, I think, is that if they compare
that cost to the prices that are being charged, there is not a
great deal of misalignment, if any, but the perception that
these prices have flown up to unreasonable levels is being
judged against a standard that is not an accurate standard. It
is what the prices looked like 3 and 4 years ago.
So again, we would be happy to submit for the record that
modeling that just simply said, had nothing changed, had there
been no deregulation in California, but the cost elements of
fuel and NOX been moved to where they are today,
here is what the cost would have looked like to Californians,
and under that model they would have been passed through
routinely.
So I think it is important to again understand where we
operate as generators in the dispatch cycle, the uniqueness of
the cost models and price models that operate around a spot
market or a peak supplier, and that whatever is done is done
with the recognition that investments were made that are long-
term investments, but against an opportunity to harvest when
prices were high, against recognition of the extended periods
of time when you have no opportunity to recover your cost.
The Chairman. Well, I appreciate your explanation, and I
agree with you in principle. I guess we cannot get a simple
answer relative to whether cost-based price-capping by FERC
would result in a stabilization, or whether it would result in
a reluctance of potential investment coming in to provide
greater generation.
So as we proceed through these questions, and I must defer
to my colleagues, because I did make a commitment of 5 minutes,
but I wanted to ask both California Edison and PG&E whether or
not you anticipate finding it necessary to request the
Secretary of Energy at the end of the 10-day period, which I
believe is, what, February 7, additional relief from the
Federal Government in requesting additional time on the energy
sales orders.
Mr. Frank. I guess from our standpoint I honestly do not
know the answer to that, Mr. Chairman.
The Chairman. We are getting pretty close to that time.
Mr. Frank. Yes, but it is an issue that is dealt with in
the whole reliability of the system, and the responsibility for
that has transferred to the independent system operator, as
opposed to the individual utility, so it is not a mix in which
we have been placed up to this point, and I think that call is
really going to have to be made by the independent system
operator, not individual utilities.
Mr. Kline. I agree with that, and in part it is dependent
upon progress made in Sacramento in the process that is
underway right now.
The Chairman. Well, maybe that is why they declined to
testify, that they knew I might ask that question, so whatever
it is worth we will ask them that question, even though they
are not here, and we will share the answer with you.
Senator Bingaman.
Senator Bingaman. Thank you all very much for coming and
testifying. It seems as though everyone has agreed that not
only do we have this immediate crisis in California, we have a
second wave of this crisis coming this summer, when electricity
demand goes up for air conditioning.
We also have another crisis this summer in the Northwest,
when we find that all the reservoirs are empty and we need the
power. I gather that is what people are saying. Are there some
actions the Federal Government should be taking? I have been
trying to sort through all of the statements as I have heard
them as to what specific things could be done to head off those
two crises which are coming down the road at us, if they do
materialize, as everybody seems to predict.
Mr. Bailey.
Mr. Bailey. As I said in my comments, I think the most
clear action that could be taken would be a temporary lifting
of the air quality limitations on the operation of existing
facilities, and there are both Federal and State layers to
that, and the reason for that is, if you look at the tools that
we have to solve the problem between now and the end of the
summer, there is simply the plants that are in place and those
that could be brought back into operation.
Senator Bingaman. You are talking about diesel-powered
plants, primarily?
Mr. Bailey. No. I think natural gas plants, under the
regulations the amount of NOX emissions available to
these plants that were sold that are gas-fired staged down over
time, and the amount available this year is less than it was
last year, and again, part of that is State-imposed, part of
that is Federal, but the key is to--I think the bottom line is
to get every generating facility available of any type
operating, because that is the only tool you have available on
the supply side to address the problem.
Senator Bingaman. Are there any other tools on the supply
side anyone wants to offer before we move to the demand side?
Ms. Johansen. I might just mention, this is not so much
with my PacifiCorp hat on as opposed to my former role at EPA,
but one area that needs to be looked at is the spill of water
over the dams, passed the dams during the summer migration of
the salmon, to assure that that is truly justified from a
biological perspective, because about 1,000 megawatts of energy
is spilled over those dams in the summer, and I think in a year
like this you just have to look at that.
Senator Bingaman. Does anyone else have a suggestion about
on the demand side? Are there things that would make a
difference between now and the summer when these two crises are
expected to hit?
Mr. Frank.
Mr. Frank. I think there are some things on the demand
side, and we are prepared to deal with that. Most of it really
has to be done I think at the State level. We made a number of
filings last summer to sharply increase the size of our demand
programs, and they tended to be scaled back almost uniformly by
our commission. I think they may have a different view of that
today, and we will be making some more filings to expand them.
One interesting idea that I think Mr. Kean brought up which
we actually engaged in last summer was the so-called megawatts
idea, where we actually pay people not to use electricity based
upon a going price, and we actually had some takers on that,
and I suspect we might get more, but in the final analysis,
sounding like a broken record here, I think that the single
most important thing is to have our consumers understand how
much they are paying for what they are using, and we are not at
that point yet.
Senator Bingaman. Does anybody else have a suggestion?
Mr. Kean. I think Steve is probably right, it is more of a
State matter, or the institutions within the State, but
purchasing demand reductions and not just for the next hour,
but paying people to reduce demand maybe for a block of time,
maybe even several months at a time during certain periods of
the day, is the fastest way to effectively add capacity, if you
will. Blackouts are not voluntary. People do not get to consent
to them oftentimes, but paying somebody and giving them the
incentive to reduce demand during a certain time is a way to do
it in a way that is acceptable to the customer as well as the
company.
Senator Bingaman. My time has expired. Thank you very much.
The Chairman. Thank you, Senator Bingaman.
Senator Craig.
Senator Craig. Mr. Hildebrand, of those new facilities you
are preparing to bring online in California, are they all gas-
fired?
Mr. Hildebrand. The vast majority of them are, yes.
Senator Craig. In light of the new cost, and in light of
the industry discussion today in the Wall Street Journal and
other publications that, try as they may, gas supplies are
declining, how does that impact your ability to generate, and
the cost, based upon what you had originally projected?
Mr. Hildebrand. We believe that it is more a short-term
issue. The reserves are still there. Current supplies are
presently declining. However, the marketplace believes that
future prices will be lower than they are today. We are at near
all-time historic highs. If you look back over time we have
enjoyed a relatively stable natural gas price profile over a
fairly distant period of time. Futures markets also represent
lower costs than what we see on today's spot market.
So marketplace as well as Calpine and most powerplant
developers believe this is an anomaly right now, and over time
we are going to be seeing much more competitive gas pricing.
Senator Craig. How much of that is based on the fact that
there might be new production, when in fact there is very
little production coming online right now?
Mr. Hildebrand. My understanding is that there is an
increase in rate counts across the country, and as well as into
Canada. I would certainly encourage the Federal Government to
take every action possible to promote additional production,
additional transportation, additional LNG, liquid natural gas
facilities and programs throughout North America. We do count
on natural gas for a significant and growing amount of our
country's energy needs, and we need to look after that.
Senator Craig. That is exactly what I was trying to get you
to say. Thank you. It has to be said. We have been in the
business of promoting gas but not producing gas, and somehow I
think that time is changing, and it is very important that
people in the industry say it to their consuming public and say
it to us. Thank you.
Mr. Gale, are you of the group here that would suggest that
we do some capping?
Mr. Gale. Well, thank you. That is problematic for us,
because we sell and buy in the same markets, and we have gone
through our winter where we have been buying, coming into the
spring run-off where we hope to sell, and if we run into price
caps at the time you hope to offset some of the cost.
Senator Craig. Then you could not recoup. Capping to put
out the fire, does it start a new one somewhere else, or does
it distort a market that should not be distorted where it is
currently headed, beyond you guys bidding it up?
I mean, I guess I ask that question generally, and that is
part of the frustration. I am sitting here, I am understanding,
obviously, the politics and the concern you have against an
uncontrolled environment, or a relatively uncontrolled price
environment. At the same time, California is being sung a
lullaby right now while Idaho and others pay for it. Now, I am
not quite sure we want to get Idaho and the rest into the
environment of thinking they are, too, in a lullaby. Does
anyone wish to respond to that?
Mr. Kean. I cannot think of a problem that price caps help
to solve. You have got some really basic problems here. You
have insufficient supply, and you have no demand response.
Price caps do not help either one of those. They do not create
additional supply and they do not in cent conservation.
The other problem you have is an insufficiency of long-term
contracting, or forward contracting, which has been discussed.
If you actively increase supply, if you actually build in
demand-side response. If you reduce your reliance on the spot
market you do not need price caps. That solves the underlying
problem.
If you have a price cap in place, what ends up happening
is, if you cannot get enough power, whatever State you are in,
enough power to serve your load at the cap levels, then you
have two choices. Either you can start turning power off, which
no one wants to do, or you can pay the price it takes to get
the power to come, and so they have not worked. They do not get
at the fundamental supply-demand problem that needs to be
solved. There are other solutions that make price caps
irrelevant.
Dr. Karier. Senator, I think when you ask people in the
industry whether they support price caps or not you find that
there is a difference between those who are sellers and those
who are buyers.
Senator Craig. I understand that.
Dr. Karier. That may change as we go into the spring and
into the summer, but I think what we find is that very few of
us would argue for price caps if we thought we were interfering
with accurate competitive price signals.
The problem in this case is that they are not. These are
signals coming from a flawed market, and so even those that are
opposing price caps because of the signal it is giving are
admitting that it is coming from a flawed market in the
California system. Do we really need prices at thousands of
dollars per megawatt hour to incent new plant construction? Do
we need prices at $500 or $250, and I think if you look at
that, those are far beyond what is needed in the immediate
incentive.
We certainly do not want to cap prices so low that we would
ruin this incentive, but I think we are smart enough to avoid
that pitfall.
Mr. Ferreira. Senator, we have advocated--the committee has
asked what can we do in the short run, and it is clear there is
no quick, easy fix to get out of the situation. We are going to
do everything we can on the short run on the demand-response,
but this notion that in a commodity market you need volatility
and you need high prices because that sends a signal for the
market to respond, this is not a traditional commodity market.
As you indicated earlier, if you are starting out with $2 a
gallon milk and you jump to $600, you do not need a $600 gallon
of milk to tell farmers they need to go out and raise more
calves. I think you can get the right price signal.
What we have advocated is a price cap which is interim.
which does a couple of things. It sends the signal to the
marketplace, this is not long term. Secondly, it is high enough
to capture the current operating costs, including emissions,
and thirdly it provides a necessary incentive to continue to
build generation. I think it can be done, and I think it needs
to be done.
The Chairman. Your time has expired, Senator.
Senator Craig. Let me close by thanking you, Richard, for
recognizing the licensing or relicensing issue of hydro. Most
of the industry knows we are working on that now, and I am
encouraging that my relicensing bill be included in an energy
package. I think it is important that we deal with that issue.
That is long term, but we have to think long term, too, and we
all know, as you know, and most of you know who have hydro, the
reality of licensing is long and drawn-out, and not
predictable, and it almost all instances reduces capacity to
generate an increased cost of operation, so thank you for
making those comments in your written statement.
Thank you, Mr. Chairman.
The Chairman. Thank you very much, Senator Craig.
Senator Feinstein.
Senator Feinstein. Thank you very much, Mr. Chairman.
Gentlemen and lady, I would like to thank you very much for
being here. I would like to use my time to make a statement, to
ask you to do something, and then to ask a couple of brief
questions.
I do not pretend to be an energy expert. I can tell you I
am involved from top to toe in watching this situation. I have
designated a lot of staff to do it. I talk with the Governor of
California frequently. I have talked with the legislators. I
believe the State is fully engaged in trying to remedy the
situation.
I happen to support a market that functions, not a broken
market. There is some price elasticity in electricity. There is
not a great deal. There are a lot of poor people in California.
I think the PUC will adjust some rates in addition to the 9 to
15 percent that they have done already. The State will begin to
fast-track plants to get them on the market.
To Calpine, I have spoken both to Mr. Chambers of Cisco, I
have spoken to the mayor of San Jose. I would offer my services
to try and bring the two parties together. The reason I have
been given, of course, is that the site is not zoned for the
Metcalf plant. I think there is a way to do this thing, and I
would be very happy to offer whatever voluntary services might
be helpful in this situation.
However, gentlemen, when the people at Sempra tell me that
spot power at 3 o'clock in the morning is 500 times higher than
it would be normally, that to me in my simple self is price-
gouging, any way you look at it, so I am making a request,
which you can ignore, as the senior Senator from the State
involved, that you go back to your CEO and you ask them please
do not price-gouge. Please--California is trying to work their
way out of this situation. Give them an opportunity to do so.
I am going to be around here for 6 years, and I am going to
be on this committee, and I am going to watch this situation,
and I believe that what happens in California will happen in
the rest of the States.
Mr. Bailey, I received that Dynergy letter, where 12
generators said that without certain credit guarantees they
were going to stop selling, effectively, into California, and
that was what encouraged the Secretary to put on the first
emergency order, and I want to really compliment the man from
the Sacramento Municipal Utilities District, because you really
said it as it is, and I think it takes some courage, and I very
much appreciate that.
If we could just get a little cooperation from the out-of-
State generators, all of you have made a lot of money off of
this. Additionally, every plant that I know of, and Reliant is
certainly one of them that has invested in plant in California
in a generating facility, the plan to amortize investment over
30 years has already gotten their money back, and so a lot of
money has been made.
I do not begrudge that. All I am asking, and you can ignore
it, is please be fair. Please give this State an opportunity to
work its way out. Please recognize that if you are going to
sell power at 3 o'clock in the morning and charge 500 times the
going rate, there are some of us that might look at that as
very real and very profound price-gouging.
If I can figure a way to get through the summer without
massive blackouts, and get that additional 2,000 to 5,000
megawatts of power--and one gentleman who testified earlier
gave me some ideas, and I want him to know that we will proceed
with every one of them. We will take a good look at every one
of them. I will talk to the Governor and the legislature about
it and see if it can be done. All we are asking for is an
opportunity to be able to do the right thing.
Now, you may say, well, she is very naive to say this, but
in my 9 years as mayor of San Francisco I had a relationship
with CEO's that any time I went to them and asked them to do
something voluntarily for the city, I never was turned down,
and there was always cooperation. PG&E knows that. Dick Clark
was CEO at that time. They always responded. Chevron responded,
Bank of America responded, every big corporation in the city.
This is really the first industry I have seen, the power
generation industry, that really is willing not to care what
happens, not to care about the people that are being thrown out
of jobs now, about the small businesses whose rates are going
up dramatically, and I can give you case after case after case.
The Chairman. Senator, your time is up.
Senator Feinstein. All I want to do is ask you to relay
that message to your CEO. He can tell me to get lost. That is
okay, but if you would just do me the favor to relay that
message I would appreciate it.
Thank you very much.
The Chairman. Mr. Bailey I think wants to respond.
Mr. Bailey. Senator, I do not have to go home to relay it
to the CEO, because I am the CEO of Williams, and again, I
would encourage you to consider a couple of things.
One, I understand the cost structure that we have, and as
we priced our power that we have made available to the State in
the spot market it has been priced just very marginally above
our actual cost, and that cost is driven by competitive markets
for both gas and NOX, and that is the reality.
It is not a matter of a traditional sort of utility, and
again I encourage you, and will be happy to furnish you with
it, what it would look like under the traditional utility
model, where the cost of operation of many of those components
were simply flowed through automatically to consumers, and we
will provide you that information.
The other thing that I guess concerns me is the fact that
we are focusing so intensely on such a narrow part of the
overall equation, and that is that marginal power that I
discussed earlier. There has not been a lot of discussion today
about the substantial amount of power that is generated by my
friends to the right, that I understand is produced profitably
at a much lower price, and is in the mix.
So the dialogue tends to unfold around, again, that
marginal power which, yes, in the shortage circumstance is the
highest price, but it is not representative of the ultimate
realized power of any particular consumer, whether there is an
intervening artificial constraint on that pricing or not, and
most of what we have done as a company has been to sell
forward.
We entered into long-term commitments in the State. We do
not consider ourselves an out-of-State company. We have 1,100
employees in the State. We have an $80 million bank roll in the
State. We have over $400 million of assets, none of which are
power-related, because of the way we entered the market through
a contractual relationship with the AES.
So again, we understand the economic reality. As a company,
in 1999 we consumed about $1 billion worth of power, and our
best estimate is, in 2000 we consumed about $1.7 billion worth
of energy and power. We recognize the impact of that as a
business.
But my response to price caps was, the term of art, a price
cap as an artificial dart in the dart board, something that
says, let's do a cost-base, cost-plus model as a bridge to a
competitive marketplace, might have some very logical
underpinnings, but to simply put an artificial stake in the
sand and say prices should not go beyond that----
Senator Feinstein. Can I just correct the record? My bill
provides the Secretary of Energy with either the cost-based
rate or the temporary regional price cap.
Mr. Bailey. But again, I make a distinction between a price
cap, which is an absolute limit, and a marketplace that has a
lot of competitive moving parts, and a cost-plus model, which
says that the people that are there may limit the amount of
margin that they incur for some period of time, but they do,
under that model, fully recover their cost and have an
opportunity for a margin that is a positive margin. That is
very different than a hard price cap or soft price cap.
The Chairman. May I terminate the discussion and defer to
Senator Smith.
Senator Smith. Thank you, Mr. Chairman. For Southern Cal
Edison and PG&E, I am wondering, Steve and Steven, if you can
tell us if the Bonneville Power Administration will be paid
$130 million for power sales into California in November?
The reason I ask it is, they have got a Treasury payment to
make here soon, and I am wondering if they are going to be able
to make it.
Mr. Kline. We are truly hopeful we will be in a position to
make those payments. I think at this point our financial
situation is well-known. Assuming that the leadership in
Sacramento can craft a solution that makes us solvent and gives
a path to financial health, that is what our goal is.
Senator Smith. Steven, we keep talking about conservation
as a part of this. Is the crisis that is affecting California
and the rest of us, have you seen a reduction in consumption of
energy? What is happening in energy consumption in California?
Mr. Kline. I think as we have stated price signals are very
muted because of the instance of the price cap.
Senator Smith. So there is no reduction in consumption?
Mr. Kline. I do not think we have seen major reductions,
no.
Senator Smith. I think that kind of answers the question on
caps.
Mr. John. Let me just add to that. There was an article in
the New York Times, I think it was yesterday. In our service
territory, SDG&E's, we found this summer when there was not the
price cap conservation was in the 9 to 10 percent range. As
soon as the price cap went on the conservation went away.
Mr. Frank. Senator, I guess I owe you an answer for
Southern California Edison as well. It is not appreciably
different from PG&E's. We are more than anxious to make the
payments, and to the extent we can get a solution in
California, which hopefully will come within the next week or
two, that can restore us to a credit-worthy position and give
us access to the credit markets, we are more than anxious to
make those payments.
Senator Smith. Part of what we are focusing on is
reduction. I wonder if any of you can speak to whether
California has any problems with transmission. Is there a
transmission problem here as well?
Mr. John. Again, I can speak for our company. We will be
filing with the California Public Utilities Commission an
application very soon for new electric transmission in a
portion of our service territory that is on the border between
Riverside County and San Diego County, and our estimate is
under the best of circumstances, if everything goes perfectly,
we could have that system in place sometime in 2004.
If we miss that deadline there is going to be a real
congestion problem, similar to what is faced right now on path
15 between southern California and northern California, and
already we are being told by a lot of people in the Riverside
County area we are going to oppose the transmission line
because the power is going to end up in San Diego.
Senator Smith. What would change minds on that?
Mr. John. My personal view, Senator, is that at some point
if these facilities are going to get built the State is going
to have to override local opposition, and I am not saying that
lightly, but if this is really a crisis, the State is going to
have to come in and basically say, it is going to get built,
folks.
Senator Smith. Well, the crisis right now has been visited
in the Northwest, and I tried to make that point earlier, and I
know California and Oregon are exchanging power all the time at
different times of day and different peak loads, by the way,
but that power is considerably different going one way as
opposed to the other.
I keep hearing more plants are coming online, but I also
read an account, Steven, where your company tried to put a
barge in San Francisco Bay. I wonder if you can tell us about
that. Why was that not permitted? Surely--I mean, it was
during, we were hearing of potential brown-outs during the
Democratic Convention in Los Angeles. It did not happen during
any of the speeches. Maybe it should have.
[Laughter.]
Senator Smith. In all seriousness, that was not allowed to
go forward. Would that go forward today? Would you make that
proposal today? I understand that would have given light to
95,000 homes in the bay area.
Mr. Kline. I think that, Senator, when we made that
proposal there was not a full understanding of the dimensions
of the current crisis. I would hope that if that proposal were
made today there would be a different response, but I could not
guarantee it.
Senator Smith. We heard earlier about a San Jose plant
being opposed. I guess my question is, what is it going to take
to change the attitude there?
The Chairman. If the lights go off.
Mr. Frank. The chairman said it. The fact is, in southern
California, Edison's territory, not only have our customers not
felt any price impact, they also have not felt any loss of
power because we have not had rolling blackouts, and there has
been no impact on customers, and so therefore no particular
reason for them to change their behavior.
Senator Smith. So is California doing enough?
Mr. Frank. No, not at this point, but I think Senator
Feinstein makes a good case that everyone I do believe today is
fully engaged. It may be later than we would have liked it to
be, but everyone today is fully engaged and working on the
issue.
Mr. John. The only other thing I would like to add to that
is, everything we have been saying, at least on this side of
the panel. It is an integrated effort. One without the other is
not going to work. You need the long-term contracts, you need
the retail rate caps removed, you need an expedited siting
process for generation and transmission, and you need
conservation. They all have to go together.
Senator Smith. Thank you. I am out of time.
The Chairman. Thank you.
Senator Cantwell.
Senator Cantwell. Thank you, Mr. Chairman, and thank you
for including in this panel discussioners from the Northwest.
It is great to see Mr. Wilcox, Mr. Crisson, and Ms. Johansen
here. Thank you for your testimony, which I did review.
Mr. Crisson, your discussion about the Tacoma situation, I
read in your testimony your support for price caps. I do not
know how much you elaborated on that in your testimony or in
answering questions, but I am interested, because obviously the
rate increase that Tacoma has looked at 50 percent for
residential rates, 75 for industrial, there has been some
discussion that in the future you plan to place more load on
BPA, which has also announced their own rate increases, so I
guess I am looking for further elaboration on the short-term
impact and your ideas on more immediate solutions for us.
Mr. Crisson. I would be glad to, Senator Cantwell. As I
said in my testimony, short term we would advocate a cost-based
pricing. There are some problems with price caps. However, we
are advocating measures that would be temporary in nature and
short term. Let us try the cost basis first, which would allow
recovery of variable cost and a reasonable rate of return, but
there may be the need for caps under certain circumstances, and
I believe, as Senator Feinstein pointed out earlier, her
legislation allows for either.
This is something that is necessary in the short term, as a
practical matter, to avoid insolvency for some of us in the
Northwest. I mean, we are not going to be taking our 50 percent
surcharge off if we have cost-based pricing or price caps, but
it might allow us to avoid borrowing $100 million that we are
going to have to pay back over the next couple of years.
As far as caps impeding price signals, I beg to differ. Our
customers are getting a very strong signal right now, with a
50-percent surcharge. We are hoping we do not have to increase
that in October, when Bonneville's increase takes effect. As I
indicated earlier, Seattle City Light is contemplating
increasing to 75 percent in Tacoma and in Seattle and other
parts of the Northwest. Our customers are getting very strong
price signals. The problem is not the price signal. The problem
is whether the customers can survive the price signal in the
next few months that has us concerned.
We are also actively promoting conservation in other ways,
as I outlined in my testimony, as well as pursuing new sources
of supply, and we are actually exploring a power buy back with
our retail customers now and, as Mr. Wilcox pointed out, BPA is
actually engaged in that kind of a program already with the
direct service industries.
Senator Cantwell. I might add, about that BPA increase,
that is 60 percent, but in 1 year they are looking at a 95-
percent increase.
Mr. Crisson. That is correct. The proposal was an average
of 63 percent over 5 years, with the first year being over 90
percent.
Senator Cantwell. So we are already seeing in the Tacoma
area, and the broad scope of your service, too, it is quite
impressive with the click network and everything that you have
done on the new technology front, but we are seeing businesses
impacted in that area today, job loss today.
Mr. Crisson. We are already seeing impacts, that is
correct.
Senator Cantwell. Mr. Wilcox, did you want to add anything
to that?
Mr. Wilcox. Bonneville's rate increase is a huge problem
for all of Bonneville's customers. Just to give you some
numbers, and we cannot solve the demand problem in California,
but we can--it is a Federal issue. We deal with Bonneville in
the Northwest. It could be an example for California.
Bonneville right now, about 80 percent of its power supply
has a cost of $25 a megawatt hour. The next rate period they
have to go out and buy 20 percent at a cost of over $125 per
megawatt hour. They can either meld that all together and get
an average rate of $45, which hurts everybody, or they can give
each individual customer a price signal at the margin and say,
we will sell you the vast bulk at the lower embedded cost for
existing resources and at the margin you will have to pay the
full cost of that additional consumption, and that gives people
the ability to respond individually, to save energy in a
responsible way.
The system we have now is, it is kind of use it or lose it,
and you do not get the price signals. You do not get the demand
response, and prices go up, so we need to use Bonneville as an
example of how you can deal responsibly with the power crisis
on the West Coast.
Senator Cantwell. I can see my time is almost up, Mr.
Chairman. I just want to add that yesterday our Attorney
General in Washington State took action in announcing an
investigation of price manipulation and unfair business
practices in our State, so we are at all fronts in Washington
State, as in California, trying to deal with this issue, and so
again I appreciate that the Northwest members were allowed to
be a part of this panel.
Thank you.
The Chairman. Senator Wyden.
Senator Wyden. Thank you. A question for PG&E. I have heard
you say, and it has been a point of contention today, that you
all have not defaulted yet in the payments that you owe in the
Pacific Northwest, but isn't the fact that you have given
billions of dollars to your shareholders described in the
newspaper this morning, isn't that action going to make it
tougher for you to repay the people in my region, a question
for the PG&E witness.
Mr. Kline. Senator, I have not seen that article you are
referring to. I assume it is referring to the audits that the
public utilities commission----
Senator Wyden. Well, just think about it.
Mr. Kline. And to my understanding there is a huge amount
of misunderstanding about what those numbers constitute, but if
you look at how dollars are segregated between the utility and
other parts of our corporations it is very clear that the
obligations of the utility are the obligations of the utility.
Those dollars are being accrued in accounts and historically
they get paid by the utility.
Right now, in essence the utility has been financing for
customers the difference between what we have been able to
recover in rates and what we charge our customers and the much
higher number of the prices in the marketplace, so they are two
very separate things.
The cost you are referring to is balancing accounts, and
the minute we are in a position to pay them, believe me, we
will be very happy to pay them.
Senator Wyden. Well, again, I will tell you, I will look at
any specifics and the way you segregate these accounts
carefully, but I will tell you that my constituents read about
something like this, that describes billions of dollars going
to shareholders, and then they listen to the answers that have
been given repeatedly about the difficulty in terms of repaying
the Northwest, and that you cannot give us the assurance, and
that is why we are so troubled by all of this.
And I guess it leads me to the other issue I feel so
strongly about, a question for you, Dr. Karier and Mr. Kean of
Enron, and that is, I think it is time to make sure that people
can get some relevant data about what is going on in this
field. I think it is important to keep the lights on. Do you
agree with that, Dr. Karier?
Dr. Karier. I certainly agree, and that has been one of the
proposals from the council, is we need much better information,
especially in a situation like this, where a lot is happening,
the market is volatile, people are really demanding to have
that kind of information, and we cannot provide it. We have
been frustrated on several accounts. One is trying to explain
why some plants are down and out of operation, and also in
trying to forecast just the short-term reliability of
identifying what generation is going to be available next week
and forecasting the loads in order to predict whether or not we
should be putting out calls for emergency conservation, and so
I think information is critical in that case, and it is going
to be essential to keep the lights on.
Senator Wyden. Mr. Kean.
Mr. Kean. I agree, absolutely. It is particularly important
to understand where the transmission restraints are so that
people can start to look for ways to work around those. Getting
data in a timely fashion so that people can do the modeling and
figure out what the solutions are is vitally important. That is
something that the Federal Energy Regulatory Commission can
make happen as the ISO remains under their jurisdiction, and I
would encourage Federal action in that regard.
Senator Wyden. This is one thing, Mr. Chairman--and I see
the chairman is occupied. I think this is one thing that we can
do.
The Chairman. I am listening carefully.
Senator Wyden. I appreciate that. This is something the
U.S. Senate can do that does not cost any money. It is clearly
consistent with a variety of different approaches, and it would
frankly provide some real assurance to people in my part of the
world that we were not seeing various kinds of money laundering
schemes going on in this field.
And I will look, Mr. Kline, at how you all segregate your
accounts, but I will tell you, when I read this morning's story
and then I listen to how you are going to have difficulty
making repayments, it is hard not to reach the common sense
conclusion that those repayments to the Pacific Northwest,
those kinds of considerations need to come first, and it looks
to me, as I read the morning paper--and I am not saying these
transactions were illegal. It just seem to me the shareholders
came first.
Mr. Frank. Senator, let me respond as well. The article you
referred to actually dealt with my company, Southern California
Edison, and was a result of an audit that was made of our
finances at the request of the public utilities commission, but
an audit which we actually commissioned, if you will. We
suggested they do it, and the numbers in question, the billions
of dollars you refer to----
Senator Wyden. This was in the paper.
Mr. Frank. Yes, in the paper this morning, are basically,
as Senator Feinstein characterized them earlier, normal course
of business. These are dollars that were paid in dividends to
shareholders over a 5-year period of time, most of which was a
period that we were not in this crisis.
The balance of the dollars had to do with the return of
money to lenders and investors who had invested in powerplants
that we were required to divest, and the public utilities
commission required us after that to seem our same capital
structure and balance it. We had to shrink the company as a
result of commission decisions, and the money simply went back
to lenders and to investors.
It is not any different than what you do to buy a house and
mortgage it, and you sell that house, you pay back the lender.
That is where the money went, and so the suggestion that there
was money laundering, if you will excuse the expression, there
is no mystery here.
Senator Wyden. I cannot tell that, and that is the problem.
What I can tell you is----
The Chairman. You are listening to the witness tell you.
That is the point of this hearing.
Senator Wyden. He has given us one explanation, but as Dr.
Karier and the folks from Enron said, this is a field where
there is virtually no data available, so one of the ways we can
actually get to the bottom of this, and it does not cost any
money, is to look at what is essential to make free markets
work, and that is good information.
What is really at risk are jobs in my part of the country
because energy prices have gone up so high and we continue to
ship energy to California.
Thank you, Mr. Chairman.
Mr. Frank. Let me beg to differ on one other point. I do
not think any of the other witnesses were making a case that in
the issue that you are talking about there is not adequate
information available. We have had an independent audit done of
it, and that is what was reported on this morning, and so I do
not think any of these other witnesses are taking any exception
to the amount of information that is available.
Senator Wyden. What I said is, one U.S. Senator, I read
this morning's paper----
The Chairman. Let me remind you time is up.
Senator Wyden. Thank you, Mr. Chairman.
The Chairman. It would be beneficial, I think, for the
record for you to submit--and I know the State of California
has all of your records, when you were mandated by the State of
California to sell all of your nonnuclear and nonhydro
facilities, what you did with that money. Obviously, it belongs
to your shareholders.
Mr. Frank. And our lenders.
The Chairman. Senator Thomas.
Senator Thomas. Thank you, Mr. Chairman.
Well, obviously the immediate issue is at hand, but so is
the future, and so I was a little--this morning in the panel
they talked a lot about signals, price signals, and that they
should be able to tell them 3, 4, or 5 years ahead of the
prices.
Tell me, from your point of view, who is responsible for
reading the signal? Was the signal read? Why wasn't something
done?
Mr. Kean. I can take a first crack at that. I would not
surmise that anybody expected the full impact of the demand
growth in California, therefore the impact on available
supplies, but it was clear that new generation was going to be
needed in the State, and many investors and developers stepped
up to site additional generation in the State. In fact,
thousands of watts more than the actual incremental increase in
demand was proposed.
The difficulty has been not a lack of interest, not a lack
of, I guess, getting the signal, if you will, to build new
generation in the State, but instead the attempt to build
generation has been slowed down significantly in California by
the way the siting and permitting process has worked.
So a good contrast to that in the Midwest, a couple of
years ago, in fact it was in front of this same committee, we
had just seen price spikes in the Midwest. Those price spikes
signaled additional generation requirements. Generation came on
within a 12- to 24-month time period. Within 2 years, things
were very much settled back to normal, and I think that is what
you are going to ultimately see in California if supplies are
allowed to come online.
Senator Thomas. In the past, where you had energy, electric
energy pretty well controlled, when you decided to build a
generating plant you were promised pretty much by the State
agency that your fees would be such that you could pay for it.
If that is not the case, then is that the problem, and what is
the solution to that, long-term contracts?
Mr. Kean. Long-term contracts are certainly part of that. I
think that even if utilities were attempting to build
generation today, under an old regime, if you will, they would
still be having these same kind of problems. It is not any
easier to get a facility sited, because you are an investor-
owned utility.
Senator Thomas. So you do not think there is reluctance on
the part of the generators to build?
Mr. Kean. No, absolutely not. There was an over-exuberance
to build, I think, but it remains extremely difficult to get
facilities built, I have to tell you, from my perspective. I am
not a generator in the State.
The Chairman. What we are going to do is, Senator Bingaman
and I are going to make a short closure that will conclude the
hearing.
I want to thank you all for your willingness to give us
enlightenment, and I think it is fair to say that, while we are
sensitive to California's needs, the solution in California
that is being developed now has yet to be finalized in
relationship to how the investment community is going to see
its adequacy to invest in new additional facilities, because
what we have got here are two things.
We have got an energy insufficiency, if you will, in
California from the standpoint of generating facilities, and
the ability to attract energy from outside California becomes a
credit problem, and the fact that the administration has
guaranteed in one sense, by ordering the energy sales of
natural gas which extend to February 7, and electricity, which
extends to February 7 as well, with five extensions, puts all
the residents of the United States at risk if, indeed, the
California utilities cannot pay for that energy.
Obviously, those that are ordered to provide that energy
are somewhat reluctant, inasmuch as it might be up to 2 months
before they know if they are going to get paid, and we do not
know if the California restructuring effort is going to meet
the test that it must.
Now, one of the things that bothers me is the statement
from the gentleman from Tacoma that they are looking at rate
increases of 50 percent, and the reality that the California
average has been a 9-percent increase, but that is somewhat
subject to analysis, because there was a 10-percent reduction
sometime ago in rates, and then a 9-percent addition, so I am
told that the average rate in California for a consumer and
industrial is about 9 percent, which is hardly reflective of
what others are experiencing.
So the question of how we get the attention of the
California consumer in the sense that sometimes it is pretty
hard to get things started until somebody's ox is gored--and I
hate to use that direct reference, but clearly we have got a
situation of inequity here, and it is up to California, along
with the role of the Federal Government, in an appropriate
manner to assist in that, because, as we have seen from
testimony, other areas of the country are experiencing severe
exposure relative to rates, but still we have to generate more
power. The question is, are we going to have to do that through
emergency regulations, or waivers, or expediting permits, or
all of the above?
I am also concerned about a couple of other things. This
suggests it is going to get worse. Judi Johansen, formerly
associated with Bonneville Power, I understand that our U.S.-
Canadian treaty regarding the development of the Columbia River
Basin expires in 2002. Now, if you really think about that, and
the contribution Bonneville makes in the Pacific Northwest, we
use Canadian water to spin generators at U.S. locations down-
river. We get that power until the year 2002. After 2002,
Canada has title to that power, so Canada will not actually
take the power. They will just sell it to us, and we will pay
the piper whatever the rate may be.
So the point is, the exposure here is significant, and we
have got to face up to it, because this article that was
referred to by one of my colleagues earlier with regard to
natural gas--and it is the Wall Street Journal today. It says,
natural gas producers report that outcome continues to fall.
All high natural gas prices drive up heating and other bills.
Producers of the fuel are reporting that production continues
to decline, suggesting that today's high prices will not be
falling significantly any time soon.
And you know, we focused our entire energy outlook on
natural gas, to the expense of coal, clean coal, nuclear to
some extent, oil, hydro, and we simply cannot do that any more,
so we are going to have to come to grips with reality. The
environmental community is going to have to recognize that it,
too, has a responsibility to come up with some alternative
suggestions that are real. We cannot do it by conservation
alone, and that is just the harsh reality.
I do want to again thank you. There are many other
questions we could go into, but I think we have done a pretty
good job laying out the fact that there is a problem here.
There is a problem for California, there is a problem for the
Pacific Northwest, and a problem for the rest of the Nation
with regard to the energy crisis that is upon us, and it is
like a cancer that will spread.
We can have all the public hearings we want, but we have
got to induce capital to invest in energy production, and as
far as I am concerned the State of California is going to have
to address its responsibility to somehow guarantee the
legitimate indebtedness that has occurred in the resale of
power, which California consumers have had the benefit of,
because if we do not, you are going to see a bankruptcy judge
dictating the terms and conditions under which the California
consumers are going to set the rates. I do not see any other
alternative.
Again, let me thank you, thank Senator Bingaman. I am going
to allow Senator Domenici, who has been at an extended hearing
of the Budget Committee--he was here at the beginning, to--why
don't we just let the two New Mexico Senators conclude this, is
that fair enough?
Senator Domenici. Jeff, you do not have to stay around for
me.
Senator Bingaman. Well, I think probably the other Senators
here would like to make a short statement before we conclude.
Why don't we let Senator Domenici make his statement, or
comments, or questions, then, since he has not had any chance.
Senator Domenici. Thank you very much. First, like everyone
else, I think it has been a good meeting, and the two of you
are to be complimented for calling this hearing and putting on
the kind of witnesses we have been privileged to hear. I myself
am going to say to the California Senators and the people who
are most adversely affected, it is spilling over into my State,
too, and I must say I could not have been here. I had to
preside over a presentation of the budget from those who are
most informed, the Congressional Budget Office, and that is my
job and I had to do that, but I want to make just a few
observations.
First, I want to thank all of you for your testimony and
for your help. I want to start by saying thank you to the
President of the United States. He has only been in office a
little over 10 days, and I believe he has done exactly the
right thing. He has asked the Vice President to head a task
force with those from various Departments that have an interest
in energy, and then he staffed it with some very expert people,
and he has asked for the facts, and some recommendations
regarding California. I do not think we can expect much more,
considering that he just went into office.
The crisis is here, and California is still confused. I do
not mean to say that in any pejorative sense, but they do not
quite know what to do yet, and I think they are thinking it
out. In the meantime, to have the White House thinking it
through I think is a very good posture to be in. I believe we
have--number 1 we will get some real answers, and we will get
some real recommendations, and realistic in terms of whose job
it is to do what.
I know how this can spread and how it can affect the
economy, and so I am as worried about it as the Senators who
are most adversely affected, and I will do my share to try to
help out, but it is obvious to me, and I take a great deal of
pleasure in saying that I have been speaking to this matter for
at least 2\1/2\ years that I can recall on the floor, maybe
twice, three times a year.
You know, it is sort of like talking about the budget. Even
if you are chairman of it, until Alan Greenspan repeats your
words, nobody knows what you said. So whatever I have been
saying is about the same as Alan Greenspan on the budget, but
until he testified the other day, the world did not know. Some
of us knew about that and were worried about what he was
worried about for a long, long time.
But I have been suggesting that the United States was
making a very serious decision as a country and certain States
as States, and that was to not recognize that we have a huge
supply shortage. It is coming on us like a bow wave, but it is
not because we do not have energy. We have plenty of energy in
America. There is no excuse for policymakers to let America be
in this position, California and the rest of the States
included in that.
We have to make policy decisions that say, yes we can
produce more energy, rather than, it does not matter, we are
deciding policy without concern to energy, and we must
diversify. Now the answer is natural gas. I can say to all of
you from my State, and Senator Bingaman as my fellow Senator,
we are producing natural gas as fast as anybody can get out in
the field, but nonetheless, it is not right for America to be
depending upon that kind of fuel for the next 10 or 15 years,
and I would suggest it is not right for California to assume
that their new powerplants will be natural gas.
We are going to have to have a mix, a mix between clean
coal, between gas, and obviously we have to put some basic
research on nuclear power back on the burner. That is being
done in the world, and we are frightened to death of it. There
is no reason to be, and when you look at it all, we should have
an oversupply of energy each and every year. I do not know how
the market would deal with that, but obviously we are certainly
not dealing with shortages very well.
So I come here willing to do what I can when the President
makes his recommendations regarding California, but I also hope
that this committee will exercise every bit of jurisdiction and
muster to do something about the supply side in the United
States and to send out the signal that we are going to have an
abundant supply of electric energy to serve our people.
We have been very worried about crude oil imports, and
right inside of the United States there are growing shortages
have occurred in terms of electrical energy. We spoke more
eloquently about being dependent upon crude oil and less
concerned and less eloquently about the growing shortage of the
energy called electricity that puts lights in our homes and
builds our industry.
So the President is probably going to move beyond his task
force of looking at California and doing another exciting
thing. He is going to ask a task force of the Environmental
Protection Agency and the Department of Energy and Department
of the Interior and maybe some others to begin an orderly
process wherein policy decisions are no longer made on the
basis of one mission, but, rather, on the mission that if it is
an environmental issue, what about the energy problem that we
are going to be confronted with if we make a decision one way
or the other, and so it, too, can be evaluated.
I think that is going to be occurring, and hopefully that
is what America must do in all of the Departments that have
something to do with energy. The Interior Department, when they
look at locking up another 500,000 acres, maybe somebody will
be asking its energy impact, and looking at that in an
objective way so that it, too, can be considered.
It has been my feeling that we have made policy decision
upon policy decision that did not take into consideration the
energy needs of our country, and had they, we could have
adjusted policy and produced more energy and still kept the
environment that we want so much to preserve.
Thank you very much, Senator Bingaman.
Senator Bingaman. Thank you very much. Let me just ask each
of the other members to make a very short statement, if they
would. I do not think we want to go through another set of
questions here.
Senator Wyden. Mr. Chairman, I will be very brief. I just
want to make two points. The first is on operating information,
the second is on financial information.
I hope that our colleagues--and this strikes me as
completely bipartisan--will reflect on what Dr. Karier said and
what Mr. Kean said with Enron. It is clear, in my view, that
you have got to get operating information out to the public in
order to keep the lights on and make marketplace systems work.
That is point 1.
Point No. 2 deals with this question I was going into with
the utility. Here is my concern. You cannot tell a consumer
that they are supposed to get pricing signals right now, and
then they read these newspaper stories 3 or 4 years later about
billions of dollars being transferred. It does not strike them
as being very fair, and so what I want to do is work with both
sides of the aisle and our colleagues and all of you witnesses,
but we have got to have a sense of fairness here.
Those are my concerns.
I thank you, Mr. Chairman.
Senator Bingaman. Thank you.
Senator Feinstein, did you have a final statement?
Senator Feinstein. Just two quick things. The San Francisco
Chronicle has an article that says hundreds of thousands of
residents may likely have their natural gas supply cut off.
This relates to PG&E. Federal or State authorities to rescue
PG&E from suppliers' refusals to provide gas. If I might ask
for a written comment from PG&E on this specific article, with
as many facts as you can provide. It is a January 28 San
Francisco Chronicle article.
And if I might ask any producer that has a plant in
California to let me know if your plant is not operating
because of air quality concerns, and if that is the case,
specifically what those concerns are.
Thank you, Mr. Chairman.
Senator Bingaman. Senator Cantwell.
Senator Cantwell. Thank you, Mr. Chairman. I just wanted to
qualify the chairman's statements earlier, Senator Murkowski
about Tacoma, that they have actually implemented a 50-percent
surcharge, not discussed, which amounts to about a 43-percent
increase to residential customers and 75 percent to industrial
customers. BPA is in the announced phase but not implemented.
I bring that up because I just want to remind my colleagues
that these rates really do translate, as Mr. Wilcox pointed
out, into impact on paychecks and the economy of the Northwest,
and I will be working with Senator Feinstein on these cost rate
solutions and hoping to focus not just on the long term but
obviously on some short-term relief for the Northwest economy.
Senator Bingaman. Thank you very much. Again, I thank all
the witnesses. I do think the hearing has helped us to
understand the complexities of this problem.
I think our next step is obviously to pull in some of the
Federal officials with authority in this area, the Federal
Energy Regulatory Commission, the Department of Energy, and get
their reaction to some of the suggestions, some of the ideas of
cost-based pricing of wholesale power on a temporary basis, if
that is something that they are looking at.
That is the question that needs to be asked of them, and I
know there are many other questions that were suggested in
today's testimony.
Thank you all very much for coming.
[Whereupon, at 2:35 p.m., the hearing was adjourned.]
APPENDIXES
----------
Appendix I
Responses to Additional Questions
----------
Southern California Edison,
Rosemead, CA, February 28, 2001.
Hon. Frank Murkowski,
Chairman, Committee on Energy and Natural Resources, U.S. Senate,
Washington, DC.
Attention: Mr. Howard Useem
Dear Chairman Murkowski: Thank you for the opportunity to testify
before your Committee on January 31, 2001. Per your request, enclosed
are my responses to additional questions posed by Senator Ben
Nighthorse Campbell.
Please do not hesitate to contact me again if I can be of further
assistance in your continuing review of the California energy crisis.
Sincerely,
Stephen E. Frank,
Chairman, President & Chief Executive Officer.
[Enclosure]
Responses to Questions From Senator Campbell
Question. Many statements have been made that California's
electricity crisis is a regional crisis. I know that when California
needed or wanted water they got water from Colorado, now when they need
power are they going to take Colorado power? What impact will
California's current problems likely have on Colorado and other Rocky
Mountain states?
Answer. Economic growth throughout the West has increased demand
for power throughout the interconnected Western grid, known as the
Western Systems Coordinating Council. Eight of the Western states are
listed among the fastest growing states in the U.S. The California
wholesale market is broken, and the high prices it attracts have the
net effect of increasing prices throughout the West. To the extent that
peak loads in California require increased imports from other states,
the entire Western grid will be affected. To the extent that the
wholesale electricity market in California continues to be broken, the
entire Western wholesale electricity market will be affected. This
means that:
1. New generation reserves will be required throughout the Western
grid to meet demand, and
2. Temporary wholesale price controls are necessary to bring prices
in the West to reasonable levels until additional generation can be
brought into service and a healthy, competitive market is
reestablished.
Question. What can we all do to ensure that the rest of the Western
region is minimally affected by the crisis in California, because I
don't want my home state of Colorado's resources and consumers hit by
these problems?
Answer. The federal government has jurisdiction over wholesale
electricity prices. The Federal Power Act requires that the Federal
Energy Regulatory Commission (FERC) provide ``just and reasonable''
rates in the wholesale market. Because FERC has failed to do this, it
is incumbent on Congress to set cost-plus rates to achieve ``just and
reasonable'' rates for the West. Without such action, wholesale
electricity prices will continue to rise throughout the West until new
generation is added sufficient to meet growing demand. This will likely
take two to three years to implement. Nothing else can protect Western
consumers from the broken wholesale market during the time it takes to
build sufficient generating capacity to support a competitive market.
Question. I am skeptical of price caps. Many say they are likely a
disincentive to investment in new generation. Won't they hurt in the
long run?
Answer. It is true that those looking for the astronomical returns
earned by generators over the past 10 months would prefer to keep
earning these returns, rather than those that result from ``just and
reasonable rates.'' However, despite the presence of wholesale price
caps, substantial new generation was proposed in California and
elsewhere in the West even before the tremendous price run-ups of the
past ten months. Thousand of megawatts of generation have also been
proposed elsewhere in the country where wholesale electricity prices
are far lower than they have been in the West. Temporary cost-plus
rates that provide generators with a reasonable profit, above and
beyond their costs, provide the certainty needed for new investment in
the short run. The current legislative and regulatory uncertainty in
California due to the continued broken market is a far greater
disincentive to new investment in generation than is a fixed,
reasonable rate of return. However, to alleviate concerns in this area,
new generation could be exempted from cost-plus limits, thus
eliminating even the perception of a disincentive.
As for the long run, cost-plus rates need not be, and should not
be, permanent. They can be limited to one or two years, or be indexed
to a generation reserve margin that would create an automatic sunset
once the reserve margin in achieved. A healthy market will then provide
further incentive for future investment and greater efficiencies.
______
The Williams Companies, Inc.,
Tulsa, OK, March 1, 2001.
Howard Useem,
U.S. Senate, Russell Courtyard, Washington, DC.
Re: January 31, 2001 Oversight Hearing of the Committee on Energy and
Natural Resources
Dear Mr. Useem: Please find attached the responses of Mr. Keith
Bailey, Chairman, Chief Executive Officer and President of The Williams
Companies, Inc. to the February 9, 2001 letter of Chairman Frank H.
Murkowski. By the February 9 letter, Chairman Murkowski requested that
Mr. Bailey respond to three questions submitted by Committee Member,
Senator Campbell. Responses were requested to be sent to your attention
by March 2, 2001.
Respectfully submitted,
Alex A. Goldberg,
Senior Regulatory Counsel.
Responses to Questions From Senator Campbell
Question. Many statements have been made that California's
electricity crisis is a regional crisis. I know that when California
needed or wanted water they got water from Colorado, now when they need
power are they going to take Colorado power? What impact will
California's current problems likely have on Colorado and the other
Rocky Mountain states?
Answer. It is difficult for Williams to determine if power actually
generated in Colorado has been transmitted to California as a result of
the recent events in the California energy markets. However, on
December 14, 2000, former Department of Energy Secretary Richardson
issued an Order pursuant to Section 202(c) of the Federal Power Act
requiring certain power companies, including Public Service Company of
Colorado (New Century Energies), to respond to requests by the
California Independent System Operator for generation and access to
transmission. This order limited the requirement to sell excess
electricity beyond that necessary for utilities to serve their firm
customers. Through a series of amendments, including one by current
Department of Energy Secretary Abraham, this Order was in place until
February 7, 2001. See attached Orders.
In terms of the Western United States generally, it is undisputed
that power has been imported into California that otherwise would not
have been generated. A significant portion of this power has been
generated as hydroelectricity. Other electricity has been generated
from natural gas or other fuels. The result of increased hydroelectric
generation has been a lowering of reservoir levels throughout the West.
Williams is concerned that as a result of the unseasonal demand placed
on this resource by the DOE orders, absent unexpectedly high
precipitation levels in the next two to three months, traditional
levels of hydroelectric production may not be available this summer.
This fact, by itself, will increase prices for both hydroelectric
generation and gas fired generation, and potentially cause the spread
of reliability issues throughout the West. See attached data showing
reservoir and snowpack/precipitation levels for this year relative to
past periods. Increased natural gas usage has also resulted in higher
prices.
As you are well aware, the spring runoff from Colorado's western
slope feeds the Colorado river system and other rivers that flow to the
southwest. Much of this water feeds hydroelectric capacity to Arizona,
Nevada and Southern California. With reservoir levels in the Pacific
Northwest being even lower than in the Southwest, this hydroelectricity
will be in high demand throughout the region this summer. Natural gas
usage is also increasing, primarily as a result of its use for
electricity generation. Gas prices are expected to remain high through
the summer. This will also result in higher electricity costs
throughout the West. As a producing state, Colorado will see some
economic benefit from this activity. However, the extent of the
negative ripple effect back to Colorado is uncertain, but could easily
result in tighter supplies, higher prices, and reliability issues for
Colorado customers. Colorado is linked with California and other
Western states in the same electricity grid.
It is Williams' firmly held opinion that the dislocation that may
result this summer should not result in renewed government intervention
into the electric and energy markets. Rather, as has been conclusively
demonstrated in other regions of the country, if both producers and
consumers are allowed to react to the markets, we will see increased
supply and moderated demand such that any dislocation would be short-
lived. Intervention, on the other hand, will prolong California's
current problems and increase their likely impact on other states.
Question. What can we all do to ensure that the rest of the Western
region is minimally affected by the crisis in California, because I
don't want my home state of Colorado's resources and consumers hit by
these problems?
Answer. California is not an island. During peak periods, it has
historically imported 20% of its electricity. One reason for the past
year's price increase was a significant net decrease in imported power.
This decrease was the result of both economic growth outside of
California, in states like Colorado, and of the California price caps.
Growth in surrounding states meant less power was available to send to
California during peak periods. When it was hot in Southern California,
it was also hot in Nevada and Arizona. As a result of price caps in
California, when prices increased outside of California, power migrated
to those high priced markets, not California. More recently, the credit
problems of the California utilities have also made some suppliers
reluctant to sell power to California. In addition, where California
retail rates were frozen, customers were not given any incentive to
reduce demand. Lastly, due to south-to-north transmission constraints
within California and the West, available power could not always move
freely to where it is most needed.
This discussion leads to our suggestions for avoiding the spread of
the California issues. First, deal with supply and demand. When
examining the electricity issues in California, all roads eventually
lead to this basic economic concept. With the appropriate level of
regulation, the electricity business will behave like any other
commodity. If markets are allowed to develop, new market participants
will bring new supply. New supply will drive down prices. Lower prices
will increase demand. Supply will tighten. Prices will increase.
Increased prices will flatten the demand curve and bring more new
participants. The cycle will continue.
In California, the retail market has been locked in a high demand,
low price, period of the cycle that could not be maintained. It simply
did not contain sufficient incentives for conservation. In addition,
without retail customers receiving price signals, the permitting
process for new generation was allowed to move so slowly that few
proposed facilities were actually constructed. It has only been since
the general population has perceived that there was a crisis that the
political will has been generated that was necessary to speed the
permitting process. Recently, the majority of the rest of the West has
started to allow prices to go up. Customers are reacting by reducing
usage and the industry is building plants to make more power as fast as
they can. New transmission projects are not as far into development,
but must not be ignored. It is as important to build new power lines as
it is to build new plants. In a competitive market, reducing the
barriers of getting product to market provides great price and
reliability benefits. The government has an interest in moving through
this part of the business cycle as quickly as possible. It can aid in
the process by working to amend laws and regulations that will
streamline the siting and construction process for new plants and for
new transmission as well as providing temporary relief from regulations
that limit the operation of any existing capacity during this period of
crisis. The government can also aid in providing incentives for demand
side management and conservation such as allowing pricing to more fully
reflect the actual cost of production, approving block rate programs
which cause each increment of demand to be more expensive than the
prior increment, and approving capacity buy-down programs which can be
a very effective proxy for new supply in times of capacity shortage. We
believe this can be accomplished while still insuring that electricity
is always available for communities in need.
The next step in avoiding the spread of the electricity issues from
California is to avoid the temptation to repeat California's mistakes.
As is discussed more fully below, price caps do not provide any
significant benefits and actually will harm market development. Next,
while competition will lead to increased supply and lower prices, it
does not happen over night. In order to hedge against uncertainty while
markets develop, buyers must have the ability to obtain long term
energy contracts for a significant portion of their current needs. The
costs of these contracts must be allowed to be passed through to
customers even if competition may lead to the prices being over market
during the last years of the agreements. The certainty in the early
years is also balanced by the ability to meet needs brought on by
growth with more short-term purchases.
Lastly, California should be encouraged to work more closely with
its neighbors and should consider abandoning the California Independent
System Operator (``CAISO'') in favor of joining a Regional Transmission
Organization (``RTO''). Remaining as a single state transmission
operator hampers California and its neighbors ability to enhance
intraregional power flows, coordinate transmissions planning, and take
advantages of greater scale to add the flexibility needed to respond to
emergency situations.
While no guarantee against what may be a difficult summer, the
above steps will shorten or eliminate the California issues and the
spread of those issues throughout the West.
Question. I am skeptical of price caps. Many say they are likely a
disincentive to investment in new generation. Won't they hurt in the
long run?
Answer. Williams has actively opposed the imposition of any price
cap in the electricity markets for several reasons. Primary among those
reasons are: (1) Price caps are arbitrary ceilings that have no
relation to the cost of production and, as a result, tend to exacerbate
shortages; (2) price caps distort market signals and undermine investor
confidence necessary to attract new generation; (3) price caps mask
signals that are necessary to motivate demand response; (4) price caps
fail to provide for recovery of costs, compensate for risk or provide a
reasonable rate of return; and (5) price caps constrain supply and
threaten reliability.
1. price caps are arbitrary ceilings that have no relation to the cost
of production and, as a result, tend to exacerbate shortages
Recent history has demonstrated conclusively that when price caps
are imposed, they are often set at some arbitrary ceiling that has no
relation to the costs of production. This is best evidenced by the Cal
ISO's reduction of its purchase price cap to $250 in mid-Summer 2000 at
the behest of those seeking a ``quick fix'' to high electricity prices.
However, as discussed below, such arbitrary action actually reduced
supply by encouraging exports, discouraging imports, and causing
certain peaking resources to be taken off-line due to an inability to
recover costs. Additionally, such arbitrary caps did nothing to
mitigate price--indeed, as discussed below, average prices actually
increased as the cap was lowered.
Hence, if some form of price control is deemed necessary on an
interim basis, it must be cost-based and have an appropriate profit
component for the supplier. Power providers must have the opportunity
to recover fixed and variable costs, including costs for natural gas
and emission credits, as they change from day to day. In addition,
power providers must be able to collect some form of profit in order to
act as an incentive, not just to maintain the existing facilities, but
to be able to compete in equity markets for the capital that is
necessary to invest in new facilities. Lastly, any price controls that
are put in place state-by-state should include lost opportunity costs
that result from keeping power in-state, as opposed to pursuing higher
out of state markets. The only way to avoid this issue would be to
consider regional price controls.
Moreover, the price control must be truly temporary in nature. Lack
of regulatory certainty will reduce any business' interest in any
market. While Williams generally opposes any effort to impose price
controls, as such is adverse to a competitive market, Williams believes
that if price controls must be implemented, they must not be arbitrary
or permanent.
2. price caps distort market signals and undermine investor confidence
necessary to attract new generation
Price caps are antithetical to a competitive market, and, rather
than operating as an appropriate solution to perceived market flaws,
they actually act as a temporary band-aid (but, as discussed below, not
a very effective one), only exacerbating long-term problems by
threatening reliability, sending the wrong price signals, jeopardizing
much-needed investment in generation and creating an atmosphere of
extreme uncertainty. A rational supplier may not willingly choose to
expose itself to such risks, and a rational generator may not consider
entering a market subject to price caps to build additional generation.
This is especially true when a market has indicated a willingness to
lower those caps in an arbitrary fashion, which has been the case in
California on multiple occasions. Because rational generators will seek
to invest and sell in more stable markets where the ground rules are
known and adhered to over time, the lasting consequences of price caps
may come in the form of ever expanding reliability problems. Rather
than new, environmentally friendly gas fired power generation being
built, price caps encourage a reliance on older, less environmentally
friendly, less reliable generation and on the good-will of neighboring
states and hydroelectricity.
Price caps discourage generators outside of a price-controlled area
from selling into that area because such generators can either obtain
market-based prices elsewhere, or they do not wish to take the risk of
doing business under an environment subject to artificial price
controls. Similarly, generators located in an area subject to
artificial price controls are encouraged to export power to higher
priced, non-capped markets. Additionally, in times of surplus, as
generators bid into the market at prices just under the caps, the
purchase price cap may actually become more of a price floor.
Price caps distort price signals, diminish incentives for the
correction of market flaws, and are inconsistent with the policy of the
Federal Energy Regulatory Commission (``Commission'') of encouraging
the development of a competitive market. As the Cal ISO stated in its
Amendment No. 21 filing, ``The ISO's strong preference would be to
eliminate price caps completely in its Energy and Ancillary Services
markets, so that market participants could receive undiluted price
signals that would provide incentives for investment in new generation
resources and in enhanced capability of Demand to respond to prices.''
(emphasis added).
3. price caps mask signals that are necessary to motivate demand
response
Artificial price caps do not send the proper price signals in terms
of either new generation or transmission or in terms of demand side
management, and, consequently, much needed generation and transmission
will not be built nor will demand side programs be successful; this
must be considered in light of an ever-expanding population and
increasing demand for electricity.
Moreover, the Cal ISO's Market Surveillance Committee has stressed
that price caps are not an appropriate long-term solution to perceived
market flaws. The MSC found that ``price caps treat the symptom . . .
rather than the causes . . . of California's electricity woes. For this
reason we also believe it is important not to set the price cap too
low, as doing so could discourage both the emergence of price-
responsive demand and the construction of new generation.'' The MSC
continued, noting that ``setting the price cap too low can have
perverse effects on bidding during off-peak periods, discourages the
emergence of price-responsive demand, and operates at cross-purposes
with California's urgent need to increase the available supply of
electricity.'' Lower price caps also leave ``the ISO and PX at a
competitive disadvantage with respect to other buyers in the WSCC
market.'' It should also be noted that customers must feel the price
signals that are needed to create demand side responsiveness.
Incentives to customers to reduce demand are an integral part of
removing price caps.
4. price caps fail to provide for recovery of costs, compensate for
risk or provide a reasonable rate of return
Price caps, especially caps set arbitrarily and unreasonably low,
fail not only to provide a reasonable rate of return on a generator's
investment, they may also fail to provide for the mere recovery of
costs associated with generating electricity. Indeed, because the
variable costs of operating certain older peaking units exceeded the
Cal ISO's hard price cap of $250, which was in effect from mid-Summer
2000 to late Fall 2000, during non-emergency periods these units were
taken out of the market. Thus, consistent with the Cal ISO's stated
concerns included in its resolutions authorizing the lowering of its
price caps, the Cal ISO's $250 cap did, in fact, cause the removal of
much-needed generation from the market.
Artificial price caps, and the regulatory uncertainty created by
the haphazard use of such price controls, therefore have a direct
impact on the willingness of merchant power plant developers to
generate power for price controlled areas or invest in new generating
capacity that is critically needed in such areas. Williams continually
assesses nationwide opportunities for investing in new generation;
however, Williams is finding it increasingly difficult to justify any
new investment in California given the current regulatory climate and
tremendous instability. It is Williams' preference to invest in markets
where Williams' own efficiency and ability to react to customers' needs
determines its success or failure, not where its performance is
dictated, or where the rules change frequently. Although many new
generation projects have been proposed for California, those projects
are competing against development opportunities in other states and
other countries, and their fate may ultimately be decided by whether
artificial price controls are maintained.
5. price caps constrain supply and threaten reliability
Price caps pose a real threat to system reliability that cannot be
adequately measured. The continued use and lowering of price caps only
result in an increase in power exports and a decrease in power imports
during times when power is needed most. Such a situation can only
increase the possibility of more serious system emergencies and a much
greater occurrence of blackouts. This fact was acknowledged by both the
CEO of the Cal ISO, Terry Winter, as well as the Cal ISO's Staff at the
June 28, 2000 Board meeting where caps were lowered to $500. This fact
is also a prime driver behind the push by California for regional price
caps.
Moreover, price caps result in serious burdens in the real time
market. When energy trades above the Cal ISO's cap in forward markets,
Load underschedules in order to buy from the Cal ISO in real time at a
lower net price. In conjunction with the prohibition that existed
against the utilities in California entering into substantial long term
power contracts, price caps are a root cause of the Cal ISO's problem
of excess volume in the real time market under high demand conditions,
which threatens reliability and increases price volatility. The
Commission has ordered the Cal ISO to resolve this problem--however, a
simple solution to the problem is the elimination of purchase price
caps. Once caps are eliminated, Load will no longer have an incentive
to limit the price of their bids in the forward markets.
6. price caps fail to achieve their intended result
Not only are price caps an inherently bad policy, they have also
proven quite ineffective at mitigating price. The Cal ISO's Market
Surveillance Committee found that monthly average energy prices during
June 2000, when the price cap was $750/MWh, were lower than monthly
average energy prices during August 2000, when the price cap was $250/
MWh. This result occurred despite the fact that virtually the same
amount of energy was consumed in California during these two months.
conclusion
Williams agrees with the Commission's recognition in its November 1
Order that price caps serve to disrupt the market and discourage new
generation, and they have proven to be largely ineffective at
moderating prices. Indeed, as the Commission also noted, average prices
actually increased as price caps decreased. Williams also agrees with
the Commission's prior finding that the ``price cap is not an ideal
approach to operating a competitive market, and we do not expect it to
remain in place on a long-term basis.'' AES Redondo Beach, L.L.C. et
al., 87 FERC para. 61,208, at 61,818 (May 26, 1999). Appropriate price
signals are needed to attract investment in new capacity, and Williams
agrees with the Commission that ``the most crucial task ahead is to
ensure that a robust supply enters this market, both now and in
response to any future price signals.'' November 1 Order at 46.
Accordingly, Williams EM&T recommends the prompt elimination of all
such caps.
______
Calpine Corporation,
Western Region Office,
Pleasanton, CA, March 1, 2001.
Mr. Howard Useem,
U.S. Senate, Russell Courtyard, Washington, DC.
Dear Mr. Useem: On behalf of Calpine Corporation, I am pleased to
provide the following responses to questions from Senator Campbell
regarding the California energy crisis. I have repeated the questions
here and follow them with our responses.
Sincerely,
Curt Hildebrand,
Vice President.
Responses to Questions From Senator Campbell
Question. Many statements have been made that California's
electricity crisis is a regional crisis. I know that when California
needed or wanted water they got water from Colorado, now when they need
power are they going to take Colorado power? What impact will
California's current problems likely have on Colorado and the other
Rocky Mountain states?
Answer. For the near future, California's electricity problems will
probably not affect Colorado in any substantial or significant way. The
Colorado electricity market has yet to deregulate and it appears
unlikely that will change in the near future. Since the Colorado
utilities continue to operate under state public utility commission
regulation, the utilities' first obligations are to their own
customers. Any sales to California must come after Colorado's utilities
meet their obligations to serve their own customers. A recent analysis
of Colorado utility generation resources suggests the Colorado
utilities are largely self-sufficient, purchasing only on the wholesale
electricity market when it is cheaper to buy power rather than generate
it themselves. There is the possibility that Colorado utilities might
enter into contracts to sell their excess power to California entities
and unforeseen circumstances could arise that would make such contracts
uneconomic. However, the Colorado Public Utilities Commission would
never permit the Colorado utilities to defray the costs of such
contracts at the expense of Colorado ratepayers. Indeed, it is more
likely that sales to California will defray costs to Colorado
ratepayers since such sales will reduce some of the burden of raising
capital for new generation that could serve either Colorado or
California.
Question. What can we all do to ensure that the rest of the Western
region is minimally affected by the crisis in California, because I
don't want my home state of Colorado's resources and consumers hit by
these problems?
Answer. Currently there is not too much Colorado should be doing.
By retaining its current regulated status, the California problems
should not affect the Colorado market or resources. Some of the
protections noted in the response to the first question should provide
some safeguards for Coloradans.
Question. I am skeptical of price caps. Many say they are likely a
disincentive to investment in new generation. Won't they hurt in the
long run?
Answer. Caution is a wise and prudent response regarding price
caps. A price cap that is set too low will have a disincentive effect
on building new generation as well as potentially threaten the economic
viability of existing generation a price cap set too high will be
unsatisfactory from a consumer standpoint. At best, a price cap can
prevent only the most egregious exercises of market power, e.g., the
$6,000/MWh price that occurred last May in New England. The ISO-New
England set a price cap at $1,000/MWh after that incident. Price caps
can also suffer from rigidity of implementation. The large increases in
the price of natural gas may make a price cap as high as New England's
too low to permit financially viable entry by new generation. Thus,
unless the price cap receives regular review for such effects, it may
have a substantial negative impact.
We hope these responses are helpful to you. Please advise if you
have questions or wish to discuss. Like you, we hope to see the end of
this crisis through added energy resource development and new plant
capacity additions.
______
CERA,
Cambridge, MA, March 2, 2001.
Mr. Howard Useem,
U.S. Senate, Russell Courtyard, Washington, DC.
Dear Mr. Useem: On January 31, 2001, I testified on the California
power crisis at the oversight hearing held by the Committee on Energy
and Natural Resources. Below please find three additional questions
from Senator Campbell and my responses. The questions were forwarded to
me by Senator Frank Murkowski, Chairman of the U.S. Senate Committee on
Energy and Natural Resources.
I hope I have answered Mr. Campbell's questions sufficiently.
Please let me know if I could be of further assistance.
Sincerely,
Lawrence J. Makovich,
Senior Director.
Responses to Questions From Senator Campbell
Question 1. I know that when California needed or wanted water they
got water from Colorado, now when they need power are they going to
take Colorado power? What impact will California's current problems
likely have on Colorado and the other Rocky Mountain states?
Answer. Water and electric are both tradable commodities, but there
are important differences. Unlike water, the western electric
transmission network is highly integrated. In addition, given its
physical character, electricity flows are much more difficult to
control than water. Electricity moves in a free flow system in which
electric follows the path of least resistance. The attached figure
shows the highly interconnectedness of the Western system and the
degree to which it is hard to predict flows. In the figure, 100 MW of
power is generated in Utah for consumption in Wyoming. Because of the
interconnectedness of the system and physical characteristics of
electricity, the flow of electricity from Utah to Wyoming will depend
on power production and consumption in the surrounding areas as well as
temperature (which effects the flow of electricity through transmission
lines), and thus will be hard to predict.
As experience has demonstrated, large interconnected transmission
systems generally are economically beneficial as they enlarge markets,
increase competition, and raise overall power supply system security.
The downside of interconnectedness is that when a problem arises in one
area, it will impact other areas. Hence, it is difficult if not
impossible to isolate Colorado from the effects of the California power
shortage.
Question 2. What can we all do to ensure that the rest of the
Western region is minimally affected by the crisis in California,
because I don't want my home state of Colorado's resources and
consumers hit by these problems?
Answer. The most important step Colorado and the rest of the
Western region can take to minimize the impact of the California crisis
and future crisis's is to ensure that there is sufficient generating
capacity in the region. This means removing unreasonable restrictions
to new power plant development, something that California did not do.
In addition, because of its key role in shipping power and creating
larger markets, transmission constraints should be removed. FERC's
efforts to promote large Regional Transmission Organizations (RTOs) to
ensure the non-discriminatory access of power and the efficient
operation and expansion of transmission networks is a step in the right
direction.
Question 3. I am skeptical of price caps. Many say they are likely
a disincentive to investment in new generation. Won't they hurt in the
long run?
Answer. Your skepticism regarding price caps is well taken. As we
explained in our recent CERA report on the California power crisis,
``price caps will do nothing to address the two pressing needs for
power markets this summer--increasing supply and/or decreasing demand.
Indeed, they will do quite the opposite.'' The well-documented history
of price controls demonstrates again and again that such controls
distort the market, send the wrong signals, create shortages, and cause
more problems. So yes, in the long run they will hurt.
______
The Brattle Group,
Washington, DC, March 2, 2001.
Mr. Howard Useem,
Committee on Energy and Natural Resources, U.S. Senate, Russell
Courtyard, Washington, DC.
Dear Howard: Enclosed are my responses to Senators Campbell and
Shelby regarding questions that they poised after my testimony on
January 31, 2001 to your Committee. If they need further assistance,
please feel free to call.
It was good to see you again and I hope our paths cross soon again.
Sincerely,
Peter Fox-Penner,
Chairman.
[Enclosure]
Responses to Questions From Senator Campbell
Question 1. Many statements have been made that California's
electricity crisis is a regional crisis. I know that when California
needed or wanted water they got water from Colorado, now when they need
power are they going to take Colorado power? What impact will
California's current problems have on Colorado and other Rocky Mountain
states?
Answer. Electric power markets are regional in nature, so high
wholesale prices in California will affect the wholesale price of power
in other western states, including Colorado and the Rocky Mountain
states. However, high and volatile regional wholesale prices are not
likely to have as much of an impact on either the price or reliability
of electric service in Colorado as they've had in California. Utilities
in states with traditional regulation, like Colorado, can be and
generally are required to serve their native load (retail and firm
wholesale customers) before selling power to others. This means that
Colorado utilities only can sell their excess generating capacity--
i.e., capacity not needed to serve native load customers--into other
states, regardless of the financial attractiveness of such sales.
Furthermore, under traditional regulation, Colorado electric customers
only will pay Colorado utilities' actual average costs per unit of
power generated, regardless of the regional unregulated price, for all
self-generated power.
Some Colorado utilities are buying power on the spot market, and
these purchases will be much more costly than in prior years. These
higher-cost purchases will eventually cause rates to increase. The
amount and timing of the increase is difficult for me to predict.
The impact of the California energy crisis on short-run reliability
is likely to be small. Although California may experience rolling
blackouts this summer, such events should not affect Colorado unless
there is an unusual confluence of event leading to a severe regional
physical shortage, such as major plant and line outages across the
West. While region-wide outages are very unlikely, this is a good time
for Colorado and every western state to make outage contingency plans
for all power-sensitive areas, and to accelerate the introduction of
price-responsive demand and cost-effective energy efficiency programs.
Question 2. What can we all do to ensure that the rest of the
Western region is minimally affected by the crisis in California,
because I don't want my home state of Colorado's resources and
consumers hit by these problems?
Answer. While Colorado cannot completely isolate itself from the
California crisis, traditional state regulation of electric service and
rates can, as I explained above, largely ensure that Colorado residents
do not experience the high prices and supply disruptions currently
plaguing California. The long-term solution, however, is to foster the
creation of competitive and efficient wholesale power markets that
provide low cost and reliable power to electric customers throughout
the U.S. Passing federal legislation that includes the provisions cited
in my testimony will help create the basis for such wholesale power
markets.
Question 3. I am skeptical of price caps. Many say they are a
disincentive to investment in new generation. Won't they hurt in the
long run?
Answer. Price caps could discourage new investment in generation,
especially if they are set too low. More specifically, price caps will
discourage investment in new generating capacity, particularly peaking
capacity, if they prevent developers of such capacity from recovering
all of their costs, including a market-based return on their capital.
Determining whether a price cap would in fact prevent owners of new
capacity from recovering all of their costs is an empirical issue.
While I do not in general favor the imposition of price caps in
wholesale power markets, I believe that they can be an effective short-
term or temporary remedy to the exercise (or potential exercise) of
market power. If used, price caps should have an established
termination or phase-out date and should be set high enough so as not
to discourage new generation investment.
Response to Question From Senator Shelby
Question. Dr. Fox-Penner, while there are important national and
economic issues implicated in this situation much of the testimony
provided here today indicates that this is more of a California or
state issue than a federal issue. That said, there are some actions
that Congress can take to help ease the regulatory burdens that
presently exist. One such measure would be to repeal the Public
Utilities Holding Company Act or ``PUHCA.'' What are your views
regarding the potential positive or negative effects of PUHCA repeal?
Answer. I have seen no evidence suggesting that PUHCA has been a
barrier to building new generating capacity in California or elsewhere
in the U.S. The difficulties that developers have encountered in siting
new generating facilities in California are a result of the state's
siting regulations and processes.
Nevertheless, I think that PUHCA's uneven incidence is harmful to
fair competition and provides little in the way of consistent consumer
protection. Thus, I favor the replacement of PUHCA with the compromise
language agreed to by stakeholders in the 106th Congress regarding
state regulator access to books and records and related provisions.
______
PG&E Corporation,
Washington, DC, March 5, 2001.
Hon. Frank H. Murkowski,
Chairman, U.S. Senate Committee on Energy and Natural Resources,
Russell Courtyard, Washington, DC.
Attention: Howard Useem
Dear Senator Murkowski: In response to your letter dated February
9, 2001, attached are the answers in response to Senator Campbell's
questions in conjunction with the oversight hearing held on January 31,
2001.
Sincerely,
Steven L. Kline,
Vice President.
[Attachments]
Responses to Questions From Senator Campbell
Question. Many statements have been made that California's
electricity crisis is a regional crisis. I know that when California
needed or wanted water they got water from Colorado; now when they need
power are they going to take Colorado power? What impact will
California's current problems likely have on Colorado and the other
Rocky Mountain states?
Answer. The entire Western region of the United States is facing a
serious shortage of electricity supplies at the same time that demand
for power has increased significantly. From 1996 to 1999, summer peak
load for the Western System Coordinating Council (WSCC) region grew
5,700 MW, while existing generation in the region grew only 2,048 MW
during the same time period.
The Western grid is fully interconnected, and the region has a long
history of wholesale power exchanges and mutual reliance. This
cooperative arrangement makes sense because it recognizes and takes
advantage of regional diversity in resources, seasonal demand, and
available supply. It is an arrangement that can continue to provide
benefit into the future.
Development of generation resources and expansion of transmission
facilities is required throughout the West. California has taken
significant steps to streamline and facilitate such development over
the next several months. Colorado also is working to ensure that new
generation is in place to meet its growing peak demand. And during
those times of the year when Colorado's demand is not at peak,
exporting the power from in-state generation facilities will make those
resources more cost effective for Colorado ratepayers.
Question. What can we all do to ensure that the rest of the Western
region is minimally affected by the crisis in California, because I
don't want my home state of Colorado's resources and consumers hit by
these problems?
Answer. Because we are all facing supply challenges in the West,
California offers some valuable experiences and some important lessons
to all states, whether they choose full retail competition or just
reliance on the competitive wholesale market. Siting laws and
regulations must provide for the rational and expeditious development
of generating resources on a competitive basis. In order to attract
adequate investment, states must foster an environment that is
conducive to business, including a stable regulatory program. Markets
must be structured and rules developed to provide for true competition
and to encourage accordant behavior, such as hedging and demand
responsiveness. It is no less true today than it was a year ago that
competition in the electricity industry can reliably provide the widest
possible range of products and suppliers at the best possible prices.
Legislators, regulators, and market participants must work diligently
and cooperatively to bring creative market solutions to bear.
Finally, given the interconnected nature of the grid, it is
important to resist the temptation to become insular in the face of
looming short-term regional pressures. As discussed above, the West has
always benefited from mutual dependence and regional coordination, and
that approach will continue to optimize the use of the region's
resources.
Question. I am skeptical of price caps. Many say they are likely a
disincentive to investment in new generation. Won't they hurt in the
long run?
Answer. PG&E Corporation agrees that, as a general matter, price
caps dampen appropriate price signals in a competitive market. However,
where market design flaws or other market problems exist, price caps
may be necessary for a limited duration.
Due to the supply shortage in the West, prices for this essential
commodity are so high that the economic and social well being of the
entire region is threatened. Under these circumstances, many observers
believe that a temporary price cap on wholesale rates is necessary to
provide a ``time out''--to protect ratepayers and the regional economy
for the relatively short time period while supply and demand are
brought into balance. They argue that a regional cap would recognize
the interconnected nature of the Western electricity market and prevent
buyers from bidding up energy prices as they seek to meet inelastic
demand and avoid curtailing their customers. If regional caps are
employed, we believe defined, periodic review of the status of Western
wholesale markets is essential so that caps are eliminated as soon as
they are no longer necessary.
In summary, regional price caps may be appropriate for the current
circumstances of the wholesale electricity market in the West, so long
as they:
are short-term in nature,
include either a specific end date or a defined process for
sunset, and
apply only to existing resources in order to minimize
interference with price signals.
______
Reliant Energy,
Houston, TX, March 6, 2001.
Hon. Frank H. Murkowski,
Chairman, Senate Energy and Natural Resources Committee, Senate
Dirksen, Washington, DC.
Dear Chairman Murkowski: Reliant Energy greatly appreciated the
opportunity to testify before your committee on January 31, 2001 on the
electricity crisis currently facing California, and we commend you on
the leadership role you have taken to explore what constructive role
the federal government might assume.
Enclosed are expansions on the areas of Joe Bob Perkins' testimony
about which several of your colleagues raised concerns during the
course of this hearing. We request that this material be made a part of
the official record of the hearing. As you know, this is a very complex
issue, and Reliant Energy is committed to doing everything necessary to
ensure that all parties involved understand this issue completely.
We are committed to working with you and all parties as you face
this difficult issue. We appreciate the opportunity to present our
views and, as always, are available to you at any time to answer
questions pertaining to energy or other issues.
Again, thank you for inviting Reliant Energy to testify before the
Senate Energy and Natural Resources Committee.
Sincerely,
Bruce Gibson,
Senior Vice President,
Government Affairs.
[Enclosures]
Comparison of 6/29/99 v. 6/29/00
Regional supply and demand balance. An examination of June 29, 2000
data shows that at 4 p.m., net imports were 4,500 MW lower than the
same period in 1999. The reduction in supply resulted in putting upward
pressure on wholesale electric prices. In addition to the reduction of
net imports, many generators sold forward to other parties. (The IOUs
did not purchase forward even though provisions had been approved that
would have allowed them to make such purchases.) The result was a
reduction in the supply bid curve of approximately 7,000 MW. This,
coupled with higher than normal demand and lower net imports, meant
that the supply bid curve was now composed of higher cost generating
units which also contributed to the upward pressure on wholesale
prices.
Increases in natural gas/emissions credit prices. Substantial
increases in the price of natural gas delivered to the California
border have contributed greatly to price increases in the California
market. In fact, most market participants would readily admit that
these gas price increases alone have created a situation where the
frozen retail rates in California cannot fully recover the cost of the
procurement of energy from gas-fired resources. The following graph of
California gas prices from November 1998 to the present, as documented
by the California ISO's own Department of Market Analysis, illustrates
the trend of gas prices in the California market. Although not shown in
this graphic, California border gas prices has exceeded the prices
underlying the graphic. In addition to the gas price indices shown
below, the burnertip price for Reliant Energy typically includes an
additional $0.46/mmbtu for intrastate transportation.
The general approach to evaluating the impact higher gas prices
have on the cost of energy is to look at the heat rate of the typical
generating units at maximum output. However, operational limitations on
starting and cycling of units often requires dispatch at minimum load
levels. If a supplier wishes to participate in the ancillary service
markets, it must frequently run its units at minimum loads in order to
maintain capacity for regulation service and operating reserves. At
minimum load levels, the heat rate of most units undergoes a
substantial increase. The following chart illustrates the marginal cost
impact of this effect for three of Reliant Energy's generating
units.\1\
---------------------------------------------------------------------------
\1\ Statistics shown in this graph reflect minimum and maximum
output levels for Etiwanda 2 and 4. Only maximum output conditions are
shown for Etiwanda 5 due to the fact that this is a simple cycle peaker
and does not normally run at minimum output levels.
---------------------------------------------------------------------------
As the chart illustrates, the impact of gas prices in 2000 (up to
$7.00/mmbtu at the burnertip) vs. gas prices in 1999 (as little as
$2.25/mmbtu at the burnertip) produces an increase in cost per megawatt
hour ranging from $45-$125 per megawatt hour depending on the heat rate
and load level of the unit in question. Considering that average power
prices in previous years were less than $30 per megawatt hour, it is
apparent that the effect of natural gas prices alone can cause power
prices to jump to 5 times or more the previous years norm. Especially
significant is the impact on prices when units are at minimum load,
because minimum load levels typically occur during off-peak hours.
Market critics have consistently pointed out that off-peak power prices
in California are substantially higher than one might expect. However,
the fact that gas-fired units must stay online overnight at minimum
load levels causes substantially higher marginal costs than most
critics admit.
Just as the price of natural gas has increased substantially, so
has the cost of NOX emissions credits. In January 2000,
emissions credits were selling for under $2 a pound. By the end of
August, purchases made by Reliant Energy were at prices of $49 per
pound, a 25-fold increase. The following graph illustrates the trend of
the price of NOX emissions credits during this year.
The effect of increased emissions credits prices has actually
caused, for some units, a greater increase in variable cost than the
increases due to fuel prices. The following graph shows the change in
the variable cost due to emissions credits \2\ for three typical units,
Etiwanda 2, Etiwanda 4 and Etiwanda 5.
---------------------------------------------------------------------------
\2\ In this example we have used prices of $1.35/lb for 1999 and
$46.50/lb for 2000.
---------------------------------------------------------------------------
As is apparent from the graph, the increased cost due to the rapid
rise in NOX emissions credits has caused increases ranging
from $25 to $150 per megawatt hour. As with the impact of fuel costs,
the cost of emissions is also magnified when the units are operating at
minimum load conditions, which further exacerbates the problem of off-
peak energy prices.
The combined impact of both increased natural gas prices and
increased air emissions credits on Reliant Energy's units are
illustrated in the following chart, which shows the combined increase
on market clearing prices to be from $70-$230 per megawatt hour. In
comparison with the under $30 per megawatt hour prices that were seen
in the California market during 1998 and 1999, the fact that overall
market costs increased 3-fold is not an unjust or an unreasonable
outcome.
Buyer bidding behavior. At the FERC public hearing on November 9,
2000, Reliant Energy provided testimony conclusively demonstrating that
high prices in the PX day ahead market on June 29, 2000 were the direct
result of competitive bidding between buyers. Even though the bids of
suppliers dropped, market clearing prices quadrupled. As explained in
that testimony, this evidence clearly demonstrates that the $750/MWh
prices reached that day were not affected by the bids of the sellers.
In fact, even if the sellers had reduced all of their offers to just $1
per megawatt hour, the end result would have been essentially the same.
This same pattern occurred on a daily basis throughout June, July and
August based on an analysis of publicly posted data.
A review of the information made public on a regular basis by CAISO
shows that the suppliers' curves on June 29, 2000 are almost identical
hour after hour. But, there was an important, yet subtle difference
worth noting. On almost every day, between 9 am and 1 pm, suppliers
were offering more power into the market. As with any commodity,
increased supplies effectively lower the market clearing price for a
given volume of load. Yet, market clearing prices consistently
increased substantially during this period. The reason is simple, buyer
to buyer competition. Buyers attempt to leap frog each other by raising
their bid price each hour beginning about nine or ten o'clock in the
morning until the load is at the daily peak. This forces the market to
clear at higher and higher prices until it hits the price cap.
The competition that exists between buyers is similar to the sort
of competition that exists in an auction through the on-line auctioneer
eBay, where a seller offers a scarce product and posts a minimum price
that they will accept for the product. Assume that the seller sets a
minimum price of $100. If there were no competition between buyers and
a bidder offered to pay $100, that bidder would get the product at the
supplier's minimum price. In the event there is competition between
buyers, however, the auction process allows the buyers to bid against
one another until the buyer who places the highest value on the product
is identified as the winning bidder. Assume that the winning bid in
this auction was $500. While the scarcity of the product may have
provided opportunity for the seller to charge $500 outright for the
product, the auction process also permits the buyers to set the
clearing price, which results in a premium over the price originally
offered by the supplier. As shown by this example, the $400 premium
that was paid over the sellers offer was determined by the buyers. That
premium fits the classical definition of scarcity rent not the classic
definition of market power abuse.
Price Caps. Amidst promises of lower prices through increased
competition, California was the first State to fundamentally transform
its electric industry from a vertically integrated structure based on
cost-of-service ratemaking to a new competitive paradigm. Consequently,
it is not surprising that over the last several years, a lot of
attention has been directed towards the California experience.
Unfortunately, the results have failed to meet the early promises when
the legislation was passed. Today, in the case of PG&E and SCE, the
high price of wholesale electric power combined with retail rates that
continue to be regulated have placed severe strain on the financial
integrity of both companies. SDG&E, which has faced similar prices in
the wholesale market but whose retail rates are unregulated has seen
customer bills increase significantly.
Some assert that the root cause of this problem is the exercise of
market power on the part of non-utility resource suppliers who now play
a very significant role in the California generation market. Further,
forced to divest themselves of at least 50% of their generation assets
under deregulation, California's investor-owned utilities successfully
auctioned-off large blocks of generation capacity to out-of-state
merchant providers who, now through the unbridled exercise of market
power have raised wholesale electric prices to unparalleled levels.
The facts, however, tell a different tale. The facts point to a
system that is not only severely capacity constrained but one that is
further burdened by a dysfunctional system of rules and regulations
that lead to perverse consequences and high prices for wholesale power
that California has experienced over the last year.
Although the significant exercise of market power continues to be
cited as one of the major factors underlying the high prices for power
in California and the need for some sort of price caps, this conclusion
is unsupported by factual evidence. Under the circumstances, market
power is being held up as the regulatory scapegoat for what ails the
system. However, as noted by Dr. William W. Hogan of Harvard
University, ``The difficulty in the present case is that there has been
no direct showing that such traditional market power has been exercised
at all, much less that it has been exercised on a widespread and
significant basis.'' \3\ Dr. Hogan goes on to further point out that,
``The often mentioned tendency of generators and loads to avoid the
day-ahead market in preference to the real-time market is a response
[emphasis added] to bad market design and pricing incentives (including
price caps), but does not demonstrate the exercise of market power.''
\4\ Similarly, nor does the fact that prices may be bid above so-called
marginal cost indicate the exercise of market power.\5\
---------------------------------------------------------------------------
\3\ See John D. Chandley, Scott M. Harvey, and William W. Hogan,
``Electricity Market reform in California, `` November 22, 2000, page
13.
\4\26Ibid., page 13.
\5\ See Severin Borenstein, James Busnell and Frank Wolak,
``Diagnosing Market Power in California's Restructured Wholesale
Electricity Market,'' August 2000. See also Frank A. Wolak, Robert
Nordhaus and Carl Shapiro, ``The Competitiveness of the California
Energy and Ancillary Services Market,'' March 9, 2000.
---------------------------------------------------------------------------
A more plausible explanation for the high prices is scarcity. Under
existing market rules for example, tight supply conditions in
California combined with higher than expected demand, not only in
California, but throughout the western U.S., have created a strong
incentive by generators to export power from the State exacerbating the
already tight supply conditions. This is a normal response to market
conditions. Nevertheless, the FERC has recently adopted a $150/MWH soft
price cap among its remedies for the California market.\6\ This use of
price caps has also been endorsed by Governor Davis, the California
Public Utility Commission (CPUC), and the California Independent System
Operator (CAISO) in an effort to hold down the cost of power purchased
by the CAISO and the California Power Exchange (CalPx) thereby
attempting to protect the financial integrity of California utilities.
---------------------------------------------------------------------------
\6\ See Federal Regulatory Commission News Release, ``Commission
Adopts California Price Remedies Aimed at Fixing Malfunctioning
Electric Markets,'' December 15, 2000.
---------------------------------------------------------------------------
no need for price caps
``Price caps are a case of a remedy far worse than the disease.''
\7\ While conceptually price caps have the appeal of lower prices which
is difficult for most consumers to ignore, any short-term benefits from
lower prices are usually far out-weighted by the adverse effects on
competition. Both FERC in its study of the California market and the
CASIO fully acknowledge that price caps are not a viable long-term
solution and that they should be removed as soon as possible or
relegated to a purely backstop role.\8\ Price caps are merely a
convenient substitute for market failure. Even where it has been
suggested that price caps should be put in place, if for no other
reason, than to backstop the system in the event of a market breakdown,
this is a hollow argument. Adequate supply coupled with sufficient
demand-side responsiveness and the ability to hedge future prices, all
lacking in the California market design, dispel the need for price
controls of any kind. It is interesting to note that in the
deregulation of other industries such as natural gas and long-distance
phone rates, there were no price caps left lurking in the closet and
market discipline has been maintained. The case of natural gas is a
good example. Between January 2000 and January 2001 spot market prices
for natural gas at Henry Hub rose four-fold to more than $10/MMBTU, yet
no one was calling for price controls. Why? It is simply the wrong
thing to do. Rather than lead to lower prices, price caps on natural
gas would lead to declines in production as it did under earlier gas
price regulation and even greater uncertainty in the market.
---------------------------------------------------------------------------
\7\ See Scott Esposito, ``Californians Need More Utility
Deregulation, Not Less,'' LA Daily News, December 17, 2000.
\8\ See Frank A. Wolak, Robert B. Nordhaus, and Carl Shapiro,
``Long-Term Price Cap Policy,'' Opinion of Market Surveillance
Committee California Independent System Operator, September 21, 2000.
---------------------------------------------------------------------------
price caps in other markets
Price caps are neither new, novel nor generally effective. One can
point to failed efforts at broad price controls during the Nixon
Administration in the early seventies as well as the ill-fated
regulation of inter-state natural gas prices which lead to severe
shortages in the inter-state gas market to see the consequences from
such ill-advised policies.\9\ Perhaps with the exception of the Eastern
Interconnect where price caps have been largely unbinding,\10\ most of
the experience with price caps in other electric markets have either
proven to be ineffectual or in the case of the U.K. have resulted in
perverse consequences resulting in further market intervention on the
part of the regulatory authority.
---------------------------------------------------------------------------
\9\ Proven gas reserves in the lower 48 states fell in every year
between 1966 and 1978. See Robert J. Michaels, `` The New Age of
Natural Gas: How the Regulators Brought Competition,'' The Cato Review.
\10\ FERC has set price cap at $1,000 in PJM, New England and New
York markets.
---------------------------------------------------------------------------
price caps harm the market
Price caps treat symptoms not causes.\11\ Consequently, they offer
no long-term relief. Both the FERC and the CAISO have acknowledged this
point yet continue to press the case for some sort of price cap
mechanism. Ultimately, high market prices can only be effectively
mitigated by the addition of new capacity. Although the existence of
demand-side elasticity, also currently lacking in the California
market, along with certain other market reforms such as lack of forward
contracting may help to curb the increase in wholesale prices, the
heart of the California problem remains insufficient generation
capacity. Under the circumstances, everything that can be done to
encourage rather than discourage new investment should be undertaken.
---------------------------------------------------------------------------
\11\ Op Cit. Wolak, Et al.
---------------------------------------------------------------------------
Under any set of market rules, the imposition of price caps will,
on balance, do far more harm long-term than any short-term benefit that
might arise. The fundamental problem with price caps is that they send
the wrong price signal to the market. Not only do price caps shield
buyers from the true cost of power, thereby minimizing the tangible
benefits of price elasticity by reducing peak load and load shedding
they also discourage new investment in the market. New investment is
critically needed in order to provide a long-term solution to the
problem of high market prices. Only additional generation capacity will
provide the necessary long-term market discipline sought by FERC and
others. Although FERC has suggested that $150/MWH is sufficient to
attract new investment that is not readily apparent nor is it widely
accepted as a fact. Moreover, it is quite likely the mere presence of
price caps would create enough uncertainty about future prices or the
future regulatory environment that even if price caps were set
sufficiently high, new investment would still be discouraged. Any
investor will weigh his options carefully. Opportunities for new
merchant plants exist in any number of markets across the U.S. If
California, or any market for that matter, wishes to attract new
investment it must demonstrate that prices offer the prospect of a
sufficient rate of return and that the regulatory climate is conducive
to new entrants. Price caps and other artificial market constraints can
only serve to detract from those opportunities.
In addition to sending the wrong price signal to the market,
capping prices in one market (i.e., California) while prices in
neighboring markets remain uncontrolled creates the opportunity for
pricing arbitrage. In fact, this has been evidenced in California by
the increased exports of power to surrounding regions when prices have
risen above the price cap in California. These out-of-state market
opportunities will also lead to higher prices in California as
generators bid into the market based on their opportunity costs rather
than simply marginal production costs.
Finally, it is very difficult to determine the optimal price cap.
Price caps in California for instance have, at one time or another,
been set at prices ranging from a $750/MWH hard cap (October 1999) down
to the current $150/MWH soft cap outlined in FERC's December 15, 2000
ruling. Under these circumstances, it seems that the choice of a price
cap has so far proven to be simply trial and error, which has proven to
be an ineffective approach to a serious policy dilemma.
conclusion
Are price caps a necessary evil? No. While price caps may provide
some short-term restraint from the exercise of significant market
power; they offer no long-term solution. Ultimately, price caps send
the wrong market price signal, one that can only discourage new
investment. Moreover, the lack of new investment coupled with a growing
demand such as being experienced in electric markets from California to
New England will only lead to tighter supplies and possibly even high
market prices in the future.
______
Sempra Energy,
San Diego, CA, March 8, 2001.
Hon. Frank Murkowski,
Chairman, Committee on Energy and Natural Resources, U.S. Senate,
Dirksen Senate Office Building, Washington, DC.
Dear Chairman Murkowski: On behalf of Sempra Energy, I am pleased
to provide input on three matters that have arisen as a result of my
testimony before the Committee on January 31. In addition to answering
the questions raised at the hearing regarding whether federal rules
and/or regulations exist that hinder the expeditious siting of
powerplants (and if there are actions that can be taken by the federal
government to expedite the siting of plants), I am also providing
answers to Senator Campbell's three written questions. I would also
like to rebut input the Committee received from Williams Companies
regarding whether the cost of electric generation in California would
be less if utilities still operated the plants that were sold to non-
utility generators under the state's restructuring law. We do not
believe that the analysis presented by Williams accurately portrays the
costs associated with operation of a 320-megawatt plant.
i. impact of environmental regulations on siting of power plants
The Clean Air Act (Act) requires that emissions from all new
sources in nonattaininent areas be offset by reductions from existing
sources. Since existing sources in California have already
significantly reduced emissions, little opportunity for further
reductions remains. Existing Environmental Protection Agency (EPA)
policies must be modified to allow implementation of innovative
emissions reduction projects that will offset the emissions from new
power plants within the region. If necessary, Congress should amend the
Act to accommodate the need for greater flexibility.
The lack of offsets has become an obstacle to building new, cleaner
and more efficient power plants in California's Mojave Desert, Imperial
Valley and San Diego County, where efforts to build additional power
plants have been stymied because of emissions offset requirements.
While both areas have land, water, gas and access to electric
transmission lines, they are areas that have historically had few
emissions. Consequently, there are no emissions credits in the bank and
little ability to generate new reductions, unless mobile source
emissions can be used as offsets for new stationary sources.
The situation is as challenging in the counties of Los Angeles,
Orange, San Diego, San Bernardino and Riverside. Since more than 90
percent of the NOX emissions are from mobile sources (only 8
percent from stationary sources), it makes little sense to seek offsets
for new power plants solely within the stationary source sector.
Discouraging offsets for new plants to the stationary source sector,
which is the effect of current EPA policies, diminishes the ability of
all stationary sources to grow, since there are fewer offsets available
to cover their increased activity. While some local air districts have
tried to be responsive to this issue, their efforts have been limited
because of existing EPA policies. Either through changes in policy or
amendments to the Act, EPA should allow greater flexibility to new
power plants equipped with Lowest Achievable Emission Rate (LAER)
control technology. LAER-equipped plants would have the option of
temporarily not providing offsets, of obtaining offsets from a growth
allowance offset pool, or using mobile source emissions as offset
credits. By increasing the availability of offset credits, new power
plants can be sited within the strict compliance guidelines in non-
attainment areas.
Another critical impediment to power plant construction in
California is the manner in which EPA treats modifications to an
existing facility and the construction of a new facility. Currently,
both construction efforts are considered the same, which makes the
simplest modification complicated and expensive because it must undergo
an extensive review process. EPA should be required to revise its
emissions calculation methodology for determining whether an emission
increase will result from a modification to an existing source by
comparing the existing potential to emit pollutants to the future
potential to emit pollutants. The current policy, which compares
historic actual emissions to future potential emissions, is punitive to
existing sources and results in the abandonment of upgrades to existing
plants, further thwarting the state's ability to meet increased power
demands.
Responses to Questions From Senator Campbell
Question 1. Many statements have been made that California's
electricity crisis is a regional crisis. I know that when California
needed or wanted water they got water from Colorado, now when they need
power are they going to take Colorado power? What impact will
California's current problems likely have on Colorado and the other
Rocky Mountain states?
Answer. Eleven states (including California and Colorado) comprise
the Western States Coordinating Council (WSCC). The supply and demand
capabilities and needs of states within that pool affect each other.
Like California, most of the West has also outgrown its electrical
system, and energy experts predict that it would soon be facing supply
problems similar to those occurring in California absent California's
current crisis.
Except for Montana, no states in the West have increased power
production to keep pace with population growth of the last decade. Many
states have not completed construction of a single new power plant.
Since California is at the forefront of electric restructuring, the
challenges associated with its electric generation system and the
impact upon the states within the Western region are highlighted.
Industry, financial and government experts agree that in addition
to problems with the market structure, supply is a key culprit behind
California's energy crisis. I would also note that energy related
infrastructure (natural gas pipelines and electric transmission) has
not kept pace with new demand, further compounding the problem. These
factors, a 32 percent growth of California's economy since 1995 and an
increase in electricity demand by 24 percent (a byproduct of the
computer revolution), have made California the world's sixth-largest
economy. Yet despite that enviable growth and 5 million new residents,
no major power plants have been built in the last 10 years.
Fortunately, the state is working to correct that problem. To date,
nine power plants have been approved for construction and six are now
under construction. Furthermore, the state is pushing aggressively to
lower the rate of energy consumption within California, despite the
fact that it is already the second most energy efficient state in the
nation.
However, the strain on energy resources is compounded by equally
significant growth in neighboring states that California relied upon to
cover its electricity supply shortfall. In fact, when California's
demand growth over the 1999-2000 period (when price spikes began) was
relatively flat, demand growth throughout the interconnected grid of
the western region was strong. It has been estimated that nearly 85
percent of the growth in electricity demand over the past five years in
the western region has occurred outside of California. The timer has
been ticking on this time bomb for quite some time.
As electric generation plants are built in California and in the
other states within the western region, supply will better meet demand
and power supply and demand imbalances in the region should be
corrected.
Question 2. What can we all do to ensure that the rest of the
Western region is minimally affected by the crisis in California,
because I don't want my home state of Colorado's resources and
consumers hit by these problems?
Answer. In the long term, the permitting and construction of power
plants must be expedited both in California and throughout the Western
region so that adequate supply, combined with conservation efforts, is
available to meet the region's demands.
However, immediate action must be taken to protect consumers from
soaring electric prices. We believe that consumers can be best
protected by a government sanctioned ``time-out'' so that the market
can cool off and participants can work together to reach agreement on a
reasonable price for the electric commodity.
Until the market is fixed and is truly competitive, the Federal
Energy Regulatory Commission (FERC) must implement this ``time out'' by
establishing interim wholesale cost of service (plus) rates for
electricity, which would sunset once the market is fixed. To ensure
market equilibrium, the wholesale price of natural gas must also be
capped (as Senator Feinstein has proposed in S. 287). While FERC has
admitted that the market is broken and that prices are not
``reasonable,'' it has failed to take the next logical step to provide
an interim solution. We believe that FERC must establish a price that
is fair and reasonable for consumers, and that also provides an
incentive for the continued construction of electric power plants. It
is a deal that only the federal government can broker because the FERC
pre-empts state action in this wholesale market.
Question 3. I am skeptical of price caps. Many say they are likely
a disincentive to investment in new generation. Won't they hurt in the
long run?
Answer. We agree that price caps are not a long-term solution to
the current energy crisis. Simply put, what happened in California is
that demand grew while supply remained flat. As demand exceeded supply
and retail prices were capped, which proved to be a disincentive to
conserve energy, the state began to experience shortages. Prices that
rise as demand rises not only signal suppliers to add production but
also signal consumers to reduce consumption. When consumers did not see
these price signals, consumption continued and demand continued to
outstrip supply. Even today, California residential customers have not
seen price increases.
Unfortunately, the result has been a dysfunctional market in which
all of the market power resides on the supply side of the equation. To
prevent further unreasonable and economically disruptive dislocations
from this unbalanced marketplace, we need a temporary measure that will
cool off the overheated market and facilitate an orderly transition to
long term contracting. Rather than implement a flat regional price cap,
a more equitable near term solution to the crisis is the creation of
``Cost of Service Plus'' rates where generators have not already agreed
to enter into long-term contracts. Under this approach, each generator
would provide to FERC the unit cost per kwh to operate its plants. FERC
would then add-on a profit margin to the price per kwh that is high
enough to provide generators with an incentive to continue developing
new capacity but low enough to meet concerns regarding consumer energy
prices. By avoiding the implementation of a ``one size fits all'' price
cap, Cost of Service Plus' rates would distinguish between baseload
plants (that run continuously) and peaking plants (that only go online
when demand reaches very high or peak levels). This approach would more
accurately reflect the costs of generating electricity. Importantly,
temporary ``Cost of Service Plus'' rates would protect consumers by
providing price stability and at the same time provide assurances to
generators that plant costs, including a healthy profit, will be fully
covered.
response to williams letter of 2/14 to chairman murkowski
Finally, I would like to rebut the conclusion made in a letter sent
to you on February 14, 2001 by Mr. Keith Bailey of Williams. There are
several inaccuracies in Mr. Bailey's analysis, which concluded that the
cost of electrical generation in California is high due to the cost of
natural gas. The Williams letter used ``a given day, January 18'' to
depict a hypothetical scenario in which the cost of generation would
have been $261.24/MWh for a historic utility generator and $269.91/MWh
for non-utility generator. The assumptions used in Williams'
hypothetical day represent neither the prices that existed on that
``given day,'' nor the prices that can reasonably be expected to
prevail in the future. The problems with the assumptions Mr. Bailey has
used are discussed below.
It is unclear how Mr. Bailey reached a gas cost assumption of $20/
MMBtu for this ``given day,'' since the average cost of gas purchased
at the California border for delivery on January 18 was only $11.71 (as
reported by Gas Daily). Further, of the $11.71/mmbtu, $3.66/mmbtu
reflects the imputed value of interstate pipeline transportation
(which, if acquired directly from the pipeline rather than through spot
or short-term markets costs between 31 and-67 cents per mmbtu). This
difference is important because utilities have historically purchased
gas at the producing basin and acquired long term firm transportation
on interstate pipelines to have the gas delivered to the California
border at a price of between 31 and 67 cents per mmbtu under current
FERC-approved rates. The ability to purchase pipeline transportation
services is an option that has been available to all generators (and
likely used by some). Because the price of gas in the San Juan basin
was $8.05 on January 18, if one conservatively assumed that
transportation was obtained by a generator at full tariff rates
(including fuel charges), the total cost of gas delivered at the
California border, particularly for utility-owned generation, would
have been approximately $8.75/mmbtu on January 18.
Mr. Bailey's estimate of the NOX credit cost of $50 per
pound is extremely high. On this subject, one has to distinguish
between Emission Reduction Credits (ERCs) and RECLAIM Trading Credits
(RTC). ERCs are needed by new power plants to offset emissions
(primarily NOX) in non-attainment areas. The cost to acquire
sufficient ERCs for a 500 MW Combined Cycle would be about $15 million,
or roughly 6 percent of the capital cost of the project. Amortized over
the life of the plant, this cost factor would not significantly impact
the plant's cost of generation. However, emissions from a new or
existing power plant in the South Coast Air Quality Management District
(SCAQMD) were until recently capped by their allocation of RTCs. The
cost of the RTCs increased from $1.50 per pound of NOX
emissions one year ago, to almost $50 per pound in the latter part of
2000. Since then, however, the SCAQMD has negotiated compliance orders
with the power plants to remove them from the RTC market, and is in the
process of changing its rules so that the power plants will add
emission controls rather than purchase RTCs. Many variables exist that
impact the cost of the controls for each given generating unit,
including size, boiler specifics, heat rate, etc. that would dictate
the controls needed and influence the cost for a particular generator.
However, it can be assumed that the cost of adding controls is
approximately $8 per pound of NOX. Unit size, boiler
specifics, heat rate. etc. would dictate details of the controls needed
and influence the specific cost for a particular generator. These
variables could cause some fluctuation in the $8 per pound figure.
Using these revised assumptions, the actual cost of generation at a
time of extremely high natural gas costs (and these costs are expected
to decline significantly in the future), becomes far more clear. Using
Mr. Bailey's assumed day of January 18 and only modifying his gas cost
and NOX credit assumptions ($8 per pound for NOX
credits and $8.75/mmbtu for fuel), the calculated cost of electricity
for the utility-owned plant in Mr. Bailey's hypothetical would be
$102.98. Using these revised assumptions, the calculated cost of
electricity for the non-utility owned plant in Mr. Bailey's
hypothetical would be $111.66.
Another way of looking at this situation is from a rate of return
perspective. On January 18, reported prices for Palo Verde on-peak
energy charges were $427.50,/MWh and off-peak was $245/MWh, for an
average of $366.67/MWh. Using all of Mr. Bailey's assumptions about the
non-utility plant but assuming that this plant actually paid only the
reported January 18 California border price of $11.71/mmbtu for gas
(rather than the $8.75/mmbtu utility-owned plant assumption), and $8
per pound for NOX credits, the calculated cost of
electricity for the non-utility owned plant in Mr. Bailey's
hypothetical would be $139.78/mwh. This equals a before tax annual rate
of return on the equity piece of the non-utility generator's investment
of more than 1,600 percent.
Thank you for the opportunity to comment on these critical issues.
Sempra Energy is committed to working with you and other Committee
Members to help resolve the energy crisis.
Sincerely,
Frederick E. John,
Senior Vice President.
______
Idaho Power Company,
Boise, ID, March 12, 2001.
Howard Useem,
U.S. Senate, Russell Courtyard, Washington, DC.
Re: Committee on Energy and Natural Resources Hearing Additional
Questions
Dear Mr. Useem: In response to Senator Murkowski's letter of
February 9, 2001, these are my responses to the questions presented:
Question 1. Many statements have been made that California's
electricity crisis is a regional crisis. I know that when California
needed or wanted water they got water from Colorado, now when they need
power are they going to take Colorado power? What impact will
California's current problems likely have on Colorado and the other
Rocky Mountain States?
Answer. The Rocky Mountain States can expect the following impacts:
record high wholesale electricity prices during periods of high demand,
erosion of financial strength of utilities, insufficient capacity to
serve all customer requirements, rapid price increases in primary power
plant feed stock (natural gas), and customer confusion, fear and anger.
Each of these impacts has already been felt in California, and to a
lesser in extent in the west. If there are short-term corrective
measures taken with medium-term solutions to follow similar volatility
should be expected during 2001 and beyond.
Question 2. What can we all do to ensure that the rest of the
Western region is minimally affected by the crisis in California,
because I don't want my home state of Colorado's resources and
consumers hit by these problems?
Answer. There is clearly a need to act in a manner that restores
the confidence of customers, policy makers and utilities in the
competitive marketplace. However, quick fixes (e.g. rate caps) and/or
re-regulation are not the answer, especially in states where
substantial deregulation has taken place (e.g. generation divestiture
in California). It is also important to note that commodity markets by
their very nature are volatile and that restructuring is not meant to
produce cheap stable prices, but is a means to competitive choice that
should produce innovation and thereby result in customer benefit.
Today the west, California in particular, is confronted with a lack
of generation capacity and flexible transmission paths. Normally, the
availability of these assets would keep market price volatility at an
acceptable and healthy level. Regulatory and political uncertainty has
also served to reduce company's interest in new generation investment
just when it is needed most. Moreover, the increasing reliance of new
generation facilities on natural gas is putting extreme demand side
pressure on energy markets.
Some short-term and medium-term recommendations for the crisis that
confronts us are as follows:
Fix the Load/Resource Imbalance in the Short-Term
1. Dramatically retail rates on discretionary usage. With a price
elasticity estimate of -0.1 in the short-term, a 50% in total electric
bills would cause a 5% reduction in usage. The load reduction would
equate to some 3,750 MW, just what is needed in the short-term for the
WSCC crisis.
2. Ensure California gas storage injections are maximized. Whenever
there is insufficient hydroelectric production, gas-fired generation is
critical. Since most gas-fired capacity resides in California, having
gas in California storage is effective insurance against failure to
reduce loads through increased rates.
Promote Balanced Deregulation Programs
Competitive Market Rules should contain the following elements:
1. Price transparency--market price signals and information on
consumption patterns for end-users,
2. Phase in by customer class thereby avoiding market inability to
adapt to instantaneous change,
3. Alternate buying channels and energy purchasing flexibility to
reduce price volatility (bilateral contracts, ability to use financial
derivatives to hedge against price volatility).
Facilitate Timely Construction of New Facilities
1. Streamline siting and permitting process of new generation
facilities,
2. Develop new gas supplies and construct additional transportation
infrastructure,
3. Encourage alternate fuels for generation facilities,
4. Encourage new electricity investment by changing depreciation
rules.
Sustain Utility Financial Stability
1. Require California to assume the full extent of utilities
liabilities,
2. Utilities should be able to recover costs associated with
performing ``default'' service,
3. Require California to compensate the PX for full market value of
confiscated block forward positions.
Implement Market Monitoring Controls and Procedures
Require more sophisticated monitoring of market abuse or price
manipulation by companies who produce power or supply it to utilities.
Question 3. I am skeptical of price caps. Many say they are likely
a disincentive to investment in new generation. Won't they hurt in the
long run?
Answer. Supporters of price caps frequently believe that a price of
$X, $Y, or $Z/MW should be sufficient to attract new investment.
Generally speaking, this may be true. However, the dilemma occurs when
investors in new generation operate under a price cap, but their power
plant feedstock continues to be market based. The fuel provider takes
most of the margin and the generator only makes money if the margin
above fuel expenses can cover the capital charge and operating
expenses. Accordingly, if a load/resource balance exists electricity
caps serve to cause gas-fired generation to become uneconomic.
While wholesale rate caps may temporarily mitigate price increases
in the market, a cap will surely reduce the effectiveness of price
signals for demand-side options, negatively impact the willingness of
developers to build new facilities, requires curtailment policies to be
adopted in the event of supply shortages, and extend periods of
uncertainty and price pressures.
The reality is that even in the short-term, power can and will flow
to neighboring markets that can support prices above artificial caps.
Utilities must counter by either disconnecting customers if sufficient
supply is not available under the price cap or by ignoring the price
cap and paying the market price for ancillary services or other
mechanisms that do not have caps. These less efficient actions,
justified in an effort to secure supply, require enormous cash. These
cash outlays will compromise the liquidity of utilities and jeopardize
further purchases of electricity. In the words of Mr. Allan Stewart of
the PIRA Energy Group, ``the irony is the obvious solution will be
handed to you.'' That is, sooner rather than later, loads will be lost
at a huge long-term cost to the region.
At best, price caps are load-resource neutral, meaning that they
have little effect on supply and demand and they will never be a
solution to the imbalance of load and resources in the WSCC.
Cordially,
John R. Gale,
General Manager,
Pricing & Regulatory
Services.
Appendix II
Additional Material Submitted for the Record
----------
[Due to the enormous amount of materials received, only a
representative sample of statements follow. Additional
documents and statements have been retained in committee
files.]
R. Jennings Manufacturing Co., Inc.,
Glens Falls, NY, January 22, 2001.
Senator Frank Murkowski,
U.S. Senate, Washington, DC.
Dear Senator Murkowski: One solution to the energy problem is to
make the transmission lines public property like highways for trucks
accessible to producers and users of power so commerce moves freely.
High prices will attract investors to produce power for sale whereas
today this will not happen as long as the power companies have monopoly
control over the avenues of commerce.
Power sells for 12 cents/kwh and more, but costs 3 cents/kwh or
less to produce. The profit margin to create incentive to invest is
there. The transmission lines were mostly built more than 20 years ago
and are therefore fully depreciated. The utilities have recovered their
investment. There is almost no maintenance cost to transmission lines.
Only the public utility commissions which sanction monopolies stand in
the way of reduced power costs to fuel our economic-growth.
Do you remember only a few years ago the power companies were
complaining about having to buy power from independent producers @ 6
cents/kwh? So under the banner of ``deregulation'' (Power Choice in NY)
the power companies were freed of their obligation to buy power at 6
cents/kwh. Now there is a shortage of power.
Several years ago before Power Choice the CEO of Con Ed told
shareholders Con Ed would not have to build another power plant until
at least 2050, because so much co-gen power was available. Now that
independents have no options where to sell power, Con Ed is considering
a new power plant.
After the last gas crisis when cars were in lines at the gas
stations the Federal Energy Regulatory Commission supported the
requirement that public utilities had to buy independently produced
power at 6 cents. Even at that low price old hydro dams were brought on
line, and co-generation plants were built to convert garbage, bark,
tires and many other items to power and steam. Power from wind, solar
and gas turbines was generated. That spark has now been doused, but
would be re-ignited by giving producers the opportunity to sell their
power where they wish. In terms of our environment, most of these
options are better than fossil fuels and have greater public acceptance
than nuclear. If you release American ingenuity, the energy crisis will
be resolved.
Our Company has no interest in the outcome, but we are very
knowledgeable about the issues. Formerly we designed and supplied over
4000 high voltage substation and transmission projects. Today we are
out of the power business, and we have no intention to be a supplier
again.
Sincerely,
Roger L. Jennings,
President.
______
Irrigation & Electrical Districts
Association of Arizona,
Phoenix, AZ, January 29, 2001.
Hon. Jon Kyl,
U.S. Senate, Washington, DC.
Re: Current Economic Damage in Arizona Being Caused by the Distorted
California Power Markets and Application of Environmental
Regulations
Dear Senator Kyl: Since you have rejoined the Senate Energy and
Natural Resources Committee, for which we are very thankful, we thought
you could benefit from a brief report about the damage that electricity
supply problems are creating for several utilities in Arizona because
of the simultaneous impacts of the disastrous California power market
and reduced federal hydropower generation in the Colorado River Basin.
As you already know, the San Carlos Irrigation Project (SCIP) is
facing up to a 300% rate increase to some 3,000 Gila River Reservation
homes and more than 8,000 homes off the reservation, many of them
belonging to retired and low-income residents of rural Arizona. The
Navajo Nation and the Tohono O'odham reservations face similar
problems. Rural electrical and irrigation districts are increasingly
strapped for cash because necessary power purchases in this horribly
dislocated power market carry prices ten to twelve times the equivalent
costs only this time last year. Our metropolitan areas have not escaped
either. The City of Mesa, for instance, is facing serious impacts next
summer because several of its contracts are expiring and it has no
choice but to buy power to keep the lights on for its citizens.
At the very same time, environmental experiments at Glen Canyon Dam
in Arizona, Flaming Gorge Dam on the Utah/Wyoming border, and the three
Aspinall Units on dams on the Gunnison River in Colorado have combined
to reduce the federal hydropower available at these Colorado River
Storage Project (CRSP) facilities to be less than half the amount that
those power plants are capable of producing. Suspending these
experiments at Glen Canyon Dam and returning to full capacity, by
itself, could produce enough additional power to substantially
alleviate the problems of Arizona CRSP power purchasers, such as SCIP,
Mesa, NTUA, ED-2, etc. Suspending March-April ``water flattening''
environmental practices at Hoover Dam could help as well.
We have consistently supported the concept of competition in retail
electricity for the benefit of Arizona consumers. Indeed, most of our
members have been in competition with other utilities since the 1920's.
We also have supported the development of sound science to gauge
whether power operations at federal dams on the Colorado River are
adversely impacting endangered fish. The failure of AB1890,
California's legislative experiment in partial deregulation, is beyond
our understanding to repair. However, we have actively participated in
the various Colorado River environmental studies for nearly two
decades. The experiments continue. Several hundreds of millions of
dollars have been spent and no conclusive results have been produced.
Surely, these experiments could be suspended at least until sanity
returns to the power market in the West. Scientists could study these
``original Congressional intent'' conditions, using new scientific-
methods developed during these studies, and report to Congress the
scientific baseline such studies would produce. Congress would be much
better prepared to evaluate any later proposals for long-term
restrictions on hydropower generation.
We hope this brief report and our views are helpful to you and the
Committee in its deliberations beginning with Wednesday's hearing. If
you see fit, we would be pleased to have this letter submitted by you
for the record.
If we can be of further assistance or answer any questions you may
have, please do not hesitate to contact us.
Sincerely,
Robert S. Lynch,
Counsel and Assistant Secretary/Treasurer.
______
Tucson Electric Power Company,
Tucson, AZ, January 30, 2001.
Hon. Jon L. Kyl,
U.S. Senate, Washington, DC.
Dear Senator Kyl: Thank you for the opportunity to share our
thoughts with you on the California energy crisis as you prepare for
tomorrow's Senate Energy and Natural Resources Committee hearing on
this topic. Tucson Electric Power Company (``TEP'') shares your concern
that the breakdown of the California market may have serious negative
consequences for Arizona and other Western U.S. markets.
Your staff specifically requested that we provide you with a copy
of the information requested of TEP by Arizona Governor Jane Hull's
office. My letter to Governor Hull is attached.* It provides a detailed
analysis of TEP's potential exposure as a result of the breakdown of
the California market.
---------------------------------------------------------------------------
* The letter has been retained in committee files.
---------------------------------------------------------------------------
Our immediate concern relates to financial exposure for sales into
the California Power Exchange (``Cal PX''). We are hopeful that any
solution being considered should focus on maintaining the solvency of
the California utilities. TEP is subject to the Secretary of Energy's
order to sell power into California, but we have not been ordered to do
so yet. TEP has important obligations to our customers in Arizona and
our shareholders that may be effected if we are ordered to sell into
the current California market.
TEP is also subjected to system risk associated with the failure of
California utilities to deliver energy in accordance with the terms of
existing bilateral contracts. Of specific concern is the delivery to
TEP by Southern California Edison of 110 megawatts of firm power during
the summer months. Additionally, TEP is concerned that California's
failure to properly provide for new transmission and generation will
potentially impact the reliability of the Southwestern U.S.
transmission grid in the heavily loaded peak summer conditions. We will
of course undertake to operate our transmission facilities in such a
manner as to assure continuity of service for our customers. However,
the fact remains that the lack of appropriate generation and
transmission reserves in California has created an unnecessary and
inappropriate risk to reliability of the entire Southwestern U.S. power
grid.
The longer term resolution of this crisis resides in the ability to
construct a comprehensive national energy policy that appropriately
balances our energy needs with environmental concerns. We must move
quickly to fashion a policy that encourages an appropriate mix of
proven fuel sources--coal, natural gas, hydro and nuclear--while
accelerating the development of solar, fuel cells and clean coal
technologies. TEP strongly supports provisions in Chairman Murkowski's
draft energy legislation that would provide tax credits for the
development of new energy resources and create a more reasonable and
timely process for siting new facilities. We can no longer afford the
delays in bringing new generating and transmission facilities on-line
created by the current layering of local, state and federal
regulations.
Until otherwise advised, we will copy your office on all
correspondence with Governor Hull's office relating to the California
energy crisis.
Please let us know if we can provide any further information or
assistance to your office or the Senate Energy and Natural Resources
Committee.
Sincerely,
James S. Pignatelli,
Chairman, President & CEO.
______
Phelps Dodge Corporation,
Phoenix, AZ, January 30, 2001.
Hon. Jon L. Kyl,
U.S. Senate, Washington, DC.
Subject: Economic Impacts of the California Power Crisis on Western
States
Dear Senator Kyl: Thank you for the opportunity to comment on the
economic impact of the California power crisis which is now being felt
throughout the West.
The economies of the Western states are intricately linked and
interdependent. At no time in recent history has that mutual reliance
been more critical than in the last eight months, when market demand
exceeded the capacity of the shared power grid that delivers
electricity to residents, communities and businesses in the West.
In late Spring 2000, the shortage of power in California and that
state's severely limited generating capacity became evident. By mid-
summer, temperatures in the West were on the rise, driving up the
demand for power. The shortage in California and the increased demand
for energy in the West drove energy costs to astronomical levels. By
December, skyrocketing power costs forced some industrial power users
into a non-competitive operating environment, ultimately causing
production curtailments and employee layoffs in Montana, Washington and
Oregon. Exacerbating the California shortage is a continuing drought in
the Pacific Northwest, which has limited hydroelectric power
generation.
The unpredictability of power transmission also has exacerbated the
economic ripples caused by the California power crisis. One such
example is the Kinder-Morgan Santa Fe Pacific pipeline, a transporter
of petroleum fuel from California to Arizona, which was forced to shut
down when its power was temporarily terminated by the California
utility that held its interruptible power contract. The shutdown sent
the end-users of diesel fuel, including Phelps Dodge, on an urgent
search for an immediate, alternate source of diesel fuel.
In 2000, Phelps Dodge was hit hard by energy-related costs. Market
power costs increased more than 300 percent; diesel fuel costs rose 65
percent; and natural gas, used primarily in our self-generating power
plants, realized price increases of 171 percent. Further, our mining
and metals processing facilities operate 24 hours per day, 7 days per
week, 365 days a year. Unscheduled shutdowns, start-and-stop production
interruptions, and the last-minute unavailability of energy-related
resources wreak havoc on our production-cost structure. With no short-
term relief in sight for the first half of 2001 on either energy-
related costs or resource availability, we recently informed 2,350 of
our Arizona and New Mexico employees that production curtailments and
temporary job cuts may be necessary.
For industrial users of power, diesel fuel and natural gas, the
California power crisis has triggered a number of economic dominoes to
fall, the effect of which has not yet been fully realized by the
communities, companies or residents of the West. Until the power crisis
is resolved, its negative impact on industrial facilities in
surrounding states, including Phelps Dodge operations in New Mexico and
Arizona, may be enormous in terms of additional plant closings and
employee layoffs. On a broader scale, the energy crisis has the
potential to be a catalyst for accelerating and deepening the economic
slowdown we are experiencing in the United States. In New Mexico and
Arizona alone, the annual impact of the announced Phelps Dodge
curtailments, if required, would have a negative economic consequence
of nearly $1 billion.
It is incumbent on those of us in leadership roles within the
private and public sectors to work aggressively, diligently,
cooperatively and creatively to pursue every immediate opportunity to
minimize the impact of these extraordinary energy-related circumstances
on our businesses, our employees, and our communities, and to insure
our global competitiveness.
For long-term solutions, a number of variables must be addressed,
which include, but are not limited to:
the development of a national energy policy that takes into
account the availability, accessibility and allocation of
energy resources; population growth; geographic population
shifts; and the growth of new business sectors; all of which
impact the supply/demand balance of electricity and fossil
fuels;
engagement of consumers in order to 1) inform and educate
them about the magnitude of their energy-consumption patterns,
and 2) ``incentivize'' them to make conservation a reality
through energy-efficient utilization of our natural resources;
the identification and development of additional fossil fuel
resources within the United States, including the increase of
natural gas development in the near term; and
a thorough review of the regulatory approval process,
including the creation of a more streamlined and time-certain
permitting process which ensures that power-generating capacity
and vital transmission requirements are developed through a
reasonable and achievable process that is mutually conducive to
environmental stewardship and economic prosperity.
In the last decade, the citizens of the United States have enjoyed
one of the strongest periods of economic prosperity in the history of
our country. Our economic growth can be attributed, in part, to the
burgeoning service, hi-tech, and information-based sectors, as well as
to our strong appetite for all of the conveniences associated with
enjoying the highest standard of living in the world. Unfortunately,
some of us also have developed amnesia--amnesia about the necessity of
essential industrial underpinnings, including power and energy, that
support and drive all robust economies.
The California power crisis provides us with an opportunity to
identify new ways for communities, consumers and companies to thrive in
an economy that is both energy-sufficient and energy-efficient. The
employees of Phelps Dodge and many other companies throughout the West
are counting on us to reach resolutions and deliver solutions to this
crisis as quickly as possible.
I appreciate the opportunity to present our concerns and views on
the economic impacts of the California power crisis. Please know that
you can call on me, and other members of the Phelps Dodge team, if we
can be of assistance in resolving this important issue.
Sincerely,
J. Steven Whisler,
Chairman, President and CEO.
______
Western Gas Resources, Inc.,
Denver, CO, January 30, 2001.
Hon. Frank Murkowski,
Chairman, Senate Committee on Energy and Natural Resources, Dirksen
Senate Office Building, Washington, DC.
Re: Oversight hearing to receive testimony on California's Electricity
Crisis and Implications for the West
Mr. Chairman: I am writing on behalf of Western Gas Resources,
Inc., (``Western''), its employees and shareholders to make you aware
of serious concerns that I have regarding the ongoing situation in
California. Western is based in Denver, Colorado, and operates gas
treating, gathering, processing, and transportation facilities in
Colorado, Wyoming, New Mexico, Oklahoma, Texas, and Louisiana. We are,
with our partner, the largest producer of coalbed methane gas in the
Powder River Basin of Wyoming, one of the nation's brightest hopes for
natural gas supplies.
The Temporary Emergency Natural Gas Purchase and Sale Order (the
``Order''), extended by the Secretary of Energy through February 6,
2001 is compelling Western to continue to provide natural gas supply to
Pacific Gas & Electric Company with no assurance that Western will be
paid for this gas. Western would not, in the ordinary course of
business, provide natural gas on credit to a customer in such an
uncertain financial condition. Under this arrangement, Western and our
shareholders are uncertain of our ability to collect payment for the
gas delivered and are essentially bearing the burden of failed
deregulation in California. The State of California and the utilities
involved have the tools to solve this problem, and must be expected to
make the difficult decisions necessary to address both the short and
long term energy needs of their state.
Western is certain you are aware of the events leading up to the
current situation in California. The essential elements of the process
of deregulation begun in 1996, from our perspective, are as follows:
The Investor Owner Utilities (IOUs) divested themselves of
the majority of their natural gas fueled generation facilities.
For Pacific Gas & Electric (PG&E) and Southern California
Edison (Edison), natural gas fueled plants represented
approximately 34 percent of their generation capacity. The goal
of these divestitures was to increase the number of generation
owners and thereby increase the competition among power
suppliers.
The IOUs were granted a freeze on rates to their customers
at a rate higher than prevailing prices at the time of
deregulation. The rationale for locking rates higher than
market was to allow the IOUs to recoup from its customers
``transition costs'' associated with the shift to an
unregulated environment. File transition costs included net
costs associated with extinguishing long term gas supply
arrangements, previously un-recovered nuclear plant costs and
other losses associated with the transition to an unregulated
environment. Following recovery of these transition costs, the
rate freeze to the IOUs' customers would cease and the
customers would see a pass through of market rates going
forward.
Having sold off nearly all of their natural gas fueled
generation plants. the IOUs needed to purchase power to offset
the loss of this generation capacity. In an attempt to insure a
robust and competitive market for power, the legislation
required that the IOUs buy physical power under so called spot
or daily purchase agreements administered by new market
clearing mechanisms called the California Power Exchange (PX)
and the Independent System Operators (ISO). The IOUs were
discouraged from mitigating their price risk though financial
hedging, exposing them to unknown purchase expense through the
new clearing mechanisms while simultaneously being held to a
fixed sale price obligation to their customers. The fixed rate
was approximately $65 per MWhr. The purchase price at the onset
of deregulation was between $15 and $50 per MWhr, depending on
time of day and season.
Beginning in the early summer of 2000, spot wholesale power
prices in the west rose significantly, at times exceeding $1000
per MWhr. This rise is attributed to several factors; (1) a
significant increase in demand in California and the rest of
western North America, (2) a decrease in the availability of
hydroelectric supplies in the Pacific Northwest, (3) a lack of
new power generation construction in California in the last
decade dictated by state and federal environmental policy and
political pressure and (4) an increase in natural gas prices.
PG&E and Edison were still selling power for around $65 per
MWhr, and paying up to the $1000 per MWhr to buy it. A cash
hemorrhage began. The differences between the price paid for
power and the price for which it could be sold have now
exceeded $11 billion dollars with no end in sight. This loss
has swamped the utilities' ability to borrow and has resulted
in their default on commercial paper obligations. Recognizing a
possible bankruptcy situation, gas suppliers like Western began
to express concerns that they would not get paid.
Reacting to concerns that the flow of power and gas to these
utilities would be curtailed owing to suppliers' payment
anxieties, the Secretary of Energy issued orders requiring
selected gas suppliers to continue deliveries. The current
order expires February 7, 2001. No further assurances of
payment have been made to gas suppliers and no actions on the
part of the utilities, the State of California, or the federal
government indicate a solution is in sight.
Governor Davis has repeatedly stated his opposition to
further rate increases so it is unclear what company, industry,
taxpayer or ratepayer in what western state will be asked to
ultimately shoulder the burden of this regulatory scheme gone
awry.
Given these events, I have the following recommendations to resolve
the California's crisis:
1. Consumers in California cannot be expected to moderate
their consumption when they are isolated from the consequences,
in this case pricing. The CPUC has to modify retail rates and
or rate structures to send consumers accurate price signals so
they can adjust their consumption accordingly.
2. Wholesale prices must be allowed to fluctuate with market
conditions. Price caps on either electricity or fuels for
generation, such as natural gas, discourage investment in the
development of these resources.
3. Regulatory hurdles that inhibit utilities from creating a
portfolio of long term, short term, and financially hedged
exposures to electricity and fuel costs must be corrected.
4. Impediments to construction of power plants and related
transmission lines need to be examined and responsibly reduced
in areas that are short of generation capacity. The State of
California must make the difficult choices required to develop
their energy infrastructure in response to growth.
Secretary Abraham must not extend the Emergency Order requiring
Western and others to continue to supply gas to California without
further assurances of payment. Let me be clear. If we had sold this gas
to some other creditworthy party and thereby avoided being subject to
the Order, our margin would be just about breakeven. Western now faces
losing the full value of the gas. Ongoing assertions that out-of-state
suppliers are gouging California utilities are, at least in our case,
patently false. Setting aside the legality of the Orders themselves, it
is fundamentally unfair to ask my company and our shareholders to bear
the cost of California's inability to manage its energy needs.
On behalf of Western, I appreciate the opportunity to share my
thoughts on this matter. At a time when our nation faces real energy
supply issues, I would like to get back to focusing on our business
objective of producing and supplying the natural gas our nation needs.
It is my sincere hope that your time and that of our other energy
policy officials can quickly be refocused on developing a sound and
sustained national energy policy. If I can be of further assistance to
you, please call me.
Sincerely,
Lanny F. Outlaw,
President and Chief Executive Officer.
______
Morrison & Foerster, LLP,
Washington, DC, February 21, 2001.
Hon. Frank Murkowski,
U.S. Senate, Chairman, Senate Committee on Energy and Natural
Resources, Washington, DC.
Dear Senator Murkowski: We are submitting two news articles for
inclusion into the record of your Committee's hearings on the
California Energy Crisis. These articles are from the Wall Street
Journal, California Edition, and the Los Angeles Times, Orange County,
regarding AES' efforts to restart two mothballed units in Huntington
Beach, California. If the necessary permits can be secured, AES would
bring on line 450 megawatts of generation to help meet next summer's
energy needs in California. We also enclose AES' recent firm
announcement on its plans to reactivate the Huntington Beach units.*
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* The enclosures have been retained in committee files.
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AES is the world's largest global power company, which 19 years ago
began developing, building and owning cogeneration plants in the U.S.
AES' experience includes owning generation businesses in competitive
markets in Australia, Argentina and England and Wales. In California,
AES has owned and operated a 125 MW combined cycle power plant in Santa
Clarita since 1988. Ten years later, we purchased from Southern
California Edison power plants in Redondo Beach, Huntington Beach, and
Long Beach representing 4000 MW.
Please let us know if you have any questions.
Sincerely yours,
Robert Loeffler,
Attorney for AES.
______
Enron Corp.,
Houston, TX, February 26, 2001.
Hon. Frank Murkowski,
Committee on Energy and Natural Resources, Washington, DC.
Dear Mr. Chairman: Thank you for providing Enron the opportunity to
testify before the Senate Committee on Energy and Natural Resources on
January 31st. I will here elaborate on a couple of solutions I
mentioned in my testimony and provide an update on the California
crisis.
We are running out of time in California. This summer we are
expecting a capacity shortage of 10% during on-peak hours. With normal
weather and currently forecasted hydro conditions, California will face
persistent, random blackouts.
California is not solving its problem. While there have been some
welcome efforts to encourage conservation and expedite the movement of
applications through the byzantine power plant approval process, most
of the activity has now shifted to an effort to ``nationalize''
California's electricity industry. Legislation to put the state in the
power generation business and establish state ownership of California's
portion of the interstate transmission system is rapidly moving through
the state legislature.
This legislation will only make matters worse. While giving the
appearance of decisive action, a government takeover of the state's
electricity system can only delay an honest reckoning with the very
real problems that lay at the heart of the crisis. State ownership will
not increase supply or reduce demand by a single megawatt. (Further, if
previous experience with state-owned enterprises is any guide, it will
likely reduce efficiency and reliability.) Worse, the measures in front
of the California legislature will actually hinder or thwart entirely
the ability to craft workable solutions to the supply-demand problem
that undergirds the current difficulties.
At the most fundamental level, these efforts distract resources
from actions that could actually help resolve the crisis. Beyond that,
they present several significant problems. First, the reliability of
supplies throughout the West depends on an open grid to move power from
where it is to where it is needed. California's protectionist measures
will only invite countermoves by other states, many of whom California
needs to provide it with adequate supplies. Second, unless the state
overpays substantially for the utilities' transmission assets, these
steps will leave the utilities no better off than they are currently.
Whether the utilities hold the assets themselves or their value in cash
makes no difference at all to their overall financial position or to
the willingness of creditors to continue dealing with them. Third, by
funding the purchase of the assets with public monies the state
proposes to divert its hard-won surplus away from schools, hospitals,
law enforcement or other appropriate public uses, and toward a business
it doesn't belong in. By proposing to buy the grid with money taken
from its citizens in the form of taxes rather than higher electric
rates, the state continues to mask the true cost of power to
California's consumers while simultaneously driving out the private
enterprises that could bring those costs down. The only discernible
merit of these destructive proposals is their perceived political,
appeal to a constituency that views rate increases as anathema.
Let's put these legislative proposals in the context of hard
realities in the state. California entities are not paying their bills
for power purchased. Because their rates are frozen, California
customers don't know the cost of the power they are using--so they
don't conserve when prices increase. Meanwhile, they unwittingly pay
the true cost through the depletion of the state budget surplus.
Instead of reducing prices by lowering demand, the state calls for
reregulation and price caps (while neighboring states must raise their
own rates and make up California's supply shortfall). Legislation to
give the state condemnation authority over private businesses and
facilities is moving through the legislature. In short, California is
building an ``electric fence'' around its borders, and telling private
capital--which is desperately needed--to go elsewhere.
I suggest the following:
The effort to carve off California's portion of the
interstate grid from the rest of the West must be stopped.
Instead, federal policy makers should focus on fully opening
the power grid across the country to ensure the movement of
power from where it is to where it is needed. California is not
the first, and will not be the last, to attempt to interfere
with interstate commerce in the power sector. Our nation's grid
is more reliable and more efficient if it is open. As supplies
tighten around the country, the problems we are seeing in
California will be repeated.
California must reform its environmental permitting process.
The irony is that the current system actually reduces air
quality by keeping new, more efficient plants off the grid
while decades-old facilities that emit NOx at levels
40 times higher, continue to run.
California must institute a program of demand ``buy downs.''
There is not enough time to build new generation for this
summer. But, the state could take bids for voluntary demand
reductions. This will reduce prices more effectively than price
caps and will reduce or avoid involuntary blackouts. California
is tapping into an enormous amount of money from the General
Fund to finance DWR's power purchases. California could likely
reduce demand more economically by running an auction to
determine the payments businesses would be willing to receive
to reduce their demand for a sustained period (e.g., through
the summer months). DWR could easily run an on-line auction to
determine the price it could pay for these demand reductions.
To participate, businesses would be required to have the
metering equipment necessary to monitor and verify that they
are, actually achieving the reductions. To be successful,
customers need access to the following key elements:
--An internet based hour-ahead price posting system to
track the market price for hour-ahead power in real
time.
--Real-time metering systems for baseline demand and
voluntarily curtailment verification.
--A Settlement process that allows for market clearing
prices of energy to be paid for load reduction
(``Megawatts'').
--The potential benefits of an effective demand
response program would include:
--``creation'' of additional summer peaking
capacity in California, particularly in the
short term, without requiring construction of
additional generation resources.
--reduction of peak or super-peak load on the
over-stressed California electric system, thus
potentially reducing the overall cost of
electricity in the state.
--expansion of demand elasticity without
subjecting customers to the full risk of hourly
market price volatility by passing market price
signals to customers and allowing them to
voluntarily shed load and be compensated for
responding.
Just as important as getting these things done, is avoiding those
measures that will make matters worse. In addition to the ill advised
state takeover of the industry discussed above, price caps will
compound problems in the West. ``Soft'' or cost-based caps have not
worked in California--they left many sellers unwilling to sell, they
reduced competition from marketers whose cost structure simply does not
conform to traditional cost of service ratemaking, and they left
California power purchasers scrambling at the last minute to buy power
to avoid further blackouts. They only add to the uncertainty sellers
face in deciding whether or not to invest or make sales. Cost of
service ratemaking is at best a poor substitute for market pricing
(which is why it is avoided for all services except monopoly services
such as transmission and distribution). Rate proceedings are
contentious, often political and extremely lengthy proceedings. They
are particularly ill suited to situations like those we find in the
West today (i.e. extremely volatile cost components such as fuel and
emissions costs). At a time when investors need assurances that the
power business will not be ``reregulated'', price caps will only
exacerbate the already short power supply situation. There is a way to
get prices down: increase supply or reduce demand. The solutions
outlined above do exactly that. State takeovers and regulated rates do
not. Instead, they leave policymakers with the worst possible task:
deciding whose power to turn off. West-wide price caps will make this
even worse: how will western states decide, for example, whether Idaho
agriculture or California's high tech industry is more deserving of
power during any given hour?
Overall, California policy makers must adopt a laser-focus on
measures that increase supply or decrease demand. Any measure that does
not accomplish one or both of these objectives is a waste of time at
best. At the same time, federal policy makers should focus on opening
the interstate grid so that power can move from where it is to where it
is needed.
Since fixing the market is the ultimate goal we are very encouraged
about your proposed legislation and your leadership on this critical
issue. Your legislation addresses the fundamental issue of how the
United States can efficiently and expeditiously develop its energy
resources. Enron is encouraged that many of the provisions contained in
the legislation will improve the current investment climate.
However, we are concerned that a critical component of energy
investment has not been included. Specifically, we are concerned that
the issue of fair and efficient access to the nation's interstate power
transmission grids is not being addressed by the proposed legislation.
Non-discriminatory access to transmission facilities is a fundamental
component of investment in generation and supply. So long as it is US
policy to promote competition in generation and supply, such access
must be provided. There is no middle ground. If fair terms and
conditions of access will are not achieved in a timely manner, the
benefits available from competitive markets will be denied consumers.
Again, I thank you for the opportunity to share Enron's
observations with you and look forward to continuing to identify real
solutions to this crisis.
Sincerely,
Steven J. Kean,
Executive Vice President and Chief of Staff.
______
Statement of Marcia Merry Baker, on Behalf of EIR Economics
Dear Chairman Murkowski and Members of the Committee: As of the
point of your Jan. 31 hearing on the California energy crisis, the
evidence from all around the country showed clearly that we are neither
in a ``just-one-state'' problem, nor in a mythical ``supply-and-
demand'' energy imbalance. Instead, we face an overall, systemic
financial crisis, involving hyperinflation and economic breakdown. The
publications associated with the EIR News Service have thoroughly
documented what led up to this situation. The question now before
lawmakers and citizens everywhere--not just in the United States, but
internationally, is to recognize the nature of the crisis, and take the
appropriate steps. Addressing this directly, is a new policy document
by Lyndon LaRouche, prepared Feb. 4, and now in circulation as a mass
distribution national pamphlet, by his Presidential candidacy committee
(LaRouche in 2004). LaRouche's policy calls for RE-REGULATION, and
measures to manage the current energy system, and to begin
reconstruction for the near future. There has been great demand for
this approach, which is the traditional ``American System'' approach
that built the energy grid in the first place, especially from the
period of Franklin Delano Roosevelt.
states demanding re-regulation
At present there are initiatives for RE-REGULATION, or postponing
deregulation of energy, in most of the 26 states which have taken some
form of deregulatory action. LaRouche's policy document addresses not
only what action must now be taken to restore the energy base of the
nation, but what kind of weak-mindedness allowed this mess to develop
in the first place.
As the public is now confronted with the horror of unpayable energy
bills, and the prospect of food hyperinflation, manufacturing shutdown,
and the process of economic chaos, many are prepared to review and
reject the lies and inducements that led them to accept the premises
and propaganda of deregulation in the first place--not only for energy,
but for transportation, health care, and all vital sectors.
Therefore, in this testimony, we will not provide documentation on
the scope of the crisis--whose details are now clear, by the hour, from
every state in the nation. We will quote, in brief, from the LaRouche
policy document on the responsibilities of the federal government to
respond.
But first, one mention, of what Members of Congress have a special
duty to confront. Namely, the Bush Administration has no ordinary
conflict-of-interest bias towards continuing its current commitment to
energy deregulation, in the face of the conspicuous economic
destruction and hyperinflation underway. Not since the days of
Britain's George III and the British East India Company, has there been
such a notorious imperial ``special relationship'' between the
government and ``business,'' as the Bush Administration's connections
with the energy cartel companies. The interlink of board members, money
flows, favors, and behind-the-scenes deals, involves many prominent
names, including Enron, Dynegy, Reliant, El Paso, Williams, Duke Power,
Dominion Resources, and New Power, as well as BP-Amoco, Mobil-Exxon et
al--to name just a few.
EIR News Service has reported on this extensively, and will gladly
provide documentation. The political character of this network can best
be summarized as, ``Southern Strategy, Inc.'' Historically, the current
period in history, will be viewed as one of the politically filthiest
ever, ranking with the days when Venice pillaged the Mediterranean. For
handy reference on obvious connections, read Business Week, Feb. 12,
cover story, on ``Power Play--Enron, the nations' largest energy
merchant, won't let California stand in its way.''
It's all coming out in the open. The real nature of the energy
deregulation trend--namely that it was restructuring for the purpose of
allowing private firms new, massive profiteering opportunities, is now
becoming clear even to the most ideologically blind ``free market''
advocates. Deregulation, privatization, and globalization originated
under the Margaret Thatcher 1980s regime in Britain. Its destructive
effects are now notorious there, and we are seeing the same results hit
the United States, and other places around the globe--wherever ``de-
reg'' looting has been allowed.
what federal actions are required
This Congress is on the spot. What must be done, is here explained
by LaRouche, from his Feb. 4 document, ``On the California Crisis--As
Seen and Said By the Salton Sea:''
``Soon, unless President George W. Bush abandons his present ways,
his policies are now going to lead his Administration toward a point,
in the rapid unfolding of the current California energy-crisis, at
which Bush will be confronted with a global crisis so horrifying, that
most of you would not now even try to imagine it. The exact time that
point will be reached, may vary slightly, according to which detours
are tried; but, nonetheless, it will be reached very soon.
``For your own good, you, and President Bush, had better find the
courage to face up to that reality, now, before it is too late. For the
sake of all of us, please permit me to lead you, step by step, into
discovering for yourselves, what it is that you need to know, if we all
are to work our way out of this mess.
``The most important political issue now confronting all of the
most intelligent and moral citizens of the United States, today, is:
How could we prevent that terrible thing from happening? The only
available, intelligent answer to that question, has two parts to it.
First, speaking from a strictly technical, administrative standpoint,
what kind of U.S. policy would bring this crisis quickly under control?
Second, to speak politically, what are the chances, given President
Bush's presently stubborn attitude on the subject, of bringing his
administration around to accepting the needed, drastic changes in U.S.
economic policy before it is too late to do so?''
the specific steps larouche recommends: first steps
``The first step which must be taken, is to put the entire,
formerly regulated sections of our nation's energy industry under
Chapter 11 bankruptcy protection. This does not necessarily mean
putting each entity into bankruptcy; it means putting some entities
under Chapter 11 protection immediately, but it also means putting the
protective umbrella of Federal and state government threat to provide
such protection to any relevant entity within the domain of maintaining
national and regional energy security.
``As a leading feature of that use of Chapter 11 methods,
bankruptcy reorganization must be conducted to further the aims of
immediate reinstitution of former types of Federal and state regulation
of the generation, and distribution of the nation's energy supplies,
that at prices sustainable by businesses and typical households, and
consistent with pre-2000 trends in such prices.
``The difficulty in taking those urgently needed forms of
corrective action, is not only that deregulation has become, like
cocaine, a habit; but that the financial interests associated most
closely with the campaign for the election of the present
administration, represent chiefly a Southern Strategy-based complex of
financial interests which are deeply committed to defending the
revenues from activities which are choking California's economy to
death at this moment.
``If all among those interdependent courses of action are not
taken, no real solution to the presently skyrocketting crisis is
possible. In that case, the Bush Administration would come to be seen
soon as more or less doomed from the outset, hung, so to speak, by the
rope which supported its election.
``The Franklin Roosevelt precedent is to be understood to be
applicable to this case. The mission is to defend national economic
security, as the principle of promotion of the general welfare and
national security of all of the population and its posterity, defines
the meaning of law under our Federal Constitution, absolutely contrary
to the errant opinion of some text-offenders among the U.S. Supreme
Court justices.
``The prices and assured, regulated flow of the stream of
electrical and related supplies, must be immediately re-regulated by
the standard of pre-1977 precedents. This regulation should be Federal,
insofar as interstate commerce or national security requires, and shall
be otherwise left to the states, but with Federal support and
guidelines, as needed for coordination among the states . . .
``These emergency measures of re-regulation must be complemented by
a new matrix of combined, short-term, medium-term, and long-term
national energy policy.
short-term energy policy
``For the moment, we must operate on the working assumption that we
have presently available to our nation, approximately sufficient
capacity for generation and distribution of required energy-supplies.
Major generating installations, and their matching grid-system
elements, presently require periods in the order of three to five years
to install, even if high priorities are assigned to such installations.
Increasing of capacity for refining and delivering fuels also requires
lapsed time. That means, that only certain marginal adjustments in
primary energy-supplies are feasible during the year or two immediately
ahead.
``The suggestion that floods of fuels or electricity from abroad
would overwhelm the price-crisis, is a childish delusion. No cheap
theatrical stunts of that sort will work. Saner people will concentrate
on managing what we have, while beginning to build for the medium and
long term ahead.
``For the relatively short-term period ahead, arranging
supplementary supplies for critical points in the grids, will be
needed, in the manner of shoring up weak points in the dike. This will
be applicable to the needs for improvements in the quantity of
supplies, and for improvements in spots of less reliable performance
within the regional distribution grids.
``Among the required priorities, there must be a cautious avoidance
of over-reliance on what might be an excessively extensive scope of
load-frequency distribution operations. A large degree of local and
regional ability to isolate systems from potential calamities in the
broader distribution grids, should be considered a ability to isolate
systems national security priority. ``Just-in-time'' and ``justly
barely enough'' practices must be avoided, that as a matter of national
economic security. There must be built-in slack within the system, both
nationally, and regionally; there must be ready reserves available . . .
``Among included measures, the following are to be considered. The
use of jet-engine complexes, as relatively mobile auxiliary power
generation for patching up the distribution dike, is typical of the
kinds of short-term actions available. The logistics of fuel supplies,
for this purpose, is an integral part of that.
``Meanwhile, there must not be reliance upon hydroelectric sources
to the degree that such uses might undermine the relevant water-
management systems' other essential functions. The primary mission of
water-management systems, should be water-management, from which
hydroelectric generation serves as both an integral feature and a by-
product. The environmental impact of drawing down the water reserves,
as a way of avoiding government's responsibility for actions which some
political interests might not like, is something this nation need not,
and should not tolerate.
medium-term policy
``The notion of medium-term energy policy is pivoted on the
observation that, at present, three to five years is required, to
install a completed electrical generating facility of one to two
gigawatts average output-capacity. Most desirable, are facilities which
would supply process-heat and synthetic fuels, such as hydrogen and
methane, for local and regional industrial and other uses.
``On this account, medium-term energy policy overlaps long-term
policy. The principal generating plants of the system as a whole, are
constructed with an intended useful life of about a quarter-century, or
longer; major hydroelectric installations significantly longer. These
principal installations involve capital expenditures, and related
financing arrangements, at rates which should be sustainable in the
order of 1-2% simple interest, amortizable over long-term periods.
``Given the reality of the awful financial crisis threatening our
nation's, and the world's banking systems now, the resurrection of an
adequate energy-system for our nation, will require a long-term credit
facility of a special type, with a special mission-assignment. There
must be a Federal authority which coordinates this, and provides
Federal credit for facilitating long-term investments in medium-term
construction and rehabilitation of generating and distributing
capacities.
``In connection with this same point, we must not separate national
energy policy from its natural relationship to the financial systems of
banking and pensions. Regulated systems of national basic economic
infrastructure, operating at low simple interest rates, are the broad
base of the pyramid upon which to build national economic growth in
depth. This pertains to the natural complementarity between the
functions of local and regional banking, and the development of the
basic economic infrastructure and communities of the region in which
the banker's market is most usefully situated.
``The U.S. experience of the Reconstruction Finance Corporation and
Germany's Kreditanstalt fur Wiederaufbau, are models of reference for
such rebuilding and long-term development programs.
``This has special importance for national banking and other
policies at this present time. The perilous conditions of speculation-
ridden private banks at this time, and the need to save those banks as
functioning institutions, sometimes almost despite themselves, requires
that Federal and state government act to foster the growth of a solid
new base of bank assets, by aid of which to manage the difficult work
of financial reorganization of banking institutions which must not be
allowed to fail, even though they be awfully bankrupt.
``The fostering of public sponsorship of large-scale investment in
maintenance and improvement of long-term basic economic infrastructure,
is still, today, the most solid foundation available for mobilizing
combined public and private resources for a national economic recovery
along lines typified, by the work of the Reconstruction Finance
Corporation and the Tennessee Valley Authority, during President
Franklin Roosevelt's tenure. Clearly, Federal policy and action now,
must reference those highly successful precedents.
``In such matters, we must always shape the implementation of any
important policy, especially those of medium-term and long-term impact,
with regard to their impact upon the so-called ``macroeconomic''
totality in which such undertakings are situated. The interdependency
among large-scale infrastructure programs, regional and local banking,
and general community and business development within a region, must be
the minimal setting within which infrastructure policies and programs
must be defined.
``In that vein, consider the following.
``The location of prospective such plants, must be subject to
Federal, as well as state, local, and private initiatives. In any
rational form of U.S. national law and related policy, the requirements
for power, as measured in even such raw figures as kilowatts per square
meter, are subject to the same types of policy-planning as national
railway, waterway, and highway projections. Geography and related
considerations indicate where such facilities may lie, optimally, over
the decades and generations yet to come.
``In such respects, the kind of long-term energy-policy under which
directions for medium-term actions are subsumed, resembles long-term
general staff planning in the military domain. The indispensable role
contributed by West Point graduates, as engineers, in building up the
basic economic infrastructure of our nation, is among the experiences
which reflect the principles involved.
``Medium-term policy in this area must take into account, that
since the beginning of the Carter Administration, there has been a
catastrophic collapse in U.S. energy national security, as a reflection
of the combined failure to develop new generation, and attrition of
pre-1977 installations. The coming four years in energy policy, must be
directed to clearly concretized goals, as defined from a long-term
perspective, in choices of locations and numbers of newly constructed
generating capacities and in related improvements in grids.
``Also, present policy-making for the medium, and long term, must
take into account, that throughout the world, there have been
significant, qualitative advances in the standards for types of designs
of generating plants. Two implications of this, are not to be
overlooked in projecting national energy policy for the medium term.
``In this connection, we must also recognize a complementarity
between needs for new installations inside the U.S.A. itself, and what
should become a growing vast market for such installations in other
parts of the world.
``Our national policy must foster the resurrection of U.S. capital-
goods-producing capacity lost over the recent quarter-century, with the
intent of fostering the reappearance of firms which find the base-line
for their market in combined domestic and foreign requirements. Such a
marketing perspective warrants acceleration of scientific and related
technological progress in this field of capital goods production and
installations, and indicates a corresponding requirement in even the
medium-term programs of our universities and related institutions.
``This also points to the need for permanent functions of our
Federal government, to bring together the public and private interests
and agencies which will contribute crucial parts to implementing such a
perspective.
long-term policy and environment
``It should come to be understood, that `long-term energy policy'
has two distinct, but complementary meanings for practice. In the first
approximation, it signifies the intended cumulative effect of adding
generating facilities which each could be installed, usually, during
periods of three to five years. It should also mean something
distinctly more profound; we should see energy policy in terms defined
by the celebrated biogeochemist Vladimir Vernadsky's conception of the
noosphere.
``To make this clear, I summarize Vernadsky's conception,
resituating it in the setting of my own original work in physical
economy, and correcting some widespread, but incompetent popular
opinion on this subject.
``Vernadsky is famous for defining the term `biosphere,' as
signifying that our world's atmosphere, oceans, and much of the surface
of the Earth down tens of kilometers, is, increasingly, the natural
product of the action of living processes upon the otherwise non-living
Earth as a whole. He went further, to emphasize that the rate at which
the biosphere itself is growing, is increased by the creative economic
activity of mankind. Thus, he defined our planet as, in the first
instance, under the reign of a biosphere, which is, in turn, under the
reign of a creative force, human creativity. Vernadsky then defined
this superimposition of the noetic powers of creativity, unique to the
human species, upon the biosphere, as through physical-economic
activity, as the noosphere.
``That means, that we must view mankind's development of what we
call basic economic infrastructure, as functionally an extension of the
biosphere's role in generating and sustaining the preconditions needed
for human life.
``Therefore, domains of public interest such as mass
transportation, water management, improvements of fields and forests,
and production and distribution of energy, must be viewed as what
Vernadsky would term the natural products of the noosphere, just as he
classified atmosphere, oceans, and so on, of pre-human Earth, as
natural products of the biosphere. From a standpoint of modern economy,
the development of general basic economic infrastructure, and our
maintenance and improvement of the biosphere, are to be seen as a
continuous, single process within the noosphere. Among the relevant
points to be stressed, is the beneficial role of rational development
of basic economic infrastructure in improving what would be otherwise
called the biosphere.
``This means, that one of the goals of public administration, is to
ensure that the land-area of the world is improved, as a biosphere, to
the effect of enhancing the conditions required for human life.
``To this end, I, in my function as a specialist in the science of
physical economy, have introduced a refined notion of what I and my
associates have introduced to Eurasian policy-deliberations as
``development corridors.'' This is to be seen as an extension of what
American System economists Friedrich List and Henry C. Carey defined as
the function of a transcontinental railway system, such as those which
integrated the U.S.A., from Atlantic to Pacific, as functionally a
single national territory.
``If we examine relevant examples from both ancient and modern
history accordingly, we should recognize, rather readily, that it is
necessary to correlate general transportation routes, with power
generation and distribution, and with water management, all under a
single, unified conception. By developing corridors of this type, in
bands of up to fifty miles or more in breadth, we create the
preconditions under which what is economically otherwise more or less
marginal land-area within a continental interior, is transformed into
highly productive, economically fertile area.
``If we approach such pathways of development appropriately, the
effect of such development is, to enhance the biosphere for man's
existence, not, as many misinformed persons have feared, the reverse.
``The present crisis, born out of the follies of U.S. policies (in
particular) during the recent thirty-five years, has brought us to the
time, that our properly informed concern for the coming generations of
our population, should impel us to develop and adopt long-range
policies whose effect on the noosphere, is to enhance the condition of
the nation and the world bequeathed to our descendants . . .''
______
Statement of Craig G. Goodman, President, National Energy
Marketers Association
i. introduction
My name is Craig G. Goodman. I am submitting this testimony as
President of the National Energy Marketers Association (NEM). NEM is a
national, non-profit trade association representing a regionally
diverse cross-section of both wholesale and retail marketers of energy
and energy-related products, services, information and technology
throughout the United States. NEM members include: small regional
marketers; large international wholesale and retail energy suppliers;
energy consumers; billing firms, metering firms, Internet energy
providers, energy-related software developers, risk managers, energy
brokerage firms, customer service and information technology providers.
Affiliated and independent marketers have come together under the NEM
auspices to forge consensus and to help eliminate as many issues as
possible that would delay competition. NEM supports the implementation
of laws, regulations, standards of conduct, rates, tariffs and
operating procedures: (a) that provide all customers meaningful choice;
(b) that implement open, efficient, ``liquid'' and price-competitive
energy markets, and (c) that encourage the development of new, and
innovative energy services and technologies, at the earliest possible
date.
As a national trade organization, NEM brings a wide range of
experiences, as well as broad perspectives to its testimony in this
proceeding that should aide the United States Senate Committee on
Energy and Natural Resources and enhance the quality of the record to
be developed here. NEM currently participates in more than 50
restructuring proceedings around the country and at the FERC. The
testimony and recommendations presented here represent major issues and
barriers to price competition that are most often confronted in
proceedings around the country.
ii. background
Price competition is the goal of deregulation, whether it is for
airfares, long distance telephone rates or energy prices. Meaningful
choice and true price competition are always the best consumer
protection laws possible. When laws and regulations set prices,
restrict access to consumers, establish barriers to entry, mandate
sales of assets coupled with spot purchases of volatile commodities,
markets get distorted and everyone loses, consumers, taxpayers,
utilities, governments and suppliers. Real competition always works.
Deregulation is not a failure. California Style Deregulation, however,
is a failure.
California was first and could have established a model for other
states to follow. Unfortunately, a number of political compromises made
supply shortages and price spikes inevitable. In the face of strong and
growing demand for power, no new power plants were built. Price cuts
were legislated at the same time that tens of billions of dollars in
stranded costs were allowed into rates. Energy sellers and buyers were
prohibited from doing business with each other and all energy purchases
and sales were mandated through a state run monopoly. Simultaneously,
utilities sold most of their generating assets at values higher than
book value and purchased energy supplies in the spot market. All this
occurred at a time when no new power plant construction made future
shortages and price spikes foreseeable and ownership of existing plants
excellent investments. Financially, the utilities were selling
electricity short without generation to deliver as a hedge against
price increases. Predictably, wholesale prices grew to meet demand yet,
at the same time, retail prices were capped. This is a recipe for
disaster in any market.
California is one of the world's largest economies, the epicenter
of a worldwide technology revolution, and built around an electricity
system that is in need of significant new investments to deliver
``digital power quality.'' The direct and indirect impact to
California, the western United States and the global economy of local
decisions that stalled construction of needed supplies is potentially
astronomical. Meaningful choice and true price competition can only
occur when consumers are assured that new supplies will be available to
meet their growing demand. This has not happened in California.
Now, California is in a cycle of stage 3 energy emergencies with
rolling blackouts, major utilities are having cash flow and credit/
confidence crises, taxpayers and consumers are revolting against both
high prices and utility bailouts, new generation and construction is
stalled, and politicians have actually threatened to expropriate
private generating assets that utilities sold when values were high and
shortages were foreseeable.
While California-style deregulation is unique, the impact of the
California energy crisis is not contained within the borders of the
state, and will be felt throughout the region and could affect the
national and global economies. The impact of California's energy and
environmental choices is now being passed on to ratepayers throughout
the Northwest. Ironically, in order to allay short-term blackouts,
older, coal-burning facilities that could have been replaced with newer
cleaner plants will be running overtime for the foreseeable future.
Importantly, every state has a legitimate interest in protecting
in-state consumers from increasing energy prices. However, the current
60-year old system of federal and state laws and regulations were
designed around a local franchise monopoly paradigm. To deliver the
lowest possible prices to consumers, new laws and regulations are
needed immediately so that competitive suppliers can super-aggregate
energy demand and deliver national economies of scale to even the
smallest consumers. Competitive energy suppliers cannot succeed unless
they can offer consumers lower prices than the local franchise
monopoly.
iii. recommendations
There are a number of actions that federal and state governments
need to take to ensure the proper restructuring of the electric
industry. Members of NEM spent hundreds of man-days forging consensus
on the proper role of the federal, state and local governments in the
implementation of electric restructuring. NEM members operate in
virtually every market that has opened for competition, and their broad
base of experience was the basis for the attached document entitled,
``National Guidelines for Restructuring the Electric Generation,
Transmission and Distribution Industries.'' Since this document was
released, the California model for deregulation has produced empirical
evidence as to how the failure of one state's deregulation program can
have significant economic and environmental impacts on other states as
well as the national and global economies.
Accordingly, NEM urges the Congress to consider a number of
important actions to bring meaningful choice and true price competition
to all US consumers of energy at the earliest possible date. Generally
speaking these actions would: (a) encourage the development of national
economies of scale through more uniform rules, operating procedures,
tariff structures, scheduling coordination and technology platforms,
(b) limit utility services to pure monopoly functions (transmission and
distribution) and provide current monopoly cost-base prices to
consumers as ``shopping credits'' to procure competitive services, and
(c) expand existing energy and environmental tax credits to include
Qualified Restructuring Investments such as advanced metering, computer
system upgrades, distributed generation and provide tax and performance
based regulatory incentives for infrastructure upgrades, congestion
management, maintenance and streamlined interconnection procedures.
A. National Economies of Scale are Critical to Lower Energy Prices.
True price competition and lower energy prices require competitive
suppliers to achieve national, or at least, regional economies of
scale. Competitive suppliers can only succeed in winning customers away
from incumbent utilities if they can offer lower prices, better
services, more novel products, services and technologies or all three.
Currently, there are 50 different states with different rules in
multiple utility service territories, different data protocols and
transaction sets, different operating rules, different switching,
scheduling and customer protection rules, even different units of
measurements. As long as market participants are forced to divert
scarce resources to customize computer systems, billing, back-office,
and customer care facilities, and to develop and maintain non-
standardized information protocols or develop specialized knowledge of
different business rules in each jurisdiction, it drives energy prices
higher nationwide. Add to this the fact that one marked failure like
California can have a devastating impact on consumers, taxpayers,
financial markets and regional ecosystems.
Energy is the lifeblood of the world economy. It is time to
coordinate and implement relative uniformity among the states, in
rules, processes. procedures, scheduling delivery, and even information
technologies.\1\ There are a significant number of business rules,\2\
consumer protection laws, technology platforms and comparable operating
rules and scheduling processes which, if established fairly,
efficiently, and uniformly across the country could bring significant
cost savings and have a profound impact on the country and the
reliability of energy supplies.
---------------------------------------------------------------------------
\1\ National Energy Technology Policy (October 30, 2000). Available
on the NEM website at: http://www.energymarketers.com/documents/NEM
National Energy Technology Policy final.pdf.
\2\ Uniform Business Practices for the Retail Energy Market,
Sponsored by EEI, NEM, CUBR and EPSA. Accessible at www.eei.org.
---------------------------------------------------------------------------
B. Utilities Should Exit the Merchant Function and Consumers Should
Be Provided Shopping Credits Equal to Current Monopoly Prices to Shop
for Competitive Services. Utilities should be encouraged to ``exit''
competitive businesses and focus all ratepayer dollars on performing
services that can only be performed by a natural monopoly. In the
process, consumers should be given ``shopping credits'' on their
utility bills equal to the utility's fully embedded costs of providing
competitive services that have been historically bundled with
traditional monopoly services. Currently, captive utility customers pay
monopoly prices for a bundle of services that include many products and
services that can and should be provided by competitive suppliers at
competitive prices. Failure to give consumers credits that reflect the
full costs historically associated with these services will send
erroneous pricing signals to consumers and cause consumers to pay twice
for the same services. Shopping credits which ``back out'' the proper
amounts from utility rates will permit consumers to shop for
competitive services, encourage price competition among suppliers,
improve efficiency and stimulate innovation. If consumers are given the
full monopoly prices they are currently paying for competitive services
to shop for alternative energy services, price competition and lower
energy costs will be difficult to achieve.
C. Federal and State Tax and Regulatory Incentives are Needed
Immediately for Investments in New Energy Supplies, Conservation,
Technology, and Infrastructure Immediately. The United States has
entered the digital age with an energy infrastructure constructed for
the industrial revolution. The United States is operating on a level of
reliability that cannot support digital power quality needs. A flicker
of the lights in Silicon Valley has global impacts.
One of the lowest cost, highest yield policy solutions is to create
targeted tax incentives to encourage all forms of new energy supply,
technology and conservation investments. This includes investments in
new pipes and wires to reduce congestion, advanced metering systems,
new computer systems, new energy supplies as well as distributed
generation. Both the state and federal governments have powerful and
effective tools to encourage new investments in energy supply and
conservation. The federal tax code already contains a myriad of
targeted energy, environmental and efficiency tax credits that should
be updated to increase the supply of electricity and natural gas and
reduce consumption. Either or both the existing energy tax credits
contained in Section 48 of the Internal Revenue Code (IRC), or the
existing credit for research contained in Section 41 of the IRC, could
be expanded to include ``qualified energy restructuring investments.''
NEM recommends that the definition of ``qualified restructuring
investments'' include, at a minimum, expenses incurred to modernize and
upgrade computer and information systems, metering systems, billing
systems and customer care facilities to facilitate competitive
restructuring. The credit should be available to both regulated and
unregulated entities. To ensure that restructuring tax credits and
regulatory incentives are targeted and effective, investments that are
not ``qualified'' should also not qualify for stranded cost recovery.
conclusion
The market structure and added supplies necessary for deregulation
to succeed in California were not in place, and the failure of
California style deregulation was therefore predictable. In order to
prevent similar crises, permit meaningful choice and true price
competition and ensure the reliability of a digital quality U.S. energy
infrastructure, (a) far greater uniformity is necessary among the
states to achieve national economies of scale, (b) utilities must be
incented to exit the merchant function while consumers are given
adequate shopping credits to shop for competitive supplies, and (c)
existing tax and regulatory incentives must be expanded to encourage
new investments in energy supply, technology and conservation.
If both federal and state laws are written in a manner that ensures
meaningful price competition for the smallest retail consumer, the
country will benefit from lower energy costs, greater efficiency and
improved competitiveness internationally. Higher energy costs operate
like a regressive tax on low-income individuals and small businesses.
Conversely, laws and policies that help to lower energy prices have a
disproportionately greater benefit for lower income individuals and
those on a fixed monthly income. NEM experts are available to work with
Committee staff to draft appropriate language to implement these
recommendations.
______
Joint Statement of Hon. Gray Davis, Governor, State of California; Hon.
John Kitzhaber, Governor, State of Oregon; and Hon. Gary Locke,
Governor, State of Washington
The governors of California, Oregon, and Washington met in
Sacramento on Friday, January 12, 2001, to discuss the growing West
Coast energy problems. Governor Gray Davis of California, Governor John
Kitzhaber of Oregon, and Governor Gary Locke of Washington set up the
meeting in order to exchange information and plan joint action of the
Pacific Coast states to deal with energy shortages and soaring energy
prices, particularly with respect to electricity.
The Governors agreed on the following statement.
The Pacific Northwest states and California have for the past 30
years enjoyed a mutually beneficial exchange of electrical energy
between the two regions. When electrical demand is high in California
during summer air-conditioning season, the Pacific Northwest has sent
power to California, primarily from the surplus output of the
hydroelectric dams. In the winter, when Pacific Northwest space heating
loads are high, California historically has made power available to
Oregon and Washington. This arrangement has recently been threatened by
the failure of California wholesale power sellers to make enough power
available to serve California loads, let alone to provide power for
export to the Pacific Northwest.
The Governors agree to work together to try to restore conditions
in the wholesale market that would allow the mutually beneficial
exchange of electricity between California and the Pacific Northwest to
continue into the future.
For the immediate future, the Governors agree to work to ensure
that power flows from one region to the other during periods of
emergency, so that no state suffers blackouts when another state has
more than enough electricity to meet its own needs.
The Governors agree to support the financial viability of the
utilities.
The growing problems in the wholesale electricity market that have
brought record electricity prices threaten all the buyers of
electricity on the integrated power grid connecting the western states.
The problems in the marketplace for electricity are not just California
problems. They are problems that affect all western states.
The Governors pledge to work to involve all the western states in
the solutions to the current energy problems.
Governor Kitzhaber and Governor Locke acknowledge and commend the
efforts made to date by Governor Davis and the citizens of California
to deal with the current energy challenge. They agreed that
California's efforts to reduce electricity demand, to bring on new
supplies as quickly as possible, and to regain control over the
electricity marketplace are important steps towards resolving the
current energy emergency.
The unprecedented shortages and extraordinary wholesale prices of
electricity in California have resulted in an unexpected and
unprecedented need for imports of electricity into California. Much of
the needed supply has come from the Pacific Northwest, both during the
summer emergency and during the current winter power Governor Davis
expresses the gratitude of the citizens of California for the efforts
made by the citizens and businesses of the Pacific Northwest to supply
needed power to California during the energy emergencies of the past
year.
Apart from the current extraordinary shortages and increases in
energy costs caused by non-competitive practices in the marketplace,
new supplies of energy must be put in place, and they will cost more
than in the past. Until these supplies can be brought on line, it is
necessary for the citizens of the West Coast states to reduce their
demand for energy, particularly for electricity.
Each Governor acknowledges and commends the efforts being
undertaken in the other states to reduce demand for electricity during
the current energy emergency. The Governors pledge to:
Continue to urge citizens in their respective states to
reduce demand with a target of seven to ten per cent reduction
from pre-emergency levels;
Work towards reducing electricity demand at state-owned
facilities by ten cent or more;
Expand programs to distribute or provide incentives for low-
cost energy efficient products and services, such as lighting,
air-conditioning, and appliances;
Undertake campaigns to provide information to citizens and
businesses on low cost ways to save energy;
Investigate joint purchasing of energy efficient products
for state and local governments and school and transit
districts.
While the West Coast states are in need of new electricity
supplies, investments in energy efficiency, renewable resources, load
management, and distributed generation can often provide cost-effective
and more quickly implemented alternatives to conventional supplies. An
added advantage of many of these alternatives is fewer emissions and
other factors benefiting the environment.
The Governors will work to ensure that alternatives to conventional
energy supplies are implemented to bring about a more secure energy
future. The three states further agree to sponsor a West Coast
conference this year to investigate new technologies and to promote the
deployment of energy efficiency, renewable resources, load management,
and distributed generation. The West Coast states will institute
regular exchanges of information, expertise and technology in these
areas.
The current crisis in electricity cannot be solved by action of the
West Coast states alone. A major part of the problem has been the
unsupervised wholesale market, which has been subject to manipulation
by non-competitive forces, resulting in record rates of plant outage
and price increases frequently of over 1,000 percent. The states have
limited legal authority to regulate activity and prices in the
wholesale market for electricity, that role having been given primarily
to the Federal Energy Regulatory Commission by the Federal Power Act.
The Governors, in the strongest possible terms, call upon the
federal government, in particular the Federal Energy Regulatory
Commission, to bring stability to the western wholesale power market
through effective price controls. Such action is the cornerstone of
providing financial stability.
The Governors agree that it is unfair to pass on to consumers the
entire burden of the unprecedented increases in the wholesale cost of
electricity resulting from non-competitive practices in the
marketplace. The federal government must take up its responsibility to
prevent the chaos that threatens to engulf the entire western
electricity system by using the tools it has at its disposal. If FERC
fails to be accountable for the crisis in the wholesale markets, the
Governors call on the Congress and the Clinton and Bush administrations
to take such immediate action as is necessary to repair the wholesale
market for electricity in the West.
______
Statement of Robert M. Hertzberg, Speaker, California State Assembly
Today I urge congress to join with us in crafting a solution to the
enormous energy problems that confront the people of California and put
at risk not only the reliability of our energy, but also the great
engine of our state's economy. As many have said in recent days,
including federal reserve chairman Alan Greenspan, a failure to
adequately ensure reliability of supply at affordable rates for
Californians may have a large and negative ripple effect on the economy
of the entire nation.
While California's deregulation plan clearly has not worked out as
its creators intended, the current problem is not entirely of
California's making. In fact, about 85 percent of the growth in
electricity demand in the west in the last five years has occurred
outside California.
However, California stands ready to make the hard choices we must
make to end this crisis. Over the last few days, we have crafted a set
of principles substantially agreed to by the governor and the majority
and minority leadership of both houses of the legislature which we
believe will go a long way towards helping resolve the crisis. These
principles include:
Aggressively promoting energy efficiency.
Increasing the supply of electrical generation by stream
lining the permitting and construction of new plants.
Authorizing the state to enter into long-term contracts with
power providers and to sell power directly to ratepayers.
Providing ratepayers with an asset of value, such as stock
warrants, as equity participation in the financial recovery of
the utilities. This equity participation will be used either to
help retire bonds or otherwise provide tangible benefits to
consumers.
Continuing negotiations with investor-owned utilities and
others on a plan to deal with their unrecovered costs while
also protecting ratepayers.
Reducing the price paid to qualified facilities by
negotiating reductions in their contract rates.
Resolving outstanding regulatory and legal actions initiated
by the utilities to recover undercollections.
In addition, we have already enacted two bipartisan urgency
measures which have been signed by the governor and which are in effect
now to begin the restructuring necessary to resolve California's energy
problems. AB 5X (Keeley) removed the ``stakeholder'' governing board of
the independent system operator and substituted a board of governor's
appointees to eliminate the inherent conflict of interest in utilizing
stakeholder decision-makers. AB 6X (Dutra) makes utility-owned
generation facilities subject to PUC regulation and prohibits further
disposal of utility-owned assets prior to 2006.
Our efforts are on-going, multi-faceted and around the clock. Our
leadership is currently close to a final deal to reduce the price of
qualified facility contracts by roughly 50%. We also are near
completion of discussions with the governor and the utilities to ensure
that California can purchase the electricity that the utilities are
currently unable to purchase because of their lack of credit-
worthiness. AB 1X (Keeley), the measure which would make this change,
has already passed the assembly and may pass the Senate as early as
today. AB 18X (Hertzberg) is also subject to round-the-clock
negotiations. The team of experts we have assembled from throughout the
nation is working to craft a long-term solution that resolves the near-
bankruptcy status of our utilities in a way that ensures strong
protections for our citizens and financial safeguards for the state.
California has three new power plants coming on line this year at-
one. Nine others have been approved and five are already under
construction. Every one of us is hard at work to get this job done:
secure energy supplies and fair energy prices.
While we are committed to taking these and other steps to resolve
the crisis, there are things we cannot do without federal assistance.
We look forward to working with you and other members of Congress
as we work on siting new power plants, providing diverse energy
sources, developing substantial conservation plans, and the interstate
supply and demand issues that the entire western region is facing this
summer.
Thank you in advance for your interest and assistance. My
colleagues and I stand ready to provide you with further information in
a cooperative effort that will benefit all our constituents.
______
Statement of Daniel V. Flanagan, Jr., School of Policy, Planning and
Development, The University of Southern California, Los Angeles, CA
Mr. Chairman: As a native Californian, but long time Washington DC
executive, it was my privilege to be present on October 24, 1992 when
President George Bush signed the 1992 Energy Policy Act. I was invited
by Admiral Jim Watkins, then Secretary of Energy (whose father had
served as President of Southern California Edison), due to my personal
role in leading the private sector effort culminating in the Act's
Title VII dealing with ``electricity deregulation''.
I am delighted to be here today to review the importance of the
1992 Act's electricity title, crafted by this Committee, so that there
is a clear understanding by Californians of the benefits it has
achieved throughout the United States and in other countries.
Hopefully, this presentation can also clarify the mistakes made by
California in the 1996 ``restructuring'' of its electric utility
industry and remedial steps needed.
I am very troubled that California not only made some serious
mistakes in implementing this federal opportunity; but that the
coverage has been so confusing to the state's population. With the
sixth largest GDP in the world, and soon to surpass Great Britain and
France, it is clear that the Golden State must increase its
understanding of public policy and economics.
For the University, and its mission, we cannot afford to have
California tarnish twenty-five years of economic deregulation in this
country, which has been a key ingredient in the recipe for this
brilliant economy. How can Mexico restructure its national utility
(CFE) when opponents will cite what happened in California?
perspective
In 1996, when California's legislature ``restructured'' its
electric utility industry, at the request of the state Public Utilities
Commission, it created two new enterprises: a ``power exchange'' and an
``independent system operator'' (ISO). The State PUC had recommended
both, and while a power pool infrastructure was needed, neither was
allowed to enter into long-term electricity supply contracts. The
state's three investor owned electric utilities, subject to PUC
regulation, were required--during the restructuring period--to purchase
all electricity supply from the power exchange. Effectively, California
locked itself out of the dynamic, national wholesale electricity market
where low electricity prices were readily available.
Governor Davis is now engaged in an effort to remedy that situation
by negotiating long-term, State of California electricity supply
contracts at prices higher than available last summer, notwithstanding
even lower market prices prevalent during the '90s. For this to happen,
it will be necessary for the state legislature to amend the 1996 Act,
following on the FERC's Dec. 15th action amending its earlier Power
Exchange/ISO ratification sought by California in 1994. The prohibition
on long term contracting for electricity supply was the ``killer
virus'' that has stunned California's economy. No other state has
adopted these restraints; and, in fact, they have enjoyed relatively
stable low cost electricity supply since 1992. Electricity costs rose
nationwide by only 2.9% (commerce) and 2.6% (industry) last year
according to the US Bureau of Labor Statistics.
background
In 1995, the internet's founder, Bob Kahn of DARPA fame,
commissioned four studies dealing with the history of the American
railroad, electric utility, telephone and banking industries through
his US government funded Corporation for National Research Initiatives.
He commissioned the work in order to appreciate the regulatory history
of those industries and to prepare accordingly for the regulatory
policies that would evolve relative to the internet industry. With my
professional Washington career devoted to the deregulation of these
same industries, I am concerned that California ``gets it right'' on
these national public policy initiatives.
In developing the public policy ``recipe'' for what became the 1992
Energy Policy Act's Title VII dealing with electricity deregulation,
prominent economists including MIT's Paul Jaskow, Dick Schmalansee and
Harvard's Charles Chicchetti began work with our coalition in 1988. For
over two years, we met on a regular basis to analyze the traditional
components of such a venture: market entry and competition, risk
transfer, new technology, entrepreneurial opportunities and consumer
benefits. These were the very same ingredients from my earlier work in
the deregulation of railroads and the trucking industry as well as the
five-year effort-representing SPRINT in the breakup of AT&T in 1982.
Our findings were provided to the US Department of Energy as part of
the National Energy Strategy process submitted by the White House to
Congress in 1990.
the 1992 energy policy act
The hearing rooms in both the House and the Senate of the US
Congress were ``standing room only'', as you will recall, for over four
years beginning in 1988. The FERC, that same year, had allowed
competition to determine the avoided cost in co-generation contracts
stemming from the 1978 Public Utility Regulatory Practices Act (PURPA)
adopted during that national energy crisis.
Historically, this vertically integrated industry--comprised of
generation, transmission and distribution--had inefficiently ``built''
new generation plants in the United States resulting in reserve margins
well over 30%. Archaic transmission policies and construction
outsourcing overruns had placed a huge cost burden on American
electricity consumers.
By passing Title VII--Electricity, of the 1992 Energy Policy Act,
Congress enacted into law two critical policies:
A. Henceforth, U.S. investor owned utility generation (and
transmission) whether in this country or abroad could be exempt
from the 1935 Public Utility Holding Company Act provisions,
which required that these assets be regulated. Accordingly, the
independent power industry was launched within the definition
``exempt wholesale generator''.
B. Transmission access was to be assured by the FERC for this
independent power generation into the grid.
In the almost ten years since enactment, this federal statute has
launched a new global independent power industry dominated by the
United States. New technology, environmental benefit, risk/reward,
consumer benefits as well as protection have all occurred. Project
finance, non-existent in the USA before 1992, is now the traditional
infrastructure/IPP financing practice. As Chairman of the 1993
Infrastructure Investment Commission, my staff could not find an
American firm-during our congressional hearings that prior year--that
could explain project finance to us. We relied on the Europeans to do
so.
Today, we now have sophisticated credit enhancement and project
financing strategies, e.g. ``customer infrastructure''. If you have
customers connected to the less expensive transmission/distribution
facilities, then you can readily finance the more expensive, up stream
power generation or wastewater treatment facilities. In fact, the World
Bank--in the midst of this project finance revolution spawn by the 1992
statue--has eliminated two thousand engineering jobs replacing them
with project finance analysts. World Bank funding is now based on
projects and not on governments.
The United States is enjoying a development boom of new electric-
generating capacity. More than 250,000 MW are currently in development
in the United States, with more than 180,000 MW scheduled to enter
commercial service by the end of 2003. In 2001 along, at least 65,000
MW are scheduled to enter service. About 97% of this proposed
generation is to be fired by natural gas. Most of this new generation
is being done by independent power producers based on market supply and
demand conditions with those investors assuming all development/
construction risk which, prior to 1992, had been born unknowingly by
electricity consumers in what was known conveniently as ``rate base''.
california
In California, no new energy plants have been built in a decade in
contrast to other states; albeit five are now approved with two
possibly in service this summer. In September of 1999, 1 attended a US-
Mexico Energy Conference in San Diego. Speakers included then US
Secretary of Energy Bill Richardson and Mexican Energy Commission
Chairman Hector Olea; who I knew well from NAFTA days, and his interest
in the 1992 Energy Policy Act's electricity provisions.
During the conference, I asked California Energy Commission
Chairman Bill Keese what he was doing about reserve margins in
California. It was common knowledge that they had dropped
precipitously. In fact, the national reserve margins of 30 plus percent
in 1992 had been replaced by less than five percent in 1999. This short
fall had been supplanted by a new, dynamic electricity trading market
place bringing flexibility incorporating regional/weather patterns and
energy supply. Again, the 1996 ``killer virus'' in California,
forbidding long term-trading, had prevented California from being a
part of this new marketplace.
There is no doubt that weather patterns in the Pacific Northwest
and natural gas prices have been a factor in this recent crisis. But in
this same market, the Los Angeles Department of Water and Power manages
to be immensely profitable, and the Los Angeles Times reporting far
more objective. Why? Because LADWP is exempt from the regulatory
requirements of the California Public Utilities Commission and was
never required to participate in the 1996 California Electricity
Deregulation Initiative.
California now needs to address a number of solutions both in the
near and long term as follows:
Long term electricity supply contracts
Additional generation, apparently now being addressed
Total restructuring of the Power Exchange and Independent
System Operator
--Most importantly, long-term contracts should be
allowed for both the utilities and/or the power
exchange/ISO. (The State of California is currently
negotiating long-term contracts due to the near
bankruptcy conditions and non-credit worthiness of its
three utilities.)
--Participate in the FERC's October 2000 acceptance of
applications for ``transcos'' to assume the dominant
power transmission role in regions throughout the
country on a for profit basis.
Regional power coordination. The FERC has consistently
implored the western states to work together.
Conservation/pricing
conclusion
In a recent Southern California poll, over 70% of respondents
indicated they faulted a combination of the California Public Utility
Commission, the Legislature and the utilities for their current
electricity dilemma. Surprisingly, the press for over six months has
``put the blame on Washington''; and supported calls for public
ownership-tantamount to nationalization in foreign countries--putting
even more risk on the consumer.
Several weeks ago Bill Hewlett, the co-founder with David Packard
of a great company and of Silicon Valley itself, passed away in Palo
Alto, California. At the same time, Intel was announcing it would no
longer build new facilities in California if this electricity crisis
were to continue. Several years ago, Mr. Hewlett made a substantial
contribution to establish the California Public Policy Institute. He
was a visionary, anticipating the need for more sophisticated
understanding of this nation/state's economy in the challenges that lie
ahead.
At the 1992 Energy Policy Act signing ceremony, with President Bush
and Secretary Watkins, I felt that we had completed the necessary steps
to revitalize our nation's electric utility industry. Most experts
believe that such success has occurred with huge efficiencies gained.
My faith in the five-deregulation initiatives that I have personally
championed remains unshaken. All of those industries are prospering and
are providing greater services and benefits to its customers.
In 1997, every member of the California Congressional Delegation
signed a letter supporting the 1996 California electricity initiative
and urging Congress to grandfather its provisions in any forthcoming
federal legislation. How times change! This hearing is vitally
important in determining what, from California's unfortunate and
unnecessary 1996 experiment, can be learned and incorporated in future
Federal legislation.
Mr. Chairman, I would be pleased to take your questions.
______
Statement of Terry Smith, Chairman, California Independent
Petroleum Association
Mr. Chairman, distinguished members of the committee, thank you for
allowing me the opportunity to participate in this proceeding to share
our thoughts on this issue of critical importance to California's
economic health and well-being.
I am submitting testimony on behalf of the California Independent
Petroleum Association--a non-profit trade association representing over
450 independent producers of oil and natural gas, service companies,
and royalty owners. California produces about 40% of the oil it needs,
the remainder comes from Alaska and foreign producers. California is
the fourth largest producing state behind only Alaska, Texas and
Louisiana and has the largest untapped reserve base for oil production
in the lower 48 states. We believe that given the right conditions, we
could produce more.
California's petroleum industry finds itself in the same
circumstance as many of the state's other large power consumers--stung
by high electricity costs. Continued high electricity costs could
potentially make a large portion of the state's oil production
uneconomic, however, given the proper incentives, CIPA and our member
companies can be part of the solution to the energy supply problem
facing California energy consumers.
There are two basic ways to help ease the energy supply crisis
faced by California:
The first is to increase energy production. Policy makers must
recognize the geographical advantage of in-state oil, natural gas and
energy production and develop incentives to identify additional energy
supplies that already exist in California. Laws and regulations that
target and stimulate these critical resources and move energy supplies
to the consumer quickly must be adopted. The siting of new in-state
power plants of all sizes should be encouraged and expedited.
The second way to ease the crisis is to reduce energy consumption.
Innovative financial, tax and regulatory solutions to reduce energy
consumption that benefit both energy users and consumers should be made
available. Examples of additional incentives to encourage business
owners to shift electric load are interruptible tariffs, demand side
management programs and demand side bidding. The ability of oil and
natural gas producers to utilize distributed generation, self-
generation and co-generation technologies should also be facilitated.
california oil and natural gas producers perspective on the
energy supply crisis
I've chosen to contribute to this dialogue because today's topic is
of critical importance to the members of my association. For most
independent producers in California, electricity accounts for up to 60%
of the cost of doing business. California oil is costly to produce
because it requires steam injection driven by natural gas to get it out
of the ground. California producers also use a lot of electricity to
pump the oil out of the ground. Environmental rules prevent them from
using crude oil to make electricity so they use natural gas. High
natural gas prices and unreliable supplies of electricity have resulted
in making California crude costly to produce and are threatening to
severely curtail the amount of oil we produce on an annual basis.
CIPA has placed an extraordinary priority on assuring that it has
access to a reliable and economic supply of electricity and on ensuring
the state's private utilities are kept viable and solvent. Independent
oil and natural gas producers are some of the largest electricity
consumers in the state, and are economically vulnerable to unreliable,
high-priced electricity supplies.
Disruption in electricity supplies can result in reduced production
of indigenous oil, natural gas and energy supplies produced by CIPA
members. Almost all of the oil and natural gas produced in California
is consumed in California.
What happened to California's electrical system that has resulted
in the problems we see today? As someone representing large consumers
of electricity, I would offer the following insights.
The problem, in essence, comes down to exceptionally stringent
environmental siting guidelines and a low return on investment that
kept new power plants from being built in California during the past
twelve years. Over the past ten years, few people anticipated the
strong demand for electricity brought about by a surging economy and
technology infrastructure. California policymakers thought that other
neighboring western states would sell us their excess power if we
couldn't keep up with our own demand. They didn't anticipate the growth
of our neighboring states' economies and the fact that they might want
to keep that power for their own use.
In 1996, when the California Legislature passed legislation
deregulating California's electrical market, it did so only partially.
Not all of the market was deregulated, just the generation portion.
Investor owned utilities like PG&E were required to sell their
generation so they wouldn't be seen as competing with independent power
producers or holding back the new electricity market. In addition, the
law imposed a mandatory rate freeze that has been in effect during the
past couple of years. The rate freeze was intended to allow the
utilities to recover, from businesses and consumers like you and me,
all the past costs of purchasing infrastructure and facilities. This
also shielded ratepayers from the true cost of providing electricity.
This arrangement worked great as long as wholesale power costs were
lower than the rates utilities were allowed to collect from customers.
But, when wholesale power costs rose, the utilities tried to get the
rate freeze removed by the California Public Utilities Commission and
be allowed to pass along the true cost of wholesale power to their
customers. To date, he Governor, Legislature, and the CPUC have all
said `no' thereby forcing the utilities to continue assuming the price
differential of how much they purchase power for and how much they can
recover.
To compound the problem, the new regulatory structure set up by AB
1890--the legislation that created the deregulated market--put a price
cap on what independent power producers could charge for their power
and restricted the ability of these same producers and the utilities to
enter into long term contracts.
Finally, all of these factors converged at the same time natural
gas prices began reaching historically high levels. Higher than
expected demand throughout the west, reduced supplies, and disruptions
on major pipelines serving California all served to drive prices up,
thereby further exacerbating the generators' cost of producing
electricity.
All of these trends have manifested themselves into the current
crisis facing the committee today.
Having identified the problem as we see it, where do we go from
here? California's independent producers believe we can be part of the
solution if allowed the proper opportunities. As companies based and
operating in California, we believe we are uniquely situated to
mitigate the strains that are being placed on the supply side of the
energy equation. Given the proper combination of regulatory relief and
incentives, we believe we can increase our levels of both oil and
natural gas production beyond their current levels.
adding in state natural gas supply
According the California Division of Oil and Gas, California
continues to have some of the largest proved reserves of oil and
natural gas anywhere in the United States. Proved reserves of over 21
trillion cubic feet (tcf) have been identified along the West Coast of
the United States while over 3 tcf of proved onshore reserves have been
identified to date. With the advent of new, increasingly accurate
technology, new reserves of oil and gas are being found throughout the
state in areas previously thought to be barren.
Despite the presence of such substantial reserves, and the state's
rapidly growing demand for increased supplies of natural gas, in-state
production in California today accounts for only 10-15% of the state's
total annual natural gas needs. In the past, California production has
accounted for as much 25% of the state's total needs.
Although much of this trend can be contributed to some of the same
factors I referenced earlier--stringent environmental laws, high
drilling costs, historically low gas prices throughout the 1990's and
labor shortages--many experts believe a large part of decline can be
tied directly to the policies of the state's major gas utilities.
Existing law provides the utilities with almost exclusive authority
in setting the terms and conditions under which pipeline connections
for new natural gas wells are accommodated. Historically, many
producers have felt that the utilities have used this authority to
stifle California production and limit competition in favor of taking
larger supplies of gas from out of state sources such as Canada, the
Rocky Mountains, and the Southwest.
For the past ten years, independent producers throughout the state
report experiencing delays of six months to a year before receiving
utility approval to install a new pipeline interconnect for newly
completed wells. Overly burdensome and expensive terms of conditions
imposed by the utilities as a condition of new interconnections are now
thought to be the rule rather than the exception. In many cases,
producers have elected to simply abandon new exploratory projects
rather than try to meet the demands being imposed by the utilities.
One of the largest impediments to increasing gas production in
California are the utility's own management policies relative to its
existing pipeline infrastructure. Representatives from PG&E recently
announced that the company would no longer be adding any new metering
systems along its pipeline system in Northern California. If enacted,
the new PG&E policy would require all new wells to be connected through
an existing metering site along the pipeline--requiring in some cases
miles and miles of new pipelines to be constructed in order to connect
a remote exploratory well. Given such terms and conditions, most
exploratory projects would become automatically unfeasible. In an
related move, PG&E has also recently embarked on an ambitious plan of
``retiring'' large sections of its pipeline gathering and delivery
systems--further limiting the potential points of interconnection for
new gas wells. Many of the sections being targeted by the utility
continue to remain in operational condition. The hardest by these new
policies would be the Northern Sacramento Basin--one of the most
proliferate dry gas fields in the United States and the source of over
one-third of all the natural gas produced in California.
Significant evidence suggests that much of California's long-term
gas needs could be addressed be expanding production, and reforming the
regulatory relationship between the independent producers and the
utilities. Suggested reforms that could help accomplish this goal
include:
Establishing mandatory timeframes under which a utility must
respond to a producer's request for a pipeline interconnection.
Encouraging new exploration activity by requiring the
utility to install new metering sites, rather than requiring
producers to construct miles of new pipeline for every
exploratory well.
Allowing producers to expedite the installation of new
interconnects by authoring them shoulder costs such as pipeline
construction and labor costs if the utility's workforce is
already overburdened.
Facilitating the development of new pipeline gathering
infrastructure that enables more gas to get to market.
Requiring the utility's to sell off its existing gathering
systems to interested producers and co-ops, and provide the
producers the authority to maintain and service the gathering
systems.
By making some of these minor changes, and facilitating the ability
of California producers to get their gas to market, we believe we can
begin to help mitigate at least one element of the problems driving our
state's current crisis.
in-state generation options
On a related note, CIPA believes that Federal policymakers must act
to eliminate federal policies that discourage co-generation, self-
generation and distributed generation. Many California oil and gas
producers are uniquely situated to generate their own electricity. Some
have excess supply which could be sold to other consumers if reasonable
utility connection, siting and standby policies were in place. We
encourage you to examine the ways in which FERC, the DOE and other
agencies of the federal government could encourage and incentivize
utilities, and the regulatory community in California, to act to
approve new facilities.
In closing, independent oil and gas producers are price takers and
have no ability to set the price of crude at the wellhead where we
produce it. Independent oil and natural gas producers are like energy
farmers. We take our commodity out of the ground and sell it for the
market price set by OPEC and other producing countries, usually to an
independent refiner or integrated oil company who then refines it into
products like gasoline. As such, our members are extremely vulnerable
and can be dramatically impacted by any combination of events that
force their costs to rise suddenly. We appreciate the committee's
attention to this extremely serious matter and stand ready to work with
you in finding the proper solutions.
Municipal Utility Natural Gas Supply Act of 2001
Sec. 1. SHORT TITLE
This Act may be cited as the ``Municipal Utility Natural Gas Supply
Act Of 2001''.
Sec. 2. ARBITRAGE RULES NOT TO APPLY TO PREPAYMENTS FOR NATURAL GAS AND
OTHER COMMODITIES.
(A) IN GENERAL--Subsection (b) of section 148 of the Internal
Revenue Code of 1986 (defining higher yielding investments) is amended
by adding at the end the following new paragraph:
(4) EXCEPTION FOR CERTAIN PREPAYMENTS TO ENSURE COMMODITY
SUPPLY--The term ``investment property'' shall not include a
prepayment entered into for the purpose of obtaining a supply
of a commodity reasonably expected to be used in a business of
one or more utilities each of which is owned and operated by a
state or local government, any political subdivision or
instrumentality thereof, or any governmental unit acting for or
on behalf of such a utility.
Sec. 3. PRIVATE LOAN FINANCING TEST NOT TO APPLY TO PREPAYMENTS FOR
NATURAL GAS AND OTHER COMMODITIES.
(A) IN GENERAL--Subsection (c)(2) of section 141 of the Internal
Revenue Code of 1986 (providing exceptions to the private loan
financing test) is amended by striking the word ``or'' at the end of
section 141(c)(2)(A), by striking the period at the end of section
141(c)(2)(B) and adding a comma and the word ``or'' and by adding the
following new paragraph:
(A) arises from a transaction described in section 148(b)(4).