[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

                              ----------                              

                               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

                              ----------                              


                      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.
---------------------------------------------------------------------------
    * The article has been retained in committee files.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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.*
---------------------------------------------------------------------------
    * 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.*
---------------------------------------------------------------------------
    * The proposal has been retained in committee files.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.*
---------------------------------------------------------------------------
    * The enclosures have been retained in committee files.
---------------------------------------------------------------------------
    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).