[Senate Hearing 107-156]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 107-156
 
                   RESTRUCTURING OF ENERGY INDUSTRIES

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


                                HEARINGS

                               before the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                               __________

                             JUNE 13, 2001

 ECONOMIC ISSUES ASSOCIATED WITH THE RESTRUCTURING OF ENERGY INDUSTRIES

                             JUNE 20, 2001

 THE ROLE OF THE FEDERAL ENERGY REGULATORY COMMISSION ASSOCIATED WITH 
                 THE RESTRUCTURING OF ENERGY INDUSTRIES

                             JUNE 28, 2001

  THE IMPACT OF ELECTRIC INDUSTRY RESTRUCTURING ON SYSTEM RELIABILITY

                               __________

      Printed for the use of the Committee on Governmental Affairs


75-477              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2002


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                   COMMITTEE ON GOVERNMENTAL AFFAIRS

               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 FRED THOMPSON, Tennessee
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
RICHARD J. DURBIN, Illinois          SUSAN M. COLLINS, Maine
ROBERT G. TORRICELLI, New Jersey     GEORGE V. VOINOVICH, Ohio
MAX CLELAND, Georgia                 PETE V. DOMENICI, New Mexico
THOMAS R. CARPER, Delaware           THAD COCHRAN, Mississippi
JEAN CARNAHAN, Missouri              ROBERT F. BENNETT, Utah
MARK DAYTON, Minnesota               JIM BUNNING, Kentucky
           Joyce A. Rechtschaffen, Staff Director and Counsel
               David M. Berick, Professional Staff Member
         Hannah S. Sistare, Minority Staff Director and Counsel
                  Paul R. Noe, Minority Senior Counsel
           William M. Outhier, Minority Investigative Counsel
                     Darla D. Cassell, Chief Clerk


                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Lieberman......................................  1, 61, 163
    Senator Thompson.......................................  3, 63, 165
    Senator Carnahan...........................................  35, 96
    Senator Collins............................................  38, 85
    Senator Voinovich..........................................  42, 94
    Senator Carper.............................................  46, 92
    Senator Durbin...............................................    83
    Senator Torricelli...........................................    87
    Senator Bennett..............................................    89
    Senator Domenici.............................................    99

                               WITNESSES
                        Wednesday, June 13, 2001

Hon. Barbara Boxer, a U.S. Senator from the State of California..     5
Hon. Larry E. Craig, a U.S. Senator from the State of Idaho......     7
Hon. Dianne Feinstein, a U.S. Senator from the State of 
  California.....................................................    10
Alfred E. Kahn, Ph.D., Robert Julius Thorne Professor of 
  Political Economy, Emeritus, Cornell University................    13
Severin Borenstein, Ph.D., Director, University of California 
  Energy Institute and E.T. Grether Professor of Business 
  Administration and Public Policy, Berkeley's Haas School of 
  Business, University of California.............................    16
William W. Hogan, Ph.D., Professor of Public Policy and 
  Administration, Center for Business and Government, John F. 
  Kennedy School of Government, Harvard University...............    18
Paul L. Joskow, Ph.D., Director, Center for Energy and 
  Environmental Policy Research, Massachusetts Institute of 
  Technology.....................................................    21
Lawrence J. Makovich, Ph.D., Senior Director and Cohead, North 
  American Energy Group, Cambridge Energy Research Associates....    23
Frank A. Wolak, Ph.D., Professor, Department of Economics, 
  Stanford University............................................    25

                        Wednesday, June 20, 2001

Hon. Frank H. Murkowski, a U.S. Senator from the State of Alaska.    66
Hon. Patty Murray, a U.S. Senator from the State of Washington...    69
Hon. Maria Cantwell, a U.S. Senator from the State of Washington.    71
Hon. Barbara Boxer, a U.S. Senator from the State of California..    74
Hon. Gray Davis, Governor, State of California...................    75
Hon. Judy Martz, Governor, State of Montana......................   106
Hon. John Hoeven, Governor, State of North Dakota................   110
Hon. Christine O. Gregoire, Attorney General, State of Washington   117
Roy Hemmingway, Chairman, Oregon Public Utility Commission.......   120
Hon. Curt L. Hebert, Jr., Chairman, Federal Energy Regulatory 
  Commission (FERC)..............................................   127
Hon. Linda K. Breathitt, Commissioner, Federal Energy Regulatory 
  Commission (FERC)..............................................   132
Hon. Nora Mead Brownell, Commissioner, Federal Energy Regulatory 
  Commission (FERC)..............................................   134
Hon. William L. Massey, Commissioner, Federal Energy Regulatory 
  Commission (FERC)..............................................   135
Hon. Patrick H. Wood, III, Commissioner, Federal Energy 
  Regulatory Commission (FERC)...................................   138

                        Thursday, June 28, 2001

David N. Cook, General Counsel, North American Electric 
  Reliability Council............................................   167
Phillip G. Harris, President and CEO, PJM Interconnection, L.L.C.   169
Kevin A. Kelly, Director, Division of Policy Innovation and 
  Communication, Federal Energy Regulatory Commission............   171
Irwin ``Sonny'' A. Popowsky, Consumer Advocate of Pennsylvania, 
  on behalf of the National Association of State Utility Consumer 
  Advocates (NASUCA).............................................   173

                     Alphabetical List of Witnesses

Borenstein, Severin, Ph.D.:
    Testimony....................................................    16
    Prepared statement...........................................   194
Boxer, Hon. Barbara:
    Testimony.................................................... 5, 74
Breathitt, Hon. Linda K.:
    Testimony....................................................   132
    Prepared statement with an attachment........................   462
Brownell, Hon. Nora Mead:
    Testimony....................................................   134
    Prepared statement...........................................   484
Cantwell, Hon. Maria:
    Testimony....................................................    71
Cook, David N.:
    Testimony....................................................   167
    Prepared statement with attachments..........................   509
Craig, Hon. Larry E.:
    Testimony....................................................     7
Davis, Hon. Gray:
    Testimony....................................................    75
    Prepared statement...........................................   391
Feinstein, Hon. Dianne:
    Testimony....................................................    10
Gregorie, Hon. Christine O.:
    Testimony....................................................   117
    Prepared statement...........................................   415
Harris, Phillip G.:
    Testimony....................................................   169
    Prepared statement with attachments..........................   526
Hebert, Hon. Curt L., Jr.:
    Testimony....................................................   127
    Prepared statement with an attachment........................   430
Hemmingway, Roy:
    Testimony....................................................   120
    Prepared statement with an attachment........................   423
Hoeven, Hon. John:
    Testimony....................................................   110
    Prepared statement...........................................   825
Hogan, William W., Ph.D.:
    Testimony....................................................    18
    Prepared statement with attachments..........................   200
Joskow, Paul L., Ph.D.:
    Testimony....................................................    21
    Prepared statement with an attachment........................   351
Kahn, Alfred E., Ph.D.:
    Testimony....................................................    13
    Prepared statement...........................................   191
Kelly, Kevin A.:
    Testimony....................................................   171
    Prepared statement...........................................   533
Makovich, Lawrence J., Ph.D.:
    Testimony....................................................    23
    Prepared statement...........................................   365
Martz, Hon. Judy:
    Testimony....................................................   106
    Prepared statement...........................................   821
Massey, Hon. William L.:
    Testimony....................................................   135
    Prepared statement with an attachment........................   494
Murkowski, Hon. Frank H.:
    Testimony....................................................    66
Murray, Hon. Patty:
    Testimony....................................................    69
Popowsky, Irwin ``Sonny'' A.:
    Testimony....................................................   173
    Prepared statement...........................................   545
Wolak, Frank A., Ph.D.:
    Testimony....................................................    25
    Prepared statement...........................................   371
Wood, Hon. Patrick H., III:
    Testimony....................................................   138
    Prepared statement...........................................   504

                                APPENDIX
                             June 13, 2001

Chart entitled ``California Day-Ahead Power Prices'' (submitted 
  by Senator Thompson)...........................................   551
Chart entitled ``The Big 5 Energy Generator's Profits'' 
  (submitted by Senator Boxer)...................................   552
Chart entitled ``Closed for Maintenance?'' (submitted by Senator 
  Boxer).........................................................   553
Article by Robert J. Samelson, Washington Post, dated June 13, 
  2001, entitled ``Short-Circuiting Supply and Demand'' 
  (submitted by Senator Craig)...................................   554
Letter from Wayne D. Angell, Senior Managing Director and Chief 
  Economist, Bear, Stearns and Co., Inc., dated June 11, 2001 
  (submitted by Senator Thompson)................................   556
William C. Dudley, Chief U.S. Economist, Goldman, Sachs and Co., 
  prepared statement.............................................   558
Marcia Baker and John Hoefle, EIR News Service, prepared 
  statement......................................................   561

                             June 20, 2001

Report entitled ``Meeting the Energy Challenge: How the State of 
  California is Taking Charge of the Energy Future'' (submitted 
  by Governor Davis).............................................   569
Chart entitled ``Total Wholesale Cost of Electricity in 
  California'' (submitted by Governor Davis).....................   742
Chart entitled ``1999 Per Capita Electricity Consumption'' 
  (submitted by Governor Davis)..................................   743
Chart entitled ``Table 1: Average Monthly Bill By Sector, Census 
  Division and State, 1999'' (submitted by Senator Collins)......   744

Prepared statements for the record:
    Hon. John A. Kitzhaber, M.D. Governor, State of Oregon.......   746
    Jerry Ellig, Ph.D., Senior Research Fellow, Mercatus Center 
      at George Mason University, with an attachment.............   749
    Vernon L. Smith, Ph.D., Economic Science Laboratory, 
      University of Arizona......................................   774
    John M. Quain, Chairman, Pennsylvania Public Utility 
      Commission.................................................   786

Question for the record and responses from:
    Governor Davis...............................................   788
    S. David Freeman, Sr. Energy Advisor to Governor Davis.......   800
    Chairman Curt L. Hebert, Jr..................................   802
    Commissioner Linda K. Breathitt..............................   810
    Commissioner William L. Massey...............................   812
    Commissioner Patrick H. Wood, III............................   815

                             June 28, 2001

Chart entitled ``Bundled'' (submitted by Senator Lieberman)......   819
Chart entitled ``A Fully Unbundled Electric Industry Model'' 
  (submitted by Senator Lieberman)...............................   820


 ECONOMIC ISSUES ASSOCIATED WITH THE RESTRUCTURING OF ENERGY INDUSTRIES

                              ----------                              


                        WEDNESDAY, JUNE 13, 2001

                                       U.S. Senate,
                         Committee on Governmental Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 9:33 a.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Joseph I. 
Lieberman, Chairman of the Committee, presiding.
    Present: Senators Lieberman, Durbin, Cleland, Carper, 
Carnahan, Thompson, Stevens, Collins, and Voinovich.

            OPENING STATEMENT OF CHAIRMAN LIEBERMAN

    Chairman Lieberman. Good morning and thank you all very 
much for coming.
    Since this is our first hearing since the transition within 
the Senate, I wanted to begin by just saying what a great honor 
it is for me to become Chairman of the Senate Governmental 
Affairs Committee. This is a Committee with a proud history, 
and I hope and believe on a bipartisan basis we can make its 
future as proud.
    It is an honor for many reasons for me to become the 
Chairman, but perhaps the most meaningful is that one of my 
childhood heroes and later one of my mentors, Senator Abe 
Ribicoff of Connecticut, served as Chairman of this Committee 
back in the 1970's. Under his leadership the Committee did what 
was right to protect the interests of the American taxpayer, 
and that is a legacy that I hope all of us will carry on.
    I want to particularly thank my friend and colleague, 
Senator Fred Thompson of Tennessee, for the distinguished and 
thoughtful leadership he has given this Committee over the past 
several years. Though we are switching seats today, I know that 
Fred and I will continue our very strong working partnership in 
pursuit of the fulfillment of the responsibilities of this 
Committee, which, as I see them, are to make sure that the 
people that we represent have the most responsive, efficient, 
ethical, and economical government that we can provide them. 
Sometimes fulfilling this responsibility will lead to producing 
legislation, but I think uniquely within the Senate 
Governmental Affairs Committee more often it will involve 
oversight.
    Over the course of the next 2 weeks, we will be paying 
particular attention to the economic interest of the taxpayers 
as consumers of electricity and natural gas. As a Committee 
charged with oversight, it is our job to make sure that Federal 
agencies are doing their job to fairly and appropriately 
protect the interests of the American people.
    America now faces an array of serious energy problems. 
Whether it is the price of gasoline in the Midwest, shortages 
of heating oil in the Northeast, consumers and businesses 
struggling to pay their natural gas bills, or electricity 
blackouts and price spikes in California, energy price and 
supply problems are becoming regular events from one end of the 
Nation to the other. I think that if we ignore these problems, 
we put our economy at risk. California accounts for 15 percent 
of the U.S. economy. If you add its Western neighbors Oregon 
and Washington, which are also part of this most recent crisis, 
we are talking about the health of roughly one-fifth of the 
American economy. And earlier this spring, the North American 
Electric Reliability Council issued warnings not only about 
California and the Pacific Northwest but New England and New 
York City as well. So none of us should say of the West's 
problems today that we will not face them in our part of the 
country tomorrow.
    What the Federal Government does in this situation out 
West, I think, will set a precedent for what it will do in the 
next energy crisis elsewhere in America. So today and again 
next Wednesday, when we will hear from the members of the 
Federal Energy Regulatory Commission, Governor Davis of 
California, and another witness that Senator Thompson will 
call, we will be looking at the role of the Federal Government 
in addressing the issues of energy price and supply. In 
particular, we are going to be looking at the effects of 
deregulation on the energy market and how FERC has carried out 
its responsibility to oversee these changes.
    FERC was created in 1977 under the Department of Energy 
Organization Act and charged with the same responsibility as 
its predecessor, the Federal Power Commission, to set just and 
reasonable wholesale energy rates. But I doubt that there is 
any among us today that would say that California's energy 
costs are now just and reasonable.
    In 1999, the State spent $7 billion--that is all of the 
consumption of electricity energy, $7 billion on energy. Last 
year the number multiplied to $27 billion, and estimates for 
this year go as high as $70 billion, even though Californians 
are conserving and using 11 percent less energy today than last 
year.
    In fact, last fall FERC itself said that electricity prices 
in California were not just and reasonable. Like most of our 
expert witnesses today, in fact, I think maybe all of them, I 
am a fan of free markets. I do not believe in price controls or 
price caps or other economic contrivances that inhibit the free 
marketplace, but the energy market in California and the West 
is not free today. It may not even be functional. So we need to 
examine, I think, the appropriate role for regulators when the 
market does not work.
    This is a matter about which we may differ, but the 
differences should not be, and I do not believe are, partisan 
or personal. In fact, the primary legislative response to the 
crisis in the West that has been proposed is bipartisan, the 
legislation authored by Senators Feinstein and Gordon Smith, 
and I hope that our deliberations in this Committee will focus 
on finding a solution rather than on finding a scapegoat.
    We are fortunate to have a distinguished panel of 
nationally renowned economists to help us understand the 
changing nature of the energy markets and how consumers have 
been affected by the transition from the regulation of 
electricity and natural gas at the State and Federal levels to 
an unregulated, more market-oriented system. The fact is that 
25 States and the District of Columbia have moved to deregulate 
their electric utility systems, but the recent experience of 
California in both electricity and natural gas markets and the 
price hikes in the Midwest in 1999 and the Northeast last 
spring have very serious doubts about this new world of spot 
markets, electricity futures, and open access to natural gas 
and electricity transmission systems.
    Several States on the verge of regulation, including two of 
California's Western neighbors, New Mexico and Nevada, have 
blinked and put the brakes on deregulation, and that is 
understandable considering what has been happening in 
California. So I think that if the Federal Government doesn't 
find a way to provide temporary price relief out West now, the 
natural and, I think, desirable trend toward deregulation 
across the country will come to a halt.
    So I look forward to the testimony of our witnesses. I hope 
they will help us learn the lessons we need to learn from what 
is happening in California and in the Western grid and outline 
for us the role they think the Federal Government needs to play 
in these new markets. I hope they will tell us what we can do 
when, as in the case of California, good intentions go 
painfully off course.
    I am now going to call on Senator Thompson. I do want to 
say in this first hearing that I have the privilege to Chair 
that I am going to borrow some of the procedures that I have 
learned on the Armed Services Committee, with the indulgence of 
my colleagues, and just have Senator Thompson and myself give 
opening statements but extend the time for questioning in each 
round by the Members of the Committee to 10 minutes, so that if 
they wish to make an opening statement they can do so during 
that 10-minute time. And we will call on Senators in order of 
arrival, switching parties as we go along.
    Senator Thompson.

             OPENING STATEMENT OF SENATOR THOMPSON

    Senator Thompson. Thank you very much, Mr. Chairman, and 
you know, as the old saying goes, if it had to happen, it 
couldn't have happened to a nicer guy. I look forward to 
working with you as we have in the past. We went through some 
interesting and trying times a couple of years ago, and 
throughout all of that and up until now, we have had a good 
working relationship. You have been very cooperative with me in 
every respect, and I intend to be the same with you. So I am 
looking forward to it.
    The energy troubles that have plagued the State of 
California and the West over the past year are well known to 
all Americans. Most are probably as aware of the problem from 
stories about blackouts as they are from stories about 
fingerpointing and placing blame.
    I think it is important to know that California's problems 
did not begin on January 21, 2001. Efforts to place blame on 
the current administration, to hire consultants at $30,000 a 
month to spin the issue, or to pit one State against another 
are not only misplaced, but do not help arrive at a solution.
    In truth, there appear to be many causes of the problems 
now faced in the West. The restructured energy system in 
California had flaws. There was evidence of mounting problems a 
couple of years ago, but the State was reluctant to address 
them. The State was slow to react when prices rose sharply last 
summer. It has shied away from passing rate increases along to 
consumers sufficiently to affect demand, and it resisted the 
kind of long-term contracts that could have mitigated the 
current crisis.
    In addition, natural gas prices have risen sharply, 
increasing the cost of producing energy. A lack of rainfall in 
the Northwest has decreased the available hydro power in the 
region, and the best way to head off this problem, building new 
generations, has been difficult given the State's burdensome 
requirement for building new plants. In sum, California has not 
provided an energy supply that could meet the demand of its 
growing economy.
    The question we face now is what should be done to address 
the short-term problem of power shortages and certain blackouts 
this summer and the long-term problem of ensuring sufficient 
supply to the West in the future. The long-term answer appears 
more clear: More supply. New generation is being built, and 
some estimate a sufficient amount will be online within 18 
months.
    In addition, signing long-term contracts could help provide 
stability to the region. The short-term solution is more 
difficult, particularly because it is so late in the game. 
Prices exploded last summer and stayed high all winter. Now 
Governor Davis has asked the Federal Government to step in and 
fix the problem now that it is too late for anyone to prevent 
rolling blackouts.
    Some suggest temporary price controls through early 2003. 
While that may get us through the next election, temporary 
price controls have rarely stayed temporary, nor have they 
worked. President Nixon's wage and price controls, oil price 
controls in the 1970's, and rent control in New York City are 
just a few examples of temporary fixes that lasted far longer 
than intended and actually did more harm than good. And 
governments do not have very much credibility with investors 
when it comes to talk about temporary price controls.
    Many economists, including two that we will hear from here 
today, believe that introducing price controls into the current 
situation would do more harm than good. Setting price controls 
could provide a disincentive to new generation and drive 
suppliers to other markets, creating more shortages and 
blackouts over the summer.
    In addition, it is difficult to know how workable these 
solutions are. One option which will be discussed today is a 
cost-based price control. Under this scheme, government 
officials would set plant-by-plant price rates which are 
unrelated to the marketplace. This raises a host of practical 
implementation problems given that there are hundreds if not 
thousands of operators providing power in the Western energy 
market.
    In addition, if you only impose price controls on investor-
owned power, then half the electricity in the Western market 
escapes. That creates market distortions and loopholes for 
evasion. And with regard to the possibility that by delaying 
FERC action we are in some way delaying reform in other States, 
my concern is we may set back the case for real reform if we 
lead other States to believe they can take the same measures 
that California did and FERC will come in and bail them out.
    What FERC has done is to institute a market-based price 
mechanism on price levels during level one, two, and three 
emergencies within the State. Since that order, prices have 
dropped below $100 per megawatt hour for the first time since 
the crisis began 1 year ago.\1\ FERC has taken action, and that 
may be working. However, the State of California has a 
responsibility, too. If the governor truly believes that price 
controls are the answer, he has the authority to set the price 
that the State will pay. He can also take steps to fix the 
broken system in his State to prevent these types of problem in 
the long run.
---------------------------------------------------------------------------
    \1\ Chart entitled ``California Day-Ahead Power Prices,'' appears 
in the Appendix on page 551.
---------------------------------------------------------------------------
    I look forward to hearing from our witnesses today as to 
what possible solutions there are for the problems in the West 
and what the Federal Government could and should do.
    Thank you Mr. Chairman.
    Chairman Lieberman. Thank you, Senator Thompson.
    When we put out a notice that we were going to convene this 
hearing, we had a request from three of our Senate colleagues 
to testify, Senators Boxer, Craig, and Feinstein, and two of 
them are here and I would like to call on them and ask them to 
begin their testimony. And I believe Senator Feinstein may be 
on the way. Why don't you come to the table?
    Let me also note the presence here in the room of 
Congresswomen Jane Harman and Anna Eshoo. These members of the 
House serve on the House Energy and Commerce Committee and have 
been very involved in fashioning a response to the crisis in 
their State. Obviously, this is a topic of enormous importance 
to the people of California, and the presence of these two 
distinguished colleagues from the House testifies to their very 
deep and active interest, and I thank them for being here.
    Senator Boxer.

TESTIMONY OF HON. BARBARA BOXER, A U.S. SENATOR FROM THE STATE 
                         OF CALIFORNIA

    Senator Boxer. Thank you Mr. Chairman. I want to give the 
largest thank you to all of you, Republicans and Democrats 
alike, from my constituents, 34 million of them in California. 
This is really the first hearing we have had on our emergency 
situation. We have had emergencies before. We have had 
earthquakes, floods, fire, and everything else, and you have 
always been there for us. This one took a little longer because 
it is not as obvious an emergency. But trust me, it is an 
emergency. So thank you very, very much.
    Today you are going to hear from economists about the cost-
based pricing. I give it another name, Senators. I call it 
anti-gouging pricing, and I hope you will think of it in that 
light. And I called for such pricing by FERC last August, and 
last September I introduced a bill with Representative Filner 
of San Diego. Those are the people that felt this first. We 
called for such pricing.
    California is facing price gouging by the electric 
generators. The generators' profits increased on average by 508 
percent.\1\ I have a chart here. We go through the various 
large generating companies. We average them out at 508-percent 
increase, and at that time that they were making the 508-
percent average increase, demand was going up by 5 percent. So, 
Senators, I have to tell you, when you see this, it makes your 
stomach turn.
---------------------------------------------------------------------------
    \1\ Chart entitled ``The Big 5 Energy Generator's Profits,'' 
appears in the Appendix on page 552.
---------------------------------------------------------------------------
    I have to also tell you one of these companies, who was 
just advertising in Roll Call and all the other--the New York 
Times--I have a copy of the advertisement here. I want to just 
hold it up. It is bragging about keeping the lights on in 
California, reliant energy. Their profits went up, Mr. 
Chairman, 1,685 percent during that period.
    This is the ad. It says, ``Helping California keep the 
lights on, reliant energy.'' What they did not say is ``and 
gouging California consumers at the same time.'' They left out 
that part. It is very, very disheartening and discouraging.
    One of the primary causes of price gouging in my opinion--
and I leave this to you to ponder--is the generators' holding 
back supply. So when you talk about a free market, I say to my 
friends, you cannot hold back supply if it is really a market 
that is working.
    We will show you this amazing chart.\2\ The blue shows you 
how much power was taken off-line for maintenance last year. 
And this is how much power was taken off for maintenance this 
last year, current year, in the yellow. It is hard to imagine 
that suddenly you would have this great disparity in how much 
power has to be pulled off-line.
---------------------------------------------------------------------------
    \2\ Chart entitled ``Closed for Maintenance?'' appears in the 
Appendix on page 553.
---------------------------------------------------------------------------
    I am going to be quick--because I know you have so many 
folks--and make a couple more points. If the average price of 
milk went up the way the average price of electricity went up, 
we would be paying $190 a gallon for milk from $3. I want you 
to think about that. It is just stunning. And I want to leave 
with you this point, Mr. Chairman, and your Ranking Member and 
all of you good Members who care a lot about people.
    We are getting letters from businesses. I have a letter 
from John Odaman of San Marcos, California. He wrote to 
President Bush and sent me a copy. He said, ``I am a father and 
a husband in a single-income family. My wife and I very 
carefully planned our family economics in order to give our 
daughter the benefit of having a full-time parent at home. We 
are currently spending money on electricity bills that should 
be going into family investments for college and retirement 
planning.''
    Mr. Odaman and other Californians have less disposable 
income. I have other letters.
    I have another letter from a California farmer, Ann Zack. 
Ms. Zack wrote to me asking for help.
    She writes, ``Our family has owned and operated an alfalfa 
ranch since 1965. Our crop is irrigated in the summer with 
water pumped from wells by electric pumps. We have been 
informed by Edison that our power rate will double this summer, 
will possibly be raised beyond that in the future. Since we 
have narrow profit margin''--their profit margin is not 508 
percent, Mr. Chairman--``this will effectively put us out of 
business.''
    So my question to you is: How can these electric generator 
executives go to sleep at night? I honestly to God do not know. 
They are hurting real people. This is not right. We all want 
our businesses to operate at fair profits. God knows that is 
the essence of our system. But gouging is something that must 
be stopped.
    I met with the Vice President yesterday. It was a cordial 
meeting, Mr. Chairman. We did not make too much headway on this 
issue of caps, but I hope he will rethink it, and I hope that 
you will help us by getting FERC to understand that their job 
is to protect us from unfair and unjust and unreasonable prices 
and to stop the gouging now.
    Thank you, Mr. Chairman, for your concern about California.
    Chairman Lieberman. Thank you, Senator Boxer, for your 
concern and for your testimony this morning.
    Chairman Lieberman. Senator Craig, we just had the second 
run of bells goes off, but we have got a good 8 to 10 minutes 
left. Thanks for being here this morning.

TESTIMONY OF HON. LARRY E. CRAIG, A U.S. SENATOR FROM THE STATE 
                            OF IDAHO

    Senator Craig. Mr. Chairman and Members of the full 
Committee, thank you very much for an opportunity to come and 
visit.
    This is the fifth hearing on the California energy crisis I 
have participated in since it began well over 6 months ago. I 
also asked for and convened a hearing of FERC in Boise of the 
11 Western States to examine what is truly a broken energy 
system in the West. So it is not the first time that the 
Congress has focused on--and I am guessing it will not be the 
last time that we will focus on this issue.
    But my message today, Mr. Chairman, is that with the energy 
crisis in the West, we pay closer attention to the facts and 
move away from a great deal of the political myths involved. 
There has been much too much distortion and rhetoric in this 
debate. In part, I guess it is understandable.
    Like other serious and complicated problems we face, the 
Western energy crisis is laced with both emotion and I believe 
now some partisanship. This is clearly evident in the 
statements on the crisis of high prices that have been charged 
for the wholesale electricity in California.
    In this debate, Mr. Chairman, there have been many for 
their own purposes engaged in what I believe is an intentional 
distortion and misstatement of the facts. They say that there 
is no lack of supply in the West. They say that there are 
plenty of power plants and transmission lines to meet all of 
the demands for electricity. And they say that small groups of 
companies, based primarily in Texas, have conspired to withhold 
electricity from the market in order to drive prices up to an 
unreasonable, indeed unconscionable level.
    It is they who are, I think, the unconscionable crowd in 
this rhetoric. They are either unconscionably ignorant because 
they have not looked at the reality of what is going on out 
there, or they are unconscionably and deliberately distorting 
facts.
    Now, Mr. Chairman, in all of these kinds of situations, I 
think we have some who are always in search of a conspiracy. 
And as you know, Mr. Chairman, conspiracy theorists are always 
around at the right time, despoiling and oftentimes using 
public discourse in a variety of critical ways. Conspiracy 
theorists reject what most of the rest of us view as plain and 
real. Instead, they search and usually find villains and 
conspirators. Some of these conspiracy theorists engage in the 
craft full-time. I must tell you that, as I have listened to 
the rhetoric of the Governor from California, I am frustrated 
in trying to understand where he is.
    Since 1990, there has been a 26-percent increase in the 
demand for electricity in the State of California. During that 
time, not one major new power plant was constructed. I repeat, 
not one. Even Governor Davis, who has led in what I believe is 
misdirected and politically inspired assaults on independent 
generators in his own State, has repeatedly alluded to the fact 
that California has been derelict in new generation. In other 
words, it appears that he is working full-time to be on both 
sides of this issue.
    Governor Davis in a prime-time speech delivered last spring 
said that the major problem facing the State in this crisis was 
a lack of available generating capacity. Despite a chronic 
shortfall in electrical capacity to meet peak demands, 
Californians have until recently been able to get bailed out of 
their blackouts and their price spikes, and here is why. They 
have relied on the hydro power of the Pacific Northwest, but 
now, as you mentioned, and as I think Senator Thompson 
mentioned, the Pacific Northwest is suffering from what is 
probably the worst drought since 1930. Our reservoir levels are 
the lowest since the 1930's.
    In addition, the economic growth in the Pacific Northwest, 
in Arizona, and in Nevada have caused power plants in these 
areas to dedicate more of their output to their own localities 
and less to California.
    To be specific, peak summer demand in the West has 
increased at an annual rate of 8 percent in Arizona, New 
Mexico, and Nevada, 3.2 percent in California, 2.8 percent in 
the Rockies, 2.4 percent in the Pacific Northwest. Yet, from 
1991 to 1998, the growth rate of new generation capacity 
additions in that whole region was less than 1 percent.
    All of these factors have resulted in a stark exposure of 
the electrical supply deficiency within California. California 
has been subsisting off the surplus of its neighbors, and now 
those neighbors have no surplus, and they have to take care of 
their own.
    Another important part of the reality in California has 
been the high prices of natural gas and of securing necessary 
emissions credits. The cost of both have soared through the 
roof. The reality of the charts that have just been shown in 
many instances are real. This has created enormous upward 
pressure on the price of electricity and generating capacity of 
old gas-fired plants. A shortage of electrical generating 
capacity, a regionwide drought causing reduction in imported 
power and high natural gas and emission credits, these are all 
fundamental causes of the electricity crisis. Any of these 
factors could cause or would have caused the problem. All of 
them combined have probably crippled the market.
    Now, I believe that is the big picture, Mr. Chairman, and 
frankly I believe that is the true picture. How do we deal with 
it? And that is, of course, part of what you are looking at 
today. And how do we deal fundamentally with our electric and 
gas utilities?
    I know now that the spot market in California is lower than 
the long-term contract prices that Governor Davis negotiated. 
Why? Because California recently began to expose the consumer 
in California to the real market price and the consumer in 
California began to make real choices.
    It is also happening across the West as our power rates go 
up. Is conservation the only solution to our problem? 
Absolutely not. But there are no blackouts in California at 
this moment, and one of the reasons why is that there is an 11 
percent conservation that has now taken hold in the State of 
California. The major utilities of California have stated that 
during deregulation, conservation almost stopped altogether 
because the consumer knew the price was fixed. Those were the 
realities of the situation.
    Chairman Lieberman. Senator Craig, forgive me. We are down 
to about 2 minutes left on the vote.
    Senator Craig. Then I will conclude. I must tell you that 
Governor Davis has moved swiftly. While I criticize him, I must 
also recognize the fact that 5,000 new megawatts of power are 
going to come online next spring in California and 5,000 within 
a year, and that is an effort at reducing and changing 
regulation and process, and the governor ought to be applauded 
for that.
    Let me quickly refer to FERC and what I think FERC is doing 
now in a very responsible fashion. Out of the Boise hearing 
came the new order, and that new order largely says all of 
those in the market have to supply capacity to that market on a 
full-time basis. That has helped bring those prices down.
    Satisfying political preserve by choosing price caps, is 
not a way to fix the market. Investment is rushing to 
California at this moment to supply a need. They are rushing 
there because they believe the market is becoming more free and 
will be allowed to operate in a more unfettered fashion.
    Let me ask that you allow to be part of the record an op-ed 
by Robert Samuelson this morning in The Washington Post. I 
would recommend it for your reading. It is called ``Short-
Circuiting Supply and Demand.'' \1\
---------------------------------------------------------------------------
    \1\ The article referred to by Senator Craig appears in the 
Appendix on page 554.
---------------------------------------------------------------------------
    Chairman Lieberman. Without objection.
    I have noticed that the Ranking Member has been reading 
that op-ed here at my side this morning. I thank you Senator 
Craig and Senator Boxer. I think the two of you in some ways 
have framed the discussion that will go on here in the coming 
weeks.
    We are going to recess now. We will come back and hear 
Senator Feinstein and then proceed with the witnesses. Thank 
you.
    [Recess.]
    Chairman Lieberman. The hearing will reconvene. I apologize 
to our witnesses and others here for the interruption which was 
necessitated by two votes on the floor of the Senate.
    We are privileged now to have the third of our colleagues 
who asked to testify before this hearing and lead co-sponsor of 
the legislative proposal responding to the price crisis in 
California and the West, Senator Dianne Feinstein. Thank you 
for being here.

  TESTIMONY OF HON. DIANNE FEINSTEIN, A U.S. SENATOR FROM THE 
                      STATE OF CALIFORNIA

    Senator Feinstein. Thank you very much, Senator Lieberman, 
and Senator Collins, and I saw Senator Carper. He is over here. 
I want to thank you for this opportunity.
    I have been carefully watching as a member of the Energy 
Committee now what has been happening with the deregulation in 
California, and I have watched the problems spread to seven 
other Western States. So California is no longer alone.
    I must tell you, Mr. Chairman and Members, that I have 
really come to question whether deregulation of electricity and 
natural gas can work. You know, when we deregulated airlines, 
individuals had a choice of airlines. If they did not like one, 
they could go to another. When we deregulated telephones, 
individuals had a choice. If they did not like one service, 
there was another.
    In the area of natural gas and electricity, the consumer 
has no choice. You get your bill. You cannot change companies 
if you do not like it.
    What I have also seen is that it is a broken market, caused 
in part by California's not having adequate generation. 
However, having said that, I have got to make a point. 
Californians have been conserving. In January, the State 
consummed 5 percent less energy than the previous year.
    In February, the savings was 7 percent. In March it was 9 
percent. And in April, Californians saved 7 percent. The energy 
savings last month was 11 percent, and the cost of all 
electricity for California in 1999 was $7 billion. The cost in 
2000 was $28 to $30 billion, and the costs this year are 
predicted to be $50 to $65 billion.
    In that milieu, you have had two big investor-owned 
utilities, the middlemen, buying the power on the wholesale 
market, selling it to the consumer, go into bankruptcy. One is 
in bankruptcy. Southern California Edison, if it does not work 
out an arrangement with the State, will be in bankruptcy. And 
you have the State so far this year having spent $8 billion 
buying electricity to try to keep the price low. As recently as 
2 weeks ago, electricity prices in California were almost 10 
times higher than they were a little more than a year ago.
    Now, the Federal Power Act clearly states that if FERC, the 
Federal Energy Regulatory Commission, finds prices to be unjust 
and unreasonable, FERC must regulate and set those rates. They 
did find the rates unjust and unreasonable last November. They 
have really refused to move aggressively to set those rates, 
and I and many other Californians have tried to sound a 
consistent drumbeat to move to do that.
    In late April, FERC issued a limited--what is called price 
mitigation order, which would cap wholesale costs during stage 
one, two, and three emergencies. And it now appears that on 
Monday, FERC may extend this order to the entire Western energy 
market and may ensure that the order stays in place at all 
times--in other words, going to 24 hours a day, 7 days a week, 
and requiring power generators in the entire Western region to 
sell electricity back into the grid. That is another step 
forward.
    The question I have about it is manipulation. Because this 
is tied to the least efficient megawatt, so it is tied to the 
dirtiest, most polluting plant.
    Now, I ask this question: Is that then an incentive to keep 
dirty plants in order to drive up price and produce 
profitability for clean plants? And we are going to have to 
see.
    I called the head of the independent systems operator--
known as the ISO--yesterday, Terry Winters, and he agreed that 
this could be manipulated. He agreed that we do not have enough 
information yet to know whether, in fact, the acute drop in 
prices over the past week or so is a result of the April FERC 
order, whether it is a result that the generators now feel that 
the heat is on, whether it is a result of the Senate having 
changed power, whether it is a result that Senator Smith's and 
my bill now has a markup date in June which would set Western 
regional caps, we do not really know yet what the case is. But 
we do know a couple of things, that just a few days ago one 
generator admitted to selling electricity into California at 
$3,000 a megawatt hour, 5,000 megawatts at that price, and that 
another generator fessed up to $1,900 a megawatt. So what we 
still have out there is a ribald, unregulated marketplace.
    The natural gas issue has been an interesting one because 
natural gas is three times higher in California than anywhere 
else in the United States. FERC is looking into this. There is 
no transparency when it comes to natural gas. It is very hard 
to tell what is going on. But when you have three times the 
price, when the transportation cost of natural gas should be 
between 50 and 70 cents a decatherm and the gas is selling, 
instead at $3 or $4, $12 to $15, you really come to question 
what is going on.
    Let me give you a couple of examples of what has happened. 
We have one sugar refinery in my backyard. It is in Crockett, 
California, C&H Sugar. They employ about 1,200 people. Their 
normal cost of natural gas to produce steam is $450,000 a 
month. It has risen to $2 million a month. They have had to lay 
off people. They have had to close down the plant. They have 
had to try to get bridge financing. I can tell you about 
California steel industries with the costs escalating 
literately millions of dollars. Now, that is not restaurants. 
That is not others that use electricity as well.
    You should know that yesterday the Attorney General of 
California announced that he will convene a criminal grand jury 
to investigate whether power generators illegally manipulated 
energy prices. The investigation will begin shortly after July 
1 when a new 19-member Sacramento County grand jury is seated. 
As Mr. Lockyer said, this does not indicate we have reached a 
conclusion. It is a process to get at the truth. This is the 
beginning of the criminal focus.
    So the belief is among many of us--and I am one--that the 
generating community has made use of the problems in 
California, quite simply stated, to manipulate the market and 
gouge prices.
    John Bryson, CEO of Southern California Edison, testified 
before the Energy Committee, in answering a question of mine, 
that when they divested of generating facilities and sold those 
facilities to out-of-State generators, I asked this question: 
What were you selling a megawatt hour power from the facility 
when you owned it? The answer was $30. Then the next question 
was: When it was divested, what did the company that took over 
ownership charge? The answer was $300 a megawatt hour.
    So, in other words, power that had been selling at $30, 
when the facility was sold, they had to buy that same power 
back at 10 times the price. One of the reasons they are close 
to bankruptcy today.
    I am sure Senator Craig mentioned the concerns in Idaho. I 
am sure Senator Burns and others can mention the concerns in 
Montana where you have got a mine closing where people are 
losing their jobs, and in these seven Western States where it 
is anticipated that there will be rate increases from a low of 
14 percent to a high of over 100 percent.
    So the situation is changing dramatically and I thank you, 
Mr. Chairman. I wrote you a letter urging that you take a look 
at some of the relationships between the big generating 
companies and the regulatory agency that is supposed to be 
regulating these very companies. We see no semblance of really 
meaningful regulation yet, and particularly in the area of 
natural gas, there is very deep concern.
    My bill will be marked up, I believe, on June 27. Whether 
we can get it to pass the Senate or not, let alone get it to 
pass the House, I do not know. I should tell you, when Senator 
Smith and I went to see Congressmen Tauzin and Barton, they 
were not very sympathetic. I now think that is changing in the 
House, and instead of the word ``control,'' the word 
``mitigation'' is being substituted. Whatever you call it is 
fine with me, as long is it works.
    Thank you very much Mr. Chairman.
    Chairman Lieberman. Thank you, Senator Feinstein, for very 
thoughtful testimony. I want you to know that we are in receipt 
of the letter you referred to, and we are looking into the 
questions that you have raised.
    I am going to call now on the panel of economists who I 
think will begin to answer some of the questions that Senator 
Feinstein and others have posed. We have a very distinguished 
panel of economists who were asked both by myself and Senator 
Thompson, and I appreciate the trouble that they took to come 
and be with us. I have read the papers they submitted. In my 
opinion, though they are more accustomed to grading than I am, 
they all deserve high grades. They are very thoughtful and very 
thought-provoking.
    It had been my intention to call people in alphabetical 
order, but since this is the Senate where we follow the 
seniority rule, I wonder if his colleagues would mind if I call 
Dr. Kahn first.
    Mr. Kahn. No one is more senior than I, sir.
    Chairman Lieberman. Well, we do have Senator Thurmond here. 
But among the witnesses you are definitely the most senior.
    Dr. Kahn has certainly been, I guess I would say, if you 
will allow me the liberty, the father of the modern 
deregulation movement in our country, perhaps best known for 
his work as Chair of the Civil Aeronautics Board during the 
1970's. He is currently a professor emeritus of political 
economy at Cornell University, and I am delighted that he was 
able to be with us today.
    We are going to run this clock and ask you to try to stay 
within 5 minutes for your opening statements, although your 
full statements will be entered into the record. And then it 
will give each of my colleagues here an opportunity to engage 
in discussion for a greater period of time.
    Dr. Kahn, thank you for being here.

  TESTIMONY OF ALFRED E. KAHN, PH.D.,\1\ ROBERT JULIUS THORNE 
  PROFESSOR OF POLITICAL ECONOMY, EMERITUS, CORNELL UNIVERSITY

    Mr. Kahn. Thank you, sir. It is an honor to be here. I 
should begin by recognizing that the only reason I am here is 
that I did play an important role in deregulating the airlines, 
trucking, railroads, and telecommunications, and I do not offer 
myself as an expert on the electric power industry. In point of 
fact, I have tried to stay away from the electric one because 
it frightened me.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Kahn appears in the Appendix on 
page 191.
---------------------------------------------------------------------------
    I agreed partly because there are around me people who know 
much more about the electric industry generally, and, after 
all, one of them is a former student of mine, so he has been 
very well trained, and I urge you to listen to him carefully.
    Just one other introductory remark. The discussion of the 
California situation has become so deplorably simplistic, if 
not ideological, and again I am hoping that by my having 
decided that I wanted to subscribe to the letter that Professor 
Wolak started, that we can de-ideologicize it, if you will, and 
I have all sorts of examples that I would be happy to cite, but 
I am not going to waste your time because you have encountered 
them as well.
    I think perhaps I will merely quote that eminent economist 
William Safire, who referred to ``the demagogic call for energy 
price caps, always politically satisfying, populist 
interference with the market's self-correction that would lead 
to worse shortages and rationing, to inflation and wage 
control.''
    I suppose Mr. Safire deserves a good grade for the first 2 
weeks of elementary economics, but from there on he flunks.
    I hope he, however, and others like him will be satisfied 
that all the sybarites in California with their hot tubs and 
the politicians and militant consumer advocates who promised 
them the benefits of free markets but without the risks of 
being exposed to the free market--I hope the opponents of 
putting caps on will be satisfied that those parties have been 
sufficiently rewarded for their opportunism.
    I have in a paper I have written--and, in fact, Paul did 
the same--about the opportunistic nature of the move for 
deregulation. Nobody was in favor of deregulation of electric 
power in the 1950's and 1960's when real rates went down. No 
one was in favor of deregulation in the 1970's and 1980's when 
it looked clearly as tough regulation was holding rates below 
competitive levels. It only became a bonfire movement when in 
the middle 1990's, because of mistakes that had been made in 
the past, it looked as though prices would go all the way down.
    Of course, we should have realized that since the big 
errors were made in the past, we should have realized that this 
one, too, was based on an unrealistic assessment of the future. 
But, in any case, here we are in the situation that has been 
described so well by other people, and moving beyond the first 
2 weeks of Economics 101, let me just mentioned the factors 
that have induced me to sign on to this letter, apart from the 
fact that I have great confidence in the other people who 
signed.
    First, when you have extreme inelasticity of supply and 
demand, when prices can go up 5-fold, 10-fold, 15-fold and not 
induce a substantial response in demand, very largely because 
these prices operate in spikes by particular times of day and 
particular days of the year, and consumers do not have meters 
that tell them those prices. So demand is highly inelastic.
    But, similarly, when you have a highly inelastic supply, 
you reach a certain point, if you look at Severin Borenstein's 
figures at the end, where supply just suddenly turns vertical, 
and you do not get any more supply as the prices double, 
treble, and quadruple. Markets do not work very well, to put it 
mildly.
    And that leads me to the second point that everybody who 
talks about wage and price controls in the past or caps in the 
past have interfered with supply, and there is a letter by some 
very eminent economists who apparently know even less about the 
electric power industry than I, who say there are all sorts of 
plants, higher-cost plants that will come online as prices go 
up. I ask you to pose that question particularly to the people 
who know what is going on in California. It is simply not true. 
The supply--no matter how inefficient the plants, there is 
ample reason for them to be operating if the price gets above 
the incremental cost of operating, and yet we have a virtually 
totally vertical supply curve. In those circumstances, this 
equilibrating character of free markets just doesn't work very 
well.
    Third, it is true that the elasticity response was 
prevented by the ridiculous freezing of retail prices. That was 
one of these cases of ``we will give you all the benefits but 
you will not have to bear any of the risks.'' And the increases 
that have come since have been grudgingly inadequate. But since 
the extreme shortages, producing 10-, 20-fold increases in 
wholesale prices, have been the spikes and consumers do not 
have meters that tell them when those spikes occur, you are not 
going to get the demand response. And, therefore, you can say, 
well, you would not have blackouts if you let the price go up 
to whatever extent necessary, but that extent necessary is 
reckoned in terms of not doubling but increasing 10-, 20-, or 
50-fold. Then you have to say as against the possible benefit 
of a 10-fold increase in prices in getting a better balance of 
supply and demand, you have to realize, first of all, the 
income distributional consequences of that and, second, the 
macroeconomic consequences.
    I had the misfortune to be adviser to President Carter on 
inflation just when we had the increase in OPEC prices from $10 
a barrel to $40 a barrel on the East Coast, and we know that 
that extraction of those dollars from the pockets of consumers 
had a major role in promoting the stagflation from which we 
were all suffering. Well, look at what is happening to the 
California economy and the widespread distress that it is 
causing to a lot of innocent people, without eliciting 
increased supply, without bringing about re-equilibration.
    Fourth, the spectacular cases in history where price 
controls have done more harm than good cited by all the 
opponents, and correctly so, particularly in the 1970's when we 
held the price of crude oil below marginal costs--marginal cost 
was the cost of imports, and so we held the domestic prices 
below that. Of course, that interfered with supply, and the 
same thing was true with the case of caps on the price of 
natural gas. That clearly did interrupt supply. But the notion 
that caps automatically interfere with the increase of supply 
in the electric industry is absurd. It ignores the whole 
history of regulation. Look at my ``Economics of Regulation.'' 
There must be 50 pages on the fact that regulation of the 
electric industry through this entire history has not 
interfered with expansion of capacity. The major criticism has 
been that it has led to overexpansions of capacity because it 
guaranteed the investors a return on their capital and they 
made money by investing more. So it is simply historically 
incorrect that regulation, recognizing the full costs of 
additional capacity, necessarily interferes with supply.
    Moreover, one can make certain of that. The problem is that 
we are not going to get any new plants for 2 or 3 years. Make 
the caps temporary. Make them automatically sunset in the 2 to 
3 years. Make them not apply to new power.
    There is no shortage of people interested and willing to 
build new power plants, and for that they do not have to have 
$1,000 a megawatt or $1,500 or $2,000 a megawatt. That is 
Economics 101.1, and I wish Mr. Safire would come back and 
learn it.
    So we must not interfere with the fundamentally required 
correctives. We must press ahead with time-of-day metering or 
something like that. We must be willing to let retail prices go 
up more than the grudging amount by which they have. But where 
the demand and supply response takes years, it is simply 
sadistic to insist that elementary economics tells you that 
price controls do not make any sense.
    Thank you.
    Chairman Lieberman. Thanks, Dr. Kahn. You got us off to a 
very good beginning, a provocative beginning.
    Dr. Severin Borenstein is a professor of public policy and 
business administration at the University of California's Haas 
School of Business. He has focused on electricity deregulation, 
market formation, and competition. In addition, he is the 
director of the University of California Energy Institute and a 
member of the Governing Board of the California Power Exchange 
Corporation. So he is right in the middle of the California 
crisis. Thanks for being here, Doctor.

TESTIMONY OF SEVERIN BORENSTEIN, PH.D.,\1\ DIRECTOR, UNIVERSITY 
 OF CALIFORNIA ENERGY INSTITUTE AND E.T. GRETHER PROFESSOR OF 
  BUSINESS ADMINISTRATION AND PUBLIC POLICY, BERKELEY'S HAAS 
          SCHOOL OF BUSINESS, UNIVERSITY OF CALIFORNIA

    Mr. Borenstein. Thank you, Senator Lieberman. I just want 
to start out by talking for a few seconds about how we got 
here, into the crisis that California now faces, and 
understanding what the problems are and, more importantly, what 
the problems are not.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Borenstein appears in the 
Appendix on page 194.
---------------------------------------------------------------------------
    There is no question that demand has grown rapidly in the 
Western United States and that we are now in a situation where 
there is a real tight market in the entire Western grid. There 
is also no question that that creates a real supply-demand 
mismatch. That has two effects.
    One is the effect that you learn in the first 2 weeks of 
Economics 101, which is when demand shifts out and supply does 
not keep up, the price goes up.
    The second effect, which is just as easy to understand if 
you sat through the first 6 weeks of Economics 101, is that 
when you are a seller and you are in a market where there are 
few substitutes for your product on the demand side and the 
other sellers are unable to expand their supply because they 
are already at capacity, you can raise your price without 
losing much in sales. Economists do not call this market 
manipulation. They call this exercising market power. This is 
not illegal under U.S. antitrust laws, and it is, in fact, what 
businesses do.
    When Microsoft decides how much to sell its software for, 
it is not basing it on its cost. It is trying to figure out how 
much money it can make, how many sales it will lose as it 
raises its prices. That's what the sellers in the California 
electricity market are doing.
    The problem is that we have set up a market where they can 
raise prices quite a bit without much demand response at all 
and, because of the technology of electricity, without other 
sellers able to expand their output.
    Let me address two myths about how we got into this. The 
first myth is that the California crisis is the result of rabid 
environmentalism in California that blocked the building of new 
power plants. There is a lot of environmental consciousness in 
California, and there is no question that the permitting 
process in California takes a bit longer than it takes in most 
other States, on the order of months. But this is not a case 
that California just closed its eyes and refused to build new 
power plants when they were necessary.
    The reason no new power plants were built or started 
between 1995 and 1998 is because nobody applied to build new 
power plants during that time. And they did not just apply in 
California. They did not apply in Arizona. They did not apply 
in Nevada. They did not apply in Montana or Wyoming or the 
other parts of the Western grid.
    The fact was that the sellers in the Western grid in 1996, 
1997, and 1998 believed that the prices in Western United 
States were going to be low, that there was not going to be a 
shortage, and that there was not going to be a need for this 
capacity. They did the economic calculation and they found out 
that it did not make sense to build power plants at that time.
    By late 1998, they figured out they were wrong. Demand was 
growing and we were facing a tighter market. By the way, most 
of the demand growth was not in California. It was outside 
California, but it was all part of the Western grid. And so the 
market tightened up, and at that point there were plenty of 
applications. Firms started building power plants. They started 
trying to get power plants sited. Unfortunately, the process of 
getting from starting to build a power plant to having the 
power online is a 4- or 5-year process, and that is why we are 
still 1 or 2 years away from solving that problem.
    The second myth is that wholesale price caps caused these 
problems in California. California has had wholesale price 
caps. They were at $250 throughout most of the market. They 
were $750 for a period from October 1999 to June 2000. They 
were not frequently hit, and during that time, if you look at 
the rate of return on owning these power plants, it was 
astronomical. These firms have made plenty of money. There was 
no period essentially until November 2000 where you could 
possibly argue that the price caps actually deterred 
production. In November 2000, we actually did see this 
happening. In November 2000, the price of natural gas 
skyrocketed in California, and there was a period of time where 
it cost $400 to buy the gas for which you could then sell the 
power for $250.
    That is the bad old problem with price caps. That is 
exactly what we had in natural gas. That is exactly what we had 
in gasoline in the 1970's. That is the danger of price caps. It 
can happen.
    But prior to that, it did not happen and suggesting that 
firms were not building plants or firms were not producing from 
those plants is just not supported in the data.
    So California now faces two issues, and I think it is 
important to keep the two issues clear and separate from one 
another. California and the entire Western grid faces a longer-
run problem of building power plants, of getting investment in 
the West. The market is solving this problem. I think this 
really is not a major issue. This is the problem of power in 
summer 2004, and I think the problem of power in summer 2004 is 
going to solve itself.
    The question we are facing now is the problem for power in 
summer 2001, and telling California at this point to build more 
power plants is not a solution to that problem. Power plants 
are not going to get built for this summer. There are only two 
areas where California can help itself or be helped to get 
through this summer. One is conservation, and the State has 
been way too slow to get its conservation plans going. They are 
now moving on them. We have been way too slow to get real-time 
pricing in place so that particularly large commercial and 
industrial consumers would actually see those high prices on 
hot summer afternoons and would have an incentive to scale back 
their consumption.
    We have not sent price signals and we have not done enough 
to encourage voluntary conservation. We are moving. We are 
getting some results. We need a whole lot more results to get 
through this summer without a major economic crisis.
    The other area is the area of price controls. As Professor 
Kahn said, price controls can be used in a way that would 
prevent a massive transfer of wealth from consumers to 
producers without having the adverse effects. The idea of 
dismissing price controls because they were used, frankly, 
extremely badly and without much analysis in the 1970's is as 
silly as the idea of dismissing electricity deregulation 
because California electricity deregulation has gone awry. 
Price controls can be used well and carefully. It has to be 
done extremely carefully. And electricity restructuring can 
work successfully. We cannot dismiss it based on California's 
bad experience.
    However, I have to say, listening to some of the testimony 
this morning reminds me of the dangers of price controls. That 
is, once we go down this road, we are going to have to be 
careful to recognize what price controls do effectively is 
control market power. What price controls do in a damaging way 
is attempt to just control the transfer of wealth in a regular 
competitive market.
    In the 1970's, we tried to control that transfer of wealth 
in a very competitive market, and we ended up completely 
screwing up the market and causing shortages. What we need is 
the analytic capability to tell the difference. Unfortunately, 
the Federal Energy Regulatory Commission, which came into this 
deregulation as a legal-oriented process, has not shown the 
policy skills to do that sort of analysis and as a result has 
been blindsided by a lot of the economic operation of this 
market. I think if they had the policy skills to do it, they 
could implement price caps in a way that would be very 
carefully done, that would not solve all of the problems--a lot 
of the problem is a real shortage and real scarcity--but that 
would solve a significant amount of the problem without causing 
the sort of damage that price caps did cause in the 1970's.
    Thank you.
    Chairman Lieberman. Very interesting. Thanks, Dr. 
Borenstein.
    Dr. William Hogan is a professor of public policy and 
administration at Harvard's Kennedy School of Government, also 
a research director for the Harvard Electricity Policy Group, 
which is exploring the issues involved in the transition to a 
more competitive electricity market. Professor Hogan has also 
held positions dealing with energy policy analysis in the 
Federal Energy Administration. We are delighted to have you 
here, and I look forward to your testimony now.

 TESTIMONY OF WILLIAM W. HOGAN, PH.D.,\1\ PROFESSOR OF PUBLIC 
     POLICY AND ADMINISTRATION, JOHN F. KENNEDY SCHOOL OF 
                 GOVERNMENT, HARVARD UNIVERSITY

    Mr. Hogan. Thank you very much, Mr. Chairman. I have a 
prepared statement which I would like to submit for the record, 
but in the few minutes that are available I will summarize the 
highlights of the initial points I would like to make.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Hogan appears in the Appendix on 
page 200.
---------------------------------------------------------------------------
    I would emphasize three ideas. First, echoing the comments 
of my colleague, the diagnosis of what the problems are in 
California should be the first thing we do in order to 
understand the recommended policies, because different 
diagnoses lead to different policies.
    Second, I would say a few words about the price caps 
debate, which I think has motivated much of this hearing and 
the discussion, and to re-emphasize the theme that the details 
matter. People are talking past each other on this subject.
    The third point would be to return to the question of what 
should be done about market design, which is the long-term and 
continuing problem in California. I have some suggestions that 
I will summarize.
    The problems in California are quite serious, and they had 
been serious well before last summer. It is not apparently 
widely known, but the Federal Energy Regulatory Commission 
found that the many design features of this market were 
fundamentally flawed, in their words, in late 1999. So this is 
not a new problem, but it became much more serious when the 
prices increased.
    Essentially, because of the problems that developed after 
the summer and the collapse of the market earlier this year, 
things fundamentally changed as people stopped paying their 
bills. Market participants were not paying for the power they 
were taking. Some of the utilities got in financial trouble. 
One of the utilities went bankrupt. I think the diagnosis of 
that problem is widely accepted.
    This situation was unsustainable and it also tells us what 
needs to be done to deal with it. First, California should pay 
its bills in order to re-establish the credibility of 
transactions. No system can work without creditworthy buyers; 
and then, further, to provide incentives for conservation, 
retail prices for incremental energy electricity should be 
raised to market levels, at least for commercial and industrial 
customers. Changing the rules and metering to support demand 
responses would help on many fronts, and I agree with my 
colleagues on that matter.
    Other topics are more controversial, about in particular 
whether or not the principal cause of the high prices is 
scarcity or the principal cause is strategic withholding by 
generators in the exercise of market power. There is a debate 
about this issue, and unfortunately, this is one of the areas 
where the debate tends to lead to different policies. It is not 
so obvious what to do.
    Broadly speaking, I think we are talking past each other 
when we talk about price caps. I would identify three broad 
ideas that have been suggested. One is a uniform price cap, 
just setting a cap on the price that will be paid. Second is 
traditional cost of service regulation where you have a 
different cost for every plant and you pay them according to 
those traditional costs. And third comes what are known as bid 
caps, where you set limits on what each individual plant can 
bid. It may be different for different plants in different 
hours, but then everybody gets paid the market-clearing price. 
There also is a requirement for people to bid.
    I will not go into the details now, but I believe uniform 
price caps would be counterproductive for all the usual 
reasons. As far as traditional cost of service regulation, 
trying to reimpose that on the system, it is far from clear how 
this kind of administrative process could facilitate the market 
or be implemented in a way that would not exacerbate the 
immediate problems in the West.
    However, to the extent that the problem of high prices 
results from withholding of supply in order to raise prices, 
the better solution would be to go to the bid cap approach, 
which is already in use in other parts of the country as 
authorized by the Federal Energy Regulatory Commission in PJM, 
New York, and so on. Under a bid cap generators are required to 
bid and they cannot bid more than a certain level, which is 
related to their cost. But unlike with the price cap, the 
generators would still be paid the market-clearing price. The 
requirement to supply works in support of a competitive market 
and would counteract the effect of market power. On the other 
hand, to the extent that the problem is scarcity, bid caps will 
not do much to reduce prices. But if scarcity is the problem, 
then administrative action to reduce prices would probably make 
conditions worse, not better.
    If we are going to intervene, the best of this bad bargain 
would be to do so with bid caps. This is basically the 
direction that the Federal Energy Regulatory Commission went to 
at the end of April with the order that they presented at that 
time. And I think that is the right direction. There are some 
fixes that you could put that to make it work better but, 
nonetheless, I think basically what they are doing is in the 
right direction.
    The problem that I emphasize in my prepared remarks is not 
dealing with the symptoms of prices and rolling blackouts. The 
problem that I would emphasize is that the Federal Energy 
Regulatory Commission has not gone far enough or fast enough in 
dealing with the market design problems, how to change the 
basic rules of how the market operates in the West. The details 
I summarized in my prepared remarks reduce to a simple 
prescription. Namely, the market for the West should be set up 
to emulate that which is working so well in the East, in the 
PJM system, in New York, and is soon to be adopted in New 
England. These systems are not perfect, but they are the best 
systems that we know about, and they are much different than 
what California adopted.
    Market design is not necessarily the cause of the high 
prices, but it constitutes another set of problems which are 
fundamental and have been ignored or delayed, as everybody is 
worried about the symptoms of high prices and blackouts. It is 
time to move on, because we are running out of time if we want 
to see electricity restructuring work.
    Thank you.
    Chairman Lieberman. Thanks, Dr. Hogan. I feel like I am 
going back to Economics 101. It has been very helpful, and this 
brings me logically to Dr. Joskow, who is engaged in teaching 
and research at the Massachusetts Institute of Technology in 
the areas of industrial organization energy and environmental 
economics and government regulation of industry. Dr. Joskow has 
been focused on the competitive electricity markets for over 20 
years and in that time has published five books and over 100 
articles and papers.
    Senator Thompson, in the interest of full disclosure, I do 
want to reveal that while a graduate student at Yale in 1970, 
Dr. Joskow was a very important volunteer in my very first 
campaign for the state Senate. [Laughter.]
    Is that where you learned your economics?
    Chairman Lieberman. That is why I mentioned Economics 101.
    Dr. Joskow, nice to see you.

  TESTIMONY OF PAUL L. JOSKOW, PH.D.,\1\ DIRECTOR, CENTER FOR 
    ENERGY AND ENVIRONMENTAL POLICY RESEARCH, MASSACHUSETTS 
                    INSTITUTE OF TECHNOLOGY

    Mr. Joskow. Thank you, Senator Lieberman, Senator Thompson. 
It is a pleasure to be here. Actually, my job on that campaign 
was to be a poll watcher and make sure that people who died in 
the past 2 years did not vote.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Joskow with an attachment appears 
in the Appendix on page 351.
---------------------------------------------------------------------------
    Senator Thompson. We should have had him for our prior 
hearing.
    Chairman Lieberman. You are a very valuable witness in most 
matters this Committee is interested in.
    Mr. Joskow. I have a prepared statement that covers a 
number of issues related to FERC's responsibilities and 
performance across the country. In my oral remarks, however, I 
would like to focus on California.
    The causes of California's electricity crisis are complex, 
reflecting a combination of bad market design, bad regulatory 
decisions, unanticipated changes in gas prices and other supply 
and demand conditions, credit problems, and, I believe, 
supplier behavior which rationally took advantage of 
opportunities created by these conditions to further increase 
market prices above competitive levels.
    I would like to agree with Senator Thompson. These problems 
did not start on January 21, 2001. Indeed, they did not start 
in 2000. The first problems in California's markets began to 
emerge as early as July 1998, and in my view, the events of the 
past year were an accident waiting to happen.
    Some progress has certainly been made in the last year. 
However, I continue to believe that both Federal and State 
officials can and should do more to deal with the immediate 
problems and to make longer-run reforms in California's 
wholesale and retail market institutions. While wholesale 
electricity market problems have been most severe in 
California, they are not unique to California. I think it is 
important for the Committee to understand that. There have been 
market performance problems requiring a variety of reforms and 
mitigation measures in the new wholesale markets in New York, 
New England, and the Pennsylvania-New Jersey-Maryland pool as 
well.
    And this should not be surprising. Electricity has unusual 
physical attributes that make the design of well-functioning 
competitive wholesale markets a significant technical 
challenge. Spot markets perform especially poorly when supplies 
are tight, demand is completely inelastic, and a large fraction 
of demand is served out of the spot market.
    Midcourse corrections have frequently been necessary after 
competitive electricity markets first go into operation. Price 
caps, bidding rules, cost-based contracts, and a variety of 
other mitigation mechanisms have been used and are being used 
in most new wholesale electricity markets in the United States 
and other countries. I must say some of the recent discussion 
about ``price caps'' is a bit of a mystery to me because we 
have been using them for several years.
    In this regard, the term ``price caps'' has become so 
ideologically loaded and means so many different things to 
different people, I think we should just use a different term. 
My concern is not that wholesale prices are high per se. My 
concern is that prices are significantly above competitive 
levels because of a variety of market failures. What I would 
like to see is a comprehensive, short-run market failure 
mitigation program, not rigid uniform price caps, combined with 
a longer-term program to fix market design and regulatory 
flaws. You can call it anything you want--price mitigation, 
since Fred Kahn is here, let's call it a banana. The issue is 
to move forward.
    Of course, we need to be sensitive to the possibility that 
mitigation measures can make things worse rather than better if 
they are poorly designed. Of course, we want to use mitigation 
mechanisms that do not discourage new investment in generating 
facilities. Of course, the proper long-run strategy is to fix 
the market and regulatory institutions that are broken. But we 
also must be concerned about the interim cost to consumers and 
the economy of unmitigated market failures.
    Despite the recent break in wholesale prices in the West--
and I would be happy to answer questions about that if you have 
questions--I remain concerned that hot weather plant 
breakdowns, reduced hydroelectric supplies, and remaining 
market design flaws are likely again to present conditions that 
create the incentive and opportunity for suppliers to engage in 
behavior that increases prices significantly above competitive 
levels this coming summer. It is this potential problem that 
should be the focus of immediate mitigation efforts while we 
continue to focus on longer-term fixes.
    As Senator Thompson observed, the summer is now upon us. 
The practical mitigation options for this summer are, 
therefore, quite limited. FERC did put in place a supply and 
price mitigation protocol in California on May 29, and I will 
not call it price caps, price mitigation. Let's see if we can 
build on it.
    I would like to see FERC extend the number of hours to 
which these mitigation rules apply to all summer hours, 7 by 
24. I would like to see it identify and close remaining 
loopholes available to re-sellers, and I think very importantly 
to find ways to integrate suppliers in other Western States 
into this mitigation program.
    I do not think this is going to be easy. I do not think it 
will be successful if FERC follows its usual course in applying 
these mechanisms. But I think it can be done if FERC staff and 
the control area operators in the West work together to make it 
happen.
    I also would continue to urge California officials to 
continue their efforts to remove unnecessary barriers to the 
construction of new generating plants, if any still exist, to 
raise retail prices to reflect wholesale market prices, to 
implement real-time pricing, to restore credit to the system, 
and to continue energy efficiency and conservation efforts.
    Thank you. I would be happy to answer any questions you 
have.
    Chairman Lieberman. Thank you, Dr. Joskow. Thank you very 
much. Right on time, too.
    Dr. Lawrence Makovich is senior director of Cambridge 
Energy Resource Associates, an energy consulting firm started 
by Daniel Yergen, who many of us have been pleased to know and 
worked with over the years. Dr. Makovich is an expert on 
electricity markets regulation, economics, and strategies, the 
author of several reports and articles on the future of the 
electric power business, and a lecturer on managerial economics 
at Northeastern University's Graduate School of Business.
    A pleasure to have you here.
    Senator Stevens. Mr. Chairman, do we have a copy of his 
statement?
    Dr. Makovich. I did submit a copy of the statement, yes.
    Chairman Lieberman. He did. We can get you one.
    Go right ahead, Dr. Makovich.

 TESTIMONY OF LAWRENCE J. MAKOVICH, PH.D.,\1\ SENIOR DIRECTOR 
   AND COHEAD, NORTH AMERICAN ENERGY GROUP, CAMBRIDGE ENERGY 
                      RESEARCH ASSOCIATES

    Mr. Makovich. Power prices in California are too high 
because the power market has a real shortage caused by serious 
structural flaws in the market design and in its 
implementation. California did not follow the example of other 
power markets that use rules to create a market for capacity. 
In addition, California's complex siting and permitting 
processes have created formidable barriers to the development 
of new generating capacity that the State so badly needs. Quite 
simply, California ran out of capacity because it did not set 
up a market to pay for it or a process to enable it.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Makovich appears in the Appendix 
on page 365.
---------------------------------------------------------------------------
    A third flaw in the California market design was the use of 
price caps in retail power rates. As scarcity drove up 
wholesale power prices in 2000, the majority of customers in 
California continued to consume power at price levels frozen at 
1996 levels. The retail price caps distorted the market by 
increasing demand and driving price spikes higher. Yet 
utilities remained obligated to provide all the power people 
wanted at capped prices. As a result, price caps had the 
unintended consequence of driving Pacific Gas and Electric, 
California's largest utility with $22 billion of assets, from 
an A credit rating to bankruptcy court in less than 4 months.
    Of course, the bankruptcy also distorted the market by 
making suppliers reluctant to buy fuel and produce power to 
deliver to someone who was not likely to pay for it. Price 
caps, although well intentioned, usually distort the market and 
create unintended consequences. We have already seen this in 
California, and the history of price controls is a record of 
distortion and unintended consequences.
    Price caps may sound simple in theory, but, in fact, they 
are anything but simple. The bureaucracy to administer them 
always becomes many more times complicated than originally 
expected.
    Now, many people want price caps because they believe that 
power suppliers are withholding capacity to drive up prices. If 
this were true, then price caps would limit their gains. 
Further, this argument goes, if we could just get them to knock 
it off, then this artificial shortage would end and power 
prices would drop back down to reasonable levels.
    Why do so many people want to believe in market power? 
Putting the blame on suppliers diverts blame from the basic 
design flaws and weaknesses in the current California power 
market. An examination of the California power market does not 
support the market power hypothesis. Power generators have 
market power if they can act to set prices; however, high 
prices alone can occur for many other reasons as well.
    The California power exchange began operation in 1998. In 
anticipation of this, we developed a computer model in CERA to 
analyze the interaction of supply and demand in the 
determination of prices. When we simulate the Western power 
markets in 1998 and 1999 and compare the results to the actual 
market-clearing prices, the evidence is quite compelling. 
During this period the California power market was in a demand 
and supply balance, and we observe that wholesale power prices 
cleared at the level of short-run operating costs--fuel, 
environmental costs----
    Chairman Lieberman. What time periods was that, Doctor?
    Mr. Makovich. This is 1998 and 1999.
    Chairman Lieberman. Thanks.
    Mr. Makovich. Fuel, environmental costs, and other 
operation and maintenance costs.
    Over this time frame, the California energy market was 
doing just what it ought to do: Efficiently determining the 
utilization of power plants to meet demand at each hour with 
price signals reflecting the operating costs of rival 
producers.
    We must confront the fact that the industry structure that 
delivered a competitive outcome in 1998 and 1999 did not change 
in 2000. What did change was the demand and supply balance. 
Since no significant generation additions were made, demand 
finally outstripped supply. Any market with a severe shortage 
of a commodity that customers value highly and have few 
substitutes for will end up with buyers' bidding up scarce 
supply--in other words, a shortage or scarcity premium.
    We must recognize that when supply and demand were in 
balance, the competitive energy market in California produced 
prices with a level and volatility that was half of what was 
necessary to support new power plant development. During 1998 
and 1999, the annual wholesale power price of power was between 
$14 and $30 a megawatt hour. The evidence is clear. The energy 
market alone in California did not provide a timely price 
signal for new investment. As a result, the shortage was both 
predictable and preventable, and as early as April 1997, CERA 
published a report predicting just that.
    Other markets have capacity markets along with energy 
markets--like Texas and New England--and they have been able to 
attract more than enough power investment in just a few years 
to avoid similar shortages. We must face the fact that 
California competes with other power systems around the world 
to attract power plant investment and price caps discourage 
investment. Remember, the power business is one of the most 
capital-intensive businesses in U.S. economy. California 
remains a highly flawed power market in which the only way to 
recover costs above short-run operating costs is through a 
periodic shortage premium. By adding price caps to the current 
flawed California market design, investors will see no way to 
recover the full cost of power investment through the market. 
California cannot afford to continue to bring forth power 
development by guaranteeing payment through long-term power 
purchase contracts from the Department of Water Resources. The 
State's record in long-term power contracting is abysmal. 
Remember, half the stranded costs in California that drove the 
State to deregulate were due to long-term power contracts the 
State mandated under the Public Utility Regulatory Policy Act. 
California has not fixed its market to create a positive 
investment climate for power development. To assist California, 
the FERC should insist on a minimum set of structural elements 
in its wholesale market design. It will be a mistake to make 
price caps the centerpiece of a Federal response to the 
California power shortage. They would make a bad situation 
worse, and they do nothing to fix the flaws that so desperately 
cry out for solution.
    Thank you.
    Chairman Lieberman. Thanks, Dr. Makovich. Thanks for your 
testimony.
    And, finally, Dr. Frank Wolak, whose impressive credentials 
I will describe now. Dr. Wolak specializes in industrial 
organization and economic theory at Stanford University where 
he is professor in the economics department. His recent work 
studies methods of introducing competition into infrastructure 
industries and assessing impacts of this competition policies 
on consumer and producer welfare.
    Dr. Wolak is also notably the chairman of the Market 
Surveillance Committee of the California Independent System 
Operator and, therefore, again, right in the middle of the 
California crisis. Thanks for being here.

TESTIMONY OF FRANK A. WOLAK, PH.D.,\1\ PROFESSOR, DEPARTMENT OF 
                 ECONOMICS, STANFORD UNIVERSITY

    Mr. Wolak. Thank you very much. I would like to focus my 
remarks on a specific issue, and that is really the design of 
what I will call--Paul Joskow called it bananas. I will call it 
regulatory interventions required under the Federal Power Act 
to protect consumers from unjust and unreasonable wholesale 
electricity rates.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Wolak appears in the Appendix on 
page 371.
---------------------------------------------------------------------------
    First, I would like to state the two goals of regulatory 
intervention, and then I will briefly explain why I believe 
that the plan recently implemented by the Federal Energy 
Regulatory Commission will fail to achieve these goals. And, 
finally, I will just summarize the plan that has been proposed 
by the Market Surveillance Committee in its December 2000 
report to FERC, which I do believe satisfies the goals.
    The first goal of market power mitigation is to reduce the 
average wholesale price that California pays to a level that 
would occur in a competitive electricity market, given 
California's current supply and demand conditions and the cost 
of input fuels. And any successful market power mitigation plan 
has to guarantee that it can at least satisfy this goal.
    The second goal of a market power mitigation plan is also, 
I think, very important, to alter the incentives faced by the 
market participants so that it will no longer be profit 
maximizing for generators to essentially withhold capacity from 
the spot market by bidding substantially in excess of the 
variable cost of producing electricity from their facilities. 
The idea is essentially to alter the rules in such a way that, 
post-intervention, spot market functions in a manner that is 
consistent with the competitive market in the vast majority of 
the hours.
    I believe the market power mitigation plan that has been 
recently implemented by FERC is very unlikely to achieve these 
goals. In the first place, the plan provides for no mitigation 
during hours without system emergencies, and unfortunately, as 
has been noted by a study prepared by the Department of Market 
Analysis at the ISO as well as my own work with Severin 
Borenstein and Jane Bushnell at the University of California 
Energy Institute, the majority of overpayment due to the 
exercise of market power occurred during the hours when there 
were no system emergencies. Consequently, this market power 
mitigation plan currently fails to address the greatest source 
of the unjust and unreasonable prices in the California 
electricity market noted by the Federal Energy Regulatory 
Commission is its November and December 2001 orders.
    So even if this mitigation plan was extended to all hours, 
it still has the potential to be virtually ineffective at 
mitigating market power. For example, the plan only requires 
generators give all their uncommitted capacity into the ISO's 
real-time energy market at what is called a proxy bid price, 
which is computed by ISO to essentially account for the heat 
rate of the unit, the price of natural gas, and the price of 
other inputs that the firm might use.
    However, a very straightforward way for generators to avoid 
this requirement, is simply to sell its energy in advance to a 
power marketer, and then even if this firm sells its energy to 
an affiliated power marketer, that will satisfy the condition 
that FERC now has to saying the capacity is committed, and 
therefore not subject to the mitigation measure.
    So this aspect of the FERC plan creates a very simple 
strategy for a generation owner to essentially obtain higher 
prices. The firm simply sells its energy to an entity located 
outside the State on a day-ahead basis. This effectively 
commits the capacity, so it is no longer subject to the real-
time bid rule. Then in real-time market approaches, the ISO 
discovers it is short of electricity in California, and must 
find some out-of-state producer to sell into the market. Under 
these circumstances, the out-of-state suppliers can effectively 
bid whatever they wish into the ISO's real-time energy market, 
because they certainly have the option of not supplying energy 
into California if they do not receive the price they want. And 
through this process, a generator located in California can 
effectively achieve significantly higher prices than what are 
certainly seen to be envisioned by the mitigation plan by 
selling outside of the State at a high price, knowing that in 
all likelihood, this power will be sold back into the State in 
real time when the ISO calls the out-of-state supplier to 
produce more energy, because as all market participants know, 
California is a net importer of energy, and this is 
particularly the case in the summer months.
    And to give some idea of the potential profitability of 
this activity, it is not unusual for a megawatt delivered to 
California to trade between 5 to 10 times in the forward market 
before it is actually consumed. So a second aspect of the order 
that I think will render it ineffective, even if it is applied 
to all hours, is that generators still have the ability to 
receive their justifiable costs, rather than the market-
clearing price computed by the ISO using the generator's proxy 
big prices. So, for example, if a generator's proxy bid price 
is computed by the ISO to be $50, and if this unit is necessary 
to serve demand and it bids its cost-justified bid of $150, if 
the bid is necessary to serve demand, the generator will be 
paid its bid for $150 for the energy supplied, not the $50 per 
megawatt proxy bid market clearing price.
    So, consequently, even though the market-clearing prices 
posted on the ISO website would say $50, generators can receive 
substantially in excess of this market clearing price if they 
are willing to cost justify their bids in the ISO's real-time 
energy market. And given FERC's unwillingness to order 
significant refunds from generators and their use of a 
methodology that is exceedingly generous to generators in 
determining the recoverable production cost, it is no surprise 
that right now many generators are currently submitting bids 
that are accepted and paid as bid at prices significantly 
higher than the market-clearing price set by FERC under its 
recently implemented market power mitigation plan.
    So this provision for paying as bid for energy is very 
similar to the $150 soft-cap policy, which was implemented in 
2001. This policy said that all bids in excess of $150 had to 
be cost justified, and if necessary to serve demand, they would 
be paid as bid. And during the period July 1, 2001 to May 1, 
2001, even though there was $150 soft price cap in place, 
average prices in the ISO's real-time market were in excess of 
$250 per megawatt hour. So this guarantee by FERC in its former 
soft-cap regime, and in this recently implemented mitigation 
plan to pay as bid any cost-justified bids, as I think the best 
illustration of the point that cost of service regulation, 
which is essentially what the soft-cap policy is, without a 
prudency requirement, is the equivalent to no regulation at 
all. Unless FERC seriously investigates the prudency of these 
claims cost, something it did not do during the former soft-cap 
regime, the current mitigation plan will once again return 
California to a world without effective market power 
mitigation.
    And the final aspect of the FERC mitigation plan is that if 
it were applied to all hours, and even if these two problems 
described above were solved, it is extremely unlikely to 
achieve the second goal of market power mitigation, because it 
just does nothing to alter the incentives of generators to bid 
aggressively in the spot market and to maintain their units in 
top working order. This is effectively the point made by 
Senator Feinstein. In fact, on the contrary, the plan creates 
strong incentives for generators to declare forced outages and 
planned outages of their low-cost units so these units will not 
set the market-clearing price, but instead, their higher cost 
units will more frequently set the market-clearing price that 
is earned by all the units.
    And, so, moreover, this mitigation plan creates incentives 
for generators both in and out of California to sell outside 
the State for the reasons discussed above, so consequently, the 
FERC plan has the potential of creating the worst of both 
worlds for California, a less reliable grid, because generators 
do not want to sell into California and have little incentive 
to maintain their plants, and high prices because it is very 
easy to cost justify virtually anything with no serious 
prudency review on the cost incurred.
    And just to finish up, the December 1 Market Surveillance 
Committee Report presents a plan which I think can achieve both 
of these goals, and this remedy does not impose a soft cap on 
the spot market, but it does require FERC to make a one-time 
regulatory intervention that results in just and reasonable 
rates in California for the next 2 years. The essence of this 
plan is that all sellers in California would be ineligible to 
continue to receive market-based rates only if they offer 75 to 
80 percent of their expected annual sales in the form of a 2-
year forward contract at a price set equal to the perfectly 
competitive benchmark over this time period. This after all is 
market-clearing price that the FERC no-market-power standard 
explicitly stated in its competitive market requirement for a 
participant to receive market-based rates. So consequently, 
with this mitigation measure in place, the firm still has a 
significant upside potential, but California consumers are 
protected from the significant volatility in the spot market 
for at least 75 percent of their sales, and moreover, this plan 
will create the incentives for generators to be aggressive 
competitors in the spot market, to maintain their plants in top 
working order, and the other advantage of it is, it is simply a 
one-time intervention, and has no danger of essentially, once 
implemented, remaining in place. Thank you very much.
    Chairman Lieberman. Thank you Dr. Wolak. Thanks to all of 
you for very interesting and thoughtful and helpful testimony. 
You have come from different places. In fact, four of you were 
asked by the majority, two by the minority.
    Generally speaking, it sounds to me that though there may 
be some disagreement on what action FERC should take, just 
about all of you agree there should be some price mitigation 
action, although I do want to give you a chance to clarify, Dr. 
Makovich, because at the end of your statement, you spoke out 
strongly against price caps. Do you think there is any role 
here for FERC to play in what Dr. Joskow and others have called 
price mitigation in the Western markets now?
    Mr. Makovich. The price mitigation idea, as Dr. Wolak has 
said, there is this opportunity to get around it with the power 
traders. There is also a problem here that half of the power 
produced in the west is not under FERC jurisdiction. So on a 
practical basis, it is hard to imagine that this kind of bid 
capping or price mitigation is really going to work, given the 
reality of the jurisdiction limits out there and the ways to 
end run this set of regulations.
    Chairman Lieberman. So what would your answer be to folks 
in California who say that prices are too high; in a year and a 
half, supply is going to equal demand because of the power 
plants that are coming online; we have done all we can in 
California; the power plants are moving again; conservation is 
working, we are 11 percent down; but we need the Federal 
Government, through FERC, to come in and do something for us in 
the short-term, temporary price leash. What would you say in 
response to somebody from California who asked you that?
    Mr. Makovich. Well, there is a number of things that needed 
to be done in the short run, some of which were not done. So 
the price increases that we have seen were important, but they 
are very uneven. We have yet to----
    Chairman Lieberman. Things not done by FERC, you mean?
    Mr. Makovich. The retail pricing pieces. What has not been 
done in the short run is there should have been more done to 
bring additional supply in for this summer. And people say, 
well, it takes 4 years to build a power plant. But the truth 
is, I know people that can build barge-based emergency power 
systems in the Houston ship channel, and within several months 
could have that power plant--they could have hundreds of 
megawatts of additional supply in various locations through 
California. There were proposals to do that last year. Those 
proposals were denied. There are, according to the California 
Energy Commission, 5,000 megawatts of emergency backup 
generation that we have never taken the legal and environmental 
restrictions off temporarily to coordinate that supply to have 
it available for this summer to help meet these demands. So 
there are a lot of things that can still be done in the short 
run, short of price caps, to help mitigate the blackouts that 
are coming.
    Chairman Lieberman. Dr. Borenstein, would you like to 
respond to that?
    Mr. Borenstein. Yes, I would like to respond to a number of 
things. First of all, I think Dr. Makovich did not hear the 
news, that in the last couple of days, there has been a lifting 
of a lot of the environmental restrictions, and so a lot of 
those backup generators are going to be allowed to run.
    Chairman Lieberman. By the State.
    Mr. Borenstein. By the State. They are heavy polluters and 
that is certainly not the way I would go. If I ever asked 
beyond price caps what the State should be doing, is pushing 
much, much harder on conservation than we are pushing. We still 
have buildings air conditioned to the point that people need 
sweaters, and that is just crazy, given the situation.
    I think it is really not accurate or at least not relevant 
to say that half of the power produced in the west is not FERC 
jurisdiction. Most of that is public power. In the case of 
municipals, who produce their own power, those are not--they 
generally are not ones exercising market power. It depends on 
their net import or net export position. Most of that power is 
produced by public utilities who are just consuming their own 
power. So I think the argument that there is a lot of power you 
could not control, is not a reason to implement price 
mitigation. It is true that demand has outstripped supply, but 
I really have to say, if Dr. Makovich's company is advising 
companies and telling them that you cannot exercise market 
power in this market, they need a refund, because if you are in 
this market, and you own 4,000 megawatts of capacity in 
California, and you cannot exercise market power, you are not 
paying attention. It is really pretty straightforward. It is 
something that many of us pointed out before the market even 
opened. It is something that we have interacted with people at 
these companies, who are certainly aware of their ability to do 
it. They have argued that they are not doing it, but I think 
that if that is the case, it is out of benevolence, which is 
not how capitalist systems actually work well.
    Chairman Lieberman. Let me ask one or more of the five of 
you, who have advocated some sort of price relief by FERC on a 
temporary basis, to respond--there was some mention of it, but 
I would like to hear a little bit more about it--to respond to 
the argument that price relief or price caps--although that is 
a bad term; price relief or mitigation is better--if they are 
imposed, they are going to cut off supply by reducing the 
incentive for new power and new power plants by intervening in 
the market in that way.
    Dr. Kahn, what is wrong with that argument?
    Mr. Kahn. The whole history of regulation of the electric 
power industry has been one in which the effective regulation 
on capacity has always been deemed to be one of encouraging 
excessive expansion of capacity. There is no reason why, if you 
set rates that insure an operator return on investment that is 
sufficiently high to do so, that it will discourage 
construction of new capacity. And it seems to be it is very 
useful to look in history. People just say it and say it and 
say it, but I was never aware of any contention--I was chairman 
of the New York Public Service Commission and studied this for 
50 years--that anyone has ever argued that had the effect of 
retarding investment. On the contrary, it is a very well-known 
phenomenon, which Paul Joskow has studied, and it is not always 
empirically demonstrable, but I have never seen anybody argue 
it had the opposite effect. The only thing that had the 
opposite effect was, of course, the uncertainty in the 1990's 
about what was going to happen.
    Mr. Joskow. Senator Lieberman, let me take a crack at this. 
I think the greatest danger right now to new investment in 
California and the rest of the west is the continuing chaos in 
the markets out there and the uncertainties about public 
policy. The price mitigation programs that have been proposed 
by a variety of different people, yield prices that make it 
very profitable for new efficient generating plants to enter 
the market. Those plants lined up for permits back in 1998 when 
prices were very low. The new plants are 30 percent more 
efficient thermally than the existing plants. They emit a tenth 
of the nitrous oxide of the existing plants. There are just 
enormous incentives, once those plants can get licensed, to 
come in to the market, and many of them are being built in 
California, and in Arizona, and in Nevada. So if this is done 
effectively I think it will in fact, make it easier for 
investors to commit resources to the west because they will 
have a stable market and regulatory environment against which 
to shoot at.
    Chairman Lieberman. Let me just say it is an important 
point, because we hear this in a host of different economic 
areas here in Congress. The business community is always asking 
for stability, predictability to base their judgments on. But 
as both of you are saying, obviously, a price mitigation will, 
under anybody's vision of it, preserve a healthy profit margin 
for the producer. So, presumably the market will still be 
there, sufficient to encourage them, particular with the 
stability and predictability we are talking about, to get into 
the business, which they are.
    Mr. Joskow. Yes, indeed, and there is a very good study 
that has been done by an economist at the California ISO, Eric 
Hildebrand, which looks at exactly this question, if we kept 
prices at the competitive levels that a number of us have 
simulated, there is still a very healthy margin for new 
investors. I would like to get us out of the game of placing 
blame, of demonizing the suppliers, to recognize we have to do 
something in the short run to keep the system from going out of 
control, make long-run fixes, but to provide a stable 
regulatory and economic environment for new investors to invest 
in. I think that is substantially more important than 
continuing what I think will be continuing chaos and the blame 
game over the next 18 months if we do not take effective action 
now.
    Chairman Lieberman. Dr. Wolak, did you want to say 
something?
    Mr. Wolak. I just wanted to add something following up on 
what Paul Joskow said. I think it is very important to bear in 
mind the time lag that it effectively takes in a decision maker 
deciding whether or not to build new capacity. What he is 
interested in is not the prices right now, not the prices a 
year from now, not the prices even 18 months to 2 years from 
now, but the prices after the period when the plant is in the 
ground and producing.
    So following on what Paul Joskow said, if what we--the fear 
I think of many firms is, what will happen in California if we 
go through this summer and it is a complete implosion, then it 
will be public power or whatever strange solution comes out of 
the California initiative process and that will be the sort of 
thing that I think will chase all investment away, because of 
the fact that it takes 2 years to build a power plant. So high 
prices now do nothing to signal new investment to come into the 
market. It is the expectation of high prices 2 years from now 
to 3 years from now, when that plant is in the ground and 
operating, that cause me, as a rational firm, to invest in the 
market. All you are doing by mitigating prices within the 
interim 2-year period, is simply just not distorting any 
investment decisions, but just reducing essentially the 
punishment, as Professor Kahn said, that consumers have to bear 
during that period.
    Chairman Lieberman. Thanks. My time is up. Senator 
Thompson.
    Senator Thompson. Thank you very much Mr. Chairman. This is 
a great panel, because we have so many people who are so much 
more knowledgeable than we are, and it is always good when we 
are struggling to try to keep up. I think maybe we are making 
progress.
    But on that point of investment, and listening to you talk 
about that, it sounds like a rosy scenario compared with some 
of the things we have heard from some people involved in the 
activity. In a June 11 letter,\1\ Bear, Stearns' senior 
managing director and chief economist Wayne Angell writes that 
price controls are a recipe for disaster. He goes ahead and 
makes the usual points, I guess, concerning price control, but 
he says the confidence in the investment community has already 
been severely damaged by California's regulatory policies, and 
it will take time to repair the damage and regain credibility 
with investors. The worst thing regulators could do at this 
time would be to impose still more controls. A prepared 
statement of June 13 from William C. Dudley,\2\ chief U.S. 
economist, Goldman, Sachs; he says that price caps would deter 
the type of investment in electric power generation and 
transmission capacity that the State of California seeks to 
encourage. The risk would rise because the imposition of price 
caps is by nature arbitrary as to level, timing and duration. 
If caps were imposed, this would increase investor anxiety that 
the caps could in the future be lowered, broadened, extended, 
in terms of duration. He says, ``In my view, the solution to 
the California energy crisis lies not in price caps, but in 
encouraging the installation of additional electric power 
generation and transmission capacity, and imposition of price 
caps work against this.'' We may be comparing apples and 
oranges here, but I would ask that these two statements to be 
made a part of the record here.
---------------------------------------------------------------------------
    \1\ Letter from Wayne D. Angell, Bear, Stearns and Co., Inc., dated 
June 11, 2001 appears in the Appendix on page 556.
    \2\ Prepared statement from William C. Dudley, Goldman, Sachs and 
Co., appears in the Appendix on page 558.
---------------------------------------------------------------------------
    Chairman Lieberman. Without objection.
    Senator Thompson. People in the community are concerned 
about the attractiveness of California in the current 
environment as far as future investment is concerned. It seems 
to me that it is important to understand the nature of the 
problem, complex in some respects, not so complex in others, 
perhaps. It seems from all of you have said, and other experts 
have said, that we do in fact have a system, that is not 
working and from the very beginning, had inherent flaws: Retail 
caps, which went against our need for conservation; utilities 
with no ability to enter into long-term contracts, had to 
operate on the spot market, which looked good at the time, and, 
well, looks good today, as I understand. Now that California 
has gone to long-term contracts, the spot market is down. So 
they are buying high and selling low in both respects. 
Insufficient capacity, perhaps insufficient infrastructure, 
weather, all these problems come together. But in looking at 
all of that, and listening to these comments, would anyone 
disagree with the proposition, that as a part of this mix, 
California needs to allow retail prices to rise more and be 
more consistent with the actual cost?
    Mr. Kahn, if I understood you correctly, you referred to 
ridiculous freezing of retail prices. Mr. Borenstein, you 
talked about the need for conservation. I do not see how we can 
get there without that. Does anyone disagree with California's 
need to do that?
    Mr. Wolak. I think it is important to make the distinction 
between the cost, prices that reflect cost versus prices that 
reflect what people offer the power at. So I do not think 
anyone would disagree that prices that reflect cost should be 
passed on to consumers. The big debate is over exactly the 
extent to which the prices that are currently being charged in 
the market, are reflective of cost, because of the fact that 
there is the standard under the Federal Power Act that says 
that rates must be just and reasonable, and one way to obtain 
just and reasonable rates is rates that recover costs, and as I 
said with the various studies that have been done by the 
various members of the panel here----
    Senator Thompson. Even if the retail prices were what you 
feel like they ought to be, without the influence of market 
power, would you still not agree that the idea of retail caps 
was a bad one?
    Mr. Wolak. I think the other thing to remember with the 
retail caps is this is not something that is unique to 
California. This exists in every market that has been 
restructured in the United States. The other thing that I think 
is important to remember from the retail caps----
    Senator Thompson. Retail caps, letting alone the wholesale 
prices----
    Mr. Wolak. Fluctuating wholesale prices and----
    Senator Thompson [continuing]. And caps along these lines?
    Mr. Wolak. Yes, it exists in PJM, New England, New York. It 
is just the only difference is, is the extent to which there is 
an outstanding position on the part of the retailer to sell the 
power to purchase from the spot market. And the other markets, 
the extent to which they have to--if you like their net short 
for energy--is much less. They own significant amounts of 
generation capacity to meet their own loan obligations, whereas 
California, because of the divestiture, had large amounts of 
net short, and that really is a major source of the problem.
    Senator Thompson. These other States that have deregulated, 
for example, have allowed long-term purchases, have they not?
    Mr. Wolak. Yes. California did as well. It is just that--
the unfortunate thing is that California allowed the investor-
owned utilities to do that. It is just that the incentives that 
the investor-owned utilities faced at the time were such that 
it was a good deal not to engage in long-term contracts, so it 
is not an explicit prohibition.
    Senator Thompson. Mr. Kahn, would you comment about the 
efficacy of these price caps?
    Mr. Kahn. Yes. Two things. One, looking at it now, of 
course, it is clear that the imposition of rigid retail caps 
was a mistake. At the time, it may have seemed a reasonable 
bargain, because you will remember that 4 or 5 years ago, the 
main concern was that the distribution companies, the big 
electric utilities, would be left with stranded costs. That is, 
the cost of over investment in capacity, the cost of those huge 
contracts that they were forced to buy at artificially-set 
prices, and so at the time, it looked like a bargain. You give 
us the assurance that we will be able to recover our stranded 
costs. In exchange, we will freeze retail prices. So we have to 
be a little bit gentle. The fact is, after the fact it has 
proved to be a catastrophe from the point of view of the 
companies who in effect----
    Senator Thompson. There comes a point in time in which 
public officials, theoretically, should be able to perceive 
that it was a bad idea.
    Mr. Kahn. I think that is right.
    Senator Thompson. Mr. Makovich, do you have a comment?
    Mr. Makovich. Well, I think the idea that this problem can 
be solved simply by long-term contracting is one that is also a 
fairly dangerous idea. There is a couple of problems there. One 
is, suppose we got 80 percent of people to voluntarily contract 
long run of their demand in California. If then we rely on the 
spot market to supply the rest of it, and people will not build 
on the basis of the spot market, which we have already seen, 
and we come up short again. We do not have the capability to 
cut off the customers that are covered under long-term 
contracts versus those that are not. So there is an enforcement 
problem here, because when we shed electric customers in a 
blackout situation, we shed circuits. We do not differentiate 
one customer to the next.
    Second, if long-term contracts are the solution, and they 
keep the market in balance because the price is high enough to 
cover all the cost of a new power plant, power marketers are 
going to attack them because they are going to be able to buy 
on the spot market that clears on short-run costs, and they are 
going to be able to have a short position, sell long term----
    Senator Thompson. You are getting a little down into the 
weeds for me. [Laughter.]
    Mr. Makovich. Right.
    Senator Thompson. I am not making a case for long-term or 
spot. I assume you need both. What I am trying to get at is a 
decent analysis of the structural situation that underlies this 
and presents the problem.
    Mr. Makovich. Suffice it to say, long-term contracts alone 
will not solve the problem we have in California.
    Mr. Borenstein. If I can answer on retail rates, I very 
much agree with you, and we were very slow in California to 
raise retail rates, and I am fearful that as the bills arrive 
in the next few weeks, particularly residential customers are 
going to find out their bills did not go up very much because 
they did not on average. But I think it is important to 
recognize that electricity is not a storable good. The cost of 
providing electricity is something that varies hour to hour 
tremendously, even in a completely competitive market.
    Senator Thompson. So these great spikes we see, I 
understand, are just momentary.
    Mr. Borenstein. Right. We have deregulated the supply side 
of the market and have not deregulated the demand side of the 
market in the way we really need to to make that work, and that 
is with real-time pricing. That is, prices that are sent 
through reflecting the rate, the real rates. If all we do is 
just raise the flat retail price you are going to be facing an 
incredibly high price in the middle of the night which is way 
too high, and the same price on a hot summer afternoon when it 
is way too low. What the real mistake California did on the 
retail rate is not the freeze, I would say, although I think 
that is a big part of the problem, it is that we did not get to 
pricing on the retail side that really reflects the scarcity.
    Senator Thompson. Can I impose on the Chairman, and ask Mr. 
Joskow to respond to that also?
    Chairman Lieberman. Sure.
    Mr. Joskow. I agree completely with Mr. Borenstein, who by 
the way, was my student. I think California was too slow in 
increasing retail rates, but I also think it is important to 
make these markets work, that at least some significant 
fraction of demand be on real-time prices.
    Just to give you an example from June 2000. On June 8, the 
demand was low and the price was $50. On June 13, 2000, demand 
spiked and the price went up to $750. You cannot respond to 
that if you are not seeing those prices, and if you get your 
bill a month later that tells you that you paid that. One of 
the things that makes markets work is that consumers can say no 
when they see a high price. If you go into a restaurant and you 
see on the menu that a hamburger is $85, you say I am not going 
to have a hamburger. I will have a tuna sandwich, or I will 
have a salad. You cannot do that now in these electricity 
markets, and they are just not going to work until we implement 
these kinds of strategies.
    We have made a lot of mistakes. There is a lot of blame to 
go around, not just in the west. In New England, in New York 
and PJM, this was much harder to do than a lot of people 
thought. We need State and Federal regulators to work together 
to fix these problems, not just in California, but elsewhere in 
the country, and I think that really is the big issue, not 
finding blame. There is plenty of blame to go around. But to 
get FERC, to get the State commissions, to get the reliability 
councils together to make the system work in the short run and 
the long run. I think we can mitigate prices in California this 
summer if we take that approach. I agree with Frank Wolak. It 
would have been better if they had followed advice that was 
given to them by the Market Surveillance Committee last summer. 
But FERC essentially ignored the Market Surveillance Committee. 
But here we are. It is June 13. The summer is upon us. We have 
got to work quickly together to get us through this summer and 
probably next summer, while we do not forget that we need to 
fix the longer run problems as well.
    Mr. Kahn. This is not a new idea, 25 years ago the price of 
electric power on Long Island was 5 cents a kilowatt hour, 
morning, afternoon, evening, summer, fall, winter, and spring. 
By the time I left, we had all big commercial and industrial 
consumers on time-of-day meters, and the prices ranged from 2.5 
cents at night to 30 cents when the thermometer got above 84 
degrees. That was 1976.
    Mr. Joskow. Fred was being modest when he said he knew 
nothing about electricity. He was the chairman of the Public 
Service Commission in New York, and in fact, implemented these 
ideas in New York State.
    Chairman Lieberman. Thank you both. Senator Carnahan.

             OPENING STATEMENT OF SENATOR CARNAHAN

    Senator Carnahan. Yes, thank you, Mr. Chairman.
    I realize that our topic today is about energy in 
California, but I want you to know that the people of Missouri 
are very concerned about the energy picture as well. They have 
watched as the crisis has unfolded in California, and they have 
worried also as their own fuel prices have spiraled. I have 
heard from a number of people whose natural gas bills have 
doubled, and in some cases tripled, just since last winter. 
Many of them are seniors on fixed incomes and working families 
who are barely making ends meet.
    So as we talk about the economics of the electricity 
industry today, we should be mindful that this discussion is 
about far more than just competing theories. And it is about 
more than beliefs in free markets. It is about the everyday 
lives of real people and the impact that our decisions have on 
them.
    The price spikes in many States, combined with the crisis 
in California, and the current debate about a national energy 
policy, have caused confusion and anger all across America. In 
the past, most of us purchased our electricity from a single 
regulated utility. State agencies determined the utility's cost 
in producing the electricity, added a reasonable profit, and 
set the price charged to consumers. Changes in the electricity 
industry, including technology, have allowed us to consider new 
deregulated systems. Under such a system, consumers would 
choose from whom they wished to buy electricity. Many have 
argued that competition should lead to lower prices, but 
California's experiment with deregulation has caused serious 
doubts among many Americans.
    Whatever the original cause, California's problems have 
been compounded by the hands-off approach of FERC. Instead of 
vibrant competition, California has suffered from shortages and 
skyrocketing prices.
    Does this mean that deregulation is bad policy? No. We may 
very well conclude that the best interest of the American 
people are served by deregulated electricity industry, but I 
think we must ask a very fundamental question. Is a deregulated 
market the same thing as a competitive market? I think 
California's experience shows us that the answer is clearly no.
    Obviously, the deregulation must be approached with 
caution. The transition from a regulated industry to a 
competitive model is a process that will require a willingness 
to make adjustments. When the initial approach proves 
unworkable, corrections must be made. During that transition, 
we must ensure that someone has both the legal authority and 
the will to look out for the purchasers of electricity. Thus 
far, the sellers have proved adept at protecting their own 
interest.
    Undoubtedly, as academics, each of you will continue to 
study the wisdom of California's approach to deregulation for 
some years to come. However, one thing is clear today: The 
responsibility for insuring just and reasonable prices in the 
wholesale electricity marketing in California and around the 
Nation lies with the Federal Government and particularly FERC.
    As you may know, Senator Lieberman and I recently wrote to 
the General Accounting Office to express our concern about 
recent reports that market power has been abused in California. 
It is alleged that this, in turn, has contributed to the 
spiraling cost of electricity in the State. We have asked the 
GAO to use its oversight authority to review whether FERC is up 
to the task of ensuring just and reasonable rates.
    The recent debate has centered on whether FERC should take 
measures to help ease the pain during the transition to a 
competitive market, and I hope that today's discussion will 
continue to shed light on that question.
    I believe that part of the long-term solution to 
California's problems lies in additional infrastructure--more 
generation and additional transmission capacity. Some have 
argued that any transitional efforts by FERC would disrupt much 
needed investment. I must tell you that I am not entirely 
convinced by that argument. Pennsylvania is often held up as an 
example of how to manage the transition to a competitive market 
correctly. I find it interesting that there are price caps on 
both the wholesale and retail markets in Pennsylvania during 
the transition.
    I understand the need to protect incentives for investment. 
However, I must question how much incentive is required. It 
seems to me that the profits of the energy companies are more 
than adequate incentives to be a part of this industry. For 
example, last year the operating income of Enron, a Houston-
based energy company, rose 140 percent from the previous year, 
from $802 million in 1999 to $1.953 billion in 2000. By 
comparison, Anheuser-Busch is a Missouri-based Corporation with 
a reputation for being a very well managed company. Last year, 
they experienced outstanding sales and growth. Their operating 
income grew by 8.4 percent, compared to Enron's growth of 140 
percent. Last year, the S&P 500 declined by 9.1 percent. 
Anheuser-Busch outperformed the index with a return of 30.5 
percent, but Enron surpassed the S&P 500 with a whopping 89 
percent return. This level of return indicates that the 
incentives to invest in the energy sector are firmly in place.
    I believe we can reasonably conclude that this will result 
in additional supply. Once this additional supply is in place, 
I would hope the market would level out. So my concern is how 
we protect the interest of the consumers during the intervening 
period. As we make the transition to a truly competitive 
market, who will ensure that prices are just and reasonable? 
Thus far, FERC's response has been timid. In my view, this will 
not do. I hope that today's questions and answers will provide 
insight into how the Federal Government can play a constructive 
role in relieving this temporary but extraordinary crisis.
    Mr. Chairman, I am having to leave in just a moment, but I 
would like to ask Mr. Borenstein one question before I do.
    As you know, many States are examining the deregulation 
proposals now. These States may continue to believe that 
competitive electricity markets can provide long-term benefits 
to consumers. However, they are concerned about what is 
happening in California. You have researched the situation in 
California extensively, and based on your research of what is 
happening there, what lessons can States like Missouri--that 
have not yet moved to deregulation--what can we learn? What 
guideposts should States use as they design a deregulation 
process?
    Mr. Borenstein. Well, there are a number of things that I 
think we can learn from the California experience. And they 
almost all fall under the general notion of making sure that 
there is the infrastructure support for having a competitive 
market. If you are going to move to a competitive market, you 
have to make sure that the supply side of the market will be 
competitive. To do that you have to have analytical tools that 
will let you look into the structure of the market and what 
sort of prices it will yield. In fact, these tools were around 
in 1995, and many of us were suggesting FERC use them, and FERC 
ignored them, and went ahead using a completely antiquated 
approach of simply looking at the market share of each player. 
But if you use the right tools, you can see how much 
divestiture into separate companies would be necessary to get a 
competitive market. At the same time, you have to have price 
responsiveness. You have to be willing to let people see the 
prices, and as I said to Senator Thompson, you have to be 
willing to let the people see the prices in a way that reflects 
in real time what is going on so they have an opportunity to 
respond to those prices.
    Then of course you have to have the infrastructure to 
actually carry the power around. One of the mistakes that 
California made, which has not really come to the fore yet, but 
will in the next few years, is that we deregulated without 
having a real vision of how to invest in transmission capacity 
in a deregulated market, and transmission investment, as a 
result, has virtually come to a halt. So we really do need to 
have a system that will beef up transmission and will then 
price power appropriately at each location in the system. If 
you do that, if you make sure you have a competitive supply in 
the market, if you make sure you have a demand that can respond 
to prices, I think you can go forward with electricity 
restructuring that can really work. At the same time, you do 
want some fall-back position, and the way you get that is as 
you enter restructuring, you have long-term contracts in place 
or ownership by the regulated utilities, that are effectively a 
hedge. One of things I pointed out in Pennsylvania is 
Pennsylvania has had huge price spikes. It is just that 
Pennsylvania buys very little power on the spot market because 
they have effectively hedged, because the utilities continue to 
own almost all of their capacity.
    But I think if you follow that recipe, it is still a recipe 
for success and eventually for benefits to consumers in 
electricity markets.
    Senator Carnahan. Thank you very much.
    Chairman Lieberman. Thanks so much, Senator Carnahan. I 
just want to indicate that I appreciate that you were one of 
the first to draw this subject to my attention anyway. I know 
our staffs have met with GAO, and we hope for some kind of 
interim report in the next three or 4 weeks to our request. 
Thank you. Senator Collins.

              OPENING STATEMENT OF SENATOR COLLINS

    Senator Collins. Thank you very much Mr. Chairman. I have 
really enjoyed this hearing today and the chance to hear such a 
distinguished panel of economists present their divergent views 
on this issue. I think that the competition that we have seen 
among ideas here is as important as the competition that we 
hope to see among electricity generators.
    I do want to take advantage of this opportunity, as the 
Chairman has suggested, to share with the Committee some of my 
thoughts on this issue. Many of our States, including my home 
State of Maine, are striving to promote more competition in 
electricity markets. Maine was one of those States that 
pioneered this and plunged very early into the brave new world 
of deregulation. Competition in properly functioning markets, 
should, over the long term, result in cheaper prices, better 
service, and more innovative products for our consumers. Since 
price caps limit competition, they should be avoided in 
properly functioning markets. Unfortunately, however, 
electricity markets do not always function properly, and, as we 
have seen, California is a clear example. California's 
electricity markets are not functioning correctly because they 
were not set up correctly. When you do not allow retail prices 
to rise in the face of electricity shortages, you are setting 
up a flawed system. It is clear to me, based on the testimony 
we have heard today, that California needs to restructure its 
market to remove artificial barriers that inhibit the 
marketplace. Even in an electricity market without the kinds of 
major design flaws that we have seen in California, however, 
there are still some factors inherent in the nature of 
electricity that can cause the market to function improperly. 
Because electricity is generated and consumed simultaneously, 
and cannot be meaningfully stored or inventoried, there are 
essentially 8,760 hourly electricity markets each year. Even if 
the markets work most of the time, there may be hours when, 
because of an imbalance between supply and demand, they are not 
workably competitive. This can lead to incredibly high prices. 
Since it is impossible for most consumers to respond to high 
hourly prices, the sellers of electricity can raise their 
prices an unlimited amount for short periods.
    I want to give you an example that affected my State last 
year. During a few hours last May in Maine and the rest of New 
England, the price of electricity in the spot market went to 
$6,000 per megawatt hour. That is more than 100 times its usual 
level, and, as Dr. Kahn and others have pointed out today, very 
few customers saw this price spike in a timely way. They could 
not adjust their demand. They could not respond by turning off 
their air conditioners for a few hours, or waiting until later 
to do their laundry. So in this instance, in my judgment, the 
market simply did not work. Subsequent to this price spike, 
FERC imposed a price cap of $1,000 per megawatt hour in New 
England during periods of significant supply shortages. Given 
its limited applicability and the extremely high level, this 
cap seems to me to be a reasonable response. Furthermore, there 
is no evidence at all that it is deterring new plant 
construction in our region.
    I want to emphasize that ultimately our goal by speaking is 
to alert the consumers, not just in California, but in the 
Nation as a whole. In Maine, homeowners and businesses alike 
are burdened by some of the highest electricity rates in the 
country. In fact, one of the reasons that Maine jumped into 
deregulation early was the hope and the elusive promise that it 
would lead to a lowering of electricity rates since we have 
always been at a competitive disadvantage compared to other 
regions in that area. Households are seeing their electricity 
and other energy costs eat up more and more of their incomes, 
and many businesses, particularly manufacturers, are seeing 
smaller and smaller profit margins as more money goes to 
purchase energy. Some businesses in Maine are even threatening 
to move to other regions where electricity prices are lower. I 
hope that we can succeed today in helping to identify solutions 
for California, but I also hope that our goal is to identify 
ways to lower electricity prices in the rest of the Nation. We 
need to look closely, and we have looked closely, at the 
lessons that we can learn from California, and we also need to 
be careful that we do not blindly apply California-size 
solutions to New England, which has been by and large very 
successful in avoiding California-size problems. In fact, we 
have had a number of new generating plants come online, and yet 
we are still experiencing these distortions in the market.
    In the final analysis if we are firmly committed to 
competition, as I believe that we should be, we cannot seek 
government intervention whenever the prices are high. But on 
the other hand, we must recognize that electricity markets have 
unique characteristics which may cause them to not work 
competitively at times. Thus, in dealing with electricity 
issues, I think we need to combine competition with common 
sense. Finding the right mix, that which will lower electricity 
prices for all Americans, is no easy task, but this hearing 
provides a basis for us to try to strike the right balance.
    I do want to ask Dr. Kahn a question, since I agreed with 
so much of what you said in your statement.
    Mr. Kahn. That is funny, Senator. I was going to say I wish 
I had written what you just said.
    Senator Collins. The approach you have suggested makes much 
sense to me, as does the idea for short term carefully 
constructed price caps. My one concern is that we have seen 
price caps that were intended to be temporary, become 
permanent. We have seen these results. And I like what you have 
suggested about having them designed to be temporary, to 
automatically sunset them and to make them inapplicable to new 
capacity coming online. But, can you give us some more guidance 
on what you think should trigger the expiration of the price 
caps in the kind of scheme that you have described?
    Mr. Kahn. There are only two ways that occur to me, both of 
which I have mentioned. I like the idea of automatic sun 
setting; that is to say, one makes a reasonable estimate of 
what it takes for new capacity to come online and then requires 
a reenactment, rather than requires an explicit repeal. So that 
was the one that I suggested. We have been through a period 30 
or 40 years ago where we tried to differentiate caps on old and 
new sources of supply in the case of natural gas. And I think 
we would have to say that was not a success, to put it mildly. 
Whether that is feasible in these circumstances, I truly do not 
know. Certainly, it is not a good long-term expedient. Power is 
power is power, and it is absurd to have discrimination in 
charges to different people. But some way of making absolute 
the guarantee that new investment will not be subject to any 
kind of--even if it is an arbitrary cap.
    The only other observation follows partly from what I have 
said. In electric power we have not had a problem of shortage 
under regulation. On the contrary, regulation, by assuring an 
adequate return on investment, has tended if anything, to 
encourage gold plating of service, and having excess capacity.
    Senator Collins. Which is why everyone thought it was going 
to be this boon to consumers.
    Mr. Kahn. That is why we thought we had such enormous 
excess capacity, including by the way, the inflated prices that 
the electric distribution companies were forced to pay to 
independent generators. I think Dr. Makovich mentioned the 
ridiculous prices under the Public Utility Regulatory Practices 
Act. It has all been in the direction of encouraging excess 
capacity. That is why I kind of bristle when people say yes, 
but price controls always restrict supply. You have to look at 
the particular situation. That is not true historically. But 
other than that, I am really repeating what I said, different 
ways of ensuring automatically that new capacity coming online 
will not be subject to these.
    Senator Collins. Thank you. Dr. Joskow, do you have 
anything to add to that?
    Mr. Joskow. Yes, Senator Collins, very briefly. By the way, 
I would love to subscribe to your statement as well.
    Let me talk about New England just to move across the 
country. I remember those $6,000 megawatt hours very well, and 
I think I paid for them in August. In New England I think we 
can establish a relatively small set of criteria for when the 
market is sufficiently reformed to remove price controls, 
except perhaps for these kinds of damage control price caps at 
very high levels, so that the price does not go to $1 million a 
megawatt hour. So in New England right now we are in the 
process of a major market redesign. There are specific items 
that have to be completed. When they are completed, we should 
be in much better shape in terms of operating the spot market 
and dealing with congestion management. We have a number of 
power plants in Maine, New Hampshire, Massachusetts and Rhode 
Island that are in the process of being completed. The New 
England ISO has a target minimum reserve margin. We are going 
to reach that I hope next summer. That is another criterion. 
Third, I think contract cover is important, that retail 
customers and the entities that serve them, have substantial 
contract cover. We are pretty good at that in New England right 
now, and I think we need to stay at around 70 percent. Finally, 
I would like to see us get about 10 percent of the load in New 
England on real-time prices, really, some of their demand, so 
they in fact, can see and respond to the $6,000 a megawatt hour 
prices if they emerge again. I see those structural fixes being 
in place over the next 18 months, and I am hopeful that the 
markets in New England will really be working well then, and 
that we can take off any of the heavy-handed regulation and 
rely on continuing very, very light-handed regulation to ensure 
that the markets work competitively.
    Let me note that since last summer I have had more calls 
from State officials in New England than I think I have the 
rest of my life. Five of the six States in New England have 
restructured radically. They did many of the same things 
California did, and the people there are scared. We cannot do 
what they can do in Missouri, which has not moved forward, and 
I have been very, very pleased to see the kinds of cooperation 
that the market participants, the ISO, the kind of cooperation 
they have gotten from the public utility commissions in the 
region, from the Governors of the States, from the attorney 
generals. I really see people working together in New England 
in a very, very constructive way, and I must contrast that with 
the atmosphere in California. Maybe we are just more civilized 
in New England. I do not know, but----
    Senator Collins. I have always thought so.
    Chairman Lieberman. We show a bipartisan agreement on that.
    Senator Collins. That is right.
    Mr. Kahn. I think it shows we can do a lot better if we 
work together, rather than just screaming at each other. Thank 
you.
    Senator Collins. Thank you. Thank you very much. I really 
enjoyed your testimony. It was very interesting.
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you, Senator Collins, and thanks 
for asking some questions about New England. Senator Voinovich.

             OPENING STATEMENT OF SENATOR VOINOVICH

    Senator Voinovich. I, too, have enjoyed the testimony this 
morning. It may come as a surprise to you that Ohio is the 
third-largest energy dependent State in the Nation behind 
California and New York, and back in March 1999, in my first 
State of the State address as Governor of our State, I called 
for a comprehensive energy strategy to keep the lid on energy 
and utility costs for our citizens, and to try and stay 
competitive with other States that I was concerned would be 
taking some of our businesses away because of the lower cost of 
energy, particularly the State of Pennsylvania, which was one 
of the first States to restructure. As a result of that effort, 
we proposed and published the energy strategy report. That was 
back in 1994, and we started to discuss the whole issue of 
restructuring and did not pass the legislation until 1999, but 
a lot of the heavy lifting in anticipation of it was done 
during the 3 years prior to my leaving the governorship.
    One of the major provisions in the restructuring effort was 
that rates were capped during the first 5 years of energy 
restructuring to protect our consumers, but we were careful in 
terms of the rate because we had to recover stranded costs, and 
we tried to get a reasonable return for our utilities, and it 
has worked out, and we have had new energy producers come 
online, several thousand megawatts, and have another 13,000 or 
14,000 in the pipeline. The thing that bothers me about the new 
facilities coming on is that they are all powered by natural 
gas, and because of some environmental concerns, a new source 
review and lawsuits that were filed by some folks in the 
northeast, they have turned away from the use of clean coal 
technology for our coal, and of course we are all aware of the 
fact that we could be doing a much better job in terms of 
taking advantage of nuclear energy in this country.
    But the fact is that we have a crisis in California, and 
everybody's wringing their hands, and I think California did it 
the wrong way. They separated the major functions of the 
generation transmission and distribution system. Three of 
California's major utilities were required to divest large 
portions of their generating capacity. They precluded major 
utilities from entering into long-term contracts for 
electricity supply and required that they sell their remaining 
capacity on the spot market. I do not think they did it right, 
and now the chickens have come home to roost, and they have a 
problem.
    The question I have for this panel is this: Does Congress 
need to get into this and start passing legislation to deal 
with this problem, or should we let this problem be worked out 
through the traditional ways? Now FERC is involved. They got in 
a little bit late, but they are involved in the process. Do we 
need Federal legislation to deal with this, or should we leave 
it to the system that we have in place? You were talking, Dr. 
Joskow, about the governors and the utility commissions getting 
together and working together. FERC is now involved. What is 
your opinion about that? Should the U.S. Congress get involved?
    Mr. Joskow. Senator, I think that is a very good question. 
Ideally, I think no. I think FERC should enforce the law, and 
if I could recommend anything, it would be perhaps a letter 
from the U.S. Congress to remind FERC the Federal Power Act has 
not been repealed, Congress has not just deregulated wholesale 
power markets, that their job is to ensure that they work well 
and to continue to oversight, of FERC, to get them to do their 
jobs. I think in the longer run there are some questions in my 
mind as to whether FERC is currently structured, both in terms 
of personnel and its conception of its missions and its 
procedures, to oversee the development of well-functioning 
competitive electricity markets. I would like to see FERC 
evolve more into an agency that is involved in monitoring, 
identification of market failures, and mitigation. It is 
structured as an agency that for almost 50 years basically did 
rate cases when investor-owned utilities sold power to 
municipal utilities. I think the agency needs to change. It has 
got to be more like the SEC in monitoring these markets, and I 
think that would be a very productive thing for Congress to 
look at and to explore whether amendments to the Federal Power 
Act are necessary to make that happen. FERC's responsibilities 
are now very different from what they were only 5 years ago in 
terms of the quantities of electricity, the amounts of money 
and the nature of the industry. I think it does make sense to 
revisit whether that agency is properly structured and whether 
its objectives are properly focused on the new world rather 
than the old world.
    Senator Voinovich. Thanks. Dr. Hogan.
    Mr. Hogan. Senator, I think this is a very good question. 
Legislation by the U.S. Congress at this point would be 
premature, and I think it is because the problems that you are 
dealing with here are so complex, that trying to prescribe the 
solutions that are going to be applicable for California and 
the rest of the country, cannot be done through legislation. We 
have an example of that going on in the discussion here today. 
When Fred Kahn introduced into economist lexicon the term 
``banana'', because of the difficulty of getting the ideas 
across, he was talking about, as I recall, a situation where he 
wanted the same idea but a different name, because he wanted to 
be able to talk about it politically. I think what is going on 
here is we are talking about different ideas and putting them 
all under the same name, and people are very confused as I have 
heard it in the discussion today. For example, Senator 
Lieberman said that five of us were in favor of price 
mitigation. But I think, at least for part of the discussion, 
when I heard Paul Joskow talking, he was talking about market 
failure mitigation, and that is a helpful contribution to this 
discussion. I am in favor of market failure mitigation, and I 
described a mechanism, the bid cap scheme, that FERC has been 
pursuing that is directed at that problem. It may lower prices. 
It may not lower prices. It is not targeted at price 
mitigation. That is not the objective, and I do not think it 
should be the objective. I think correcting the market failures 
as quickly as possible should be the objective and that is 
something that is not a good thing for the Congress to try to 
do. That is something you need FERC to do. And then when you 
look at FERC--I agree with Paul Joskow's observation. I do not 
have any question in my mind about it. I do not think that the 
commission is able to deal with these problems at the moment, 
and I think they have been going in the wrong direction.
    FERC's responsibilities have changed in reality, if not in 
their perception, and their responsibility has to be to design, 
and make sure that people adopt the rules for effective 
markets, the kinds of market infrastructure that Severin 
Borenstein has been talking about. They have been very slow to 
do that, partly because they feel confused by these very 
complicated problems. And if they are confused by these 
complicated problems, imagine what it would be like trying to 
write legislation. So the real challenge is to beef up the FERC 
staff and change their mindset.
    Senator Voinovich. One of the issues that this Committee 
has been dealing with, and I have been addressing in the 
Subcommittee on Oversight of Government Management and 
Restructuring, is the human capital crisis that we have in the 
Federal Government. I would be interested in your observations. 
If it is like some of the other agencies, such as the Nuclear 
Regulatory Commission, for example, the number and quality of 
people really needs to be punched up if we expect it to do the 
job that it is supposed to be doing.
    Mr. Hogan. They have some very good people at FERC, but 
they do not have enough, and they need more, particularly 
people trained in markets and able to deal with market design 
issues. They increased the size of that staff to reorient the 
agency and to make the Commission take it on that it has a new 
job--market design.
    Mr. Joskow. And let me give you a couple of good examples. 
The Federal Trade Commission has a large economic staff that is 
fully integrated with the lawyers and others in enforcement and 
investigations. It is considered to be a prestigious place to 
spend a couple of years if you are an economist. The Antitrust 
Division of the Justice Department is a similar type of 
arrangement. FERC has lost some very good people in economics 
and markets, and they never really had enough. I really think 
that we should look at other agencies that have been 
successful, like the Federal Trade Commission and the Antitrust 
Division, to see if we can bring the best skilled people to 
bear with the appropriate focus. I do think there are 
compensation issues that have to be addressed. It is one thing 
for me to come and spend a couple of years, take a leave from 
MIT and spend a couple of years. It is another thing for a 
civil servant to spend his or her whole life in the agency. We 
need to recognize and compensate these people, as well as to 
make it a rewarding professional experience for them.
    Senator Voinovich. Dr. Wolak.
    Mr. Wolak. I guess on your first question, what I would say 
is, I think that the same fundamental problem is going to arise 
again and again in competitive electricity markets until the 
following issue is addressed, is that competitive markets do 
not, by their very nature--or markets, rather, by their very 
nature, do not yield just and reasonable prices. And having in 
the Federal Power Act, a standard that rates wholesale 
electricity prices must be just and reasonable, is really in 
some sense incompatible with a market, because it creates, I 
think as Senator Thompson said, ``this sort of incentive of OK 
we will do what we do, but if things go really bad because of 
the just and reasonable rate standard, we will get bailed by 
the Federal Government.'' So if I was going to say the one 
thing that would be necessary is to essentially either get rid 
of it, of that standard in the Federal Power Act, and say, 
look, in a market, prices will be what prices will be, so you 
need to take the precautions necessary in advance to make sure 
that those sorts of eventualities do not occur, and then I 
think the market will work. But if you create the sort of 
circumstance where there is this just and reasonable rate 
standard, then you always have this problem that I always have 
the recourse, and in some sense, that is to me the fundamental 
incompatibility between a competitive market and this just and 
reasonable rate standard.
    Senator Voinovich. Any other comments?
    Mr. Borenstein. I had one comment. I know personally of a 
couple of economists who have gone to the FERC, and 
compensation is an issue, but I think the much bigger issue is 
the mindset. The economists and the policy analysts at the FERC 
have not really had enough influence on decisionmaking. I was a 
staff economist at the Civil Aeronautics Board during airline 
deregulation. I was lucky enough to work under Professor Kahn, 
and I was lucky enough to work at a time when we were going 
through deregulation and we were spending many days sitting 
around, saying, ``Well, if I were an airline and these were the 
rules, what would I do trying to make as much money as I can?'' 
And just walk through that analysis. Had the FERC had people 
who were doing that and were being listened to in 1996, we 
would not be here today because there were many people telling 
the FERC, ``If I were a generator and you set up these rules, 
here is what I am going to do.'' Unfortunately, FERC did not 
have that mindset. FERC had the mindset of, ``We have a legal 
process we go through. People file documents. We read them, 
etc.'' FERC really needs to get the staff, and to listen to the 
staff, who are going to do that sort of policy analysis. And if 
they do that, I think they can be quite successful.
    Senator Voinovich. Thank you.
    Chairman Lieberman. Dr. Makovich.
    Mr. Makovich. My final comment on that. I think what you 
see here is a general consensus that the California market was 
set up flawed. Because it was so complicated and difficult to 
do, it was not done well. What we have also, I think, agreed on 
here, is it has not been fixed, and price caps are a Band-Aid, 
not a solution to the problems there. So the role of the 
Federal Government, either through FERC or legislation, is to 
provide leadership here on how power markets have to be set up 
right, and there are a minimum set of structural requirements 
that we have to have in all power markets to avoid the market 
failures that we have been talking about.
    Chairman Lieberman. Thanks, Senator Voinovich. That was a 
very interesting series of questions, and they really go right 
to the heart of the Committee's oversight role, because what we 
are really overseeing here is not the California or Western 
energy crisis that happens to engage us, but it is what is FERC 
doing about it? And I appreciate the comments you made about 
the role of staff within the agency, and there is no question--
may be one of the unexpected results of this crisis is that 
bright, young economists will think about going to work at 
FERC.
    Mr. Borenstein. Well, bright, young economists did in the 
last few years, and they were there for a year, and they left.
    Chairman Lieberman. That has to change then.
    Senator Thompson. Speaking of the jurisdiction of the 
Committee, I am reminded of the fact that it is very relevant 
to another subject we spend a lot of time on, and that is 
federalism. Here you have the classic question of what should 
government do and at what level should it do it? We have got a 
State responsibility and a Federal responsibility, and they 
overlap somewhat. Each is trying to cast responsibility on the 
other side, and each wants perhaps the best of all worlds. It 
is a fascinating federalism issue.
    Chairman Lieberman. True.
    Mr. Kahn. A very brief answer, if I may, to Senator 
Voinovich is, that this is an oversight committee, and I have 
had 6 years of experience in two places with oversight 
committees, and legislation, I do not think you could get any 
agreement right now what the legislation would be. But inducing 
the kind of discussion and thinking that is going on, or should 
be going on here, I think that is where you all play a very 
essential role. Everybody seems to agree with that.
    Chairman Lieberman. That is certainly my hope here. I would 
rather that we not have to go forward with the legislation, 
that FERC provides a response that is adequate to the occasion, 
whatever that might be. So thank you. Senator Carper.

              OPENING STATEMENT OF SENATOR CARPER

    Senator Carper. Mr. Chairman, I apologize to our panel and 
to my colleagues. I have been presiding over in the Senate 
during the debate on education, and I have missed, with the 
exception of Dr. Kahn's comments, I have missed all of your 
comments, and I will not ask you to repeat yourself, but I will 
ask you to do one favor for me, and sort of provide us with a 
benediction. I like to say sometimes when I am speaking to a 
group, I try to tell them what I am going to tell them, I tell 
them, and then when I finish, I tell them what I told them. And 
we are at that point where I am going to ask you to tell us 
what you told us.
    What I want to do is this. I am going to ask each of you to 
take maybe a minute, tell me where you agree. Tell me, 
throughout this panel, where you agree and what is the 
appropriate role for us in the Federal Government, in the 
Senate, where is the consensus? And I will just start with you, 
Dr. Borenstein.
    Mr. Borenstein. You want to specifically focus on what the 
appropriate role of this Committee is?
    Senator Carper. The Federal Government, where is your 
consensus? No, where is your consensus of the role of the 
Federal Government?
    Mr. Borenstein. I think the consensus is that California is 
in the midst of a crisis this summer, that a lot of it needs to 
be done at the Federal level. I think there is near consensus 
that the FERC can do something to help mitigate prices for this 
summer, and I think there is widespread consensus that that 
should not be a long-run tool that the FERC should be using.
    Senator Carper. Is part of that consensus that the FERC has 
every authorization that they need to proceed without our 
legislating?
    Mr. Borenstein. I am not an expert in that area, but it is 
certainly my impression that the FERC, if they wanted to step 
up to the plate, would have all the powers they needed to.
    Senator Carper. Thank you very much. Dr. Hogan.
    Mr. Hogan. I think there is also a consensus that there are 
a number of things that have to be done in California that have 
not been done or done fast enough to raise prices to retail 
customers, put in metering, get the demand side included in 
this marketplace, and that is an urgent matter. It has been for 
a long time, and it continues to be. This is something FERC has 
relatively little control over, but it is something that 
California has a lot of control over. And then fixing the 
market design, which has been a problem since day one of 
operation of this market, not just this last year, should be 
completed, and that is a problem not just in California. It is 
a problem in the west. It is a problem in the midwest, the 
southwest, the southeast. About the only place that has, I 
think, a workable market design is the northeast.
    Senator Carper. Good. Thank you, sir.
    Chairman Lieberman. Here here.
    Senator Carper. When I was leaving, Dr. Kahn was saying 
that there was somebody on the panel who was his former 
student. Is that you?
    Mr. Joskow. It was me.
    Senator Carper. I noticed when he spoke, your lips moved. 
[Laughter.]
    Chairman Lieberman. In the interim, Tom, Dr. Joskow 
indicated that Dr. Borenstein in turn was his student.
    Senator Carper. And Dr. Borenstein then told us that he 
worked for Dr. Kahn at the CAB, so it is a little bit--pretty 
incestuous, is it not?
    Mr. Joskow. Senator, I think there is actually a lot of 
agreement on this panel. We all agree that the markets in 
California and the west are broken. There is a lot of blame to 
go around. We agree that there are both long-term problems and 
short-term problems. We agree that FERC has the authority and 
needs to do a better job in fixing both short-run and long-run 
problems. I think a majority of us agree that mitigation 
options exist for this summer that are important both to 
protect California consumers as well as to convince other 
States that are on the path to restructuring competition, that 
Federal officials will not abandon them if they have problems. 
We agree that these mitigation methods have to be designed 
sensibly, that they can be designed in a way that does not 
deter investment in new generating capacity, and I think on all 
of those things, I think most of us agree. We have some 
differences as to exactly what is wrong, exactly how much of 
the price increase is due to market failures, market power, and 
how much is due to higher gas prices and higher demand, and 
higher NOX credit prices and so on.
    But I think what you are hearing from this panel is that 
FERC needs to step up to the plate, they need to become 
informed, they need to do something. And I would add my 
personal view, just looking at this over the--I do not know if 
there is agreement--over the past year, there has been too much 
screaming and too much paper flying back by Federal Express 
written by lawyers, back and forth between Washington and 
Sacramento. And I really would like to see the technical people 
at FERC be able to get together with the technical people at 
the ISO, with some of the economists in California, have a 
series of technical conferences and work out some fixes for 
this summer. I think this is not as hard as everybody has made 
it. We need to have a more cooperative spirit here, and as I 
said when you were out, there is plenty of blame to go around, 
and let us all accept the blame and let us move forward. I just 
think we can do much better.
    Senator Carper. Well, as one who was trained as an 
economist, not as a lawyer, I do not take any umbrage to which 
you just said here. Dr. Kahn.
    Mr. Kahn. I really do not have much to add to what the 
people on my right have said. I do not think that legislation 
is necessary. You have got the provisions of the Federal Power 
Act now. It seems to me that the oversight function of getting 
FERC here and saying, ``OK, there are your responsibilities, 
what are you doing about it?'', is terribly important. You are 
never going to get complete agreement about in what respect 
these designs were perfect or imperfect, so there is a very 
wide range of agreement. I am curious that no one has raised 
the question about whether it was wise totally to require the 
generating companies to divest their--I mean the distribution 
companies to divest their generation.
    Mr. Borenstein. I think there is agreement it was not wise.
    Mr. Kahn. Obviously, it was not undertaken lightly. No one 
has raised it. Obviously, if you still owned all the generation 
and you were still regulated at the distribution level, the 
situation would be very different.
    The one area in which we may not have come sufficiently 
close to agreement, but we have never really encountered, is 
that there have been studies by people like Dr. Borenstein and 
Professor Joskow, which purport to find definitively that there 
has clearly been evidence of withholding, of exercising market 
power, and I have not seen anybody directly challenge that 
except The Wall Street Journal, which published an editorial 
saying he left out five other causes--the price of natural gas, 
the cost of NOX emissions--well, read his letter in The Wall 
Street Journal today. As Paul says, I looked at every one of 
those things. I mean, The Wall Street Journal is still trying 
to get President Clinton impeached. It paid no attention to the 
fact that he had done all these things, and so I have been 
acting in part on the belief, and I think Frank Wolak has done 
the same thing, that there have been people who have found that 
there has been a market power problem here. Well, mitigation of 
that is surely something you have the right to demand of an 
agency that operates under your jurisdiction.
    Senator Carper. Mr. Chairman, thank you. I really want to 
thank you for being here today and for your good work over the 
last several decades, as well as training a whole new 
generation of economists. Please.
    Chairman Lieberman. Senator Voinovich, did you have 
something you wanted to say?
    Senator Voinovich. I was just going to comment that I think 
that Dr. Kahn, as one who has observed this whole area for many 
many years, has two students, or one student and one indirect 
student here, has made a great suggestion, and probably the 
most positive thing that you could do as Chairman of this 
Committee is to bring FERC in here and have a hearing and have 
them respond about what they are going to do about it.
    Chairman Lieberman. And in fact, they are coming in next 
Wednesday on the 20th.
    Senator Voinovich. Good.
    Chairman Lieberman. That is exactly what we would want to 
do. And I do want to repeat, I hope that FERC will act in a way 
that the move to have legislation adopted here ends, because it 
is not the best way to do it, particularly in the short-term 
case here where everybody is saying what is needed is temporary 
relief. Those who are saying that any relief is needed, say it 
is temporary relief, so I look forward to having them in--all 
five commissioners will be here next Wednesday.
    Senator Carper. Two more witness, please, if you would just 
conclude. Go ahead. Thank you.
    Mr. Makovich. I think there is a consensus here that power 
markets are very complicated, and as a result, we have got 
multiple flaws as we look to the California example in 
particular, which means that there is no simple solution 
including price caps, that it is difficult to fix in the short 
run, and that there are however, examples of people that have 
done things far better than California, like New England, and 
Pennsylvania, New Jersey, Maryland, the way they set up their 
markets.
    Senator Carper. PJM?
    Mr. Makovich. Yes, PJM.
    Senator Carper. Glad you mentioned that. Thank you.
    Mr. Makovich. This can be done right. Just to differ on--
there is not a consensus here that market power is the problem. 
It harkens back to, for example, when we had the blackout in 
1965, 9 months later The New York Times ran an article about 
the record births at Mt. Sinai Hospital, and there were experts 
that had testified or had reported to The New York Times that 
there was reasons to expect that the blackouts had lead to 
people become amorous. And it was 5 years later----
    Senator Carper. I am anxious to see where you are going to 
take this.
    Chairman Lieberman. I may have to exercise the gavel on my 
first day as Chairman.
    Mr. Makovich. It was 5 years later in August 1970, that 
there was a study done by the School of Public Health at the 
University of North Carolina that went through all the data and 
debunked the notion that there was a boomlet of births after 
the blackout.
    Mr. Kahn. How disappointing.
    Mr. Makovich. Some of this outage data, we have to be 
careful, that we may be misinterpreting it right now. It is 
complicated.
    Senator Carper. Thank you, sir.
    Chairman Lieberman. This might have led to an appeal for 
more blackouts, and we would not want to have that adverse 
market effect.
    Mr. Wolak. The advantages of being last is you do not have 
much to say, but the only thing I would say is, to follow-up on 
what Paul Joskow said, as the chairman of the Market 
Surveillance Committee, which was, believe it or not, 
established by FERC to be, if you like, the eyes and ears in 
the California market, it was shocking to me that in sort of--
when the crisis sort of first started, there was absolutely no 
communication with the Committee, despite the fact that we had 
prepared over the intervening 2 years, numerous reports, had 
analyzed the bid data, the production data, etc., so I really 
think that, exactly, rather than the lawyers talking it out, a 
very good thing would be a discussion among the staff at FERC, 
as well as the market monitoring committee, as well as the 
department of market analysis at the ISO, to essentially work 
to formulate a solution that will help to make things work, and 
I think there are a lot of very good and capable people at the 
ISO that I think could very much help FERC do its job very 
well.
    Senator Carper. My thanks to each of you. I again apologize 
for missing much of your testimony.
    Mr. Chairman, thank you for indulging me and I am delighted 
to hear, in response to what Senator Voinovich said, that we 
have got all five commissioners coming in next week, and we 
will look forward to that. Sounds like a great idea.
    Chairman Lieberman. Thanks, Senator Carper. That was very 
helpful to do that.
    I think Senator Thompson and I at least, and maybe Senator 
Voinovich, want to ask a few more questions. So that was a 
great summary of what has happened.
    I appreciate the focus on FERC, and it is interesting that 
as this discussion was going on today. It was noticeably 
different, and one of the reasons I think is that we have been 
thinking at least here in very legalistic terms, because after 
all, FERC operates under a law and we have been talking about 
just and reasonable rates and what powers they have and should 
have to exercise them. I think there has been a lot of common 
sense here at the table.
    I am curious about whether so much experience and good 
thinking around the table--are any of you ever consulted by 
FERC in what they do?
    Dr. Borenstein. When FERC did their investigation last 
summer, I am on the governing board of the California Power 
Exchange and director of the UC Energy Institute, and I called 
Scott Miller, who was the person--I guess one of the people 
running that, and never was called back.
    Chairman Lieberman. Dr. Joskow.
    Mr. Joskow. When the California markets were being set up, 
FERC, at that time in 1996 and early 1997, had a series of 
technical conferences, and they invited me to speak. Indeed, 
one of them involved setting up a market surveillance committee 
at the ISO, and what data they should collect. And so one of 
the great mysteries to me in all of this, is why they set up 
these entities which were supposed to be independent, and then 
for 2 years, ignored them. I thought that was a brilliant idea, 
to sort of decentralize the monitoring, that Frank Wolak, Carl 
Shapiro, who has been the chief economist in the antitrust 
division is now at Berkeley. Al Klevorick was on the PX, and I 
think it is a worthwhile question to ask FERC. You set up these 
market monitoring entities. They have got great people on them, 
they do good studies. Why do you not build on that and work 
with them? And I have asked them that, and I do not understand 
the answer.
    Chairman Lieberman. We will ask. Let me ask another 
question. I think I will ask Dr. Wolak this one, and invite 
anyone else who wants to respond. There has been some concern, 
as you know, that even though FERC determined last November 
that the prices in the California market were not just and 
reasonable, that they have done not enough regarding examining 
past overcharges and providing refunds to wholesale customers, 
which might make up for some of the high costs. Do you have a 
reaction to that?
    Mr. Wolak. I very much agree with that.
    Chairman Lieberman. Excuse me. Dr. Kahn, you have to 
depart, am I right?
    Mr. Kahn. In a few minutes.
    Chairman Lieberman. Thanks very much for being here. You 
contributed----
    Mr. Kahn. I apologize.
    Chairman Lieberman. No, not at all.
    Mr. Kahn. The people who deregulated those dammed airlines. 
[Laughter.]
    Chairman Lieberman. Thanks very much for coming.
    Mr. Kahn. I am awfully sorry.
    Chairman Lieberman. Not at all. We are going to wind up 
soon. You were a great help.
    Mr. Kahn. Thank you so much.
    Chairman Lieberman. Dr. Wolak.
    Mr. Wolak. I guess as I said, I definitely agree with the 
viewpoint. In fact, I would go even further to say that 
effectively FERC said that if there is market power, then we 
will essentially order refunds of any rates that reflect the 
exercise of market power. Unfortunately, effectively in my 
entire 2 years, almost 3 years on the Market Surveillance 
Committee, FERC has never determined what constitutes the 
exercise of market power, in other words, what prices would 
reflect the exercise of market power? What behavior on the part 
of the generator would result in prices that reflect the 
exercise of market power? So in many ways it is sort of looking 
for something that you do not know what it is. So what we have 
had to do, as well as Professor Joskow has had to do, is 
essentially say, well, we will use the standard definitions 
from economics to determine what are the payments in excess of 
competitive prices and what reflects the exercise of market 
power. But as far as FERC is concerned, even despite numerous 
meetings with FERC staff and conferences with FERC 
commissioners, a definition for what constituted market power 
and what constituted prices that reflect the exercise of market 
power, that definition was never given. So in some sense, it 
makes it very simple never to have to confront that issue.
    Chairman Lieberman. Anyone else want to speak to the 
question of refunds? Dr. Makovich.
    Mr. Makovich. The question of just and reasonable prices is 
a difficult one for many reasons, but right now, the prices in 
California with the shortage are too high, and that is why the 
finding of just and reasonableness by FERC was that these are 
too high. But we have to remember, when the California Power 
Exchange opened, on its first day, there were hours when the 
price of power cleared at zero. And it continued. That is 
something that we have seen through time, that the price will 
clear at zero. Is zero an unreasonable or unfair price to a 
producer? And the point that has been made here, is if there is 
a 4-year lead time on building power plants, the prices are too 
high right now but this is not the right time to give somebody 
a signal to build. It was 4 years ago that we had to give 
people the expectation that if they build a power plant, they 
could make money. And if the explanation was, sure, prices 
clear at zero. They are averaging $14, but in the year 2000 and 
2001, there will be an extreme shortage, and you will be able 
to make all your capital costs back within just 2 years, 
although you will be vilified as the cause of the problem, I do 
not think you would have got a lot of investment. So there is 
fundamentally still a problem here on investment incentives and 
just and reasonable prices. Capping them now neglects the fact 
that they are too high now because they were too low 
previously.
    Mr. Wolak. May I just respond to that? I think it is very 
important to bear in mind that the zero prices he is referring 
to were not really paid to anyone.
    They may have been paid to small, small, small amount of 
capacity sold, but primarily most of the times when those 
prices of zero occurred, these were in a capacity that is 
called ``must take'' and is being paid under a different 
contractual arrangement as primarily setting the price.
    So the other, I think, I want to also correct a few more 
misunderstandings here is the statement that these prices were 
too low. The average price for 1998 was not $18, it was above 
$30. And, moreover, generators in California also have the 
opportunity to earn ancillary service payments, which are 
payments to provide reserve capacity that roughly average on 
the order of about 7 to 10 percent more revenues to their 
facilities. Moreover, generators in California also have the 
opportunity to sign up for reliability must-run contracts, 
which pay them large amounts of money in payments to provide 
local reliability service, in addition to the prices that they 
receive for energy.
    So, I think we want to be very clear on all of the sources 
of revenue for generators in California.
    Chairman Lieberman. We seem to be replicating the ``Cross 
Fire'' show on television.
    Mr. Makovich. Just a quick one----
    Chairman Lieberman. Just a quick one because I want to ask 
one final question, though it is a good exchange.
    Thank you.
    Mr. Makovich. The $30 level is an average on-peak price.
    Mr. Wolak. No, it is not.
    Mr. Makovich. Well, even if it is across all hours----
    Mr. Wolak. Yes, it is across all hours.
    Mr. Makovich. You need something closer to $50 to justify 
building a power plant, and not everybody gets ancillary 
services. It depends on location.
    Mr. Wolak. That is not true, either.
    Mr. Makovich. The fact that nobody built power plants in 
California has to make one wonder, if they built them in Texas, 
and they built them in New England and did not build them in 
California, maybe there was a problem with the investment 
incentive.
    Chairman Lieberman. Yes. Let me move on because I was 
really asking about refunds, and we got off a bit.
    The final question is the effect of what is happening. We 
are all focused on California, but they are part of a regional 
grid, and I know seasonally power generating facilities in 
other States have fed into California. I was in Washington 
State, where, I am sure you all know, they tell me some of the 
aluminum plants have stopped because they are selling their 
electricity and making more than they could making aluminum, 
and people are out of work. So it is serious.
    I wonder whether you think that FERC should be including 
the other Western States in its response to the problems in 
California and its regulatory response to the problems in 
California.
    Dr. Joskow.
    Mr. Joskow. Senator Lieberman, if I might, I think to make 
the mitigation program that I mentioned before, which is 
extending the protocol FERC put into effect on May 29 to all 
hours, it is essential that it apply to the rest of the region, 
as well. This is the only way to deal with some of the problems 
that Frank Wolak mentioned, involving essentially daisy-
chaining the power from one reseller to another.
    So I would strongly recommend that if that is the approach 
that FERC takes that, in addition to extending the number of 
hours, that it include at least the other major control areas: 
Arizona Public Service, Tucson; Nevada, Bonneville; Public 
Service in New Mexico, in this program, and that is going to be 
the only way to tag the power plants that are supplying the 
power and applying their marginal cost base mitigation plan.
    Chairman Lieberman. Dr. Borenstein.
    Mr. Borenstein. Yes, I agree with Dr. Joskow that we really 
do need to do this on a regional basis because there are a lot 
of loopholes that can easily be exploited. I think it is also 
important to recognize, when we get onto this investment 
subject, I should also say, as director of the Energy 
Institute, I do not do consulting for any private companies in 
the business. So I have no financial interest here.
    It really concerns me when we start talking about the need 
to give firms capacity payments in order to get them into the 
market. Economics tells us pretty clearly that if you have 
competitive prices all of the time, you will get the right 
investment. Now it is going to be pretty disruptive in the 
electricity industry if you do not have a demand that can 
participate, and that is why you want to have long-term 
contracts and that is why you want to have demand 
responsiveness.
    But we need a regionwide approach to this, and we need to 
recognize that the goal here is not the lowest prices in 
history. The goal here is competitive prices that will 
ultimately serve consumers, and sometimes those competitive 
prices will be very low, and sometimes they will be high. The 
goal is to make sure they are the competitive ones.
    Senator Joskow. Could I add a note of history to this? When 
I was at Yale, I taught economic history. The Federal 
Government induced California to build long transmission lines 
to link them with the Northwest in the 1960's: Two AC lines, 
one DC line, and then in the 1980's a third AC line for the 
municipal utilities, and they were encouraged to rely on the 
Northwest for power and for the whole region to operate as an 
integrated system.
    One of the things that has happened as a result of this 
crisis is that every State is trying to grab onto its power 
supplies, which is just the opposite of what we hope to emerge 
in competitive wholesale markets, and abandoning would have 
been one of the best examples of regional cooperation anywhere 
in the United States, and I really think that we do not want to 
go back to a system where every State think it has to be energy 
self-sufficient. It would be a terribly, terribly costly 
mistake.
    Chairman Lieberman. My time is up, but, Dr. Hogan, I want 
to give you a chance to respond.
    Mr. Hogan. On this question of extending the FERC order to 
around the clock and to around the region, there are a number 
of things you have to be very careful about in doing this. It 
is not so simple.
    The FERC order includes a requirement that people bid in, 
under these bid caps that they have put in place, and it is one 
thing during these emergency hours. But it would be another 
thing during all hours. For example, there is the credit 
worthiness problem. They also are going to require that they be 
paid, and right now a lot of the problem is that people are not 
being paid, and that is why they do not want to produce. And if 
the Federal Government is going to mandate that you produce, 
they have to address that problem.
    Second, there is the problem of dealing with facilities 
that have cumulative limits because of environmental 
restrictions or any other kind of constraints, hydro facilities 
and the like, where the amount that you can produce over the 
year is limited, even though in any particular hour it might 
not be. And right now the order punts on that because they did 
not know how to deal with that problem, but they were only 
dealing with it during shortage hours so it did not matter so 
much. But if they go around the clock, this is going to become 
a big problem that they are going to have to address.
    Right now they have a system where they have discriminatory 
pricing rules for inside California and imports and power that 
is coming from outside California. That creates the opportunity 
for the marketers to get around the rules, as they perceive 
them, which I think is a good thing. The way to solve that 
problem is to simply go to a single-market clearing price. As 
Fred Kahn said earlier, when the imports are the marginal 
supply, then you should use those to set the marginal cost, not 
trying to set multiple prices for different markets.
    If they extend to the rest of the rest, they are going to 
have to deal with the problem of reserves. Do you want to draw 
down the reserves in Idaho in order to satisfy California and 
create reliability problems? These are not trivial issues and 
they are going to have to be worked out. There are solutions to 
these problems. They are going to have to get demand-side 
participation into the system somehow, which so far they have 
not been able to get in California, and that should be done 
across the whole West, if they can get to it.
    Chairman Lieberman. Thanks very much. I will think about 
your answer. Senator Thompson.
    Senator Thompson. Thank you very much, Mr. Chairman.
    I think it is good that we have FERC in, but least we spend 
all of our time concentrating on what they might could do with 
what I read is about 50-percent of the power that we will be 
dealing with, I think we need to understand that we are in the 
midst of a political issue. I mean, this is something public 
officials are going to have to decide, and I think until then, 
we need to take a close look at what FERC's proper role in this 
should be.
    But until we have some acknowledgment that California will 
allow its consumers to pay a little closer to what their energy 
costs really are, instead of relying on other forces and 
outside forces to do that for them, I think politically you are 
going to have great difficulty on shifting responsibility all 
on FERC.
    I just do not think that when you look at all of the 
factors that everyone acknowledged played a part: The 
structural situation that they set up, the insufficient 
capacity to meet the demand, the infrastructure problems, the 
weather problems--you are just not going to get most people to 
believe, I do not think, that all of this is because of wicked 
suppliers in Texas. So we need to look at a whole part of the 
picture. The governor will be here, and hopefully we will be 
able to see whether we could get the State and the Federal 
entities to agree that everybody needs to do a little something 
here and have a more likely solution.
    I want to ask one question, but I want to lead into it a 
little bit. I want to ask about the risk of not getting this 
cap situation right. In the first place, Dr. Hogan, do you 
agree that there is near unanimity with regard to the role of 
market power in this problem or do you think that is 
questionable?
    Mr. Hogan. I do not agree with that. I have looked at the 
analyses of this study, and I have done some independent 
analysis of some of the data that we can get in the public 
domain. My position on it at the moment is that it, with the 
information that we have in the public domain, which is 
insufficient, it is not possible yet to make a determination; 
in other words, that the margin of error is larger than the 
size of the effect we are trying to estimate.
    Senator Thompson. But we have, I presume, somewhat of a 
disagreement on the panel. At least two of you have questions 
with regard to the significance of market power playing into 
this price. Assuming that it does play a part or a large part, 
I want to address the difficulty in getting the caps right--the 
unintended consequences, the deciding of who, what, where, 
when, and how. I also want to address the complexity, if it is 
going to be a cost-based situation, of having hundreds or I 
guess thousands of suppliers and trying to determine what their 
individual costs are so you can determine what they are going 
to be allowed to charge. Also there is the issue of FERC only 
covering half the system and having two tiers, new entrants who 
are not covered, and old entrants who are.
    You know, we are reminded of Marc Rich back in the oil cap 
days. That is the way he made his money, apparently, with those 
two tiers and playing them against each other. Obviously, it is 
different with electricity, but it comes to mind. The point 
being the investors. You say in a perfect world here is the way 
it could work. You put it on at the right price, not too high, 
not too low. Have it administered correctly. Then you take it 
off at the right place, knowing that there is nothing that the 
government does that cannot be undone, causing credibility with 
regard to potential investors.
    My point being that it seems to me, and I think maybe 
several of you have acknowledged on both sides of this issue, 
that this is a complex proposition. It is a complex 
proposition, perhaps not impossible, perhaps something that 
cannot be done.
    But I want to ask what if, in fact, it turns out that this 
is not primarily a problem of market power? What if, in fact, 
and let us say there is maybe even a 30- to 40-percent 
possibility that it is not primarily a market power problem, 
that it is a supply and demand problem, and we impose these 
price caps or controls? From what I can understand of this, 
there is a tremendous risk that we would have substantially 
greater problems than we would otherwise have, and the 
blackouts would be more pervasive than they otherwise would be.
    First of all, Dr. Hogan, I will start with you. Is my 
premise correct? That is, that if we are incorrect about our 
assumption, basing all of this on the significance of market 
power and it turns out to be other things, are the risks of 
imposing caps into those circumstances great?
    Mr. Hogan. I think the answer is yes. That is why I made 
the point earlier that I think the diagnosis of what the 
problem is, is critical in deciding what to do.
    Senator Thompson. Excuse me, but as I understand it, if, in 
fact, it is market power, then they are right. If you impose 
caps, then the inducement to hold back is not there any more, 
so you will come across with the electricity. Again, my concern 
is are we that certain that this is the cause, that we can go 
in this direction? And if we are wrong, what are the 
consequences?
    Mr. Hogan. Well, I think there are many causes, and I am 
not certain about which is the dominant effect here. That is 
why the proposal that the FERC is pursuing, this bid cap 
proposal, is attractive if we are going to do anything at all. 
That is because a bid cap is the most robust policy with 
respect to the problems that you are talking about. To the 
extent that it is scarcity and you have a competitive market 
out there, and it is not market power, the bid caps effectively 
become redundant. It is a complicated process to get it put in 
place, but they effectively become redundant.
    And if you have market power out there and people are 
withholding, the bid caps target that problem exactly, and that 
is what they are trying to do to eliminate it.
    This is a very delicate business because when you are 
trying to do this, there are many ways to get it wrong, but 
this is, I think, the most robust mechanism. That is why it is 
so important to be careful about trying to target the market 
failures, rather than just worrying about making prices lower, 
because our objectives should not be just to make prices lower.
    Senator Thompson. If I understand what you are saying, you 
sound to me like you are somewhere in the middle between market 
caps, on the one hand, and what FERC is doing today.
    Mr. Hogan. I would not characterize what FERC is doing 
today as a price cap, in the traditional sense. I think it is 
different, and the term of art is a bid cap mechanism. It does 
not determine what the market price will be. The market price 
can go up and down and varies with conditions at every hour and 
depending what plants are running and what is happening to the 
water in the Northwest. You do not have to decide those things 
before the fact. It adapts it the same way, trying to emulate 
what the competitive market would do, and so it targets the 
market failure. But it does not guarantee--you have to be 
candid about it--it does not guarantee that prices will be low 
because if there is a scarcity problem, prices will be high.
    Senator Thompson. Dr. Joskow.
    Mr. Joskow. Thank you, Senator Thompson.
    There is one thing I would like to make crystal clear. 
Nobody who has done the studies of market prices, market 
behavior and market power in California in year 2000 has 
concluded that the dominant source of the price increases was 
market power. We have all recognized gas prices went up, demand 
went up, imports went down, NOX credit prices went up and have 
tried to take that into account in our analysis.
    Merely $5 to $6 billion out of $27 billion, I think that is 
the average of the various studies, are due to market power. I 
think that is a lot of money. It would be a lot of money to me. 
I have done a study with public data, the ISO has done a study 
with confidential data. Frank Wolak, Severin Borenstein, and 
Jim Bushnell have done a study with public and some 
confidential data, and they basically all come to the same 
conclusion. There is evidence of market power driving prices up 
above what would have already been high prices.
    And Mr. Hogan wrote a very thoughtful paper criticizing 
some of these studies, and I am about to finish a response that 
recalculates our numbers. I would be happy to provide it to the 
Committee. I hope it will be done in a week. So that is my 
first point.
    Senator Thompson. Is it fair to say, and do not let me keep 
you from your second point----
    Mr. Joskow. Sure.
    Senator Thompson. Is it fair to say that the confluence 
perhaps of all of these circumstances in this history put 
California in a situation where market power could come into 
play?
    Mr. Joskow. Absolutely. This is not a conspiracy issue. 
This is a result of the conditions in California that provide 
suppliers with opportunities to maximize profits that lead to 
prices that are above competitive levels.
    The second point I would make is that FERC is already 
applying a price mitigation program. We can call it whatever we 
want. I will not use the term ``price caps,'' but it does 
effectively cap prices at a certain level when it is 
implemented. I agree with Mr. Hogan that is the appropriate 
framework because it is targeted on trying to simulate 
competitive prices.
    I would like to see us at least explore whether we can 
expand the number of hours, and more importantly close some of 
the loopholes in the current program by bringing other States 
into the program as well.
    And the final point I would make is that we have a lot of 
experience with applying mitigation mechanisms around the 
country. You would think from the public discussion of this 
that this is some new thing that has never been done before. It 
has been done. We have had bid caps and PJM for 6 months. We 
have had price caps in New York and in New England. It has not 
discouraged investment, it has not led to shortages. It has 
given folks the confidence that they can fix what were pieces 
of broken markets without unreasonable economic consequences.
    So I think we have a lot of experience. If they bring 
knowledgeable people to the table to fix this problem, we can 
do it in a way that minimizes the concerns, the legitimate 
concerns that you have, and we need to recognize that none of 
these schemes are going to be perfect. We need to do the best 
we can in an imperfect world.
    Senator Thompson. Thank you. Before I call on Dr. Makovich, 
we always or oftentimes go back and get the statements of 
experts or academics and cross-examine them with them. I want 
to turn the tables a little bit here and point out that Dr. 
Makovich wrote, in April 1997, an analysis of the California 
market, and said, ``There is no reliable mechanism in 
California to pay for the fix and operating costs of new 
generating facilities, since the means for doing so, that is, 
long-term contracts and high ancillary service payments are 
unlikely to be widely available for several years, given the 
rate for these and above-noted trend toward low PX prices. This 
is likely to lead to extended periods of low prices, followed 
by periods of very high prices, as supply shortages and 
surpluses develop. Price volatility will not be conducive to a 
smooth transition to competition.''
    Congratulations, Mr. Makovich. Not only apparently was this 
foreseeable by some, it was foreseen. I understand the folks at 
Bonneville, in early 1999, pointed out that it looked like 
there was going to be some hydro shortages in the Northwest. So 
that is a parenthetical. I do not want you to move too far away 
from the question I ask, and that is the consequences of 
getting it wrong.
    Mr. Makovich. Right. Well, I think the consequences of 
getting it wrong are very serious. For example, it has been 
mentioned today it would be a good idea to exempt new supply 
from any kind of price cap proposal, but it is important to 
realize, as we look back over the decade of the 1990's, a major 
source of new supply in this country, if not the majority of 
new supply over the first half of that decade, came from the 
refurbishment and investment in existing power plants.
    And so we are either going to create a disincentive to 
investing in power plants and improving efficiency, and 
availability and capability, or we are going to create a very 
complicated review process, where people are going to have to 
try to argue what percentage of my plant is now new capacity 
versus old capacity.
    We have already seen, within the past week, an announcement 
that 500 megawatts are not going to be developed in California 
by a major supplier who had a site that was permitted, and they 
were ready to go on construction.
    And, finally, with this idea, there is a bit of a circular 
argument here with withholding capacity. The conditions of the 
very inelastic supply and demand curves only exist in a 
shortage so that the only way it is rational to withhold is if 
you have got a shortage. So to argue the shortage is caused by 
withholding is a bit of a circular argument, and there are 
problems with the basic data. People are running these power 
plants far harder this year and last than they ever did before.
    So the basic data here is something that has to be looked 
at far more carefully to come to the conclusion because it is a 
very dramatic accusation to somebody that they are withholding 
capacity and supply from this market----
    Senator Thompson. You could ask why they did not withhold 
in 1998 and 1999, I suppose.
    Mr. Makovich. It would have been worth a lot more to them 
to do so.
    Senator Thompson. My time is up, but obviously----
    Chairman Lieberman. Do you want to have the last word?
    Mr. Borenstein. Well, actually, it would not have been 
worth a lot more to them to do so. In 1998 and 1999, there was 
a lot more supply, and the economics of withholding were much 
less attractive in 1998 and 1999.
    Put simply, the right question to ask is, when you put 
yourself in a position when the ISO is near a blackout, they 
have 2-percent reserves left, and you own 6 percent of the 
capacity in the State, what do you bid? And the answer is 
whatever you can get away with, and that is not to demonize the 
generators. They are out there trying to make money. That is 
what they are supposed to do. Our job is to create markets 
where when they try to make as much money as they can, they end 
up helping consumers.
    But it is a fantasy to say that this is a market in which 
generators cannot exercise market power. It is a serious issue. 
I do want to respond to Senator Thompson's question that it 
would be a major disaster to set the price caps too low. We saw 
that last November when we had this 250 price cap, and the 
price of natural gas went too high, and generators did the 
rational thing and shut it off. That is exactly the 1970's all 
over again, only worse.
    However, it would also be a major disaster to simply walk 
away and pretend there is not a problem here. Because at those 
times of peak demand, if we have no price mitigation, we will 
have billion-dollar prices. There is just nothing to stop it.
    Chairman Lieberman. Thanks, Dr. Borenstein.
    Thanks, Senator Thompson, and thanks to all of you. It has 
been a long hearing, but it has been a very productive hearing. 
I think we have all learned a lot about the situation in 
California, and frankly about FERC, and you have helped us to 
get ready to ask some constructive questions of FERC. I do 
think that there is agreement that the rates in California now 
are not just and reasonable, that FERC has some role to play 
here, although there is a disagreement as to what the role is.
    The other thing I have heard is that no one thinks, in 
spite of the drop in prices out there in the last few days, 
that the crisis is over or that everything is going to be OK 
this summer. So this calls on us all to continue to work 
together. And I hope that some of the kinds of discussions 
among technical people can occur that many of you described, 
and that may get us some way forward.
    Anyway, thanks for taking the time to come here. Thanks for 
sharing your expertise with us. It has been a very productive 
morning.
    The hearing is adjourned. Thank you.
    [Whereupon, at 1:19 p.m., the Committee was adjourned.]


 THE ROLE OF THE FEDERAL ENERGY REGULATORY COMMISSION ASSOCIATED WITH 
                 THE RESTRUCTURING OF ENERGY INDUSTRIES

                              ----------                              


                        WEDNESDAY, JUNE 20, 2001

                                       U.S. Senate,
                         Committee on Governmental Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 9:35 a.m., in 
room SD-106, Dirksen Senate Office Building, Hon. Joseph I. 
Lieberman, Chairman of the Committee, presiding.
    Present: Senators Lieberman, Durbin, Torricelli, Carper, 
Carnahan, Thompson, Collins, Voinovich, Domenici, and Bennett.

            OPENING STATEMENT OF CHAIRMAN LIEBERMAN

    Chairman Lieberman. Let me ask everyone to take their seats 
and we will begin the hearing. I appreciate very much the 
presence of all of our witnesses and guests. I wish you good 
morning and I thank you for joining us today as the Senate 
Governmental Affairs Committee continues its hearings into how 
the Federal Government has conducted itself in response to the 
deregulation of the U.S. energy industries, with a particular 
emphasis, of course, on the cost and supply of electricity in 
California and the Western United States.
    Last week, we heard from five economists, including Alfred 
Kahn, the father of deregulation himself. They agreed that the 
California market was so dysfunctional that the Federal 
Government needed to intervene and temporarily regulate. On 
Monday, the agency that oversees electricity rates, the Federal 
Energy Regulatory Commission, which is known here in Washington 
by the acronym FERC, agreed to take action.
    Today, we are going to hear about FERC's latest order and 
whether or not it adequately carries out the Commission's 
statutory responsibility to provide just and reasonable rates 
for electricity consumers in California and the West.
    I must say that I am relieved that the Commission has 
asserted itself more aggressively to address the severe 
problems in Western power markets, although I remain concerned 
that even at this late date it has not done all that it could. 
The price limits established by FERC may still be too high, and 
ratepayers in California and in other Western States may still 
deserve substantially greater refunds for overcharges that have 
previously been imposed for them.
    We are very fortunate today to have most of the key 
participants in this complex matter as witnesses before the 
Committee, including Governor Gray Davis, the Governors of 
North Dakota and Montana, Representatives from the State 
Governments of Oregon and Washington, the five members of FERC, 
as well as three distinguished colleagues here in the Senate.
    To put this hearing briefly in historical context, let me 
say that Federal oversight of wholesale electricity sales began 
in 1935 when Congress passed the Federal Power Act mandating 
that prices for electricity be just and reasonable.
    Originally, those oversight duties were assigned to the 
Federal Power Commission, which in the 1977 reorganization of 
the Department of Energy became FERC. The Federal Power Act 
remains, however, the primary statute governing FERC oversight 
of wholesale electricity sales. And the law requires that all 
rates in connection with the transmission or sale of electric 
power under the Commission's jurisdiction shall be, ``just and 
reasonable and not unduly discriminatory or preferential.''
    FERC is authorized upon outside complaint, or its own 
initiative, to investigate prices that appear suspect. And if 
the rates are found to be unjust or unreasonable, the 
Commission is obligated to take remedial action, including the 
ordering of refunds to customers.
    Traditionally, FERC has met its obligation to ensure just 
and reasonable rates by ordering rates that provided for cost 
recovery plus a margin of profit, in the same manner that most 
State public utilities authorities or commissions have done for 
generations.
    More recently, FERC has allowed market-based pricing or 
proxy pricing, such as it ordered Monday, to be the standard 
for just and reasonable.
    No matter what the methodology, FERC remains responsible 
for ensuring that the wholesale markets operate competitively 
and that the rates they produce are just and reasonable.
    As the Committee heard last week, in 1996, California 
enacted legislation to deregulate its electricity markets 
beginning in 1998. To put it mildly, it has not been an easy 
transition, either for California or other Western States, 
because of record prices for electricity, supply shortages, 
rolling blackouts, and price spikes for natural gas.
    The transition to deregulation prompted the bankruptcy and 
near bankruptcy of major investor-owned utilities, and in an 
extraordinary development, the State of California has now 
assumed responsibility for wholesale power purchases.
    So as I see it, the question today is: Has FERC responded 
adequately to this crisis? What is the record? Last July, 
almost a year ago, FERC began a staff investigation into 
electricity problems in the West and a formal investigation 
into California prices. In a December 15 order, FERC concluded 
that the California market was deeply flawed, which, when 
combined with other factors, caused electricity prices to be 
neither just nor reasonable. So the Commission ordered changes 
in the California market and established a procedure for 
refunding excessive charges.
    Yet in March and April of this year, as the Commission 
began implementing that procedure, it also significantly 
limited the number of transactions subject to refund and the 
circumstances under which prices would be mitigated.
    In April, the Commission also initiated a formal Federal 
Power Act investigation of the Western electricity market. Two 
days ago, FERC expanded those actions by setting a soft cap on 
energy prices, around the clock, and regionwide.
    In my opinion, the Commission's record in this matter 
raises serious questions about whether it will, and has, 
adequately overseen newly deregulated energy markets. It has 
been very slow in responding to this real and painful crisis. 
While the Commission by its own admission has had the authority 
to intervene to ensure just and reasonable rates, it has been 
surprisingly reluctant to do so. It did not initiate a formal 
investigation of the Western market outside of California until 
April of this year. In the past, when it has intervened in 
response to California's problem, the result has fallen short 
of what the public interest required.
    I, of course, hope that Monday's order will be more 
successful, but I continue to have substantial concerns. I 
believe the order addressed the matter of refunds for 
electricity in California in an unsatisfactory manner, and it 
did nothing for refunds for consumers elsewhere in the West.
    Monday's order will constrain some price spikes and close 
some loopholes in the previous FERC order, and that, of course, 
is all to the good and appreciated. But will it ensure that 
electricity prices in California and throughout the West are 
just and reasonable? That is not only the bottom-line question, 
it is the law. And it is that question that I hope our 
witnesses will address this morning.
    Senator Thompson.

             OPENING STATEMENT OF SENATOR THOMPSON

    Senator Thompson. Thank you very much, Mr. Chairman. I 
think it is obvious to all of us that California is in a state 
of crisis. Two of its largest utilities have gone under or one 
has taken bankruptcy. California bonds have been downgraded on 
two occasions. Producers, suppliers, who the State is going to 
have to depend upon for additional supply in the future, are 
expressing concerns. Some projects now have been delayed. We 
have seen blackouts, and we are told that, apparently 
regardless what happens from here on out, we are locked into 
future blackouts this summer. It is of concern to all of us, 
not only from a humanitarian standpoint but from an economic 
standpoint. California, of course, is extremely important to 
the rest of the Nation from that standpoint. So we are 
addressing the question of what to do about it at this stage of 
the game and who is responsible.
    I am reminded, as I look at this, of the wisdom of the 
Founding Fathers and the system of federalism that they 
created, and that was that we should have responsibility at two 
different levels of government, and one of the reasons for that 
was to assess accountability. And if there was ever a place 
where we do not have federalism, it is here. We have a split 
system where the State is responsible for the retail market, as 
it were, and a Federal system where the Federal Government has 
some responsibility in terms of wholesale prices with regard to 
private suppliers. And it ensures that no one will really have 
to accept accountability when things go wrong, and that is one 
of the reasons, of course, we are seeing all of the finger-
pointing and the blame-gaming that we are seeing now.
    But it is true that this hearing today has been focused on 
FERC. I think it is unfortunate. I see we have five panels 
here, and a certain thing in some businesses they refer to as 
``prime time,'' and FERC's appearance is not in it. And I 
certainly hope that we have at least a semblance of the 
interest in hearing the FERC testimony, which is supposed to be 
the primary subject of this hearing when they come on sometime 
probably mid-afternoon.
    But they do have a responsibility in certain areas, and 
part of that has to do with just and reasonable prices, 
whatever that may be. The idea of a Federal agency deciding 
what is just for something as important as this would be 
laughable in any other context, but that is the law, and that 
is what we operate under.
    That has led many to call for hard caps. Constituents and 
elected leaders, after thoughtfully mulling over this for long 
periods of time come down on the side of lower rates instead of 
higher rates. But we know that in any long-term sense, anyway, 
that generally speaking caps do not work when supply is the 
problem. And neither the FERC while President Bush is President 
or the FERC while President Clinton was President has thought 
that hard caps were a good idea. In fact, the prevailing 
opinion is that when supply is the problem, they make a bad 
situation worse.
    Now we are told that this is different, this situation is 
different, that we can apply a Goldilocks test to this one and 
we can get the rates not too high, otherwise, they would be 
ineffective; not too low, otherwise, we would drive supply out 
of the market; and we would lift it just at the right time and 
all of that would work out, although I see no model for that in 
history anywhere. There are a lot of very credible people who 
think that that is the way to go.
    So there has been tremendous pressure on FERC because of 
that. They have taken several actions. I was reading a summary 
of the written testimony of FERC Commissioner Linda Breathitt. 
She says that since last August, FERC has issued 50 orders 
implementing important remedial measures and price mitigation, 
instituted investigations into rates and market design flaws, 
established programs to maximize electricity supply and 
delivery and demand reduction, and directed sellers to provide 
refunds.
    And, of course, those refunds, rebates, are an important 
part of this process. It does not shock me to find out that in 
a matter involving this much money and this many people and 
this many suppliers that there probably have been some out 
there who have not behaved as they should, even though I see no 
allegations of criminal activity--at this point, anyway. Those 
investigations are ongoing, and they should be ongoing. But for 
most people, the idea that this problem was caused solely or 
even primarily by that is far-fetched, to say the least. So let 
that play out as it may. Let's acknowledge that that might be a 
part of the mix.
    FERC, on April 25, of course, entered into a price 
mitigation system. Prices have dropped since that time. Now we 
are switching somewhat from a blame game to a credit game, and 
everybody is scrambling to claim credit for the recent drop in 
prices in California, and we will watch that play out with some 
interest. But now they have expanded the price mitigation 
system. It is not a hard price cap, and it is not price 
controls in the normal sense of the word, I would think. But it 
has been expanded to all of the Western grid and to an around-
the-clock operation.
    However, some people believe that this problem has to do 
with more than just a Federal agency fine-tuning wholesale 
prices, and I am one of those. And some people believe that to 
determine where to go, it is good to consider how we got here 
in the first place.
    Now, for Governor Davis, the answer is simple. A bunch of 
Texas cowboys got down at the corral and decided they were 
going to take advantage of helpless California, and we are 
seeing the results of it. In fact, we have seen no shortage of 
villains. The governor at one time or another has blamed 
Federal regulators, State regulators, the President, suppliers, 
the former governor, and a bankrupt public utility.
    However, I think we need to cast our net a little wider. 
Clearly, there are other factors at play. We know, for example, 
that we had a drier Northwest during crucial periods of time 
that cut back on the hydropower that the West normally sent 
down during the summer months and that California depends on. 
We had an inordinately hot summer. We had an inordinately cold 
winter. During all of this, we were experiencing increased 
demand throughout the West, and especially in California 
because of the growth of that part of the country. It was clear 
that California was becoming more and more dependent upon 
imports.
    Surely, none of us can blame anyone for those factors, but 
the other interesting point about that is none of those factors 
were secret developments. One would have thought that State 
officials might have noticed those things as they were 
occurring, especially since they were getting warnings as early 
as early 1999 with regard to the problems in the hydropower 
situation, at least.
    Other factors, of course, enter into play, and that has to 
do with the policies of California, the policies of the Public 
Utility Commission, and the governor. No power plants in 10 
years. The governor is not responsible for most of that. But 
capped retail rates at a time when the utilities were locked 
into spot markets, which everybody acknowledges was a mistake. 
When deregulation came about, we had a supply surplus of about 
30 percent in California. That situation, as we saw, rapidly 
changed, but the policies did not change with it.
    So PG&E was paying 30 cents and selling for 3 cents and, of 
course, ultimately went bankrupt as they were saying last year 
that they needed relief and others were saying they needed 
relief. No relief was coming.
    So no additional power, capped retail rates, locked into 
spot markets, a siting process that was longer than apparently 
anybody else's made it very difficult to put new power online. 
And then even more warnings from experts who were talking about 
the storm clouds that were looming, and then, of course, we saw 
shortages in May 2000.
    So all of the policies that were clearly a part of the 
problem were locked into place and kept there until the problem 
became a disaster. I think that it is instructive to look at 
other States around the country that have deregulated, that 
have not had similar problems. They did not have some of the 
natural problems either that California had, in all fairness, 
but they did not have some of the policies or adhere to them 
the way that California did either.
    Now, after blackouts are inevitable, apparently, according 
to the experts, some changes have been made. California now 
enters into long-term contracts, but apparently they are paying 
very high rates for the contracts, higher than spot markets. So 
when spot market prices were higher than long-term contracts, 
they were paying spot market prices. Now that long-term 
contracts are higher than spot market prices, they are paying 
long-term prices. A policy of buy high, sell low. And we do not 
know exactly what prices they are paying because California has 
not been willing to release the prices that California citizens 
are paying for the long-term contracts for municipalities, 
which, of course, continue to be large suppliers of power.
    So I do not want to rain on anybody's parade here today as 
we bring FERC to task, but I guess, as Paul Harvey would say, 
perhaps we ought to look at the rest of the story and, before 
the day is over, perhaps a more balanced view we will have not 
only as to what should be done at the Federal level but as to 
how we got here in the first place.
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you, Senator Thompson.
    It is a long hearing. We do have serious questions to ask. 
I assure you I will be here when FERC comes on, regardless of 
what hour it comes on. And in some sense, the morning testimony 
will pose questions which I think will be fair and reasonable 
both to those who are in the morning and to those who will 
follow in the afternoon.
    As is our custom, we will now go to Members of the Senate 
who asked to testify this morning, though I do note the 
presence of a growing number of members of the California 
delegation. I do want to welcome them here. I see Congresswoman 
Jane Harman, Ellen Tauscher, Hilda Solis, Anna Eshoo, Joe Baca, 
Lois Capps, and Lynn Woolsey. And I thank you. Obviously your 
presence here is an expression of your concern about the 
ongoing problems regarding electricity rates in your State and 
your hope that we and FERC together can bring some relief to 
citizens and businesses in your State and to the economy of the 
State generally.
    I am pleased to have three colleagues with us. I can go in 
alphabetical or seniority order. Do you have a----
    Senator Murray. Seniority order.
    Chairman Lieberman. This is most encouraging. Your two 
colleagues from Washington State, acknowledging that you are 
obviously much older than either one of them, Frank, have 
yielded to you. So, Senator Murkowski, ranking member of the 
Senate Energy Committee, we thank you for being here and look 
forward to your testimony.

 TESTIMONY OF HON. FRANK H. MURKOWSKI, A U.S. SENATOR FROM THE 
                        STATE OF ALASKA

    Senator Murkowski. Thank you, Mr. Chairman, and let me 
thank the two gracious ladies on either side of me. I am most 
appreciative that you included Energy and Natural Resources 
Committee representation here at your hearing.
    Everybody seems to want to get in on the energy crisis at 
this time. There are many chairmen holding hearings, and that 
certainly is the prerogative. Some are even involved in 
spinning away their responsibility associated with the crisis 
in California. We have heard criticism of our President, of our 
Vice President, for being chummy and cozy with big oil, 
criticism that indeed the higher costs associated with the 
shortage are the responsibility of the administration.
    It strikes me, Mr. Chairman, that if you have a sickness--
and we have a sickness right here with the gentleman that just 
turned the chart over. It is upside down. [Laughter.]
    He is relatively highly paid--or I mean he was.
    Chairman Lieberman. Of course, there was some chance that 
we were upside down and the chart was right side up.
    Senator Murkowski. Well, we have been accused of that, too.
    Senator Thompson. I am glad we noticed.
    Senator Murkowski. But the point I wanted to make relative 
to the criticism of the President and the Vice President for 
being too chummy and out of the oil patch and part of the bad 
guys from Texas, I think somebody did a calculation that 
suggested that Texas-owned companies contribute about 12 
percent of the energy that California consumes. But, 
ordinarily, if you have a sickness or a crisis of some kind, 
you address it with some degree of expertise as opposed to 
holding a public hearing. And I think the energy situation in 
this country is a sickness. You need people who know something 
about it, how to correct it, and how to bring about change. And 
I think both our President and our Vice President fit that 
category.
    Now, we know something about energy as well, Mr. Chairman. 
We have held 24 hearings, Senator Bingaman and I. We have had 
164 witnesses. And what we found is very simple: We must 
increase production, we must develop alternatives and 
renewables, and we must improve conservation. It is just that 
simple. And those that suggest it is more complex are leading 
you down either goat or rabbit trails, as the case may be.
    We had a hearing in this room yesterday. We had FERC here. 
We had all five commissioners. And it was rather interesting 
because they did reach a conclusion. All five concluded that 
Congress should not legislate price control legislation or 
wholesale price caps, as the case may be.
    I would also remind you that FERC is just recently up and 
running. They just obtained the last two members, and now they 
have a five-member commission. Further, both sponsors of the 
price cap legislation, Senator Smith and Senator Feinstein, 
have indicated they will not push for legislation to a markup 
on their proposed wholesale cap bill, which I think is relative 
to the action that FERC has taken and their belief that FERC is 
doing the job that they were set up to do.
    Now, I commend the President and the Vice President for 
staying the course, staying the course against wholesale caps. 
This is the only way the energy supply will increase. If you 
put caps on, you will not get investment. We heard testimony 
given yesterday by the investment community relative to the 
fact that if you have tight caps, there is not the incentive 
for investment. And the investment can go a number of places.
    I think it is also important to point out that under the 
Bush Administration, FERC has taken their responsibilities 
seriously, somewhere between 30 and 50 orders, as Senator 
Thompson indicated, since they took over. Now, where was FERC 
before that? Well, they were running pretty lean. But, 
nevertheless, the crisis did not occur beginning in January. 
The crisis in California was in effect beyond that. And why 
FERC did not act, why, perhaps you could pursue that. Their 
just-issued West-wide order will further help both California 
and the entire Western United States.
    Now, we do have the chart now right side up, and the point 
I want to make with that chart is that it is working.\1\ What 
you are looking at is California's price structure relative to 
the peak power costs. And you will see it is down now to 
somewhere in the area of $48, and when you compare it to what 
it was, nearly $550 or $600, I think you can see that it is 
moving in the right direction.
---------------------------------------------------------------------------
    \1\ The chart entitled ``California Day-Ahead Power Prices,'' 
appears in the Appendix on page 551.
---------------------------------------------------------------------------
    Now, basically, that FERC has done its part, the question 
is what must California do, and I think that is an important 
reflection on the responsibility of the Congress.
    California, of course, has driven one investor-owned 
utility into bankruptcy and has put the other two on the brink 
of bankruptcy. The governor once said that he could solve 
California's problems in 15 minutes if he just let the true 
cost of electricity be passed on to the consumer. Well, you can 
ask him about that. But it appears that California has 
continued to try and hide the true cost of power by having the 
State now pay for it instead of the utilities. This puts the 
taxpayer of California on the hook for somewhere in the area of 
$47 billion.
    My question is: What is the difference between the 
ratepayer and the taxpayer? I find little difference. Although 
California officials accuse investor-owned power as being 
``pirates,'' they have done little to protect California 
consumers from power sold by municipally owned utilities that 
are within California's own authority.
    A recent Los Angeles Times article reported that the city-
owned Los Angeles Department of Water and Power was one of the 
largest moneymakers in the California spot market and made 
$17.8 million. And I would remind you that is owned by the city 
of Los Angeles.
    Further, California's problem is not lack of regulation. It 
is really a lack of generation. California bet it could stop 
building new power plants and instead import power from outside 
the State. California ordered its investor-owned utilities to 
divest their fossil fuel generation but exempted the municipal 
utilities. Why would they exempt one and not the other? Well, 
you can ask the governor.
    California prohibited its investor-owned utilities from 
using long-term contracts for power and forced them to rely on 
the spot market. This strategy can work for a time when there 
is excess in that spot market. But it did not work when that 
excess was removed.
    California has taken steps to expedite power plant 
construction. It has let a lot of permits. But the question is: 
How many of those permits have firm take-outs from financial 
bodies that are prepared to back them without a degree of 
certainty on the rates that those investments are going to 
amortize?
    So I think the jury is still out whether the California 
investor will want to build in California given the investment 
climate the State has created.
    As we look at the issue, Mr. Chairman, of those that are 
alleged of profiteering, I am going to ask that this be 
included in the record, the ``Top 10 in Profits.''
    According to the California independent systems operator 
say that they total $505 million. Two-thirds of that are 
associated with British Columbia Power Exchange, $176 million, 
Mr. Chairman; Bonneville Power, $30 million; Los Angeles 
Department of Water and Power, $17.8 million. There you have a 
significant portion of those overcharges, and they are 
municipally owned. In the case of BC Power, they are outside.
    Finally, in conclusion, the solution to California's 
problems is more power plants of all types, natural gas, 
nuclear, renewables, and incentives for conservation. And you 
provide that incentive for conservation when you pass on the 
true cost of power to the consumer. Then the consumer will 
conserve, go down and buy a new refrigerator or whatever. 
FERC's order clears the way for Congress to focus on the 
national energy crisis that is affecting millions of families 
from coast to coast, not just California. Before the recent 
change in the Senate, we were on a course to bring President 
Bush's task force legislation to the floor, Senator Bingaman 
and I in a bipartisan package. As I have indicated, we have had 
the hearings. Senator Lott said at that time the energy 
legislation would be the next order of business after the 
Senate finished education. But under the new Senate schedule, 
energy has slipped on the Senate schedule. That is unfortunate 
in view of the fact that polling indicates that energy is the 
number one issue in the country at this time.
    So now is really the time for action on a comprehensive 
energy legislation to bring about a long-term and meaningful 
solution to the Nation's real energy problems, and I am 
convinced that the time for talk is behind us. The time for 
action is now.
    Thank you for the courtesies extended to me. I would ask to 
be excused. I have another hearing on the Energy Committee at 
this time.
    Chairman Lieberman. Thanks, Senator Murkowski. Thank you 
for being here.
    Senator Murray.

 TESTIMONY OF HON. PATTY MURRAY, A U.S. SENATOR FROM THE STATE 
                         OF WASHINGTON

    Senator Murray. Thank you very much, Mr. Chairman and 
Members of this Committee, for calling this hearing. In my home 
State of Washington, there is no more important issue than the 
energy crisis today. Two days ago, after months of delay, the 
Federal Energy Regulatory Commission finally woke up and took 
action against alarming energy rates. FERC, as all of you know, 
put in place price controls that are similar to what Senator 
Lieberman and I and Senator Cantwell and others have been 
urging for months. I am glad that FERC finally came around, 
helping us bring some order to this volatile energy market, but 
this one step is not going to solve the energy crisis.
    The energy crisis is very real, Mr. Chairman. It is not 
going away, and the Federal Government needs to do its part to 
help our communities. Today, I want to share with this 
Committee how the energy crisis is hurting Washington State, 
and then I want to offer six things that the Federal Government 
must do to protect our people and our economy.
    Let me begin with the impact in Washington State. We have 
already lost thousands of jobs because of rising energy rates. 
Entire industries could be idle just to prevent massive rate 
increases. According to one estimate, Washington State could 
lose another 42,000 jobs over the next 10 years unless we take 
action. Not only are there economic costs, but there are 
environmental impacts as well, including our ability to recover 
endangered salmon.
    I want to share with you a typical letter I received from a 
constituent in Washington State. Mrs. Valeria Mesler of 
Okanogan, Washington, wrote to me: ``I am a 91-year-old widow 
living on my Social Security check each month, which is small. 
I cannot afford any increase in the cost of my electricity. I 
am sure there are many like me and also younger families on low 
incomes.''
    Mr. Chairman, she is right. There are thousands like her.
    Today, the energy crisis is hitting our pocketbooks, and 
unless we act, tomorrow it will threaten our prosperity. Even 
Washington State schools are feeling the impact. Nancy Olson, 
who is the superintendent at the Ocean Beach School District 
wrote me that energy costs will add another $200,000 to their 
budget. As a result, they are going to have to lay off the 
equivalent of 3.5 teachers. According to Superintendent Olson, 
``We have no extras anywhere in our budget. We will now have to 
resort to cutting teachers, which means increased class 
sizes.'' They are even, Mr. Chairman, considering going to a 4-
day week in that school because of the costs.
    Energy is impacting everything from our kids' education to 
jobs in our economy, to every family's personal quality of life 
and finances. We in Washington State are doing our part. We are 
conserving and we are cutting our energy use. Several of 
Washington's public utility districts have worked with 
consumers and have agreed to cut back on the amount of power 
they receive from Bonneville Power Administration. Last week, 
the Benton County PUD agreed to reduce its energy load by 10 
percent. Recently, Clark Public Utilities, Franklin, and 
Ponderay and Grace Harbor PUDs have signed load reduction 
agreements as well.
    People are changing their habits and buying more energy-
saving products. In fact, in many parts of my State, you cannot 
even find a compact fluorescent light bulb on store shelves 
because they are all sold out.
    We are also bringing new energy sources into service, 
especially renewable sources like wind. We have a 300-megawatt 
wind field being developed near Walla Walla and another 150- to 
500-megawatt wind field planned for Prosser. We have a company 
in Kelso, Washington, that takes plastic from landfills and 
turns it into high-octane, low-sulfur diesel fuel. We are doing 
our part. But we need the support and the leadership from this 
administration.
    I, of course, am not saying that this administration caused 
this crisis. It did not. But I have believed that it has stood 
in the way instead of providing us the help that is critically 
needed. First, they identified it as just a California problem. 
Then, instead of urging conservation, they decried it as simply 
a personal virtue. And later, when we introduced bipartisan 
price cap legislation, the administration said no. Instead, 
they sent us an energy plan that focuses too much on drilling 
for oil and gas with very little support for alternative and 
renewable sources of energy.
    Throughout, FERC has not done anything to help Washington 
State consumers get relief from predatory pricing. This week 
the administration's FERC appointees finally came around and 
accepted what we have been telling them all along, that we need 
price caps, temporary price caps, to protect consumers from 
outrageous rates. Frankly, I think the bipartisan legislation 
we have pushed has helped them make that decision.
    Mr. Chairman, this administration has minimized this crisis 
for months, and people across my home State of Washington are 
paying the price. We are doing our part to conserve and to 
generate new, clean energy in Washington State. Now it is time 
for the Federal Government to do its part, and I want to 
quickly outline six steps I think we need to do at the Federal 
level.
    First, we need a disaster declaration so that hard-hit 
small businesses can get low-interest loans from the Small 
Business Administration.
    Second, we need real Federal support for conservation.
    Third, we need to diversify our energy sources.
    Fourth, we need to site new plants.
    Fifth, we need FERC to keep its word and investigate price 
gouging in Washington State and other Western markets. If 
prices have been unjust, there have to be swift refunds.
    And, finally, we need to make sure that as we expand our 
energy infrastructure, our oil and gas pipelines are safe.
    Mr. Chairman, those are the steps we need to take at the 
Federal level to keep this crisis from getting worse. I hope 
that this administration will see the wisdom of acting now to 
protect our economy, our communities, and our citizens before 
it is too late.
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you, Senator Murray, for that 
testimony.
    Senator Cantwell, good morning and thanks for being here.

TESTIMONY OF HON. MARIA CANTWELL, A U.S. SENATOR FROM THE STATE 
                         OF WASHINGTON

    Senator Cantwell. Thank you, Mr. Chairman and Senator 
Thompson. I thank you for this opportunity to testify before 
the Committee today and for your leadership on this important 
issue.
    The Senate Energy Committee, of which I am a member, has 
had numerous hearings on this issue, and I want to applaud 
Chairman Bingaman for the leadership and commitment that he has 
brought to this issue, and to Senator Murkowski for the number 
of hearings that we have, in fact, held for his attention to 
this issue.
    Today's hearing focuses on a subject that I believe 
Congress must explore fully and, more importantly, be prepared 
to act on: The role of FERC. Our Nation's top energy regulator 
probably has never been more important than today.
    As the energy crisis has evolved, I have had an opportunity 
to get to know all the FERC Commissioners and am pleased that 
we now have a full contingent of commissioners with two new 
members, Commissioner Pat Wood and Commissioner Nora Brownell.
    Today, the FERC is in the unenviable position of being on 
the Congress' radar screen. I think it is important to keep in 
mind that this agency is in transition, responding to a brave 
new energy world. But as our recent experience in the Northwest 
has shown, the FERC has a long ways to go in its transition.
    I am concerned about two things. I am concerned that the 
agency has been slow to respond, and even when it has 
responded, it has not always acted with equal vigilance from 
State to State. One cannot, as Senator Murray pointed out, open 
up newspapers in Washington State without finding stories about 
the energy impacts on our State, families, businesses, and 
community. As perhaps too few people realize in the midst of 
these bright lights shining on California, this really has been 
a crisis from which the Pacific Northwest has suffered. Yes, it 
has been exacerbated by a drought that has been the worst 
drought in 30 years. But, nonetheless, our need to go out and 
buy power on the spot market left us subject to rates 11 times 
what they were a year ago today.
    The results have been devastating and have touched every 
part of our economy, from traditional energy-intensive 
industries such as aluminum and paper, to small businesses, 
farmers, and even technology companies. Thousands of people 
have already lost their jobs and plants have been shut down. A 
hospital in Washington State has experienced probably $1 
million in additional energy costs that will come off of their 
bottom line. Small businesses as diverse as grocery stores and 
hotels have already started adding energy surcharges. And this 
is despite an effort by most of these businesses to curtail 
their energy consumption by over 30 percent.
    Governor Locke has issued a challenge for people and 
business in Washington to conserve 10 percent. Many businesses 
are reaching far beyond that and still seeing rate increases 
that are the same amount as what they paid for their entire 
energy bill last year. Our State's LIHEAP caseload is expected 
to rise by over 50 percent this year due to skyrocketing energy 
prices.
    These facts point to an inescapable, common-sense 
conclusion--that the Western power markets have been 
dysfunctional for quite some time and that the electricity 
prices in the Northwest have been neither just nor reasonable. 
Like many of my colleagues, I want to say I appreciate the 
steps that the FERC Commissioners took on Monday, June 18, to 
help mitigate the impacts of the Nation's energy crisis and 
rein in the runaway electricity prices in 11 Western States. I 
am hopeful that these actions will help address the crisis in 
the Northwest.
    However, during the hearing before the Senate Energy and 
Natural Resources Committee yesterday morning, I had an 
opportunity to ask the FERC Commissioner and the FERC's general 
counsel about my concerns given that we had not had a chance to 
read the order. In response to my questions, I found one piece 
of information very troubling. That is, Mr. Chairman, despite a 
year of skyrocketing prices throughout the Northwest and other 
Western States, the FERC admits that it will not provide a 
mechanism for those in the Western States outside of California 
to seek refunds--this is a very important issue--other than 
refunds that would occur after July 2, 2001.
    On the one hand, FERC has offered long overdue relief to 
Washington State consumers who are staggering from these high 
energy prices. But, on the other hand, it has taken away an 
opportunity for us to get these refunds. With the support of 
Senator Murray and other Senators from the Northwest, I am 
sending a letter to FERC Chairman Curtis Hebert today asking 
for a rehearing on the Commission's December 15 order in which 
FERC denied Puget Sound Energy's complaint regarding the West, 
outside California. We are asking FERC to set a refund 
effective date consistent with Puget Sound Energy's October 
2000 filing.
    Mr. Chairman, whether this refusal to consider consumer 
refunds outside of California is an oversight or an accident, 
it is certainly the latest in a series of FERC actions that 
have elicited questions and concerns from many people in my 
State.
    Over the last year, people in Washington State have endured 
many impacts from this energy crisis, and I think it is very 
important that FERC go further in addressing this issue of 
repayment.
    Mr. Chairman, obviously this Committee and the Congress in 
general, as policymakers, need to ferret out the many causes of 
FERC's slow-to-act performance in the face of this crisis, 
whether it is lack of a clear mandate arising from dramatic 
changes in the energy industry, a lack of necessary information 
or resources to do its job, or simply just a lack of will. But 
as we work to prevent such crises in the future, we also need 
to focus on how to correct the mistakes that have been made.
    We know that there are Pacific Northwest communities that 
have been devastated by plant closures and job loss due to an 
unprecedented run-up in electricity prices and FERC's inactions 
and omissions. It is simply unacceptable that the Federal 
agency charged with ensuring that consumers are protected does 
not meet that responsibility.
    With this in mind, Mr. Chairman, I hope that FERC heeds our 
calls to reverse its decisions on issues of retroactive refunds 
for Northwest consumers and applies the same standards of 
fairness to the constituents of my State as they have to 
ratepayers in California.
    I thank the Committee for this opportunity to speak on this 
issue, which is important to so many people in Western States, 
and I thank the Chairman for holding this hearing and look 
forward to your continued oversight of this commission.
    Thank you.
    Chairman Lieberman. Thanks very much, Senator Cantwell, and 
we will be sure to ask the members of FERC this afternoon some 
of the very relevant questions you have raised here this 
morning.
    I note the presence of another member of the California 
House delegation. I am delighted to welcome not only to this 
hearing but to the Congress Congresswoman Diane Watson. Thank 
you for being here.
    Before the Committee calls the Hon. Gray Davis, Governor of 
the State of California, Senator Boxer, our colleague, has 
asked to very briefly introduce Governor Davis.

TESTIMONY OF HON. BARBARA BOXER, A U.S. SENATOR FROM THE STATE 
                         OF CALIFORNIA

    Senator Boxer. Mr. Chairman, Senator Thompson, thank you so 
much for inviting my governor here. I promised you that I would 
make a minute, a minute-and-a-half introduction, and I will 
because I know how many people you have yet to come.
    But I want to say that in California we need the help of 
everyone on this Committee. The reason we have such a beautiful 
delegation sitting behind me here is because of their deep 
concern. They have got many other issues on their plate. I 
think it shows and demonstrates that we are all speaking with 
one voice, that we need relief for our consumers, and our 
governor has been fighting this fight in the middle of a crisis 
that he did not make. And he has been doing everything he can 
to heed what Members of this Committee have said, which is to 
bring sources of power online to push the State toward energy 
efficiency and conservation, which we are succeeding at--we 
really are--and also to call attention to the gouging. And if I 
might say, that is the only word I can use, and I think when 
you hear the governor, you will understand why we use the term 
``gouging.''
    Mr. Chairman, I think this Committee is key for us. You are 
an investigative committee. You are a Committee that is an 
oversight committee. It is very appropriate that you oversee 
the FERC. I believe with your leadership, Mr. Chairman, and 
others on both sides of the aisle, we have seen FERC finally 
look at their charter, which says they must protect against 
unjust and unreasonable prices. We have seen them take action. 
We in California welcome that action, and at this time, it is 
really my honor to introduce a man who has been working on this 
crisis day and night. It is a lonely and difficult thing, many 
times, and he has really done everything within his power to 
keep the power on in our State.
    Thank you very much for welcoming him here, and thank you 
for your deep concern, Mr. Chairman, and also Senator Thompson.
    Chairman Lieberman. Thanks, Senator Boxer.
    Governor Davis, I am honored to welcome you here. I 
appreciate very much that you took the time to come out and 
share your thoughts and your experiences with us. This is a 
hearing room that is often used by another committee. I am 
privileged to be a member of the Senate Armed Services 
Committee, and it does strike me that there are some parallels 
here. I feel like I do when we had leaders of our military come 
in from areas of battle to report on how the battle was going. 
It is not quite that serious, but you face a serious crisis 
that was not of your making. You have been tested. I think some 
of the improvement that is reflected in the charts that we have 
seen from Senator Murkowski you deserve some credit for. I am 
delighted to hear from you now, and I suppose the question is: 
How goes the battle?

 TESTIMONY OF HON. GRAY DAVIS,\1\ GOVERNOR, STATE OF CALIFORNIA

    Mr. Davis. Well, we are making progress, and thank you very 
much, Senator Lieberman, and Ranking Member Senator Thompson. 
Thank you for inviting me as well. I want to thank our junior 
Senator, Barbara Boxer, for her friendship and for her 
introduction, and our senior Senator, Dianne Feinstein. They 
both worked very hard on price relief for California and the 
West, and I want to thank all of our Congress people that have 
been staunch allies in this. You have mentioned their names, 
but I would like to repeat: Congresspersons Tauscher, Harman, 
Solis, Eshoo, Baca, Watson--have I missed any?--Lois Capps and 
Lynn Woolsey. Did I miss anybody else? And there are many 
others who are not here. They are very busy, and I appreciate 
their taking their time to be here today. Obviously this is an 
important issue. That is why so many people have come today. I 
applaud the Committee for having this hearing.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Davis appears in the Appendix on 
page 391.
---------------------------------------------------------------------------
    I want you to know that California is doing its part to 
meet the energy challenge. As you know, there are two 
constructive things the State can do: Build more plants, 
conserve more power. We have approved 16 plants since I have 
been governor starting the fourth month I was in office. Ten 
are under construction, more than at any time in our State's 
history. We are also the most electricity-efficient State in 
the Union, as that chart, based on U.S. Department of Energy 
figures shows, and we are not resting on our laurels. It is in 
our self-interest to become even more electricity efficient as 
the summer proceeds.
    Those two goals--building plants and conserving--are the 
major prongs of a long-term energy plan that we have put 
together for every Member of this Committee. Long-term 
contracts are also a big part of that, and I want to thank 
David Freeman, who is with me today, formerly of the Department 
of Water and Power--he helped negotiate those--and Michael Kahn 
who is president of our ISO, who is also with me in attendance 
today.
    Let me just elaborate for a second on the building of power 
plants and conservation. As was noted earlier, for the 12 years 
before I was a governor, not a single major power plant was 
built in our State. Not one. But we began earnestly to right 
the ship, and as I said, we have licensed 16. Ten are under 
construction. Four will be online this summer. The first one a 
week from today will come online in Bakersfield. Two more will 
come online by July 7. Those three plants will provide roughly 
1,200 megawatts of power. In addition, we have sited 10 
peakers. Through my emergency powers, I have cut the permitting 
process to 21 days to site peakers. They represent more than 
800 megawatts of power.
    Part of our effort to get more plants online involve 
reducing the time to site permits. That was mentioned earlier. 
We have cut that in half from a year to 6 months, and I have 
reduced that even further through my emergency powers to 4 
months.
    So the combination of the plants online plus additional 
renewables, distributed generation, and re-rating of existing 
power plants we believe will provide 4,000 megawatts of power 
by the end of September. Then we have 5,000 megawatts coming 
online in each of the next 3 years for roughly 20,000 megawatts 
by the end of a 4-year period. Suffice it to say, at no time in 
the history of the State have so many plants been under 
construction in California.
    On conservation, we are not resting on that laurel. I 
signed the bill for $850 million, which encourages more 
efficiencies in people's homes and places of work. Plus we 
signed an executive order which gives people and businesses a 
20-percent rebate if they reduce their electricity by 20 
percent any of the 4 months--June through September--of this 
summer. Plus we have signed agreements with 137 companies, 
including the Bank of America and Wells Fargo, Hilton Hotels, 
for them to reduce their consumption by 20 percent from June to 
September of this year. We have signed agreements with 225 
municipalities, special districts, for them to achieve between 
10 and 20 percent conservation. So all across the State, 
Californians are pulling together to build plants and to reduce 
electricity usage.
    I think the proof is in the pudding. In May, it was 
reported that Californians had reduced electricity usage over 
last year by 11 percent and by 10.4 percent during peak 
periods. I think that is a remarkable contribution, but we are 
going to do even more.
    So I think it is fair to say on long-term contracts, which 
have reduced our dependency on the spot market by roughly 40 to 
45 percent, on building plants, more than any governor has done 
before, and on conservation, California is doing its part. The 
one mission element, at least until Monday, was any efforts to 
regulate the wholesale price of electricity. As the Chairman 
correctly pointed out, that is exclusively the function of the 
Federal Government. The State has no control over that, even if 
it wanted. Our only power is the power to advocate, testify, 
occasionally to shame, to make sure that action is taken.
    As the Chairman also said, the Commission is responsible to 
see that rates are just and reasonable. That comes as a great 
shock to some people who think that market forces should take 
hold no matter what. I am going to speak to that a little 
later. But that is not the law. As Ranking Member Thompson 
pointed out, the law does require just and reasonable rates be 
enforced, and FERC by its own admission has allowed those rates 
to remain in effect, even though they made a finding November 
2000, reiterated in December 2000, reiterated again in April 
2001, that our rates were not just and reasonable and our 
market was dysfunctional.
    Under law, the Commission must order refunds once they make 
a finding that a marketplace is dysfunctional and rates are not 
just and reasonable. Under law, if rates are not just and 
reasonable, they are by definition unlawful, and the ordering 
of refunds is not a matter of discretion. It is a matter of 
law.
    Yet at every point where the Federal Energy Regulatory 
Commission could have restored some sanity to wholesale prices, 
it failed to do so. I have done my best for approximately a 
year to advocate, to urge, and to encourage appropriate Federal 
action. I have testified before the Federal Energy Regulatory 
Commission. I have written countless letters. I have spoken 
personally to Presidents Clinton and Bush. Our electricity 
oversight board, the independent service operator, and the PUC 
have made at least 100 filings for relief. But in every case, 
even in the face of mounting evidence in support of our 
position, our requests have been denied or ignored.
    Two days ago, the Federal Energy Regulatory Commission did 
bow to public pressure and took a step in the right direction. 
But here is what the Commission's inaction over the last year 
has yielded, and I refer you to the chart on the right where it 
says ``Total Wholesale Cost of Electricity in California.''\1\  
In 1999, Californians paid roughly $7.4 billion for 
electricity. In the year 2000, with demand up only 4 percent, 
we paid $27 billion, roughly a 400-percent increase in 
electricity costs. This year, we are on track to spend between 
$50 and $60 billion, even though we are reducing our 
electricity usage by roughly 9.5 percent each month. And as I 
explained to President Bush when we had a nice visit in Los 
Angeles, a functioning market in which the consumer is reducing 
use by 9 to 10 percent a month should produce a reduction in 
prices, not a doubling. So we are looking at ratepayers' paying 
700 to 800 times more for electricity than they did just 2 
years ago.
---------------------------------------------------------------------------
    \1\ The chart referred to by Governor Davis appears in the Appendix 
on page 742.
---------------------------------------------------------------------------
    You will not be shocked to hear that Duke Energy Company 
acknowledged not too long ago that they charged the State about 
$3,800 a megawatt in January. Reliant, I pointed out, charged 
us $1,900 a megawatt on 2 successive days a month ago. So it is 
clear that the energy companies have exerted extreme power over 
our market and are driving up prices dramatically. That is why 
Governors Locke, Kitzhaber, and I, some time ago proposed cost-
based pricing which would allow for a reasonable profit on a 
temporary basis until more plants could come online.
    A number of noted economists, including Alfred Kahn, the 
proponent of airline deregulation, came before this Committee 
last week and spoke to the wisdom of temporary price relief for 
California and the West.
    On Monday, the Federal Energy Regulatory Commission again 
refused to impose cost-based pricing. I want to thank 
Commissioner Massey for his long effort in that regard. I 
believe to this moment that that is still the most effective 
way to restrain prices and provide a reasonable profit.
    Again, my thanks to our two Senators for their long efforts 
and our congressional allies, not just in California but 
throughout the West, who have worked night and day for price 
relief for the West.
    On Monday, with two new commissioners, the Federal Energy 
Regulatory Commission did grant some price relief. I thank them 
for that. The commission did correct the most obvious errors in 
its April order, but it was months too late and there is much 
more for FERC to do.
    The California ISO estimated that from May 2000 to February 
2001, power generators charged Californians $6.7 billion more 
than a competitive marketplace would otherwise warrant. They 
have recently updated those figures through May, and the 
overcharges are now $8.9 billion.
    To date, however, Mr. Chairman, not a single penny in 
refunds has been returned to California. I believe it is 
unconscionable if generators are allowed to keep these 
egregious overcharges. Mr. Chairman, FERC must move quickly to 
enforce the law. FERC must order these energy companies to give 
us back our money.
    Then, finally, Mr. Chairman, FERC must turn its attention 
to natural gas. Until very recently, California natural gas 
prices were 2 to 3 times higher than the national average, and 
for a while they were 8 times higher. That was due in part to 
the fact that El Paso Natural Gas controlled a significant 
portion of the major pipeline into Southern California. It was 
not until that contract expired and was divided essentially to 
30 other energy companies that the price started to come down 
and get close to what the rest of the country is enjoying.
    So, clearly, FERC must be--I would suggest this commission 
could do a useful service in urging FERC to exercise its 
responsibility to enforce laws against manipulation on 
interstate pipelines to California.
    Mr. Chairman, in conclusion, California will continue to do 
its part, building all of the plants California needs and 
setting an example for the rest of the country on conservation. 
With the greatest of respect, I would ask this distinguished 
body to do its part by joining us in holding the Federal Energy 
Regulatory Commission's feet to the fire. It is unconscionable 
that the commission look the other way while energy companies 
bilk Californians out of $9 billion. Californians are due 
billions of dollars in refunds. Together we have made progress 
on price relief. Now it is time to move forward on refunds, not 
just refunds for California but refunds for the entire West.
    Again, I thank you for the privilege of being here. I know 
there were a couple of questions earlier that were raised about 
California's activities, and if it is appropriate to respond to 
those questions, I will.
    Chairman Lieberman. Thanks very much, Governor Davis, for 
that excellent testimony. I think the record does make clear, 
as you have documented, that the State of California and the 
people of California have taken very significant steps forward 
in a most difficult situation which no Member of this Committee 
would want to have their State go through, to try to make 
things better. That says the obvious. I would say no governor 
of one of our States would like to have that State go through 
that either. Both in terms of bringing more power online 
through the State, but also in the very impressive conservation 
figures that are coming out now from California, which means 
that individuals, families, businesses understand the crisis 
and using less electricity, progress is being made.
    We are focused, because we are Federal an oversight 
committee, on the Federal Energy Regulatory Commission. And as 
you said, and I said before, that is the group that we have 
been asking to do what you cannot do and no one else can do--
that is, the State cannot do, and that is to deal with the 
wholesale price of electricity.
    I wanted to ask you a few questions about the order that 
came out on Monday. The first is this--I am going to get to the 
nature of the price relief in a moment, but in its order, FERC 
provided price relief until the end of next summer, September. 
And my question to you: Is that enough time? In other words, 
can we expect that by that time enough of the power plants that 
are now in the process of being constructed will be online, and 
conservation will be sufficient so that supply and demand will 
be equivalent or that supply will surpass demand and we can 
have a genuinely competitive market? So is September of next 
year sufficient time for the State at this point?
    Mr. Davis. Well, as I said, I think the Commission's action 
is a step in the right direction. They will have to be vigilant 
to make sure that there are not too many loopholes and that the 
order is enforced.
    We will not have, however, about enough power to meet our 
demand until sometime late in 2003. Alan Greenspan has said on 
a number of occasions that electricity deregulation really does 
not work unless you have 15 percent more power than demand. We 
will not get to that point until sometime late in 2004.
    So, optimally, the order should extend at least until we 
get enough power online to bring demand and supply into 
equilibrium, and that will not be until late 2003.
    Chairman Lieberman. I will ask that question of the FERC 
Commissioners this afternoon, why they limited the order to the 
end of next summer and whether they are open to extending it if 
conditions suggest that they should.
    My second question goes to this matter of refunds. In my 
own review of the law, it does seem to me that the statute is 
clear that if FERC decides that rates are unjust and 
unreasonable, not only that they have to take action 
prospectively but they have the power to act in a just manner, 
which is to order refunds.
    In the order that came out on Monday, as has been testified 
to earlier, nothing was said about refunds for the overcharges 
outside of California along the Western grid. And I was struck, 
as Senator Cantwell or Senator Murray said this morning, that 
their electricity prices in Washington State have gone up 11 
times, by a multiple of 11 in the last year.
    FERC's new plan issued Monday, as I get it, is for a 15-day 
settlement conference presided over by an administrative law 
judge. So I wonder if you have had enough time to give a 
response to that as an adequate forum in which to try to obtain 
the refunds necessary for the State. And if you do not, what 
other avenues do you have available to you?
    Mr. Davis. Well, as you suggest, there does not appear to 
be much guidance to the administrative law judge as to what to 
consider and how to proceed. Obviously, I believe California 
should have a seat at the table. So should the other States who 
believe they have been overcharged. And we would present 
information from the California ISO that is advised by many of 
the economists that you had testify before you last week and 
have come to the conclusion that Californians are owed at least 
$9 billion in overcharges.
    Again, the FERC itself came to that conclusion on three 
separate occasions, but it has taken no action to put money 
back in the pockets of Californians. So they have suggested 
that about $120 million might be subject to refund, but there 
is an ongoing process that allows the companies to rebut that 
and put in evidence to the contrary. The bottom line is no 
money has yet come back to California.
    I do not know if 15 days is enough time to resolve this 
issue, but I do believe the FERC should get a clear signal from 
this Committee that refunds are part of its function. Yes, they 
have provided some relief going forward. It is not exactly what 
we wanted, but there is no question that it will have a 
downward impact on prices, on the real-time market. But that is 
only half the job. The other half of the job is to give us back 
the money that was wrongly taken from us. The Commission made 
the determination it was wrongly taken from us. They just did 
not follow through and order refunds.
    What I would suggest is that at the end of the 15-day 
period, you call the FERC back to this hearing and ask what has 
happened, how much progress has been made, have States had a 
chance to make their case, and what is, in fact, going to 
happen on refunds. Refunds--I mean, as you know, there is 
really no justice if you have a right but no remedy. We have a 
right to $9 billion, but there has been no remedy.
    Chairman Lieberman. Thank you. I agree with you. And let me 
just say that it is my intention, though the Committee has a 
lot on its agenda, that this is an important enough crisis, and 
it is a crisis, obviously, that affects the West, but it sets a 
precedent for how energy price and supply crises will be 
responded to by the Federal Government. So I intend to continue 
to exercise, on an ongoing basis, the oversight authority of 
this Committee with regard to FERC. And I hope that will be 
helpful to them and to people throughout the country.
    Mr. Davis. If I may, Mr. Chairman, I might suggest that you 
put those questions to Commissioner Wood. I have had three 
conversations with him. I find him to be a very reasonable 
person. He suggested to me that he thought a more aggressive 
approach to refunds might be in order. So I think he might be 
sympathetic to----
    Chairman Lieberman. I will do that this afternoon. Thank 
you.
    Senator Thompson.
    Senator Thompson. Thank you very much. Governor, welcome 
very much.
    Mr. Davis. Thank you, sir.
    Senator Thompson. Governor, you heard my opening comments, 
and they will lay the basis for some questions I have. I 
started off by saying that I admire you in many respects. I 
wouldn't wish your problem on my worst enemy. You certainly 
were not responsible for many of the things that occurred, 
certainly as they developed before you became governor a couple 
years ago. I was especially impressed by the fact that you said 
you had seen all my movies. [Laughter.]
    Chairman Lieberman. Late at night.
    Senator Thompson. Which makes two of us, now that I have 
calculated. Perhaps you can talk to the Chairman about salutary 
effects of that. But you have made some pretty pointed comments 
concerning other people. You have made some here today. I have 
made some. And I am sure that you understand from one elected 
official to another that it is appropriate that we get into 
some of the history of this and some more pointed comments and 
questions. And I appreciate the fact that you do not shy away 
from that and you come here today and present yourself for some 
of those questions.
    So having said all that, I want to ask you how it was that 
you seemed to let things get totally out of hand. My 
information is that back as far as 1998, the California Energy 
Commission warned of possible energy shortages as early as 
2000. In February 1999, Bonneville put out a warning concerning 
the problems as far as hydropower in the Northwest. In July 
1999, the CEC once again warned of short supplies. All this 
time, of course, you are becoming more and more aware, and, of 
course, last summer, a hotter summer than normal, the lack of 
moisture in the Northwest, all of the other factors that we 
have mentioned concerning increased demand--I think your 
electric power demand from 1996 to 2000 increased by about 24 
percent. You were obviously becoming more and more dependent on 
imports for your power. May 2000 spikes, shortages, 
California's first two-stage alert. January of this year, a 
letter from 20 prominent economists saying it would be a 
fateful mistake to proceed with current policies such as the 
price caps and the spot contracting.
    All of those things obviously developed over a period of 
time, it looks like a couple of years. But they were there for 
anyone to see. Did you see these developments as they were 
occurring? Did they cause you concern? If not, why not? And if 
you did, why didn't you act sooner?
    Mr. Davis. In my testimony, I made clear, Senator, that we 
started licensing plants my fourth month in office. I became 
governor in January 1999. We talked about electricity usage 
increasing from 1996 to 2000. I came in in 1999. We started 
approving plants in April. That first year of 1999, before this 
matter was really--had not really been chronicled, it certainly 
was not in the newspapers with the regularity it is now, we 
approved six new plants.
    When the matter worsened in 2000, particularly in San 
Diego, which experienced the full frontal effect of 
deregulation, we passed appropriate legislation to relieve the 
problem there, and I began testifying in front of the FERC in 
the fall of 2000 after a San Diego meeting.
    So I have spent an inordinate amount of time on this issue. 
It is obviously important to the growth of the economy in the 
West and in California.
    But just to put a couple things in perspective, according 
to the U.S. Department of Energy, 85 percent of the growth of 
electricity in the West in the last 5 years has been outside of 
California. We have, as you can tell, a very enviable record on 
conservation, and that is not just the product of the work that 
I have been engaged in with our legislature. But for 20 years, 
we have been requiring energy-efficient buildings, appliances, 
all kinds of things which have reaped benefits for our State.
    So we have been working on this for a very long time, and 
to suggest otherwise is simply not accurate.
    Senator Thompson. Well, I see my time is up. I would ask 
you, though, to--I want to ask one more question. You can 
answer it now or later, if I might.
    Mr. Davis. It depends how hard it is.
    Senator Thompson. I will just take a few seconds.
    I take note of what you said, but in the eyes of many 
people, many more fundamental problems were not addressed, for 
example, the lifting of the retail caps. Mr. Kahn, who, as you 
correctly pointed out, testified here last week in favor of 
caps, said that the idea of keeping these retail caps on was 
ridiculous. You acknowledge yourself that you could probably 
solve the problem if you wanted to raise rates. So you have the 
combination of keeping the retail caps on, forcing the 
utilities to buy on the spot market, which was great when the 
spot market was not, not good when it became high. The approval 
process, the siting process, you addressed after the blackouts 
occurred, I believe.
    These are fundamental structural things, I think, which all 
investment advisers--we have had Bear, Stearns, Goldman, Sachs 
and others testify--say that these were structural things that 
clearly, regardless of who was responsible for how you got to 
that point, that clearly had to be addressed. And now they are 
being addressed at a price that is much greater than you would 
have had to have paid had you addressed them last year, last 
summer, when the crisis was obvious to everyone.
    So do you not claim--or do you not accept any 
responsibility for not having addressed these structural 
problems that were inherent in your system that obviously had 
to be changed when so many of the circumstances were changing, 
especially in light of your emergency powers, if you needed to 
exercise them?
    Mr. Davis. First of all, it is nice for us to sit back here 
and talk about passing on the true price of electricity. But 
let me assure you, if I passed on a 700-percent increase to the 
citizens of California, there would be an outrage the likes of 
which you have never seen, and electricity deregulation in this 
country would not benefit from the----
    Senator Thompson. I do not think anybody is suggesting a 
particular price here today.
    Mr. Davis. Well, but I do not know that--I do not think you 
have, Senator, but I believe I have heard many people say why 
didn't we pass on the true price of electricity. The 
legislature and I believe it is important not to shock our 
economy into recession, and so we have phased this out over 
about a 10-year period. The highest residential user this year 
will get about a 45- to 50-percent rate increase. We did 
increase rates in January of this year. They went up again 2 or 
3 months ago. There are also a number of incentives for 
conservation no matter what your rates are, and the people who 
are the most efficient, who just use 130 percent of baseline 
usage, do not see their rates go up.
    But we are trying to manage a system which, as your 
question suggests, was basically flawed. The bill that passed 
in 1996 unanimously, with every Democrat and Republican voting 
for it, and the previous governor signing it, deregulated the 
wholesale market but not the retail market. The flaws of that 
did not become crystal clear until sometime in 2000, and we 
began earnestly taking steps above and beyond the steps we had 
done in 1999 to improve the siting process and to put new 
plants online.
    So, everybody benefits from hindsight, but I make no 
apologies for the aggressive efforts we have taken to correct 
situations that we inherited. I did not, as you suggest, cause 
the electricity problem. President Bush did not cause it. 
Obviously it is on our respective watches. We have to try and 
manage it as best we can for the people of our State. And I 
think we are doing that.
    Senator Thompson. Thank you.
    Chairman Lieberman. Thank you, Senator Thompson.
    Let me just say for the record that it is my understanding 
that in almost all States that have deregulated electricity 
prices, retail caps, caps on retail prices for a temporary time 
period are the rule, the custom. That is the norm, usually. And 
so what was adopted here I know had an adverse effect because 
of all the other things that went wrong. But I would just make 
the point that if, in fact, California electricity customers 
were forced to pay the true price of electricity as it was 
being fed into the State, I think unfairly, very unfairly, it 
would have not only been a jolt to your economy and the 
American economy, because you are almost 15 percent of the 
national economy, but I honestly think it would have terminated 
the movement toward energy deregulation. I mean terminated the 
deregulation of energy which is occurring across the country, 
and is, generally speaking, I think the way to go.
    So I think what is on the line here in your response to 
this crisis and FERC's response is not only how this Federal 
agency is doing, but whether we are going to continue to enjoy 
the benefits of deregulation.
    Senator Thompson. Mr. Chairman, if I may just point out, I 
think that the issue is not a very good solution versus a very 
bad one. I think the issue is a choice between two bad 
solutions and whether or not by allowing more of the true price 
to be passed on we are creating a larger problem down the road.
    Chairman Lieberman. This dialogue could go on a while, but 
I think we will hear more of it as the other Senators question. 
I am going to call on Members as they arrive, going from 
Democrat to Republican. Next is Senator Durbin.

              OPENING STATEMENT OF SENATOR DURBIN

    Senator Durbin. Thank you, Mr. Chairman. Governor Davis, 
thank you for joining us.
    Mr. Davis. Thank you, sir.
    Senator Durbin. I have listened to your plight with great 
interest. You would think that if you are from Chicago or 
Illinois, far away from California, it would just be an 
academic endeavor. It is not. We have faced natural gas price 
increases, home heating cost increases over the last winter 
that are at record levels in Illinois. We have just seen a run-
up in gasoline prices, which mercifully are starting to come 
down again. And it has sensitized people across my State and I 
think across the Nation to the fact that this is not just 
California's problem. This is a national energy debate.
    Sadly, your State and the people living there have been the 
first victims of some of the worst things that have occurred 
here. But what I find interesting is that the debate usually 
centers on whether or not there is an understanding of market 
forces. And those who want to explain away what has occurred in 
my State and yours say you just do not understand supply and 
demand.
    I think behind that statement is the suggestion that we can 
trust supply and demand, that we can trust the market forces 
when it comes to energy. And yet for a long time here in 
Washington, we have come to the opposite conclusion.
    In 1935, when we created the Federal Power Administration, 
we basically decided that energy was so important to our 
Nation's future and that the energy corporations so 
unpredictable that they could not go unguarded or unsupervised. 
So from 1935 forward, we said we as a government, as a people, 
will regulate this market, this industry. It is just too 
important to ignore. And I think that brings us to where we 
were a few years ago and where we are today.
    In 1996, as States like your own embarked on deregulation, 
before you were elected governor, I can tell you that 
repeatedly the folks from the industry came to us and said, 
Washington, get out of the way, we do not want you involved in 
this. Every State is going to come up with its own solution. 
One size does not fit all. This is not a national thing to do. 
Let the States do it.
    And as you have noted, and Senators Thompson and Lieberman, 
in 1996, when Governor Wilson came forward with his plan, it 
passed unanimously in the California General Assembly, which is 
probably a rare occurrence on an issue of this complexity. And 
so those who were second-guessing whether that California 
deregulation was smart or not so smart have to understand that 
in the context of 1996, virtually all the parties to the debate 
said this is the way to go, setting the stage for what happened 
to California and to your administration just a few years 
later.
    I think that is a background which we should not lose sight 
of. As we look at this today, we should be reminded that 66 
years ago, this Congress created the precursor to the Federal 
Energy Regulatory Commission and said: Watch this market, watch 
energy in America. There are things here that can happen that 
are devastating. California sadly today is on center stage as 
we look at the results.
    Let me ask you about a couple things in particular. First, 
you have suggested that California should have a seat at the 
table in this discussion. I wholeheartedly agree. I think the 
residents of all the States should have a seat at the table. 
Sadly, this debate comes down to a face-off between the energy 
giants and the giant bureaucracies, and there seem to be some 
groups that are absent here, including families and businesses 
and others that are going to get nailed if we let the market 
run amok.
    I have proposed a consumer energy commission that will 
involve all three, not only the producers and the regulators 
but also the consumers, so that they could have a voice at the 
table about the need not only for generation and conservation 
but also, as in your remarks--and I thought this is critical 
from where I live--stabilization so that there is 
predictability, so a business knows from month to month or week 
to week the parameters of potential energy increases.
    I would like to have your comment on that, and particularly 
I would like you to address your repeated suggestion, which I 
can surely understand, about this need for a refund. FERC has 
the authority to give refunds. They have not addressed this 
issue. As I sit here I do not know if historically they have 
ever considered doing that. But I would like you to comment on 
that refund question, what it would mean to your State and 
whether there is any precedent that you are aware of at FERC 
for such a refund.
    Mr. Davis. Well, first of all, I appreciate your 
description of the background to the situation we currently 
face in California. It was accurate and well done.
    Obviously, refunds are a primary way of policing the 
market, and if the Federal Energy Regulatory Commission is 
supposed to be a watchdog for the consumers--and that was the 
original notion back in 1935--then their primary vehicle is to 
provide relief, not just prospectively but retroactively. It is 
one thing if--well, I was going to give an analogy, but I will 
not.
    So it is helpful to know that maybe we will not reach $60 
billion this year, although we are halfway through it, in 
expenditures for electricity--a little shocking when you 
realize it was just $7 billion 2 years ago--but that does not 
fully balance the equities since we have shelled out far more 
money for electricity than would be the case.
    All I can say is that whether or not there is a precedent 
for refunds of this magnitude, they are owed, they should be 
paid, and this oversight committee I believe, and with respect, 
should hold FERC's feet to the fire and ensure they issue the 
orders to give us back our money. That is the only message the 
energy companies will understand. If they have to reach in 
their pocket and write a check back to Californians, they will 
think long and hard before they take advantage of the market 
again.
    And in response to your question, Senator Lieberman, I 
consider myself a marketplace Democrat. My parents were 
actually Republicans. But this is a special market. You cannot 
store electricity, unlike any other commodity. The user has to 
have it on the day they need it, whether you are on a fixed 
income, whether you are a police station or a hospital, and the 
seller has to sell it on that day. And so you do need some kind 
of buffering situation, and the umpires in this contest, if you 
will, are the Federal Energy Regulatory Commission. They need 
to see themselves as the--again, another analogy--circuit 
breaker to make sure they step in when there are problems. And 
the best remedy, I think, is refunds. That sends a very clear 
message.
    Senator Durbin. Thank you, governor, and I just in closing 
would say to the Committee here, your tragic experience in 
California has taught some national lessons, and I think 
particularly in the area of conservation. You have given us 
some real guidance as to what we can do as a Nation to deal 
with energy and view conservation as more than just a personal 
virtue.
    Thank you.
    Mr. Davis. Thank you, sir.
    Chairman Lieberman. Thanks, Senator Durbin. Senator 
Collins.

              OPENING STATEMENT OF SENATOR COLLINS

    Senator Collins. Thank you, Mr. Chairman.
    Governor Davis, I would like to join my colleagues in 
welcoming you this morning. Although Maine and California are 
far apart geographically, we actually have quite a few things 
in common. We each have beautiful coastlines. We were each 
early movers in electricity restructuring. And both of our 
States have citizens that recognize that women make great 
Senators, although California has not gotten the party 
affiliation right yet.
    There are also, however, some major differences, 
particularly with how our States have handled electricity 
restructuring. Maine has been steadily building new power 
plants. California went a decade without building any. Perhaps 
most important, Maine did not make California's fundamental 
error of artificially capping retail rates.
    Fixing retail rates, even in the face of power shortages 
and escalating wholesale rates, has clearly been a disaster for 
your State. You cannot expect the benefits of a free market if 
you have a market which is not free.
    Nevertheless, as I said at last week's initial hearing, 
electricity markets are not like other markets. By its very 
nature, electricity is a unique commodity. It cannot be stored 
or inventoried. It is sold continuously on the spot market at 
prices that may vary widely.
    We had a case last summer in Maine where the spot price for 
a megawatt of electricity went to $6,000, which is more than 
100 times its usual rate. And, obviously, it is very difficult, 
if not impossible, for most consumers to respond to price 
spikes by turning off air conditioners or doing the laundry at 
a different time.
    So it seems to me that while it is fundamental that 
electricity markets must first and foremost be structured 
properly, they can also create instances where they do not 
operate in what FERC calls a workably competitive manner 
because consumers are not aware of price spikes. Therefore, I 
believe that FERC's actions to mitigate prices appear to be 
reasonable.
    But while it is important that FERC take action in the 
clearly dysfunctional California market, I would caution the 
Governor of California to be careful about what you ask for. 
While it may be tempting to ask FERC to exercise even more 
control of the California market, I know from our experience in 
New England that there may well come a day when you will wish 
that FERC would exercise less control.
    In New England, FERC decided that we needed to give 
generators more incentives to build capacity, so FERC increased 
what is known as the installed capacity fee. This is a fee that 
is paid by consumers to generators to encourage additional 
generation. What was really striking was that FERC ordered a 
50-fold increase in the I-cap fee over the level agreed to by a 
supermajority of the members of the New England Power Pool and 
recommended by the New England independent system operator.
    It is ironic that FERC ordered this increase despite the 
fact that FERC's own report shows that New England already had 
plenty of capacity, and it is even more ironic that FERC 
ordered this fee in New England when the region with the 
biggest capacity problems, California, has no I-cap fee at all.
    Governor, with better planning, your State will eventually 
be where Maine is today. You will have adequate generating 
capacity to meet the needs of your State. Generators will 
eventually charge lower rates, although, as in Maine, they 
still are unlikely to be cheap. But if you ask FERC to exercise 
more authority over your market today, how will you ensure that 
FERC does not exercise unwanted authority over your markets 
tomorrow. If you call for FERC to set prices today, how do you 
know that at some point in the future FERC will not set prices, 
or at least some components of that price, at a level that 
Californians will almost universally agree is too high? And, 
finally, if your answer is going to be that only FERC has 
jurisdiction to act on these issues and questions, are you 
recommending that we change the allocation of authority between 
State and Federal regulators?
    Mr. Davis. Well, I appreciate your comments, Senator, about 
the flip side of asking for assistance. FERC has been such an 
omnipresent factor in our market, ever since I became governor, 
that I never contemplated a day without FERC, even though it is 
probably worth a few minutes' contemplation.
    I do want to make one comment. You touched on it, Senator 
Lieberman touched on it. Electricity deregulation might work 
efficiently if there is more power than demand. That is the 
key. And to States considering electricity deregulation, I 
would discourage them from doing so unless they first acquire 
more power than demand, because otherwise you are at the mercy 
of market forces that will extract every dime FERC allows them 
to from your citizens.
    I think it is fair to say, Senator, if you were in my shoes 
and facing the extraordinary price increases that our citizens 
have, you would feel, as I do, that our first obligation is to 
fight back and try and get some relief from those price 
increases and assure people that the markets will stabilize and 
that henceforward they will not be subject to these rapid price 
spikes.
    So, yes, I am asking for assistance. What we got on Monday 
was not perfect but is a step in the right direction. And I am 
hoping that this Committee will ensure that refunds are 
forthcoming. I think that will have a very sobering influence 
on the behavior of energy generators in the future. I want them 
to make money, I want them to be profitable, but not at the 
expense of driving our economy into a recession, which will 
have an adverse consequence on the American economy.
    Chairman Lieberman. Thank you, Senator Collins. Senator 
Torricelli.

            OPENING STATEMENT OF SENATOR TORRICELLI

    Senator Torricelli. Thank you, Mr. Chairman.
    Governor, welcome to the Committee. Governor, I do not know 
that it is productive to engage in partisan blame in this 
matter. People in California simply want this problem solved. 
But I do have a sense of what is fair. Some things have been 
said about you and your administration that simply do not bear 
scrutiny. But the fact is your predecessor did not build power 
plants. You are building or planning 28. You claim that that is 
more than your predecessors or more than at any time in 
California history. You suffer from unnecessary modesty. That 
is not simply more than at any time in California history. That 
is more power plants ever built by any State at any time in any 
comparable period. And the record should reflect it.
    It has been said, indeed, that conservation should be part 
of this equation. Indeed, at no time in American history has 
demand fallen by comparable levels. California is not simply 
now exercising conservation. You have the most efficient use of 
electricity of any State in the Nation. Indeed, if the State of 
Maine were to become the model, every citizen of California 
would have to double their consumption next month to follow the 
Maine model.
    On the question of whether or not there is responsibility 
for the current flawed deregulation plan, it should be noted 
that you did not write it, you did not design it, you did not 
vote for it, and you did not sign it. You just inherited it. 
And now you are fixing it, and that is to your credit.
    Now, I do not think that matters to people of California. 
They just want this solved. But fair, nevertheless, is fair. 
And I think you have handled this very well.
    Now, second, let me say something to the people on the FERC 
board. This Senate in confirming Presidential nominations looks 
to integrity and it looks to competence. Speaking only for 
myself, I want to make clear for FERC members who come before 
this Senate again, I am going to look for something else: 
Whether in this moment of crisis for the people of California 
they were responsive.
    FERC has been late. Its response has been inadequate. I am 
glad they have acted. But unless or until this response carries 
the State of California through this building program until you 
have adequate supply, their response is not adequate. And I 
hope every member of the board who intends to return to this 
U.S. Senate listens very carefully to those words. This is now 
a Democratic majority Senate. It will remain so for some years, 
and we are watching how the people of California are treated, 
and we are watching very closely.
    Third, let me say there are those who, I think, are genuine 
in wanting to help your administration. But there is a partisan 
overlay that perhaps separates the fate of California from what 
is happening with the rest of the country. That might be true 
with some States. It is not true with your State. If the 
economy of the State of California suffers, this country will 
follow. There is no separating your economic performance from 
that of the Nation as a whole. Everybody has a stake in how 
this evolves and whether or not this is solved properly.
    Then, finally, let me add to you it is my observation that 
if this Committee were meeting on the price of corn or cotton 
or housing prices and we were witnessing falling demand, 
increased supply, and a 700-percent increase in prices, we 
would not be citing the laws of economics.
    We would be citing the criminal laws, because it is against 
the law. There is a prima facie case that there must be some 
collusion. Prices are being set. The free market is not 
working. And this is one of the greatest examples I have ever 
seen in the history of our country, watching what is happening 
with these projections.
    I, simply for my part, because you have answered so many of 
these questions, wanted to offer my compliments and to say that 
there is a public perception because of the national debate, 
that some people are talking only about increasing supply, 
other people are talking only about the controls of pricing and 
what we are doing about consumption. Indeed, you have set 
records in both directions: The greatest reductions in 
consumption with the greatest conservation and the largest 
building program in American history for supply. Everybody else 
may have run to their extremes. It appears to me, you, if you 
alone, have struck a balanced program.
    I hope the people of California in this difficult moment 
have the patience to see this through. There clearly is an 
answer on the horizon. And I hope, also, Members of this 
Committee and the administration will realize that those 
numbers of $60 billion for consumption, what is behind those 
numbers. Every rise in that cost represents a family that 
cannot meet a mortgage, cannot educate a child, is taking from 
their retirement income to pay electricity bills. These are not 
some abstract numbers. It is people's quality of life and the 
future of their children that are being impacted.
    And so when we talk about rebates from these energy 
producers, when we talk about the need to control their prices, 
this is not vengeance against some unnamed corporate entity. It 
is preserving the quality of life of individual families in 
California who are paying with their futures and their 
children's futures by this unconscionable taking advantage of 
this situation.
    So, governor, I am glad you are here. You may have noted 
there is not a question in there, but, nevertheless, I thought 
there were some things that you might have been unwilling to 
say on your own behalf that needed to be said. I suspect I have 
no time, but if I do, it is yours. Thank you.
    Chairman Lieberman. I was going to advise you, governor, 
that after Senator Torricelli's statement, you could rest your 
case. [Laughter.]
    Mr. Davis. Thank you, Senator.
    Chairman Lieberman. Thanks, Senator Torricelli.
    And now, Senator Bennett.

              OPENING STATEMENT OF SENATOR BENNETT

    Senator Bennett. Thank you. Don't get too comfortable. 
[Laughter.]
    I lived in California for 12 years. I was there while you 
were Chief of Staff to Governor Brown and I welcome you to the 
Committee now.
    I am delighted to have you say that President Bush did not 
cause this. I would hope you advise your political consultant 
of that fact. I will just leave it at that, but you saw the 
piece in the Wall Street Journal, as did I, as to how your 
political consultant tries to write economic policy by focus 
groups. I hope you will tell him, and then through him the 
people of California, that President Bush did not cause this.
    Now, having said that, let me note that by virtue of what 
you have done, you have effectively nationalized the power 
industry in California. If California were a separate country, 
you have taken action similar to action taken by the parliament 
in Great Britain when the Socialist Party, the Labor Party, 
took it over, and have started doing things yourself as the 
chief executive of California which previously were done by 
private entities. You are entering into long-term contracts on 
behalf of the State, taking out of the hands of the private 
entities the right to make those kinds of price decisions.
    Let me review, therefore, the record from California with 
respect to your administration's ability to do this. I do this 
as a cautionary note. I have a quotation here from the Wall 
Street Journal. That is seen as a right-wing newspaper, so I 
will stay with newspapers in California and the comments that 
they have made about your stewardship in this area as you now 
step up with a nationalized program.
    This is from the San Francisco Chronicle, not known as a 
right-wing newspaper. This is last February. ``Governor Gray 
Davis was slow to respond to the economic realities of 
California's power crisis despite warning signals from 
legislators, regulators, and utility executives stretching back 
to last summer. Indeed, documents and interviews with industry 
insiders, regulators, and lawmakers show Davis may have 
contributed to the meltdown of the State's two largest electric 
utilities by neglecting a repeatedly suggested strategy for 
stabilizing wholesale prices.''
    ``In addition, a top former Federal regulator said he told 
the governor's advisors and State Public Utility Commission 
officials as early as July that a key Davis proposal, to lower 
wholesale price caps, wasn't likely to solve the State's power 
problems. `The Governor resorted to a log-rolling strategy to 
get us to do things that we understood at the outset were not 
going to be real solutions,' said James Hocker, an appointee of 
President Clinton's, who stepped down in January as the 
Chairman of the Federal Energy Regulatory Commission.''
    Now, moving to March and to the Sacramento Bee, Dan 
Walters, ``Crisis Also One of Leadership.'' I will not quote 
all of it, but he says, ``It is evident that it would have been 
a relatively minor bump in the road had Davis not frozen last 
summer when the first indications of price spikes arose. Had 
Davis done what private utilities, power suppliers, and others 
urged him to do then, adjust power rates slightly and allow 
utilities to sign long-term contracts with energy brokers and 
generators, the major crisis could have been averted.''
    Now, going to a source outside of California but one of the 
leading left-wing newspapers in this country, The Washington 
Post yesterday says, and I quote----
    Chairman Lieberman. We will note that the laughter was 
coming from the media table. [Laughter.]
    Senator Bennett. Well, if I am going to refer to the Wall 
Street Journal as a right-wing newspaper, I have to be even-
handed and refer to The Washington Post as a left-wing 
newspaper.
    Quoting from The Washington Post, ``The Senate will hold 
hearings on California tomorrow.'' This appeared yesterday. 
``Governor Gray Davis, having won the argument on price caps, 
plans to use that occasion to demand billions of dollars in 
refunds from generators for the period when price caps were not 
in place. This is not a smart way to persuade generating 
companies to invest in new power plants in California, and 
without investment, blackouts will return to California sooner 
or later.''
    Now, as I said, governor, you have nationalized the 
industry in California. You have just entered into a contract 
for 8 years with Constellation Energy Group that would put a 
peak of $154 per megawatt and off-peak of $58 per megawatt. 
That is the decision you have made. The State has entered into 
that contract.
    I would point out that Enron, who has come in for a good 
degree of criticism in California politically, last summer with 
the utilities offered them 5 years at $50 per megawatt. You 
have just entered into a contract that is worse than the one 
that could have been obtained a year ago on the free market, 
and that raises questions in my mind about your ability to 
handle the nationalization of energy in the State of 
California.
    I am assuming we will have a second round, Mr. Chairman, so 
I have laid the predicate for where I am on this first round, 
and either now or during the second round, we can get the 
governor to respond, because I do not want to unfairly put him 
in a position where he cannot respond. But I think the actions 
California has taken here are unprecedented, and in the second 
round, I will quote the assumption about those actions that are 
in both the Los Angeles Times and the Wall Street Journal and I 
think we ought to explore that very carefully.
    Chairman Lieberman. Senator Bennett, it had been my desire 
that there not be a second round, but if the Members want it, 
we will have a brief one, only because we have two other 
governors and the Attorney General and the Public Utilities 
Commission and the five members of FERC. But I wonder, Governor 
Davis, if you want to take a moment to respond to the 
statements that Senator Bennett has made.
    Mr. Davis. Yes, Senator. I mean, I readily acknowledge I 
have a number of critics and you have quoted some of them. I do 
want to pick up on a couple other things you have mentioned. I 
have given President Bush credit for expediting Federal 
approvals that have allowed us to license 16 plants. I thank 
him for the extension of a couple emergency orders at the 
beginning of his term, and I believe in giving people credit 
when they do what I believe to be the right thing.
    As to why the State stepped in in January of this year to 
buy power, it was very simple. These prices have brought PG&E 
to its knees. Edison was deemed uncreditworthy, and in a 
meeting here in Washington, the generators told me, we are not 
going to sell any more power to your utilities. So you either 
find us a creditworthy buyer or your lights are going out. The 
State decided to become a creditworthy buyer and has done our 
best to keep the lights on, the power flowing, and to spread 
out the Herculean rise in prices over a lengthy period of time, 
which ensures all the power costs are fully paid, but we don't 
shock our economy into recession, which I suggest would not do 
well for your economy or for the economy of this Nation.
    If you want to get into the details, if there is a second 
round, I brought David Freeman with me. He oversaw the 
contracting process and is more familiar with it than I. But I 
have total confidence in his work. He ran the New York Power 
Authority. He ran the Tennessee Valley Authority. He ran SMUD. 
He ran the Department of Water and Power. Some people think he 
can't keep a job, but he has actually done a good job in all 
those places and he had to negotiate with these energy 
companies starting in late January when we had no leverage, 
prices were running $1,500, $1,600, and $1,700 for a megawatt 
of power, and I think he did a good job, not just in getting a 
good price for the State over 5- and 10-year period, but in 
shrinking the spot market, without which we would have seen 
higher prices than we are currently seeing this summer in our 
purchase on the spot market, because we have shrunk it to the 
point, through long-term contracts, where the price has started 
to come down.
    Chairman Lieberman. Thank you. Senator Carper, you are 
next.

              OPENING STATEMENT OF SENATOR CARPER

    Senator Carper. Thanks, Mr. Chairman.
    I want to say to my old colleague, Governor Davis, it is 
great to see you and I warmly welcome you to this place.
    When I was running for the U.S. Senate a year or so ago, I 
asked a sitting Senator who had been a governor, what is the 
difference between being a governor and U.S. Senator, he used a 
football analogy. He said, when you are the governor, you are 
the quarterback on the field calling every play. When you are 
the U.S. Senator, you are the athletic director sitting in a 
box watching the game.
    It is easy for us to sit here in the box watching the game 
to be critical of you and the other quarterbacks calling the 
plays and trying to move the team down the field. Senator 
Torricelli has already spoken, and I think eloquently, about 
your efforts, and I would just say to my colleagues, we could 
find pundits in our own States and throughout the country who 
would question our votes and our steps and missteps just as 
questions have been raised about some of the actions of 
Governor Davis. I applaud the efforts that you have undertaken 
and hope for you and for the people of California that the end 
will be a good one and a satisfactory one.
    I want to ask you, if I may, to take the lessons that you 
have learned in California with respect to electricity 
deregulation and with energy conservation and to share with us 
what applicability there is for the rest of the country for our 
national policy, particularly with energy conservation. What 
are the lessons for us as a Nation derived from your 
experiences in California for electricity deregulation and for 
energy conservation?
    Mr. Davis. In terms--I shared earlier one of my thoughts 
about electricity deregulation. States who have not yet decided 
to go down that road, in my judgment, should not do so until 
they acquire more power than their project demand. That will 
then give them leverage and allow them to say no to prices that 
are unduly high. We look forward to being there someday, so 
when someone offers us power at $400 or $500 or $600 a megawatt 
hour, we can say, well, we will just turn on one of our 
peakers, or thank you very much, if you want to offer it to us 
for less than $100, we will talk to you, and you have the 
leverage, they know you have the leverage, and you come to a 
reasonable resolution of that issue.
    On conservation, this has been very exciting because it is 
something we had to do. It is not a question of whether we 
wanted to do it, it is a question of necessity for us to 
improve upon the conservation gains that had been built into 
the system before I got there, and it is just exciting to see 
what people are willing to do.
    When the President was in town, before my meeting, we met 
with technology companies. One company is making a flat-screen 
computer which reduces electricity usage by 75 percent. Intel 
is making a new chip that makes your computer much more 
efficient on ``sleep mode,'' so it can receive information and 
still conserve about 60 percent of electricity.
    We just tell people in their daily lives, if you are not in 
a room and no one else is in the room, turn out the lights. 
Turn up the thermostat two or three degrees. I believe in 
personal example. My wife has taken this cause of conservation 
to new heights. When you come into my house at night, it is 
like entering a tomb. There is no light, none, except a little 
crack of light under whatever door in the room she is in, and 
she has replaced all the lights with fluorescent lights. In the 
winter, the temperature was down to 55 degrees, so it was--I 
went to bed with a sweatshirt on. But her bill the first month 
was down 36 percent, last month, 63 percent.
    So it is amazing what you can do if you are determined to 
reduce electricity, plus it is exciting to see some of the 
technology gains that will be on-line, not just for us but for 
the rest of the country, because no matter how much excess 
power you have today, you will get to a point when you don't 
have it and you will want the benefit of these technology 
improvements, which our crisis is forcing us to develop, and 
obviously, we will share them with everyone.
    Senator Carper. You mentioned, in fact, you described here 
and earlier the actions that the FERC announced on Monday as a 
step in the right direction. What might be some appropriate 
further steps in the right direction, one, for the FERC, and 
two, for us in the Congress?
    Mr. Davis. Well, I think they have to look closely at there 
is still some potential for manipulation. Everything is geared 
to the least-efficient unit in the State. Everything keys off 
that.
    Chairman Lieberman. Governor, can I interrupt you? 
Congresswoman Susan Davis was here from San Diego and I know 
she has to leave now. Before she leaves, I want to note her 
presence for the record. Thank you for being here.
    Mr. Davis. Thank you very much for being here. Thank you so 
much for staying. I lost my thought----
    Senator Carper. We were talking about steps in the right 
direction, appropriate next steps, one, by the FERC, two, by us 
in the Congress.
    Mr. Davis. We believe what FERC has done will offer us some 
price relief. I notice that Mr. Hebert was suggesting that the 
order that he implemented on May 29 was responsible for some 
falling prices in California, and it may well have been for 2 
days, the 30th and 31st. But we haven't had a stage one alert 
since then, so that order only affected us 2 of the 22 days it 
has been in effect. So now, by making it applicable across the 
board during any purchases, real-time purchases of power, it 
should have a downward impact on prices.
    I don't know all the potential for manipulation, but the 
people in the energy business are smart folks. They have got 
trading floors that compare favorably with the New York Stock 
Exchange. They have teams of meteorologists. They have media 
operations that would shame a network, and so I am sure they 
will do their best to find whatever loopholes are there and we 
need to be vigilant. This Committee needs to be vigilant, and 
so does FERC, to make sure that the thrust of its order is, in 
fact, carried out and the relief that is intended is made 
available to us and, hopefully, to the rest of--in terms of 
refunds, to the rest of the West.
    Senator Carper. The last half of my question. What 
appropriate steps are in line for the Congress? What should we 
be doing? Should we simply be monitoring the actions of the 
FERC, holding hearings like this, conducting oversight 
operations?
    Mr. Davis. There are many things that obviously compete for 
your attention. I tried not to give you too long a laundry 
list. I mentioned two. The President, when we met with him, and 
again, I thank him for the meeting. Even though we didn't agree 
on price caps, we agreed on this. There was no reason that the 
price of natural gas should be significantly higher in 
California than in the rest of the country, particularly 
natural gas coming from Texas, and he was open to the 
possibility, because I ran this by him twice and he said, 
``Yes, you can say this,'' he is open to the possibility that 
the tariff should be reimposed on the transportation quotient 
of natural gas. Natural gas is deregulated, but there used to 
be a fixed price you could charge for transporting it. That is 
one possibility to reexamine.
    So the two things that I would suggest this Committee focus 
on in terms of its dealings with FERC are the potential for 
manipulation on the natural gas issue, because natural gas is 
not only a cost in and of itself but a huge part of electricity 
costs, and what I think is the necessity is providing refunds 
to Californians and other citizens in this State who have been 
unduly victimized by extraordinary electricity prices.
    Senator Carper. Again, welcome. Thanks.
    Mr. Davis. Thank you. It is a pleasure to see you in your 
new capacity.
    Senator Carper. Thank you.
    Chairman Lieberman. Thanks, Senator Carper.
    Next, we will go to Senator Voinovich.

             OPENING STATEMENT OF SENATOR VOINOVICH

    Senator Voinovich. Welcome. I was just thinking that nobody 
knows the trouble a governor has unless they have worn the 
shoes of that governor. I went through the minefields of 
deregulation while I was governor of the State of Ohio. The 
deregulation legislation finally went into effect a year after 
I left.
    I have looked at your deregulation and I think that it 
ought to be revisited, and I think that some of us that came in 
afterwards learned some lessons from California.
    Last week, we had five outstanding economists come here to 
speak before us and the question to them was, do we need a 
legislative solution to the problems that you are dealing with 
in California. Their answer was, no, FERC already has authority 
to handle the situation, although they did admit that FERC has 
been slow to take on new responsibilities that have come with 
deregulation, and that they probably needed some more people 
and expertise.
    As you know, FERC has recently adopted a system of price 
controls that allow for all generating units that provide 
energy to California to recover their costs plus a reasonable 
profit. That is what we did in Ohio. We created a restructured 
electric utility system that recovered stranded costs while 
also allowing for a reasonable profit for generators. That, in 
turn, encouraged greater investment in new generation. In fact, 
by 2007, governor, we are going to have 18,000 new megawatts of 
on-line power because we had a 5-year cap, but it took into 
consideration that companies have to make a profit and recover 
their costs. I think that FERC's decision this last week is 
going to provide some short-term relief for you. But I do not 
think there is any quick fix.
    The point I am making is that price caps will not solve 
supply shortages in California. In fact, price caps that are 
set too low discourage investment, as you know. I think Robert 
Samuelson noted in the Washington Post last Wednesday that the 
root cause of your problem is demand outran supply, and for 
California to avoid the constant worry over the ability to 
provide power, investment in new power generation has to be 
encouraged, including the implementation of a streamlined 
siting process that protects public health and the environment, 
and I think that you perhaps ought to look at your deregulation 
law again.
    Other States, and this is something that is really 
significant, have worked through deregulation issues on a 
cooperative regional basis. By contrast, the California 
situation seems to be extremely polarized, with California 
insisting that Western States take definitive positions for or 
against price caps.
    The question is, at what point will California be willing 
to become part of a regional solution, as called for by FERC, 
rather than insisting on its own independent governance 
structures to run the electric grid? Instead of a single State 
operator of the transmission grid, I think the opportunity 
exists for a regional transmission organization to be 
established, just as we did in the Midwest when I was governor. 
We had a multi-State ISO. What do you think of going to a more 
regional approach instead of your current handling?
    Mr. Davis. As you know, the next largest State in America, 
Texas, is not under FERC jurisdiction because they have not yet 
separated generation from distribution. The next two States, 
Florida and Texas, have submitted to the FERC permission to be 
their own ISOs because of the size of their economies. Because 
we are the fifth--at least last year, we are the fifth largest 
economy on the planet, I think at least for the foreseeable 
future, we should be our own ISO, as well. Now, I certainly 
believe that until we get to a situation where we have more 
power than demand.
    This has been, as I am sure you can tell, being a former 
governor, one of my least favorite things to do, occupying a 
great deal of my time, and I think it is just imperative that 
we stay the course on building new power plants, on 
conservation. I am pleased that there is some response from 
FERC on price relief prospectively. I am hoping that with your 
assistance, there will be response on price relief 
retroactively.
    So I would not be open to the State joining a regional 
ISO--I would not be open at all until we reach the point where 
we got to 15 percent more supply than demand. Then I would be 
willing to revisit it.
    That is not to say I don't have great respect for our 
neighbors in the West. We have a particularly friendly 
relationship with the neighbors that border us, be it Arizona 
or Nevada or Oregon and also with Washington, and a sharing 
relationship with our neighbors to the Northwest.
    Senator Voinovich. Being next to California is like being 
in bed with an elephant, and you have had a dramatic impact on 
your regional area. Ohio is the third-largest user of 
electricity in the United States of America. We had a regional 
ISO and we have found it to be beneficial. I would suggest, 
governor, that you look at that. I know FERC has recommended 
that. I would appreciate, as a member of this Committee, that 
you seriously review that issue again and I would like to talk 
to you more about it.
    Mr. Davis. As a courtesy to you, Senator, I will do that, 
and I would be pleased to have a discussion with you.
    If I could just make this final point, until Monday, 
despite a year of effort on my part and all the agencies that I 
work with in California, we did not have a satisfactory 
response from FERC on any matter. As a matter of fact, we think 
their lifting our price cap in December 2000 was responsible 
for blackouts because there were no blackouts when we had a 
price cap in effect, none, and it was only when the price cap 
was lifted there became an incentive to withhold until the last 
minute. Gaming became a great prospect.
    And while I quickly acknowledge that price caps on a long-
term basis don't make economic sense, I also want to 
acknowledge that 12 of the 16 plants that we have licensed 
submitted their application when the hard price cap was in 
effect of $250. So they must have thought that was sufficient, 
offered sufficient return on their investment. And in terms of 
conservation, there is nothing that will discourage us from 
improving upon our conservation because we have to do that to 
minimize the potential for blackouts and disruption.
    So while theoretically I acknowledge that price caps do 
not--they may well discourage conservation and discourage 
investment, our experience in California, given the situation I 
have described, is to the contrary.
    Senator Voinovich. I have learned in my life that when 
things go wrong, so often what we do is point to other people 
as being responsible for our problems. I have found that it is 
good to look to one's self and see if there are things that one 
can do to improve the situation, and I believe that is the 
attitude that you and your State should have and work with FERC 
and everyone else. But I think that the finger-pointing ought 
to end and we ought to figure out how to get this job done, 
because it is not only affecting your State, but the entire 
country, including my State.
    Chairman Lieberman. Thank you, Senator Voinovich. Senator 
Carnahan.

             OPENING STATEMENT OF SENATOR CARNAHAN

    Senator Carnahan. Thank you, Mr. Chairman.
    Welcome, Governor Davis.
    Mr. Davis. Thank you, Senator.
    Senator Carnahan. I have appreciated the forthright manner 
in which you have responded today.
    I realize that our topic is primarily the situation in 
California, but Missourians are very concerned about the energy 
picture, as well. They have watched the crisis unfold in 
California and they have been worried about their own energy 
bills and how they, too, have increased steadily.
    It is important to focus on the proper role of Federal 
regulators as we restructure the electricity industry. As we 
consider future policies at the national and State level, we 
should learn from the problems of the past.
    We are told that a fully-functioning deregulated market 
should lead to lower prices, and, of course, this is a very 
appealing argument. But for all of the initial optimism about 
lower prices, California's experiment with deregulation has 
caused me to question how future transitions should be managed. 
If the deregulation is to continue, we must have the structure 
in place for a successful transition. Public confidence is an 
important component of any successful market, but competitors 
must also feel that there is a level playing field and that 
markets are not designed in ways that unfairly benefit some 
players while creating barriers for others.
    This brings us to FERC's role in the process. There is 
certainly no shortage of opinions on the merits of the order 
FERC announced last week. But the question in my mind is even 
more fundamental. What is the appropriate role for the Federal 
Government to play as more and more markets move from 
regulation to competition? Regardless of our views on the 
merits of FERC's order, the fact remains that FERC's action 
came long after the market was found to be dysfunctional, 
months after the rates were found to be unjust and 
unreasonable.
    Like many other States, my home State of Missouri is 
considering deregulation. If Missouri deregulates, assuring 
just and reasonable rates for Missouri consumers will be 
entirely in the hands of FERC. FERC's performance in California 
does not inspire confidence.
    This week, FERC finally began closing the door on rate 
gouging in California, but only after letting a $50 billion 
horse out of the barn. Missourians deserve assurances that if 
our State deregulates, we won't be stampeded by runaway prices.
    I am sure that leaders in California have spent countless 
hours considering what mistakes they have made in the past and 
what they can do in the future to improve the situation. Now, I 
would hope the Federal Government would conduct the same sort 
of analysis.
    In April, Senator Lieberman and I wrote to the General 
Accounting Office asking that it conduct an independent review 
of a number of matters relating to FERC. Specifically, we 
requested that the GAO study whether FERC has fulfilled its 
mandate to ensure just and reasonable prices. FERC played a 
very different role when they were Federal caretakers over an 
often stodgy regulated industry. But I am coming to believe 
that a new approach will be required to oversee what has become 
a very dynamic industry.
    FERC must seriously reexamine its role in light of recent 
experiences. This Committee must aid that effort. If we find 
that FERC is not living up to its mission, or if it simply 
cannot live up to this mission because of limited resources or 
other factors, we must determine the most effective and 
efficient remedy. Otherwise, I believe that a truly competitive 
market for electricity may well be a long time coming.
    To instill public confidence in our energy markets, FERC 
must prove capable and willing to assert its authority by 
closely monitoring markets and better anticipating potential 
problems, and perhaps most importantly, it must be prepared to 
take swift corrective action when there is evidence of flawed 
markets or abuse of market power. This is a duty we owe to the 
American people.
    I want to thank you for being here today. I admire your 
courage and your willingness to take on this very tough 
problem. I have just a couple of questions I would ask you at 
this time.
    From your experience, do you believe that FERC is equipped 
to fulfill its responsibility to ensure just and reasonable 
prices as we transition from a regulated to a deregulated 
energy market?
    Mr. Davis. I think the jury is still out on that. Clearly, 
we feel we have been denied relief, at least from November 2000 
until Monday, and then the relief we have received is 
prospective in nature. The true test of their leadership on 
this issue and whether or not they are going to fulfill the 
mandate of the Federal Power Act will be seen on how they deal 
with the refund question. So I can't answer that question any 
more clearly.
    I know it is customary for witnesses to sort of break down 
on partisan issues, but the commission did not take a positive 
step until the two Bush appointees joined it. I don't know if 
that means they will take a positive step on refunds or not. It 
remains to be seen. I hope they do.
    Senator Carnahan. And one other question. Recently, we have 
seen some individual transactions where prices were abnormally 
high and some have argued that this has resulted from 
manipulation in the market and abuse of market power. Should 
FERC be more aggressive in its investigation of abnormal 
transactions to determine if market power, in fact, has been 
abused?
    Mr. Davis. I think the answer to that is unequivocally yes, 
Senator. In our State, we have logs that indicate plants were 
shut down per marketing division. Now, in and of itself, that 
may not be conclusive, but you have to ask yourself why the 
marketing division would have an interest in telling a plant to 
shut down.
    The maintenance of our plants, admittedly old ones, some 30 
and 40 years old, averaged 3,000 megawatts in each of the years 
of 1999 and 2000, averaged about 11,000 to 15,000 megawatts the 
first 5 months of this year, and the figures I gave you before 
were a comparison, April through May of 2000. In 1999, it was 
about 3,000. This year, it started at 11,000 and went up to 
15,000. I mean, we can't prove that they withheld power in 
order to drive up the price, but it does seem kind of odd that 
so many megawatts were out of service.
    So I think that is at least one area that the FERC could be 
more aggressive in ensuring that the market is not manipulated 
and that consumers are not unduly charged with excessive 
prices.
    Senator Carnahan. Thank you very much.
    Mr. Davis. Thank you.
    Chairman Lieberman. Thanks, Senator Carnahan.
    Senator Domenici

             OPENING STATEMENT OF SENATOR DOMENICI

    Senator Domenici. Thank you very much, Mr. Chairman.
    Governor, it is good to be with you.
    Mr. Davis. I, as well.
    Senator Domenici. I want to just talk about one area that 
concerns me, and I have difficulty understanding what happened 
and why it happened, and that has to do with the absence of 
long-term contracts during most of this crisis. I have tried my 
best to go through a chronology of events with dates and I have 
been able to come up with 11 opportunities at different times. 
Starting in mid-June 2000, there are 11 times when a U.S. 
governor was either offered the opportunity to enter into long-
term contracts or you were urged by some committee or group 
that was advising you about the problem, where long-term 
contracts were recommended but that recommendation went 
unheeded. So let me go through a few and you tell us what 
happened.
    In mid-June 2000, Southern Cal met with you, according to 
what we have here, and the top advisors, and they warned that 
electric prices in San Diego could soon go sky high and that 
his company would have to take on significant debt. I 
understand at that opportunity, at that event, the suggestion 
was that long-term contracts be entered into. If that is the 
case, why was that ignored at that time?
    Mr. Davis. I would like to ask if I might bring David 
Freeman with me, who helped negotiate some of these long-term 
contracts. Could I ask him to come forward?
    Chairman Lieberman. Sure. Mr. Freeman, why don't you come 
up, take the seat next to Governor Davis, and just identify 
yourself for the record. Don't tell us all you have done in 
your life because we do not have enough time.
    Mr. Freeman. I am Dave Freeman and I am the senior energy 
advisor to the governor, I think I am the oldest guy around.
    Chairman Lieberman. That is a good sign.
    Senator Domenici. The oldest guy around, where, in 
California or up here?
    Mr. Freeman. Both. [Laughter.]
    Senator Domenici. Let me say to you, as the advisor, I 
prefer to ask these questions of the governor, but if he needs 
help from you, that is fine with me. I understand that.
    Mr. Davis. I understand that.
    Senator Domenici. Let me take two or three of them and then 
you can answer together. I just gave you one, mid-June, 
Southern Cal meets with the governor--I assume you are aware of 
this meeting--and the recommendation was that prices were going 
to go sky high in the San Diego area and that that company was 
going to have to take on significant debt. On that occasion, 
the idea of long-term contracts was broached, entered into, and 
nothing was done about it.
    Mr. Davis. I can answer that question. That was before the 
State got into the business of buying power in early January 
2001. The PUC did give approval to the three utilities to enter 
into long-term contracting. The PUC insisted that it keep its 
prudency review, which only makes sense because a utility could 
enter into a contract for 3,000 or 4,000 megawatts an hour and 
then the consumer would be obligated to pay that.
    Some of the utilities took advantage of those long-term 
contracting opportunities, others didn't, but the PUC did act, 
I believe, in August to allow all three utilities to enter into 
long-term contracts.
    Senator Domenici. OK. Well, let me move----
    Mr. Freeman. Senator, that is correct, and they just 
didn't.
    Senator Domenici. Please?
    Mr. Freeman. I think the utilities who were then purchasing 
their own power just failed to enter into long-term contracts. 
If they were here, they would say that they weren't sure that 
the PUC would approve them, but they did not try.
    Senator Domenici. Well, let me go on to a couple of other 
dates and tie two dates together. July 21, 2000, PG&E files an 
emergency motion seeking authority and guidelines to sign long-
term contracts with electricity suppliers.
    On July 27, the governor calls on FERC to extend wholesale 
electric price caps. Now, it seems to me he must not have been 
supporting long-term contracts at that point and I want to 
know----
    Mr. Freeman. No, sir. The two actions----
    Senator Domenici [continuing]. Were they not good?
    Mr. Freeman [continuing]. Are not inconsistent at all.
    Senator Domenici. Is there something wrong with long-term 
contracts?
    Mr. Freeman. No, sir. The two actions are not inconsistent 
at all. The price caps were to control a runaway spot market 
that was literally taking the money out of the pockets of the 
people of California. The long-term contracts were designed for 
the future, to establish a just and reasonable market rate. But 
the caps were needed not to control long-term contracts----
    Senator Domenici. No, I know that.
    Mr. Freeman [continuing]. But to control the spot market. 
So the two actions were completely consistent.
    Senator Domenici. I understand they are different, but it 
seems to me that I have ten instances when the governor had a 
chance to support long-term contracts and didn't. On a number 
of occasions, instead of doing that, shortly around that time, 
he suggested caps. It seems to me that is what he wanted all 
along, was just caps. That was his proposal.
    Mr. Davis. Senator, the Public Utilities Commission met in 
August and granted all three utilities the right to enter into 
long-term contracts. Some utilities took advantage of that, 
some didn't. As David Freeman correctly points out, they will 
complain that they had to be subjected to a prudency review, 
but every PUC commission in the history of our State that has 
granted long-term contracts has always insisted on an 
opportunity to review the prudency of that contract for the 
reasons I suggested earlier.
    So we did--I can't just say, you have long-term contracts. 
That is not within my power. The Public Utilities Commission, 
then consisting of three members appointed by Governor Wilson 
and two by me, did agree to grant that permission in August, 
the month after the question arose.
    Mr. Freeman. Senator, if I could just add, the minute that 
this governor had the authority to enter into long-term 
contracts, that is when we started doing it, almost the very 
day, in fact, a few days before the statute was actually 
enacted by the legislature. It wasn't until January 2001 that 
the State began buying power. Before that, it was the utility's 
responsibility and the dates that you are mentioning are all 
before Governor Davis and the State got into that business. But 
the minute we did, we negotiated $42 billion worth of long-term 
contracts in several weeks, the largest exercise of that kind 
in the history of this country.
    Senator Domenici. Well, let me just generalize and then ask 
two more questions. Are you suggesting here before our 
Committee that you, governor, and if you are his advisor, you 
can answer that, you promoted and encouraged and wherever you 
had authority, you actually pursued long-term contracts during 
all of this crisis? Were you not at some point against entering 
into long-term contracts?
    Mr. Davis. No. There are two separate periods in question. 
First is a period when the utilities were buying power, and was 
a period when we were buying power. We started buying power 
January 18, 2001. I asked David to start buying power, was it 
before the month was out?
    Mr. Freeman. Yes, sir. It was----
    Mr. Davis. We asked within a matter of days after the State 
started buying, and net short, for the State to secure long-
term contracts because we wanted to wean ourselves from total 
dependency on the spot market.
    Now, the earlier phase, when the utilities were buying 
power, at various points, they did raise to me the issue of 
long-term contracts, something, I might add, that FERC 
discouraged in 1995, 1996, and 1997. I advised the Public 
Utilities Commission, in my judgment, it made sense--they had 
to schedule the meeting, they have 30 days' notice, they gave 
permission in August 2000. I think two of the three utilities 
took advantage of that opportunity to obtain some long-term 
contracts, but all three were given permission to do it.
    Senator Domenici. If you have another chance, I will ask 
another question.
    Chairman Lieberman. Yes. Thanks, Senator Domenici.
    Governor, some of my colleagues on the Committee have asked 
for a second round, and because of the importance of the issue, 
notwithstanding that we have a couple of governors, attorney 
general, etc., waiting, I am going to go ahead and do that. I 
am going to ask my colleagues to stick to 5 minutes.
    I do want to ask you, would you like to take a brief break?
    Mr. Davis. If I could take a 5-minute break, I would 
appreciate it.
    Chairman Lieberman. This reminds me. Once before, a few 
years ago, I was going to meet with President Assad of Syria 
and probably the most significant advice I got, excuse my 
explicitness, was to go to the restroom before the meeting 
because I could expect it to go on for a long time. This 
apparently is also true of testifying before a Senate 
Committee. So we will take a 5-minute break.
    [Recess.]
    Chairman Lieberman. Let us reconvene. I am sure not just 
Governor Davis, but all of us benefitted from the break and an 
opportunity to stretch our legs a bit. I thank you very much. 
It has been a very productive and interesting morning.
    I want to say to my colleagues, though we are going to go 
to a second round, I hope everyone knows they do not have a 
constitutional or legal obligation to ask questions on this 
round.
    Senator Bennett. Yes, we do. [Laughter.]
    Chairman Lieberman. I will now call on Senator Thompson.
    Chairman Thompson. Thank you very much. Governor Davis, I 
think that one of the increasing concerns that we all have is 
whether or not these plants that may be in the process of being 
licensed are actually going to get built. There are several who 
have expressed reservations about investing in new generation 
in California.
    Merit, for example, a spokesman said that--well, this is 
from the San Francisco Chronicle, June 2, 2001. An Atlanta 
company that just got approval to build a power plant in 
Antioch is holding off construction, citing California's push 
for Federal price controls and rhetoric about possible seizures 
of power plants. The Charlotte Observer, April 27 of this year, 
says even though Duke Energy Corporation is building one, the 
Power Star, of California's biggest power plants, top executive 
Rick Prowery said the company would hesitate to build more 
California plants because the State's energy economy resembles 
that of a third world. Reliance expressed some similar 
concerns. ``Ridgewood Power said generators find it more 
predictable and less risky to operate in third world companies 
than they do in the State of California,'' griped Marty Quinn, 
Executive Vice President and Chief Operating Officer.
    Of course, obviously, some of these folks have their own 
axes to grind. There is no question about that. But we have 
also heard from investment bankers, as I indicated earlier, 
about this. You can't get away from comparing that with the 
rhetoric that has come out of California. These power suppliers 
have been subjected to all manner of description. You have an 
Attorney General there who apparently wants to introduce the 
head of Enron to your President so that he can be introduced to 
a fellow named Spike.
    Assuming that these energy executives don't want to meet 
Spike, I wonder what that is doing to the atmosphere when you 
are going to threaten to seize plants. What is that doing to 
the atmosphere when you are going to have to be, I think, in 
the future--we are talking about short-term solutions here 
right now primarily. You are going to have to be dependent upon 
substantial new investment at a time when the regulatory 
environment is very uncertain for these people to start with, 
and now they are finding a very hostile political environment. 
Is that a wise strategy at this time? Are you concerned about 
the completion of plants and suppliers who are expressing these 
serious reservations?
    Mr. Davis. Well, Senator, with all due respect, the people 
I represent are mad. They don't like paying 700 percent more 
for electricity. Small businesses in San Diego don't exist 
anymore because they had to face this problem in the year 2000 
and they want us to fight back, and that is what we are doing.
    This is a rough business. You know these energy companies. 
Many of them have a wildcatter mentality. My grandfather had 
something to do with the oil business and I know what that 
attitude is like. California has been a cash cow to a lot of 
energy companies around this country who have done 
extraordinarily well, and occasionally some harsh words get 
exchanged. But my job is to fight back and say we are not going 
to take it, and I suggest to you, if it were not for a good 
deal of what you might consider political hyperbole, we might 
not have the attention of the Federal Energy Regulatory 
Commission that stiffed us for almost a year.
    Chairman Thompson. Do you think that FERC responded to your 
Attorney General suggesting that the head of Enron be thrown in 
jail with Spike, or do you think FERC responded because you 
called the suppliers pirates and words of that nature? It may 
make you feel better, and it may be understandable in 
responding to your constituency. We all have the temptation to 
do that from time to time. You are not alone in that respect. 
The only difference here is, you are going to be very dependent 
on these same people.
    Regardless of the past, it looks to me like you have to 
look to the future. Is it the responsible thing to do to create 
an environment for the very people who are in the process of 
looking at California for future investment, and sometimes have 
requested license applications, who are now doubtful because of 
the regulatory and the political environment in your State when 
you are the head of that State?
    Mr. Davis. Well, first of all, as Senator Torricelli 
pointed out, we are building more power plants than anyone has 
ever built.
    Chairman Thompson. How much has come on-line in the last 2 
years?
    Mr. Davis. It takes about 2 years to build a plant, but as 
I said in my initial comments, there will be three plants on-
line between now and July 7, representing about 1,200 
megawatts. There will be ten peakers representing about 800 
megawatts. And there will be a total, when you count 
distributive generation, additional renewables, re-rating power 
plants, approximately 4,000 megawatts by the end of September. 
We anticipate 5,000 megawatts for each of the 3 years following 
that for a total of 20,000 megawatts.
    Now, obviously, we want the State to be an attractive place 
for investment, but we don't want companies walking all over 
our citizens. We want--responsibility is a two-way street. We 
understand the obligation to be responsible and we expect 
corporations that operate in our State to be responsible, and 
by and large, they are.
    Chairman Thompson. Thank you, Mr. Chairman.
    Chairman Lieberman. Thanks, Senator Thompson. Senator 
Bennett.
    Senator Bennett. Thank you. I want to go in the same 
direction, Governor, as Senator Thompson. Last time, you said I 
quoted your critics. This time, I will quote you, and it is 
interesting that Mr. Freeman is sitting next to you, because 
here is a circumstance where the two of you may have said 
different things.
    Here is a quotation, a release from the Office of the 
Governor on May 31, 2001: ``I met with the municipal utilities 
about 3 weeks and I was very disappointed to learn that they 
were charging us more for power than the generators. Here we 
have been maligning the generators, properly, because they have 
been selling us power at 600 to 700 percent what we paid for it 
just 2 years ago. I find out the munis are charging us even 
more. So I said, listen, you are going to sell us your excess 
power this summer at a cost-plus basis, roughly 10 to 15 
percent over cost, or I am going to seize it from you and I am 
going to make sure that we get that power at an attractive 
rate.''
    ``I gave them a couple of weeks to negotiate with the 
Department of Water and Resources. The first day they had to 
negotiate was this Tuesday. We will see what happens in 2 
weeks, but if they don't come through with contracts, I am 
going to seize the power because they are creatures of the 
State legislature. They are supposed to provide power on a 
cost-of-service basis, not make a zillion dollars by charging 
more than these out-of-State generators who set the Guiness 
Book of Records for greed themselves. The munis are doing even 
more.''
    And then, Mr. Freeman, you are quoted in the Los Angeles 
Times, not specifically in response to the Governor's 
statement, but generally. `` `These charges go under the 
heading, there is no good deed that goes unpunished in this 
State,' Freeman said, noting that DWP Power helped avert more 
blackouts across the State. He did acknowledge, however, that 
the agency has charged high prices for surplus power at the 
11th hour, but said that was only because it cost more to 
produce. `We have consistently charged Cal ISO our cost-plus 15 
percent,' he said. `It is not as though we are up there 
peddling a bunch of power to jam it down their throats.' ''
    Now, my question--first, if you want to challenge the 
statements, that is fine, but my question is, you are here 
asking for refunds and rebates from those whom you say gouged 
and bilked Californians. Are you planning to ask of that from 
California munis?
    Mr. Davis. I believe everybody that unduly took advantage 
of this situation should be required to make rebates. 
Californians expect people to treat us fairly. We expect to 
treat them fairly in return.
    The statement you quoted from me was accurate. I was 
appalled to find out that these municipal power authorities, 
which were creatures of the legislature, we gave them 
permission to exist, because they were not supposed to be 
competing with the free market, they were supposed to provide 
cost-of-service power, had, in fact, charged us roughly $360 a 
megawatt hour while the generators had charged us about $310 a 
megawatt hour, and I found that out about 30 minutes before the 
meeting we had with the munis.
    So my job is to protect all the citizens of this State from 
getting a raw deal and it doesn't matter to me if the raw deal 
comes from a generator from Houston or a municipal power 
authority in Los Angeles.
    Senator Bennett. Mr. Freeman, the governor has asked you to 
the table. Do you feel that you gouged the State while you were 
running the muni and charging cost-plus 15 percent?
    Mr. Freeman. No, sir, and your researcher overlooked one 
relevant fact, which is that the day after I left the 
Department of Water and Power, that board of commissioners 
changed their policy to start charging market prices for power, 
and it was that market price policy that Governor Davis 
correctly was criticizing. They have since then backed off and 
they have now agreed to sell at cost. So the governor is 
entirely correct, but I think that I was accurate when I said 
that our policy when I was there was to sell at cost-plus 15 
percent.
    Senator Bennett. Do you feel that----
    Mr. Freeman. But if there is any investigation that shows 
that we charged more than that, the muni should refund the 
money just like anyone else and the governor is being 
consistent. Indeed, he should be congratulated for being just 
as hard on the municipalities in California as he is on the 
other generators. It seems to me that this is just more 
evidence that he is standing up for the consumers across the 
board.
    Senator Bennett. I appreciate that clarification. Just one 
last comment, Mr. Chairman, if I might.
    Your $50 to $60 billion projected figure does not coincide 
with the earlier chart that Senator Murkowski put up that shows 
that prices are, in fact, coming down. I would appreciate it if 
you would supply information for the record as to whether or 
not you are prepared, after examining where prices are, to 
lower that projection or if you stand by it. We don't have the 
time to go through it here, but we have had two separate charts 
that show different projections for the future and I would 
appreciate whatever further clarification you could give to 
that.\1\
---------------------------------------------------------------------------
    \1\ Chart entitled ``California Day-Ahead Power Prices,'' appears 
in the Appendix on page 551.
---------------------------------------------------------------------------
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thanks, Senator Bennett.
    Just real briefly, I do want to quote with regard to the 
impact of price relief or price mitigation questions. Fair 
questions have been raised about the impact of that on the 
willingness of power producers to come into the California 
market. The Los Angeles Times, which I will not describe 
according to any particular ideological inclination, says 
today, headline, ``Curbs Won't Halt Plants.''
    First paragraph, reports reporters Nancy Vogel and Thomas 
Mulligan, ``The expanded electricity price limits approved by 
Federal regulators could squeeze big energy traders but will 
probably not discourage power plant construction in California, 
electricity producers said Tuesday.'' ``But the companies,'' I 
go on, skipping a paragraph, ``the companies generally asserted 
Tuesday that the order would not deter them from investment in 
the vast power-starved Western region, though they have often 
raised such a prospect in arguing against price controls.'' So 
that is certainly an encouraging dispatch or independent 
report.
    I think I am going to control myself and not ask any more 
questions because you have been on a long time.
    Governor Davis, you have been tested generally in this 
crisis. You have been tested this morning. But by my judgment, 
you have passed the test very, very well. I appreciate your 
testimony and I appreciate not only the fact that you have 
become an expert in something you probably weren't an expert in 
a couple of years ago, but the tone in which you have spoken.
    I think you were quite right. You said that neither you nor 
President Bush was there at the origin of this problem. The 
question is, what do we all do about it now, and that is the 
question that we are asking FERC. This is not a partisan 
matter, by any means. This is just a question of a genuine 
crisis, not of your making, not of the President's making, but 
so genuine that it threatens the economy. And I have noted now, 
California's economy is now the fifth largest, if it were a 
country, in the world, and it is critically important that we 
all do our share to overcome the crisis.
    I think, as you have testified very directly and eloquently 
today, the State of California, the legislature of California, 
the people of California have done their part and FERC has 
finally come into the arena and done some things to be helpful. 
I have concerns, as I stated at the outset, about how fully 
effective it will be. I share your concern about the inequity 
of not ordering refunds to go to electricity customers in 
California and the West because they suffered damage here. When 
you have a right, as you said, without a remedy being offered, 
that undercuts our system of justice. And, it does not deter 
future behavior of that kind by energy wholesalers or anybody 
else who would take advantage of a consumer.
    So we are going to ask that question of FERC this afternoon 
and we are going to stay on the case until we feel that we have 
done as much as we can by way of our oversight to make sure 
that the Federal Government plays an appropriate role here, or 
at least that we have adequate public discussion of the role 
that it is playing.
    I thank you for the time you took in coming out here. You 
have contributed substantially to our understanding of the 
problem and I wish you well.
    Mr. Davis. Thank you very much. Thank you, Senator 
Thompson.
    Chairman Lieberman. Thank you. We will now call the Hon. 
John Hoeven, Governor of the State of North Dakota, and the 
Hon. Judy Martz, Governor of the State of Montana.
    According not just to the tradition but the rules of the 
Committee, we try to conduct these hearings and our 
deliberations generally in a bipartisan fashion. Senator 
Thompson requested that these two governors be called and I am 
delighted that you two have taken the time and made the effort 
to be here. Your presence obviously punctuates the fact that we 
have all been testifying to, that though California may have 
been most extremely impacted by this energy price and supply 
crisis, that certainly other States in the West, let alone 
States throughout the country, have an interest in this. So we 
look forward to your testimony.
    Governor Martz, do you want to proceed first?

  TESTIMONY OF HON. JUDY MARTZ,\1\ GOVERNOR, STATE OF MONTANA

    Ms. Martz. Sure. Thank you very much. Thank you, Mr. 
Chairman, and thank you, Senator Thompson and Members of this 
Committee. My name is Judy Martz and I am the Governor of the 
Big Sky State of Montana. I appreciate the interest this 
Committee has shown in the struggles of Western States to deal 
with an electricity crisis. I may, as Vice Chairman Thompson 
said, rain on a parade.
---------------------------------------------------------------------------
    \1\ The prepared statement of Ms. Martz appears in the Appendix on 
page 821.
---------------------------------------------------------------------------
    We are here to discuss the role of the Federal Energy 
Regulatory Commission associated with the restructuring of 
energy industries. However, the real issue seems to be what 
went wrong in California and could it happen elsewhere? Let me 
try to answer this question.
    The facts show that the primary responsibility for the 
electricity crisis in the West lies within the State of 
California. A series of mistakes made by the State and the 
failure by the State to take corrective action once problems 
first arose more than a year ago led directly to the crisis we 
are in now. This crisis, I believe, could have been avoided if 
California had taken timely action.
    Instead of acting, I believe the State, unfortunately, 
engaged in a prolonged exercise of blame shifting. I don't say 
this to be disagreeable. I really don't. I say this from the 
perspective of a State that has been hurt by the California 
electricity crisis. I also say this to make sure that other 
States do not make the same series of mistakes California made 
in the recent years.
    We all want to do our share, but it is killing us. Montana 
has been hit hard by the very same issues that Washington State 
has. As a result of the California electricity crisis, Montana 
industrials have gambled on declining future power prices that 
have been hurting us as a result of the power prices rising. We 
have seen several closures in Montana, a State whose economic 
base cannot afford to lose even one single job.
    But because we are tied to the Western grid, any excess 
energy is pooled to other States and we face higher rates 
ourselves. Industries that chose to shop for energy found their 
traditionally low rates of about $30 per megawatt rise to as 
high as $300. Much of the pain that my State and others have 
felt could have been avoided if California had not shied away 
from making tough decisions when they were called upon last 
year.
    Let us review how we got here today. California was the 
first State to open its retail electricity markets to 
competitive markets in 1996, with Pennsylvania following 
quickly on its heels. The California electricity law is often 
described as deregulation, but it was nothing of the kind. 
California did not deregulate electricity markets but merely 
exchanged one set of State regulatory rules for another, which 
led to disaster. We did better than that in Montana.
    The 1996 law had a number of unusual elements. It forced 
California utilities to divest much of their electricity 
generation. It required utilities to rely completely on 
volatile spot markets to buy all of their power, something no 
other State did. It also imposed regulatory rules governing 
spot market sales that increased wholesale market prices. It 
froze retail rates.
    One provision missing from the 1996 law was reform of the 
State siting law. It can take up to 7 years to build a power 
plant in California, and on the average period, it is 4.5 
years, nearly twice the average as in Texas. This was a crucial 
mistake. Since California retained a siting process suitable 
for long-term planning by regulated utilities with 10- or 20-
year planning horizons, but completely unsuitable for a 
competitive market where independent power producers build 
virtually all power plants using much shorter planning 
horizons.
    The failure to address siting reform was, I believe, a 
major mistake. Independent power producers moved quickly to 
meet California's growing electricity demands, filing 
applications to build 14,000 megawatts of new generation 
beginning in 1997. Because of the failed State siting process, 
none of these power plants are operating yet. Montana did not 
make that same mistake. We revised our siting laws to exempt 
generation facilities.
    It is important to note that the supply shortage in 
California did not occur overnight. It developed over a 5-year 
period when electricity demand rose by 6,300 megawatts. 
Incredibly, over this same period, electric generating capacity 
in California actually declined. As I indicated earlier, 
California took a big gamble by forcing its utilities to buy 
all their power through a volatile spot market. It took an even 
bigger gamble by not ensuring that electricity supplies were 
adequate to meet the needs of consumers and businesses. It 
doesn't take a panel of economists to know that supply 
shortages and spot markets are not a good combination. They 
produce the sky-high prices that California and the West have 
been paying now for the past year.
    California has had price caps for the wholesale power sale 
since 1998. Last year, California experimented with four 
different price caps, starting with a hard cap of $750 per 
megawatt hour. This year, FERC changed tactics, approving price 
mitigation that reflects gas costs and other costs. That 
approach seems to be working, and FERC earlier this week 
expanded the scope of its price mitigation plan.
    Price caps exacerbated California's supply problems last 
year. Since the caps did not apply to the Western markets and 
State power producers often chose to sell electricity outside 
of California at prices higher than the hard cap, as a result, 
power exports from California rose 85 percent and California's 
electricity supply fell by 3,000 megawatts. By the end of the 
year, when the hard cap had been lowered to $250, the price cap 
was seriously exacerbating California's electricity supply 
problem, since prices in an uncapped market had risen to more 
than $400. Ultimately, California had to ask to lift the price 
caps on the grounds that it was causing serious supply 
problems.
    On December 8, 2000, the California ISO filed an emergency 
petition to waive the $250 hard cap, which FERC approved. At 
their request, FERC set a soft cap. Price caps last year did 
not control high prices. Each time prices were lowered, average 
monthly prices rose. The experience last year showed that price 
caps failed to control high prices and exacerbated supply 
problems.
    The lessons California apparently drew from the failure of 
price caps last year was to expand the scope of price caps to 
encompass the entire West, notwithstanding the opposition 
expressed by eight of the 11 governors in the region, and I 
repeat that. Eight of the 11 governors in the region opposed 
price caps.
    The main cause of the California electricity crisis is a 
supply and transmission shortage. It is each State's 
responsibility, not the Federal Government, each State's 
responsibility to license power plants and to get us moving. It 
has been clear for a long time that California's siting process 
is broken. Although it has made cosmetic changes, the State has 
shied away from making meaningful reforms to the siting 
process.
    The secondary cause of high prices is the disastrous 
regulatory rules imposed on the electricity market by the 
State. Unfortunately, the State has simply refused to act in a 
timely and effective manner. The California electricity crisis, 
in large part, is a result of inaction over a crucial 9-month 
period after the price spikes and supply shortages began in May 
2000. This inaction forfeited the last chance to prevent a 
crisis. State rules barred California utilities from recovering 
wholesale power costs from retail rates, forcing utilities to 
buy power at 30 cents per kilowatt and resell it for 3 cents.
    It was those rules imposed by the State of California that 
destroyed the financial health of the utilities and drove 
Pacific Gas and Electric into bankruptcy. If the State had 
allowed cost recovery, the utility's credit would not have been 
destroyed. PG&E would not have gone bankrupt, and the State 
would not be spending its surplus buying electricity and 
bailing out the very utilities whose credit is destroyed. The 
bankruptcy of PG&E could have been avoided if the State had 
allowed cost recovery.
    Perhaps the most serious mistake made by the State was 
forcing the California utilities to rely entirely on the 
volatile spot markets for all of their power, even after 
wholesale prices had risen tenfold. If the governor had allowed 
the utilities to enter into bilateral contracts last year, 
electricity prices would be a fraction of what they are now. 
The State only recognized the need for bilateral contracts 
after the financial health of utilities were destroyed and the 
State assumed the burden of buying power for Californians. Once 
the State was paying the bills, it realized reliance on 
volatile spot markets was foolish and began to enter the 
bilateral contracts. Ironically, the contract prices California 
has announced, and much of this remains secret, indicated that 
they agreed to pay up to three times higher than what Duke 
Energy offered them last year.
    The State's indecision on raising retail rates was another 
major mistake, one that led to higher rate increases than were 
necessary. Last fall, the utilities requested a modest rate 
increase. The State refused to consider this proposal, which 
directly led to the PG&E bankruptcy. In the end, the State 
ended up approving a much larger rate increase than was 
necessary if it had acted in a timely and effective manner. We 
governors have a lot of power. It is called executive power, 
and I truly believe that could have been used in this case.
    Nine months after the beginning of this crisis, Governor 
Davis began to take action. In February, he announced an 
emergency plan to build 5,000 megawatts of new generation by 
July 1. According to recent reports, only 1,300 megawatts of 
plants that were under construction before his announcement 
will be available on that date.
    Governor Davis announced a conservation plan to lower 
demand by 3,000 megawatts. I understand that plan also is 
falling short and may produce less than 1,000 megawatts in 
demand savings, which is a good savings, but nowhere near what 
the demand was.
    The governor's plan to restore the financial health of 
Southern California Edison appears to be languishing in the 
State legislature, and I am glad the State is taking this 
action, but regret they only acted in response to a crisis, 
instead of trying to prevent one.
    Threats by the governor and others to seize power plants 
and impose punitive taxes, which we did not do in Montana 
ultimately, will discourage what is needed most, investment in 
new generation. California has seen at least two power plants 
on hold now because of uncertainty about regulatory stability 
in California. As Senator Thompson said and one other power 
company said, ``I have more confidence in regulatory stability 
in Brazil than I do in California.''
    If the governor takes a rash step, investment in new 
generation in California will come to a complete halt. The 
State will find itself in the business of generating and 
transmitting electricity on a permanent basis. The State will 
continue to spend billions of dollars on electricity instead of 
on schools. The power plants and transmission infrastructure 
will slowly degrade. And California's neighbors, Montana 
included, will find that they must continue to supply the power 
that California needs, since California refuses to provide it 
for itself.
    The time has come to quit shifting the blame, quit shifting 
it to the Federal Government. We as governors have, as I said 
before, tremendous power to take advantage of our own destiny. 
FERC has taken strong actions to mitigate high prices in 
California. The time has come for the State to buckle down and 
do its job, ensure adequate electricity supplies for California 
consumers and businesses.
    So please, I am asking you, do not put caps on the 
utilities of the Western States like Montana. It will be the 
same as inflicting foot-and-mouth disease on our agriculture 
industry. It will discourage construction of generators, it 
will discourage transmission, and it will surely discourage 
people from conserving, and it does not encourage us anymore.
    I liked what Senator Carper said, that we are like the 
quarterback on a team and that you are maybe the athletic 
directors, but I tell you what. If the athletic director 
doesn't work right, the team is out of business, and I really 
see if you put price caps on us right now, if Governor Davis 
wants that for California, then I would advise him to do that 
for California. He has the power to. But do not inflict it by 
FERC on the rest of the States because it will kill us. Thank 
you.
    Chairman Lieberman. Thanks, governor. I have the feeling 
this morning that we are down on the field now. [Laughter.]
    Ms. Martz. That is right.
    Chairman Lieberman. We are no longer athletic directors.
    Governor Hoeven, thank you for being here. I look forward 
to your testimony.

  TESTIMONY OF HON. JOHN HOEVEN,\1\ GOVERNOR, STATE OF NORTH 
                             DAKOTA

    Mr. Hoeven. Chairman Lieberman, thank you for the 
opportunity to testify. I must say that I admire the diligence 
of both you as Chairman and the Ranking Member, Senator 
Thompson, for conducting these hearings and sitting throughout. 
I appreciate it very much.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Hoeven appears in the Appendix on 
page 825.
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    I have to say this. I do not know if I should, or not, but 
Senator Thompson, I really did enjoy your movies.
    Chairman Thompson. I knew I would find somebody.
    Chairman Lieberman. Do not let this go to your head. 
[Laughter.]
    Mr. Hoeven. My comments today, and I will be brief, which I 
am sure you will be pleased to hear, my comments today will 
focus on the President's leadership in setting the right 
direction for energy policy. His plan calls for a market-based 
approach that will stimulate supply, promote conservation, and 
enable North Dakota and other States to meet this country's 
energy needs.
    North Dakota exports 75 percent of the electricity 
generated in our State. We are encouraging the construction of 
new and efficient generation and the development of 
environmentally friendly renewable energy. We have also 
developed one of only two coal gassification plants in the 
world, converting coal into natural gas, and as you know, there 
is a tremendous need for natural gas right now, which will be a 
big benefit to California as they continue to site new power 
plants that utilize natural gas.
    This diverse and growing energy portfolio will serve North 
Dakota's needs for a long time in the future while allowing the 
excess energy to be exported and help serve other parts of the 
country, like California. We are also one of the low-cost 
energy producing States in the Nation, using clean coal 
technology, natural gas, and hydro, a fact that we are very 
proud of.
    We have worked hard to ensure that we have enough 
electricity to meet the demands of our consumers and 
businesses, and our citizens recognize that you cannot maintain 
economic growth if you lack the electricity infrastructure 
needed to encourage economic development and continued growth. 
We also see energy generation as an important job creator for 
our State's economy, while helping to meet a national need.
    In order to assure economic growth, our State has a 
partnership called Vision 21, investing $10 million with any 
company that undertake feasibility studies for new clean coal 
technology generation plants. This program will seek to access 
the clean coal program in the President's energy policy, if it 
is authorized by Congress, creating a Federal, State, private 
sector partnership for new energy generation.
    For America to move forward and ensure our energy 
independence, our Federal Government must utilize market-based 
policies that will encourage new and efficient infrastructure. 
We must stimulate private investment in new generation and 
transmission in order to develop a vibrant, regional wholesale 
market. To do this, I believe the Federal Government has two 
roles. One is leadership, and the other is to provide market 
and regulatory certainty.
    President Bush and Vice President Cheney have shown our 
Nation the leadership necessary to ensure our future energy 
independence. President Bush has developed a long-term national 
energy policy while also directing his administration to take 
steps that can help address short-term problems like that of 
the California energy crisis. The President's initiatives to 
help solve the California energy crisis include: Two days after 
taking office, the Bush Administration extended emergency 
orders giving the State time to enact legislation authorizing 
it to buy power on behalf of Californians. A month after taking 
office, the President issued an executive order directing 
Federal agencies to expedite permits needed to increase 
electricity supply in California. In order to reduce demand, 
the President issued an executive order directing Federal 
facilities in California to maximize conservation this summer. 
And at the governor's request, Secretary Abraham asked FERC to 
extend a waiver for qualifying facilities from PURPA fuel 
requirements, a request that FERC granted. Finally, 4 months 
after taking office, the administration took the first steps 
towards removing a transmission constraint, the Path 15, that 
has caused repeated blackouts.
    For a long-term energy independence, the President 
developed and released the administration's National Energy 
Policy. Not all of the recommendations are popular, but they 
all should be considered as part of a comprehensive national 
energy policy. America cannot depend on other countries to meet 
our energy needs.
    In order for new investment to begin in some parts of the 
country and continue in others, we must ensure that there is 
regulatory certainty at both the State and the Federal level. 
State legislative and executive agencies must show they can 
assure the investment community that rules will be set and 
followed in an expeditious manner. We must ensure that agencies 
will make tough decisions, however unpopular, that benefit the 
good of the entire State and the region. The Federal 
Government, both Congress and the Executive Branch, must move 
expeditiously to change the laws and promulgate the rules 
necessary to move our energy and electric industries forward. 
The Congress must quickly decide what laws need to be repealed 
and modified to ensure a vibrant and efficient market. The 
FERC, EPA, Interior, and other agencies must implement sound, 
market-based rules and enforce them to ensure that market 
participants are playing fair while not gaming the system.
    The FERC took a step in that direction on Monday. It 
remains to be seen if that order will work as designed, but we 
do know that all of their orders and rules must encourage new 
investment in electricity generation and transmission. 
Development of new transmission will require a reasonable 
return on investment and reasonable access to the 
infrastructure.
    In closing, given the right type of Federal and State 
regulatory environment, private industry will make the large 
investments and long-term commitments necessary to build our 
energy generation and transmission infrastructure. President 
Bush has provided a road map for the Federal Government's role, 
a market-based approach that will help States provide industry 
with the regulatory certainty needed to move forward. Though 
there will continue to be bumps in the road, we are making 
progress. The challenges are great, but by working together, I 
am confident we can develop dependable, affordable, and 
environmentally sound energy for our future. Thank you, Mr. 
Chairman.
    Chairman Lieberman. Thank you, governor.
    Governor Martz, in your statement, you put a lot of the 
blame for the crisis on inaction or mistakes by the State of 
California, by the Government of California, but let me ask you 
this. I do think that Governor Gray Davis was asked most of the 
questions that you asked, so I think he has given his answers 
for the record. Part of his response, apart from his response 
to the specifics, was that the State of California, the people 
are doing what they can now, as much as they can do now, but 
because they are so adversely affected by the price they are 
being charged by the producers outside the State who are 
wholesaling electricity into the State, that they need help 
from FERC because only FERC can do anything to mitigate those 
prices.
    It is probably hard to imagine. We were joking before about 
what if this had been Montana that had been affected by this 
crisis. But if it had been and you felt you were at a point, 
leaving aside what the causes were, at a point where you had 
done everything you could, wouldn't you also be appealing to us 
for the Federal Energy Regulatory Commission to help protect 
you from being unfairly treated by out-of-State wholesalers?
    I am coming to your point that governors have great power. 
That is absolutely right. But they don't have the power, in 
this case, to regulate or at all affect, really, certainly the 
price charged by out-of-State producers of power.
    Ms. Martz. That is a very fair question, Senator, and I 
don't believe I would be coming to the Federal Government for 
help. I really believe that I would, if I had the emergency 
powers that Governor Gray Davis does, I would be ordering 
facilities being built so that we could start to speak to our 
own energy needs.
    You talk about them having to pay high prices. Because they 
are buying our markets, they are causing us to have to pay 
those high prices. They are not doing anything that we are not 
having to do because of them.
    So I don't believe I would. You don't know until you are in 
those shoes, but I really believe this is something States 
should solve on their own and I really do think that he has 
some powers that he hasn't used yet.
    Chairman Lieberman. I know you criticized the State and the 
governor for not building enough power plants. I am sure you 
know that he was elected in 1998 and took office in 1999. It 
was pretty hard, I think, but let me ask you to respond, to 
have built enough power plants to have been on-line in that 
short of a time to deal with the price spikes that began to 
occur about a year ago.
    Ms. Martz. Well, I think he could be having power plants 
on-line right now. He has got 6,300, I think, ordered. He has 
got 1,300 coming up, and they are not there yet. Each of us in 
our own States has to do what we have to do. We are looking at 
wind, we are looking at solar, we are looking at biodiversity, 
we are looking at coalbed methane, we are looking at coal, and 
we are going to be building as quickly as we can, also.
    We have enough power in our own State--people say, well, 
you haven't built in your State, either. We haven't because we 
never needed to. We export almost as much as we use in our own 
State out of State. So we didn't need to build until 
California's crisis came upon us.
    Chairman Lieberman. Let me ask you this. I have a copy of a 
letter dated April 6 of this year that a number of governors in 
the West, I believe all Republicans, sent to the Chair of the 
Federal Energy Regulatory Commission, and the two of you signed 
it. In it, it says, ``Your resistance''--this is to Mr. 
Hebert--``your resistance to the considerable pressure to 
impose `penny wise and pound foolish rate controls' has served 
a long-term interest of our region.''
    I wonder, now that FERC, most recently, 2 days ago, has 
acted to impose what some call price mitigation, some call 
price relief, some call price control, some call soft price 
caps, how you feel about FERC's action in light of your earlier 
request to the Chairman that they not impose, as I read it, any 
form of price controls.
    Ms. Martz. In our State, already, meetings with the utility 
companies, we have a transition advisory committee working on 
these energy issues. Already, some of the utilities have 
concern over that. So we are going to have to see how that 
plays out. We did not have the full document. We had the press 
release from FERC that tells basically what that does, but we 
don't have the full document to be able to read that yet, so we 
will have to see how that plays out in our State. It may not be 
a healthy thing for us. We do not want price caps. We want the 
market to play itself out.
    Chairman Lieberman. Your 5 minutes is up, but I do want to 
give you a chance, Governor Hoeven, to give me your reaction to 
what FERC did on Monday.
    Mr. Hoeven. On the ruling? Well, I view it as price 
mitigation, designed to make sure there is no price gouging or 
overcharging. If it works that way and still allows the market 
to operate so that, again, we stimulate the increase in supply 
that we need, particularly in the Western area power pool, and 
at the same time encourage conservation, then it may work, and 
I think that is what remains to be seen.
    And I think that is the point that I am trying to make. 
FERC has to set rules of the game that are certain so that 
industry can come in and make long-term commitments and make 
investments and know that not only are they going to be able to 
recoup that investment, but they are also going to have access 
to transmission lines they build and so forth so that they can 
do business and truly solve this problem for the consumers of 
California and other States.
    Chairman Lieberman. Governor Hoeven, am I right, North 
Dakota is not on the Western grid, is that correct?
    Mr. Hoeven. Right. We are in the mid-America power pool. 
Now, we are members of the Western Governors' Association and 
we sell power, of course, to a variety of other States.
    Chairman Lieberman. Right. So it is both as a seller of 
power, but also generally interested in electricity and energy 
issues, that you are here today.
    Mr. Hoeven. Ironically, this is an incredible opportunity 
for our State. We need development in rural North Dakota, in 
Western North Dakota. We have oil, we have gas, we have hydro, 
we have clean coal technology, we are converting coal to 
natural gas, we have bio-diesel, we have ethanol. We are 
busting at the seams trying to export energy to the markets 
that need it, but we need help from the Federal Government in 
terms of the rules of the game so that our companies can invest 
in transmission and get that power to market, not only in terms 
of recouping their investment, but also in terms of access to 
the line they have built. They might build a transmission line 
and not even know what access their company is going to have on 
that line under the rules that FERC has because it is so much 
in transition and there is so much uncertainty.
    Chairman Lieberman. Thanks. Senator Thompson.
    Chairman Thompson. Thank you, Mr. Chairman.
    Governor Hoeven, I think you have hit right directly upon 
the nature of the problem when we try to look at FERC's 
actions, and I think you have the right solution, and that is 
certainty. I mean, that is what we look for across the board in 
our country. It is called the rule of law. You may have good 
laws, bad laws, indifferent laws, some kind of good, some kind 
of bad, but the main thing for business and for individuals is 
to know what the deal is, know the game that you are playing.
    So now we are launching off under this great pressure. We 
are launching off into something that has something to do with 
the business' costs, figuring out all these suppliers, 
utilities, I suppose, what their real costs are and what is 
just. And we put FERC in the position of deciding, somebody 
withholds power and they say, well, we need repairs and what 
not. Well, what is really on your mind? Why are you really 
doing this? We put them in a position of deciding what is just.
    So if I were thinking about building new power sources, I 
would have to wonder how certain is this. I mean, is somebody 
going to wake up some day and look at this thing totally 
differently? I think that is the problem. It is not that we can 
sit here and say that it is a good idea or a bad idea. I think 
hard caps are obviously a bad idea, but that is the problem.
    Carrying it further, part of the problem with hard caps is 
that it is, as I said, a Goldilocks formulation, not too hot, 
not too cold, just right, and if we do this and if we do that 
and that works out, and we lift the caps when we say we are 
going to. What supplier believes government when they tell them 
that? There is no reason for them to believe. So it is 
uncertainty, again, and that is why you are seeing, I think, a 
lot of the comments you are seeing from potential suppliers in 
California.
    I think, also, you are right when you say the prices are 
high, therefore, what are we going to do? We have got to look 
at that, and that is what we are looking at, but we also have 
to look at the front end. Why did prices get so high? How did 
it come about that we developed this supply problem?
    Governor Martz, how is Montana affected by being a part of 
the Western grid when California is in the shape that it is in 
and urging the things that it is urging? All the talk is about 
California, as I am sure you know. All the concentration is 
about California. The lead-off witness, in effect, was the 
Governor of California. We spent all morning, just about, with 
the Governor of California. You other States are out there, 
too. And I might point out, as you said, eight of the 11 
governors are Republicans and the three who are for price caps 
are Democrats. All three of those States will be represented 
here today, by the way, but eight of the 11 governors oppose 
price caps. Why is that and how is your State as a part of the 
grid affected by all the attention and the pressure that is 
being brought to bear on behalf of California?
    Ms. Martz. Well, thank you, Senator, for the question. In 
the morning, when California wakes up, say if they are down 
3,000 megawatts in the morning and they have to go out on the 
spot market and buy, we can't even buy power in Montana. Right 
now, we have tried--we are a regulated market until 2002 for 
our homeowners. Twelve major companies went off of that 
regulated market when we deregulated, had the opportunity to go 
off of the market. They are having a terrible struggle now 
buying power, even finding power to fill their need because 
most of the power is bought up at a higher price. We can't buy 
power. It is contracted out. We are looking at power, when the 
2002 market comes up, we can't even satisfy the full load that 
we need for our homeowners because of what is happening in 
California. They are paying such high prices for it, so it is 
driving our prices up.
    Chairman Thompson. And, of course, we only know part of the 
story. I can't figure out yet what has been released and what 
has not been released because the State of California has 
resisted, and relented, I think, partially now on releasing to 
the taxpayers of California and the ratepayers of California 
how much they are actually paying. And I think they still 
haven't released what the municipals are paying. And you have 
suppliers out here who don't want to reveal the high prices 
they are charging. You have purchasers in California who don't 
want to reveal the fact that they are paying several times more 
than they would have paid last year if they had done what 
everybody was urging them to do. So we know they are paying 
higher prices. We don't know how much because of that.
    I have a note here that you need to leave right away, and I 
think that is probably--well, my time is up. How convenient. 
[Laughter.]
    Chairman Lieberman. Thanks. I am going to let you go, but I 
cannot help but say you taught us something. You created part 
of a record here that we haven't had before, which is obviously 
that anybody on the grid is affected by what is happening in 
California, so that if the price goes up there, it makes it 
harder to purchase in Montana. But it also brings me back to 
the fact that, though I know you are opposed to any form of 
price mitigation or relief control, that if FERC imposed some 
sort of order here and lowered the price of electricity in 
California, wouldn't that help the folks in Montana?
    Ms. Martz. No, because we then cannot even build more 
generation to keep in the State at all.
    Chairman Lieberman. Oh, well that is the tipping point.
    Ms. Martz. See, what FERC did, it is important to remember, 
the only thing that they did, the only thing you can do to 
prevent blackouts is increase supply and reduce demand. Those 
two things, you can do. Yesterday's ruling doesn't address 
either of those. Price caps won't address getting more power.
    Chairman Lieberman. That is correct. Of course, these are 
only--I am going to let you go, but these are only temporary. I 
mean, there is no question that, conceptually, you could 
certainly reach a point where price caps were so severe that 
you would discourage supply. Nobody wants to get there. But 
what I am suggesting as I hear you is that some temporary price 
relief until supply can overcome demand in California actually 
would help folks in Montana, too, because once the price is 
lowered there, you are not going to have to pay so much more to 
buy it off the grid.
    Ms. Martz. But Senator, FERC admits this themselves. 
Anytime they have ever put a price cap, it has never been 
removed. So we are not looking at consistency for the producers 
at all, and, boy, if I owned it and I am a small business 
person, I would not invest. That is all I can say. And maybe 
some people can wait a year. Montana can't. We cannot lose any 
more jobs.
    Chairman Lieberman. I look forward to that oversight 
hearing, hopefully, in the not-too-distance future, when we 
press FERC as to why it has not removed the price cap.
    Ms. Martz. Thank you.
    Chairman Lieberman. Because supply has----
    Chairman Thompson. I thought you already guaranteed it 
would be temporary.
    Chairman Lieberman. Just listening to the governor, I said, 
if they do not remove a price cap, we will be back here when 
supply exceeds demand to ask that they do that.
    Thanks so much for making the effort and taking the time to 
come out here and I wish you both well.
    Ms. Martz. Thank you very much.
    Mr. Hoeven. Thank you very much.
    Chairman Lieberman. The next panel is the Hon. Attorney 
General of the State of Washington, Christine Gregoire, and Roy 
Hemmingway, Chairman of the Oregon Public Utilities Commission.
    I thank you both for your patience. I thank you for coming 
out. I was honored to become Chairman of this Committee 
recently and I said I was feeling like I was Attorney General 
again, which was definitely six great years of my public 
service career. Of course, one thing I missed when I came here 
was that nobody called me ``General'' anymore.
    Anyway, General, it is nice to have you here. We welcome 
your testimony.

 TESTIMONY OF HON. CHRISTINE O. GREGOIRE,\1\ ATTORNEY GENERAL, 
                      STATE OF WASHINGTON

    Ms. Gregoire. Thank you, Mr. Chair, Senator Lieberman, 
Senator Thompson. Thank you for the opportunity to come before 
you today and testify.
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    \1\ The prepared statement of Ms. Gregoire appears in the Appendix 
on page 415.
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    Let me also publicly thank both of our Senators from the 
State of Washington, who came before you this morning, for 
their support and their hard work with regard to the energy 
crisis facing the State of Washington.
    I am here this afternoon primarily in my role as chief 
enforcer of the State and Federal antitrust and unfair business 
practice laws for the State of Washington. But I also come to 
speak on behalf of my colleagues from the State of Oregon and 
California regarding the multi-State law enforcement 
investigation that we began recently.
    First, let me say that I am pleased that FERC recognized 
that this is a West-wide crisis involving all 11 Western 
States. Consumers in my State have been paying extraordinarily 
high prices for the last year. These issues are not just about 
legalities and economic theory, but about, fundamentally, the 
day-to-day lives of people, our businesses, our schools, and 
our environment. Let me share some of the impact this crisis 
has had on the people of the State of Washington.
    Our utilities, especially our publicly-owned utilities, 
have paid hundreds of millions of dollars for power over the 
last year. For example, Seattle City Light paid $312 million to 
buy power on the open market this past year compared to a 
normal year in which it spends about $50 million. Seattle 
consumers' rates were raised 42 percent since January of this 
year, and there is another expected rate increase of 22 percent 
in October. These increased costs reverberate throughout our 
economy and our society. Our schools have diverted funds from 
needed educational programs to purchase power, and we have 
idled or shut down major industries. Georgia Pacific shut down 
its Bellingham plant and idled 420 workers, citing power costs 
as the reason.
    Let me turn now into the multi-State investigation into 
unlawful business practices. The multi-State investigation 
launched by the attorneys general of Washington, Oregon, and 
California focuses on the causes of the exorbitant prices 
charged to utilities serving the West Coast consumers. We are 
concerned that the energy prices and supply in the past year do 
not appear to be the result of natural market forces. In the 
past year, let me tell you what we have observed that has led 
us to this investigation.
    First, the wholesale market rates for a megawatt hour of 
electricity skyrocketed from about $30 to $300, sometimes even 
as much as $3,000. Were these massive price hikes caused by 
some form of unfair business practice or collusive activity 
among the generators and the marketers?
    Second, sudden, unplanned maintenance outages at generating 
plants in California, to the point where 40 percent or more of 
the generation capacity has been consistently off-line, 
compared to historical averages of about 10 percent. What 
caused so many competing generating plants to suddenly go off-
line at the exact same time?
    Third, prices remaining high 24 hours a day, even though 
power is being purchased for off-peak hours. Why can prices 
stay so high when demand has been reduced?
    Fourth, transmission capacity restraints during crucial 
times, further exacerbating the high prices and the 
availability of power. Were the companies exchanging 
confidential data in a joint effort to create transmission 
problems?
    And fifth, suspicious activity in the California natural 
gas market, including claims that companies may have 
collusively agreed to suppress competition or otherwise engage 
in illegal activity.
    If we ultimately find evidence to support a violation of 
Federal or State antitrust or unfair business practice laws, we 
will seek restitution, injunctive relief, civil penalties, and 
our costs for investigating the matter. In California, a 
criminal grand jury is being convened in early July to 
determine if criminal activity has taken place. That grand jury 
will be exploring State, RICO, or other criminal violations, 
including false claims under California law.
    Let me note something else about our investigation. We are 
having difficulty getting access to power generators' records. 
California issued civil investigative demands on these 
generators in February. It is now June and these three States 
still do not have the documents that we requested. Some of the 
power generators are simply not cooperating, and this has 
delayed our antitrust investigation. They do this despite their 
public claims of full cooperation. Where is the cooperation 
with the chief law enforcement officers of these States? My 
question for the companies is, what do they have to hide? If 
you have not done anything wrong, let us see. Let us see the 
records on an unconditional basis in a way that is timely and 
responsive to our questions. Let the truth be the judge.
    Now let me return to my role as public counsel for the 
ratepayers of the State of Washington. I understand how very 
complex this issue is both for FERC and for Congress. However, 
among all the complexities is a very simple, straightforward 
principle. FERC has a statutory duty to ensure that rates in 
the wholesale market are ``just and reasonable.'' Though I am 
very disappointed that FERC did not act earlier to address the 
problem on a West-wide basis, I am pleased that it has now 
expanded its most recent order to provide relief West-wide. It 
is a step in the right direction.
    I remain concerned that the order does not provide remedies 
for all of the harm that has been suffered by Washington State 
citizens, and I want to see if, in fact, at the end of the day, 
it does address the problems prospectively. For those reasons, 
I would like to encourage this Committee in its oversight role 
to do the following.
    First, monitor carefully the implementation of FERC's 
order. Judge its effectiveness by FERC's statutory duty to 
ensure just and reasonable rates.
    Second, ensure FERC has the resources and the guidance to 
continually monitor the market and investigate rates that may 
be unreasonable, to enforce its order and any subsequent orders 
designed to make the markets work, and to provide appropriate 
refunds to all consumers, including those in California.
    Third, if this order does not appear to be working, FERC 
must take immediate, decisive, corrective steps to ensure that 
the rates are just and reasonable. In addition to protecting 
ratepayers, FERC must be vigilant to make sure that energy 
efficiency and protection of the environment is an essential 
part of any solution, both short- and long-term.
    Again, these competition and FERC issues, are not just 
about legalities. They are not just about money. They implicate 
the day-to-day lives of our citizens, our businesses, our 
schools, and our environment. As we move forward, we must keep 
these interests, truly the public interests, in the broadest 
sense, in mind.
    In conclusion, this energy crisis has had a tremendous 
impact on my State's citizens, its business, its economy, and 
its environment. It is a West-wide problem and has been going 
on now for a year. Although we will continue with our law 
enforcement investigation, FERC really is uniquely situated to 
monitor this energy market and to provide the appropriate 
remedies to all who have been harmed by unjust and unreasonable 
rates. We ask this Committee to make sure that, in the end, 
FERC fulfills its mandate that energy rates be just and 
reasonable at all times for consumers. Thank you again for 
allowing me to testify.
    Chairman Lieberman. Thank you, General, for that testimony.
    Mr. Hemmingway, welcome.

    TESTIMONY OF ROY HEMMINGWAY,\1\ CHAIRMAN, OREGON PUBLIC 
                      UTILITIES COMMISSION

    Mr. Hemmingway. Thank you, Mr. Chairman and Senator 
Thompson. I am speaking today as the Chairman of the Oregon 
Public Utility Commission. At the beginning, I want to make 
three points clear about Oregon's position.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Hemmingway appears in the 
Appendix on page 423.
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    First, Oregon believes in competition in markets. We have 
begun a gradual and flexible opening of our retail electricity 
markets to larger customers, but due to the Western power 
crisis, even this go-slow approach is in political trouble and 
I cannot predict its future in the Oregon Legislature at this 
time.
    Second, Oregon believes in sending appropriate price 
signals to retail consumers. We have passed on prices to 
consumers, as have some publicly-owned utilities in Oregon, and 
this crisis has not been brought about by the failure to pass 
on higher prices. Passing on to consumers unjust and 
unreasonable prices at 1,000 percent above cost will not 
alleviate this crisis.
    Third, Oregon does believe that there is a shortage of 
electricity in the West. Some of this, a good deal of it, is 
caused by the fact that we have had a drought year in the 
Pacific Northwest. If we had had the rainfall we had in 1998 
and 1999, we would not be here today. There would be plenty of 
electricity and our plans to build new generation would come 
on-line just in time.
    I say all this to emphasize that we who advocate serious 
Federal intervention in the Western power markets have been 
doing our part to augment supplies. We are not against market 
competition in the electricity business. We are not advocating 
repeal of the laws of supply and demand. We are simply asking 
that the Federal Government undertake its historical role in 
regulating electricity marketplaces when they are characterized 
by high prices and inadequate numbers of competitive suppliers.
    The principal argument that FERC has given for not imposing 
serious wholesale price controls is that they will work against 
bringing increased supply to the market. FERC seems to confuse 
here long-term supply issues with the immediate need in the 
Western market for power supply. There is no way, as I think 
other witnesses have indicated, that the amount of supply that 
would create a truly competitive market that could be built in 
time to significantly temper the prices that utilities have 
been paying in the wholesale market in the last year. The lead 
time is simply too long.
    Oregon, for instance, has under construction 1,500 
megawatts of new generation, and we have in a plant in the 
permitting stage 3,000 megawatts of new generation, and in the 
planning stage even more. This is in a State with 5,500 average 
megawatts of consumption, 10,000 megawatts of peak, so this is 
an extraordinary amount of generation that is under 
construction. But only one of these plants of about 400 
megawatts will be on-line by July to meet the summer problem. 
Not enough generation is likely to be able to be brought on-
line this summer to alleviate the real and contrived shortages 
in the Western market.
    In summary, the high prices supported by FERC are simply 
not needed to stimulate investment in long-term generation 
because--long-term investment in generation, because that is 
occurring, and they cannot magically bring in new supplies in 
time to deal with the crisis this year.
    Theoretically, high wholesale prices should stimulate 
suppliers to bring on generation in the short term that would 
otherwise not come to market. But in truth, the unfettered 
wholesale market favored by FERC has done little to increase 
supply. Over the last year, the California market, in 
particular, has been characterized by record levels of plant 
outages, despite these stratospheric prices.
    The high prices have had a perverse effect. Owners of 
generation do not need to bring new supplies to the market in 
order to make record profits, which almost all the energy 
suppliers in California have done, if you look at their balance 
sheets. Without colluding, energy suppliers can figure out that 
not bringing every kilowatt to the market will boost prices and 
create profits. Only as power prices have declined in recent 
months have we actually seen lower plant outage rates. The 
shortage has given incentive to suppliers not to bring all 
their supplies ready to the market because it has meant that 
they get higher prices.
    I would like to turn now to the June 18 order that FERC 
issued this week. I believe this order is a step in the right 
direction, but I want to make clear that it is a small step and 
it will not end the worst abuses that have characterized the 
Western power market this year. The order remains flawed in 
fundamental ways.
    It allows all sellers, no matter what the cost of their 
generation, to get the price of the highest cost resources 
operating at the time. While marginal cost pricing of this kind 
is appropriate for commodities in a competitive market--I think 
any economist will tell you that--in a market where consumers 
have choices, electricity in the Western power market has not 
yet reached that point. Electricity is a commodity for which 
there are no immediate substitutes and there are no technically 
feasible ways yet to send immediate retail price signals when 
wholesale prices are high. High wholesale prices on a hot July 
day do not mean that consumers will get that signal at the 
right time to reduce consumption and reduce the costs to the 
utility system.
    Worst of all, the new FERC order still provides incentive 
for gaming of the system by suppliers. All power sold in the 
market gets priced, as I said, at the cost of the highest and 
most expensive resource running at the time. As a result, there 
is still incentive for suppliers to ensure that there are not 
enough efficient resources running and that the inefficient 
price-setting resource does operate.
    With supplies tight in a small number of suppliers, a non-
competitive market results where individual suppliers can 
anticipate the actions of others. FERC has not yet shown that 
high wholesale prices in a non-competitive market will deliver 
equal or more short-term supply than in a fully-regulated 
market. In fact, recent history suggests the opposite.
    FERC is still acting as if electricity in the West were 
like wheat or pork bellies, where buyers can find substitutes 
and respond to high prices and no one supplier can affect the 
market or anticipate how other sellers into the market will 
respond. None of these conditions is true. In the current 
Western power market, we do not have a competitive market.
    For over 60 years, FERC and its predecessor, the Federal 
Power Commission, oversaw conditions that created a stable 
power market that brought electricity to utilities and 
consumers at affordable prices and rewarded investors with 
reasonable rates of return. FERC's recent ideological devotion 
to free-market principles in a market that is anything but free 
and competitive has shattered the public's faith in the Federal 
Government's willingness and ability to ensure an adequate and 
affordable supply of power. FERC's actions threaten to bring a 
political end to appropriate deregulation initiatives around 
the country, such as Oregon. This is a sad legacy, indeed, 
which I hope will be remedied as swiftly as possible by the 
Congress. Thank you.
    Chairman Lieberman. Thanks, Mr. Hemmingway.
    You touched on something fundamental to the FERC order that 
I want to ask the commissioners this afternoon, because 
although it is a step forward, there remains the question from 
our perspective, how much of a step forward? And it does seem 
to me, as you said, and I appreciate it, because you are a 
regulator, a utility regulator, that they have created a system 
here, the so-called proxy pricing, which stated in complete 
layman's terms does peg the price to the highest price obtained 
in a given period on the market and it allows everybody to come 
up to that price. As I understood it, in the off-peak hours, 
they can charge up to 85 percent of that high price. So it is a 
ceiling, and I suppose it will, therefore, protect consumers 
from the most extreme price hikes, but it is a pretty tall 
ceiling.
    What would you have done if you were a one-man FERC in this 
case?
    Mr. Hemmingway. Mr. Chairman, I would have looked for the 
possibility of reimposing cost-plus price controls. You can 
provide plenty of incentive and reward for investment with a 
cost-plus arrangement without allowing a supplier to get 1,000 
percent greater than its costs when selling into the market.
    Chairman Lieberman. And that is what we traditionally have 
thought of as utility regulation. Again, we are all for--not 
all, but I am certainly for deregulation with competition. It 
does strike me that the cost-plus system--the idea that you get 
your money back that you spent plus some reasonable profit--is 
also easier to apply than this system. It is certainly easier 
to understand, for me, than this system that FERC has adopted. 
Am I right from a regulator's perspective or not?
    Mr. Hemmingway. Well, there is the problem that there are 
hundreds of transactions that are going on and these have to be 
tracked.
    Chairman Lieberman. Right.
    Mr. Hemmingway. But FERC is experienced at this. After all, 
it did it for over 60 years, so I think they could go back to 
that.
    And I am for competitive markets and believe it is a better 
way to price a product than is regulation, but you need to have 
a fully competitive market with multiple suppliers in it in 
order to get to that point where you can say that that kind of 
pricing is appropriate and I do not think we have that in the 
Western power market today.
    Chairman Lieberman. Right. General Gregoire, obviously, the 
FERC order is good news for Washington State and the rest of 
the West in that it both extends the previous FERC order to 24 
hours a day, 7 days a week, but more importantly for you, it 
extends the order throughout the Western grid, including your 
State. The bad news for your State, obviously, is that there is 
nothing said regarding refunds that you think you are entitled 
to. So let me ask you, what, if anything, the State can do to 
right that wrong, and if you have any counsel for this 
Committee or for FERC, I suppose, as to how to deal with the 
question of refunds that electricity customers in Washington 
State may be entitled to.
    Ms. Gregoire. Well, thank you, Mr. Chair. I am one who 
believes that there have been unjust and unreasonable rates 
beginning about June 2000 and that needs to be corrected and 
refunds are in order, and you heard from both of my Senators 
this morning speaking to that issue, as well. FERC has 
suggested that it does not think it has the legal authority in 
that the Federal Power Act would call for it to be able to give 
refunds only 60 days after it had opened its investigation, and 
that would, for purposes of this particular instance, for the 
West-wide investigation, didn't occur until April 26.
    The problem with respect to that is we have been asking for 
a West-wide investigation for some time. California utilities 
first approached to FERC in August. It was joined by Washington 
in October. FERC declined to do a West-wide investigation in 
December. A motion for rehearing was brought in January, 
supported by Washington. We went to the D.C. Circuit to ask the 
D.C. Circuit to order FERC to open up a West-wide 
investigation, and that was declined.
    At the end of the day, our consumers may be with no redress 
if they have to turn to FERC. I think that is fundamentally 
wrong. At the end of the day, our antitrust investigation may 
provide a remedy, but I am not optimistic that will be done 
soon given the lack of cooperation with the generators. 
Sometimes that takes years to accomplish.
    So if, in fact, FERC says it has no jurisdiction and we are 
unable in reconsideration to convince them otherwise, I would 
ask this Committee to take that issue up so that we do not find 
this situation occurs again in the future.
    Chairman Lieberman. So the current procedure is that you 
are not entitled to refunds until the period covered 60 days 
after an investigation----
    Ms. Gregoire. Is opened. Correct.
    Chairman Lieberman. I know this should be clear to me, but 
it is not. Has FERC reached a conclusion for parts of the 
Western grid outside of California that the rates charged are 
now unjust and unreasonable?
    Ms. Gregoire. Correct. They did in their order on Monday.
    Chairman Lieberman. On Monday.
    Ms. Gregoire. So it only goes back the 60 days from the 
time they opened that investigation, which would put refunds 
due to the rest of the West to begin in July.
    Chairman Lieberman. Yes.
    Ms. Gregoire. That is fundamentally unfair, since our 
consumers have been harmed now for a year with unjust and 
unreasonable rates.
    Chairman Lieberman. Yes, I agree with you. It is very 
unfair. So you are suggesting that the Committee may want to 
look, assuming that you will do everything you can to try to 
obtain refunds through litigation and other means, appeals to 
FERC, that the law itself is flawed and we ought to, as one 
result of these oversight hearings, deal with how to correct 
that inequity so it doesn't happen again?
    Ms. Gregoire. We would ask you to do so, yes.
    Chairman Lieberman. My light is flashing. My time is up. 
Thank you. Senator Thompson.
    Chairman Thompson. Thank you, Mr. Chairman.
    Mr. Hemmingway, Governor Davis has been critical of the 
amounts charged by the Bonneville Power Administration, which, 
of course, is big in your State. Do you believe that Bonneville 
has engaged in price gouging?
    Mr. Hemmingway. Senator Thompson, no, I don't believe they 
have been. They have been selling into the ISO market and been 
a price taker in that market, and I think that they have been 
able to resolve their issues with Governor Davis on that. I 
mean, we can check with him. They have not been able to set the 
price of the power that they sell into that market. They merely 
take whatever the market clearing price is of that day.
    Chairman Thompson. So you would disagree with the governor 
with regard to that particular entity, anyway.
    Mr. Hemmingway. [Nodded head up and down.]
    Chairman Thompson. General Gregoire, with regard to your 
investigation, you were talking about the generators and, of 
course, you and I both know that saying, ``I am from the 
government and if you don't have anything to hide, turn over 
your records,'' is not the standard, of course, that we 
normally use in court or anywhere else. In fact, civil 
libertarians would have a hard time with that if it were 
anybody else except power generators.
    But having said that, you say you have issued subpoenas. 
How many generators have you subpoenaed?
    Ms. Gregoire. We have issued civil investigative demands, 
and what that provides for those companies, by the way, is 
absolute confidentiality, and to date, the companies that have 
not complied are Duke, Mirant, and Reliant. We have had 
cooperation, on the other hand, from AES and Dynergy. We have 
yet to issue with regard to a couple of the other companies and 
we are in the process of doing so now.
    Chairman Thompson. How many have you issued so far?
    Ms. Gregoire. Well, we have sent ones to Mirant, Reliant, 
Dynergy, Dynergy Inc., Dynergy Energy Services, Duke Energy 
Corp., Duke Energy Trading and Marketing, Duke Energy Power 
Services, and AES.
    Chairman Thompson. How many of them own generation 
facilities in Washington?
    Ms. Gregoire. None of them do. They sell into Washington 
State.
    Chairman Thompson. What percentage of the wholesale market 
do these generators supply to Washington?
    Ms. Gregoire. Well, let me give you an example. In 
Washington State, for example, the purchases last year to 
Washington companies by AES was $15 million, by Enron was over 
$1 billion, by Dynergy, $195 million, Mirant, $283 million, and 
Reliant, $224 million.
    Chairman Thompson. Generally, what percentage of the 
wholesale market would that be?
    Ms. Gregoire. I don't know that.
    Chairman Thompson. Well, it seems as if it would be a very 
small percentage of your overall wholesale market.
    Ms. Gregoire. We do not rely--most of our power comes from 
Bonneville.
    Chairman Thompson. Well, that was----
    Ms. Gregoire. We cannot rely on these generators.
    Chairman Thompson. That was going to be my next question. 
What are the largest wholesale suppliers, electricity 
suppliers, in your State, Bonneville?
    Ms. Gregoire. Correct.
    Chairman Thompson. Who else? Powerey?
    Ms. Gregoire. We have some coal, we have some nuclear, and 
we have these generators, primarily.
    Chairman Thompson. What about BC Hydro or Powerey?
    Ms. Gregoire. We have some, yes.
    Chairman Thompson. That is electricity generation, of 
course. Bonneville is electricity.
    Ms. Gregoire. Right.
    Chairman Thompson. Have you issued subpoenas to them to 
investigate their role in this?
    Ms. Gregoire. We have had full cooperation by Bonneville. 
We have not yet issued anything to any of the generators in BC 
Hydro.
    Chairman Thompson. So I suppose if I was a generator out 
there, when you are talking about compliance, I would wonder 
why you would be issuing these subpoenas or requests, whatever 
you call them, for those companies that have very little--have 
no presence in your State, supply what seems to me to be a 
small percentage of the wholesale market, on the one hand, and 
you really haven't done the same thing with regard to those 
generators who supply a much larger percentage of your market.
    Ms. Gregoire. Well, Senator, it is a multi-State 
investigation involving all three States, and, of course, these 
generators are located in California and have not cooperated 
with California at all, as well. They have refused to provide 
documents to California and, in fact, have brought a protective 
order motion in court to ensure that whatever documents they 
get, they cannot be released to either Washington or Oregon.
    Chairman Thompson. Of course, that is normal when a 
governmental subpoenas documents that they are not put on the 
public record unless there are further legal proceedings. 
Whether or not a company is cooperating, of course, begs the 
question, whether they are properly exercising their legal 
rights that any company or any citizen has in this Nation. So 
the fact that they are or are not cooperating, of course, begs 
the question. You will have to resolve that, as to whether or 
not they are not cooperating for appropriate reasons. But 
again, if I were one of them, I would be wondering why you are 
going after all these out-of-State folks and not going after 
the ones that are supplying most of the power.
    I have nothing further.
    Chairman Lieberman. Thanks. Very brief factual questions. 
Earlier, one of the Senators from Washington State said that 
she thought that the increase in electricity costs in the State 
was a multiple of 11 times in the last year. Is that right?
    Ms. Gregoire. That is correct.
    Chairman Lieberman. And what would be a comparable figure 
for Oregon?
    Mr. Hemmingway. Mr. Chairman, it would be a comparable 
figure for companies that are buying in the wholesale market. 
We have a number of utilities which are largely publicly-owned 
utilities which have bought a percentage of their power at 
those prices and they have had to raise their retail rate as a 
result by 20 to 40 percent.
    Chairman Lieberman. Is it possible to state what percentage 
of that in each of your States, roughly speaking, is derivative 
from the problem in California and what percentage is more home 
grown, if you will? If you can answer that, fine. If you 
cannot, then we will let you think about it and submit a 
written answer.
    Mr. Hemmingway. Mr. Chairman, it is one grid, and so it is 
very difficult to separate out the problem as a result of the 
drought from the problem in California.
    Chairman Lieberman. That is what I was thinking.
    Mr. Hemmingway. As I said before, if we were not having a 
drought, even California would not be having a problem, in my 
opinion, because we export so much power from the Pacific 
Northwest in good water years to California that it--that is 
the reason, essentially, these problems started to creep up in 
the year 2000, was that the first year that we did not have, in 
a long time, really large exports to California.
    Chairman Lieberman. General, a final question. In light of 
your multi-State investigation, to the best of your knowledge, 
is the Antitrust Division of the Justice Department 
investigating this matter at all?
    Ms. Gregoire. No. To my understanding, the U.S. Department 
of Justice is not involved. We have asked them to join with us 
in the investigation and they have not joined us as yet. It is 
a three-State multi-State investigation.
    Chairman Lieberman. How about the Federal Trade Commission? 
Do you know of any----
    Ms. Gregoire. No.
    Chairman Lieberman. No active investigation? I do not have 
any other questions.
    I thank you for coming out, for your patience. Your 
testimony was very helpful. I appreciate it very, very much and 
wish you a safe trip back home.
    Ms. Gregoire. Thank you.
    Chairman Lieberman. Senator Thompson, it is my inclination 
now to take a half-hour break to allow everyone who must be 
here to stretch their legs and get some lunch and we will be 
back at 2:15 with the five members of the Federal Energy 
Regulatory Commission. The Committee stands in recess.
    [Recess.]
    Chairman Lieberman. The hearing will come back to order.
    I thank the five members of the Federal Energy Regulatory 
Commission, at times in its history little known, I would say 
now probably at one of its highest points of visibility with 
all the attendant responsibilities thereto.
    I think you know that this Committee is an oversight 
committee. And the hearings we are conducting here are pursuant 
to that authority, to make a judgment as to how your commission 
has been responding to the general subject or matter of energy 
deregulation with particular regard, of course, to the 
electricity markets in the West, and most especially in 
California. We heard testimony last week from some leading 
economists. We heard testimony today--perhaps you followed it--
from Governor Davis, Governor Hoeven, Governor Martz, Attorney 
General Gregoire of Washington State, the Chairman of the PUC 
from Oregon, Mr. Hemmingway, and members of Congress.
    I know that you have some prepared testimony. Mr. Hebert, I 
want to start with you and we will give each of the members a 
chance after that. We have been running a 5-minute clock on the 
witnesses. Mr. Hebert, if you go a little longer, I do not 
think we will physically eject you from the room. And then 
Senator Thompson and I will proceed with some questioning.
    Thank you for your understanding about the time pressures 
today and keeping yourselves available. I appreciate it. It is 
important business and you are right at the heart of it, so we 
thank you for being here. Mr. Hebert, it is all yours.

  TESTIMONY OF HON. CURT L. HEBERT, JR.,\1\ CHAIRMAN, FEDERAL 
              ENERGY REGULATORY COMMISSION (FERC)

    Mr. Hebert. Thank you, Chairman Lieberman. Thank you for 
the opportunity to appear here to discuss the Federal Energy 
Regulatory Commission's role in restructuring of the 
electricity markets.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Hebert appears in the Appendix on 
page 430.
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    The Commission's experience in regulating electric and 
natural gas utilities and, indeed, the Nation's experience in 
pricing and allocating vital goods and services have taught us 
an important lesson. Consumers are better off if supply and 
pricing decisions are based on market mechanisms rather than 
bureaucratic fiat. Thus, the Commission is committed to helping 
move this country toward open, competitive energy markets.
    At the same time, we recognize we must ensure that broken 
and dysfunctional markets are fixed. This poses challenges, 
particularly in California and the West, where there is a 
substantial imbalance of supply and demand.
    In response to these challenges, the Commission has been 
working aggressively to reform market structures and to enhance 
consumer welfare in California and the West. The Commission has 
not lost sight of the point that the best way to lower 
wholesale electricity prices and to keep them low is to promote 
investment in badly-needed supply and delivery infrastructure 
and to encourage demand reduction. The Commission's task 
remains to balance these goals to ensure that short-term 
measures do not undermine long-term priorities.
    My written testimony, which I submitted Monday morning, 
describes the dozens of orders the Commission has issued in 
recent months addressing California and Western energy markets. 
The Commission has done everything that it can within its 
jurisdiction to extract every last drop of electricity out of 
existing resources and to free up additional megawatts from 
demand reduction initiatives. Moreover, the Commission has been 
no less active in its efforts to investigate and lower the 
price of natural gas in and bring additional pipeline capacity 
to Western markets.
    In my limited time this morning, I would like to focus on 
action undertaken by the Commission on Monday afternoon after 
the filing of my written testimony. By a unanimous 5-0 vote, 
the Commission expanded the scope of a market monitoring and 
price mitigation plan for California and the West. An earlier 
version of that plan went into effect on May 29 of this year. 
Since that date, as we all know, prices of electricity and 
natural gas in both spot and forwards markets have plunged 
dramatically. Energy prices in California and the rest of the 
West are lower than at any time in the past year and are coming 
close to prices in the rest of the country.
    Building on that success, the Commission voted unanimously 
to expand its price mitigation plan for California's spot 
market sales to all hours of the day. The Commission also 
extended the limitations on spot prices to all 11 States in the 
Western System Coordinating Council. The details of the 
Commission's plan are many. For this reason, I have submitted 
for the record the Commission's 60-page order which was issued 
yesterday afternoon and a 7-page press release on the order 
which was issued Monday afternoon.
    In a nutshell, the price mitigation ordered for the West 
and applicable during all hours is based on the market clearing 
price concept adopted in the Commission's April 26 order. The 
market clearing price is based on the bid of the highest cost, 
least-efficient unit in California that is called upon by the 
California ISO to serve load during any day in which available 
reserves dip below 7 percent. Sellers other than marketers have 
the opportunity to justify individual prices above the market 
clearing prices based on their costs.
    I am very proud of the Commission's approach toward 
reforming California and Western electricity markets. The 
Commission's mitigation plan manages what many said could not 
be accomplished, restraining prices while encouraging 
investment. The key is that price mitigation is based on market 
forces. The market clearing price is not a blunt, arbitrary 
figure that bears no resemblance to market conditions and is 
subject to political pressures and whims.
    That is what was tried in California just last summer, Mr. 
Chairman. The ISO lowered the price cap last summer from $750 
per megawatt hour to $500 per megawatt hour and then $250 per 
megawatt hour. All this did was cause an increase in the 
average electricity price and a reduction in the ability of the 
ISO to procure emergency power. Indeed, last December, the ISO, 
the California ISO, begged the Commission to allow it to remove 
the cap, explaining that it was impairing the ISO's ability to 
meet demand and undermining the reliability of the electrical 
grid, what we knew all along.
    Also, the mitigation price is not based on the cost of 
individual generators. A return to traditional regulation would 
entail months and perhaps years of administrative and appellate 
litigation over cost structures and reasonable rates of return. 
This type of delay and uncertainty is simply unacceptable at 
this critical juncture.
    The other point that certainly needs to be made is that 
under that scenario, Mr. Chairman, the most inefficient units 
would be guaranteed profits probably at levels that they will 
not get under our plan. Even more disturbing, regulation based 
on cost would provide no incentive for the various suppliers to 
become efficient and to reduce their costs and thereby lower 
prices for consumers. The Commission's plan, on the other hand, 
provides every incentive for suppliers to reduce their costs 
and improve their efficiency. Nothing is now guaranteed.
    A generator or a marketer now makes money by increasing the 
efficiency of production. Its profit is determined by how much 
of a differential there is between its own cost of production 
and the cost of least-efficient, last-dispatch unit. A 
generator is now able to recover its fixed costs, but the 
extent of its capital recovery and the size of its profit is 
determined by the very efficiency of its operations, Mr. 
Chairman.
    In this manner, a generator will find it profitable to 
retire old, dirty, inefficient units and replace them with new, 
cleaner burning, more efficient units. I am very proud of the 
green initiatives of the Commission's plan. The best way to 
clean our air, as we all know, is to never pollute it in the 
first place.
    And finally, through enhanced monitoring and coordination 
of generator outages, along with additional tools to act 
against withholding and other forms of anti-competitive 
behavior, the Commission has removed any doubt in that we are 
committed to ferreting out and remedying any form of market 
manipulation and behavior no matter when it occurs, 24 hours a 
day, 7 days a week.
    As Monday's order makes clear, anti-competitive behavior 
simply will not be tolerated by this Commission. Indeed, in 
Monday's order, the Commission directed Duke Energy to make 
refunds for the period earlier this year when it charged 
California consumers approximately $3,800 per megawatt hour for 
electricity. In other orders this year, the Commission has 
directed the refund of over $130 million for past overcharges 
and manipulative behavior and has ordered an expedited hearing 
into allegations of affiliate market power abuses concerning 
the transportation of natural gas to the California border. 
Other investigations are underway, as well.
    There should be no doubt that this Commission is actively 
pursuing refunds and other appropriate remedies for past 
behavior. Frankly, I believe that the best way for California 
consumers to be made whole is, if possible, to have the parties 
themselves negotiate a fair and comprehensive settlement of all 
outstanding refund issues. The Commission is not ducking these 
issues. Rather, it is giving the parties, including the State 
of California, 3 weeks, which is not a lot of time, to do what 
is best for the people of California.
    I hope that all parties will come to the table. I hope that 
all parties themselves will spare consumers the pain and 
uncertainty of protracted litigation over past market behavior. 
If, however, these parties are unable to reach agreement, the 
Commission stand committed to act quickly and decisively to 
resolve these issues.
    As for the rest of the West, the Commission's refund 
authority presently extends from July 2 of this year, the 
earliest refund effective date allowed under the Federal Power 
Act. I understand the pleas for an earlier refund effective 
date, and this is a matter that the Commission is currently 
considering on rehearing of its December 15 order of last year. 
In that order, the Commission denied a complaint brought by 
Puget Sound Energy which sought an investigation into rates 
charged, not for the entire West, but rather one limited to the 
Pacific Northwest.
    I can state, however, that Western parties outside 
California are not shut out of the settlement discussions 
scheduled to commence next week, as of Monday. To the contrary, 
those discussions are open to all entities which are parties to 
the proceeding that was the subject of Monday's order. Those 
parties include Puget Sound Energy, the City of Seattle, 
various Pacific Northwest utilities and industrial companies, 
and the Bonneville Power Administration.
    In conclusion, the Commission has been doing a great deal 
of work to help ease the present energy problems in California 
and the West. The Commission's efforts have contributed to the 
recent decline in Western energy prices. Monday's order, issued 
by a unanimous Commission, improves upon a plan that is good 
for California, good for the Pacific Northwest, and good for 
the entire West.
    It is a plan that respects market forces and that attempts 
to restrain prices, while at the same time offering incentives 
for investment in supply and delivery that is the only real 
solution for the West's immediate energy problems. It 
represents an effort to provide relief now, while making sure 
that mitigation is short-lived. The Commission's goal remains 
to fix dysfunctional markets and to ensure that markets regain 
their competitive footing as quickly as possible.
    There has been a lot of talk about the past and I would 
like you to know, Mr. Chairman, Senator Thompson, and the 
Committee, that this Commission--I can't speak for a previous 
Commission, I can't speak for a Commission prior to January 22. 
I had no control over that agenda. But I will tell you, sirs, 
that we have been engaged. We have issued over 60 orders for 
the State of California. We have issued a price mitigation 
plan. We have improved upon that plan. We have issued refunds 
that no other Commission has done. We are moving forward 
quickly. We are trying to resolve gas issues, asking for 
transparency. We are committed, and I assure you, sirs, I 
assure the members of this Committee that I know in my educated 
mind and I truly believM in my heart that we are well on our 
way of improving this marketplace and getting them on their 
feet while bringing the consumers reasonable prices, but at the 
same time attracting necessary investment.
    I read in today's issuance of the Wall Street Journal, and 
I brought up websites that say, under this order, they remain 
bullish and are bringing opportunities into California, and I 
think we have done it right and I am committed to it. Thank 
you, sirs.
    Chairman Lieberman. Thank you, Mr. Chairman.
    Just as a point of clarification, I appreciate your 
testimony. I think you said some things there that are directly 
responsive to questions that were raised by the witnesses this 
morning. I just want to clarify what you said, and then I will 
go on to the other Commissioners. You said that once the 15-day 
period that is called for in the order, Monday's order, in 
which parties will work together under an administrative law 
judge on the question of refunds, that if that does not reach a 
solution that is satisfactory to the Commission, that the 
Commission might--or satisfactory to the parties, that the 
Commission would consider reentering on those matters.
    Mr. Hebert. Let me take 15 seconds. One, I did not get to 
see this morning's hearing. As you know, we are busy.
    Chairman Lieberman. Right.
    Mr. Hebert. But I will tell you that the process is there 
is 15 days for the parties to reach settlement. If not, this 
Commission by a vote of 5-0 has instructed the administrative 
law judge to recommend to us a settlement within 5 days of 
that--I am sorry, 7 days of that.
    Chairman Lieberman. OK.
    Mr. Hebert. So 22 days, and then this Commission can act.
    Chairman Lieberman. And just on the second point, which was 
obviously of concern to people in Washington State and Oregon 
who believe that their quest for refunds is not within the 
purview of the administrative law judge, did I hear you 
correctly to say that, as you understand it, that they are 
wrong, in other words, that the judge will consider their 
request for refunds, as well?
    Mr. Hebert. You are going to require me to be very careful 
here, and let me do it.
    Chairman Lieberman. I am not meaning to put any words in 
your mouth.
    Mr. Hebert. No, you are not.
    Chairman Lieberman. I just wanted to make sure I understood 
what you were saying.
    Mr. Hebert. This is a very delicate situation because I 
have the December 15 order, which speaks to that, under 
rehearing at this time, so I do not want to conflict myself out 
on that case, so I have to be very careful in my answer.
    The beauty, I believe, as an attorney who has been involved 
in settlement processes, I will tell you that there are two 
things that settle issues and cases, uncertainty and deadlines. 
You trade certainty for uncertainty and there is a deadline 
that closes it out.
    We did not define the parameters of the settlement process. 
We left it open. That is, in fact, the beauty of the process. 
They are parties to that process. They will be in the room. It 
will be up to them to negotiate what they believe to be in the 
best interests of them and the parties that they represent.
    Chairman Lieberman. Well, that is very heartening. I just 
saw a copy of a letter that is on its way to you--maybe you 
have received it already--from some of the Congressional 
delegation from Washington State asking these questions, so 
they will be grateful for that. I will hold my additional 
questions.
    Commissioner Breathitt, welcome. Thank you.

TESTIMONY OF HON. LINDA K. BREATHITT,\1\ COMMISSIONER, FEDERAL 
              ENERGY REGULATORY COMMISSION (FERC)

    Ms. Breathitt. Thank you, Mr. Chairman and Members of the 
Committee. I appreciate this opportunity to appear before you 
this afternoon to discuss the role of the Federal Energy 
Regulatory Commission regarding the restructuring of 
California's electricity market and its implications for other 
States and regions.
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    \1\ The prepared statement of Ms. Breathitt with an attachment 
appears in the Appendix on page 462.
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    The problems that have been experienced by consumers in the 
West have been the primary focus of the Commission for almost a 
year now. What we have learned through our investigations and 
inquiries is that the causes of the present energy situation in 
California and other Western States are highly complex and 
multifaceted. I am sure you heard a lot of that this morning. I 
believe the Commission has taken bold and decisive actions 
within our jurisdiction to remedy the extreme distortions in 
the California markets and to address the instances of 
potential market power abuses.
    Since last August, the Commission has issued over 50 
orders--I think the Chairman said 60 now--implementing 
important remedial measures and price mitigation mechanisms, 
instituting investigations into rates and market design flaws, 
establishing programs to maximize electricity supply, delivery 
and demand reduction, directing sellers to provide refunds of 
excess amounts charged for certain electric energy sales.
    Our actions are starting to have a dampening effect on 
prices in California and the West. Prices have decreased 
significantly since our market monitoring and price mitigation 
plan for California took effect on May 29. For instance, during 
the week of June 9, prices for spot purchases of power at 
Western trading hubs fell to less than $55 per megawatt hour 
from a high of about $170 per megawatt hour earlier in the 
week. The low prices continued into the next week, and equally 
important to me, the price for the longer-term contracts has 
also come down dramatically. We have seen forward contracts 
drop for 2003 to $41 per megawatt hour in the past month.
    We have long stressed--the Commission has long stressed the 
importance of long-term contracts to minimize the reliance on 
the volatile spot market, and I believe we are down to about 20 
percent from 100 percent when we started issuing our orders.
    In my pre-filed testimony, I highlight several of the major 
orders that we have issued and I hope that you will note those 
when you are going through the testimony. It is important for 
your Committee to understand the breadth and the scope of our 
myriad actions in the Western energy crisis. Critics have said 
we have done nothing and that is simply not true.
    My testimony also discusses the relationship between the 
problems we are experiencing in Western energy markets and 
those in natural gas markets and I point to numerous 
impediments in natural gas markets that must be addressed.
    I have a deep concern about the impact of the prolonged 
periods of high natural gas prices on industries and 
communities in the West and particularly the impact on the 
electric generation costs, since so many of the units in 
California use natural gas.
    But this afternoon, I would like to focus on our most 
recent action. On Monday, the Commission instituted a market 
monitoring and price mitigation plan for the entire Western 
United States. These new procedures build on our April 26 
order, which implemented similar orders just in California, and 
we initiated the investigation that has made it possible to 
cover the entire Western United States back in April.
    The plan that we announced is designed to reduce prices in 
all hours that are just and reasonable and to emulate prices 
that would be present in a competitive market. The purpose of 
the plan is to stabilize the market in the short term and 
permit California and the Western States to repair 
dysfunctional market mechanisms. The mitigation plan is 
intended to provide breathing room for the markets to self-
correct. Importantly, the plan will apply to all sellers, 
including marketers and non-public utilities across California 
and the balance of the United States portion of the Western 
States Coordinating Council.
    I fully support the premise of this order, which is that 
all sellers in the West should be treated similarly to remove 
the incentive to sell into one area versus another, so-called 
megawatt laundering. While I wholeheartedly encourage 
conservation and embrace demand reduction, we need to 
acknowledge that natural gas and electric infrastructure needs 
to be expanded and upgraded. I believe this market-oriented 
approach that we took in Monday's order will provide the price 
mitigation needed and it is my hope that it will not discourage 
necessary investment.
    I would also like to note before concluding that I attached 
a concurrence to express my views about one aspect of the order 
that I didn't fully endorse, and that was a section that 
instructs the ISO to impose a 10 percent creditworthiness 
surcharge to the market clearing price. I believe that the 
imposition of such a surcharge virtually conceded to the ISO 
the issue of whether or not the ISO must implement our 
creditworthiness standards, and I thought that was premature.
    And finally, I wanted to state my support for the 
settlement conference. You brought that up, Mr. Chairman. I am 
keenly aware of the difficulties that the parties face and the 
compromises that will need to be made to fashion a very 
comprehensive settlement. I have long been an advocate of 
negotiated resolutions and I encourage all the parties, 
including the State--I believe I heard the governor this 
morning say that his delegated officials would be parties to 
the settlement, and I was very pleased to hear that, and I hope 
that all these parties work very hard at the daunting task of 
settling past accounts and structuring new arrangements.
    Mr. Chairman, I had a few final remarks, but I will stop 
there by saying that I think that all of these goals work 
within a market-oriented framework and that is an approach that 
I have endorsed. Thank you.
    Chairman Lieberman. Thank you, Commissioner Breathitt.
    Commissioner Brownell, welcome.

TESTIMONY OF HON. NORA MEAD BROWNELL,\1\ COMMISSIONER, FEDERAL 
              ENERGY REGULATORY COMMISSION (FERC)

    Ms. Brownell. Thank you. Thank you, Mr. Chairman, Senator 
Thompson.
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    \1\ The prepared statement of Ms. Brownell appears in the Appendix 
on page 484.
---------------------------------------------------------------------------
    Chairman Lieberman. Do you think it was a friendly act to 
appoint you to the Commission at this point? [Laughter.]
    Ms. Brownell. Well, it is full employment. I don't have any 
boring moments in my day, or night, I might add.
    Chairman Lieberman. That is for sure. Welcome. Thank you.
    Ms. Brownell. In fact, I would like to start out by saying 
that I am pleased to be here and I think that my first 
experience in getting out this order suggests a culture at the 
Federal Energy Regulatory Commission that has not been largely 
recognized. There was a sense of urgency, there was open and 
honest communication, and there was innovation in the 
development of this order. All of my colleagues and the staff 
worked very hard to address a number of concerns raised by 
stakeholders, and I think we responded responsibly. We have 
created a road map to bring certainty for the next two summers 
so that we can all get down to the business of creating markets 
that work, that work for market participants, but most 
importantly that work for consumers.
    I would like to talk a little bit today about what we 
experienced in Pennsylvania and what we learned, lessons 
learned that I think we can bring successfully to the way we do 
business at the FERC.
    First of all, we were asked to define the differences 
between California and some of the States, and I think you know 
them well, and I do not say that judgmentally. There are just 
fundamentals that it takes for a market to work--good market 
design, appropriate capacity, an independent system operator, 
and I emphasize that, and sufficient infrastructure.
    But while we have, in fact, had great success in 
Pennsylvania, there were things that didn't work and things 
that we needed to do to transform our Commission to 
successfully respond to market changes. Markets are 
transitional. You don't declare them open 1 day, declare 
victory, and walk away. They don't happen overnight. They are 
fragile and they need nurturing. And they need more work with 
the regulatory process than I would have anticipated, frankly, 
when we started. But they can't use the standard regulatory 
responses. Markets don't wait for answers. Markets need 
certainty. They need quick responses. People are making 
business decisions. Consumers are making buying decisions.
    So we designed successfully in Pennsylvania several 
flexible approaches that I believe address the issue of 
transforming markets. All of our restructuring decisions went 
to settlement processes that took no longer than 30 to 45 days 
to resolve. What did that accomplish? All of the stakeholders 
knew what the rules were. The market participants were not 
exposed in the capital markets for an undue period of time. And 
we did not have to wait for the standard litigation process, to 
wait 1, 2, or 3 years. We were able to bring the benefits of a 
retail market to Pennsylvanians, who saved in the first 3 years 
almost $3 billion. That only would have happened if we had not 
used these new flexible approaches.
    In the early stages, we had a lot of operational issues 
that traditionally would have had to wind their way through a 
rulemaking or some other process that would have taken 8 to 9 
months. We had an operational SWAT team that met, in some 
cases, every day in the early stages. The rules were, no 
lawyers, no lobbyists, no commissioners. We had a staff person 
who led a team of operations experts who brought instant 
solutions so that there were no market delays, billing 
problems, or other kinds of impediments to the market.
    The second thing we learned was that market monitoring is, 
indeed, a critical issue in managing the transformation and in 
building the credibility of the market. It is something I think 
we are all learning. I am suggesting to my colleagues that we 
bring in some outside experts who do this kind of thing for a 
living. We have been rate makers. We have not been market 
monitors. And I think the staff is the first to say that they 
have worked very hard to design a system that works, but they 
would love some advice from the FCC, from the FTC, and from the 
SEC. So I would like to move forward with that because I 
understand that you, your colleagues, and all of our 
constituents need the confidence that we are going to take a 
good look at these markets and that there will be transparency 
and honesty and equity.
    The third thing I think we realized and is more critical 
today than ever before are regional solutions. We need to reach 
out to the stakeholders in the regions, the States, the 
creation of RTOs, listen to what they have to say, listen to 
what their experiences are. Yesterday, we had a hearing on 
seams issues for RTOs and I think it made a big difference in 
informing us on how we must move forward. Our order called for 
a technical conference on technology in the introduction in 
demand-side management that will bring new technology to the 
market, I hope, as soon as we can. We are reaching out to learn 
things and to listen to stakeholders to learn. I think this can 
be very successful.
    So I understand why there are concerns, but now that we 
have moved beyond the crisis, let us move to solutions that 
will work for the longer term and create the credibility and 
the confidence that we all need to introduce the benefits of 
competition to all Americans. Thank you.
    Chairman Lieberman. Thanks, Commissioner Brownell.
    Commissioner Massey, thank you for being here. We look 
forward to your testimony.

 TESTIMONY OF HON. WILLIAM L. MASSEY,\1\ COMMISSIONER, FEDERAL 
              ENERGY REGULATORY COMMISSION (FERC)

    Mr. Massey. Thank you, Mr. Chairman. Mr. Chairman, and 
Senator Thompson, our June 18 order brings dramatically 
expanded price controls to a broken Western market. I supported 
the order because it adopts measures that I have been 
championing for the past 8 months. Price controls are now 
extended to the entire Western interconnection, thereby 
eliminating the megawatt laundering problem that has vexed the 
mitigation programs adopted by the Commission and the ISO over 
the past year. Cost-based price constraints are now extended to 
all hours, not just those of reserve deficiency. We have long 
needed 24-hour-a-day, 7-day-a-week coverage, and now we finally 
have it. These caps will remain in place until September 2002, 
giving the market two full summers to correct. I endorse these 
measures.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Massey appears in the Appendix on 
page 494.
---------------------------------------------------------------------------
    While better late than never, I wish this Commission had 
taken effective action sooner. Until this order, the Commission 
had stubbornly refused to implement full-time price constraints 
despite rather clear evidence that prices were not just and 
reasonable. Businesses have closed down, putting thousands out 
of work and hurting the Western economy, and all because of a 
broken electricity market. By acting 12 months ago, we could 
have prevented much of the economic carnage in the Western 
interconnection that has occurred over the past year, and I 
regret that we did not.
    Given that the Commission adopted measures that I have long 
advocated, however, I am tempted to declare victory and let it 
be, but I cannot. There are some aspects of the order that I 
have strong reservations about. One aspect is the addition of a 
10 percent surcharge to the market clearing price to reflect 
credit uncertainty. I do not see the need for this. The 
Commission has issued orders in the past few months instructing 
the ISO to abide by the creditworthiness requirements of its 
tariff. I am concerned that the adder may diminish the ISO's 
enforcement of those requirements. Moreover, it is my 
understanding that, recently, all sales into the ISO markets 
have been backed by a creditworthy party--recently, all sales, 
not until recently.
    Instituting this surcharge does have a modest bright side, 
however, I must admit. Generators may no longer attempt to 
justify bids on the basis of credit risk above what is provided 
for in the cost-based clearing price methodology. This was a 
major flaw in the old, ineffective $150 benchmark in our 
earlier mitigation program announced in December. Eliminating 
that ground for high prices is a positive development.
    Second, the order should have provided guidance to the 
parties that will participate in this massive settlement 
conference that we order. I believe we are avoiding our 
responsibility under the Federal Power Act to set just and 
reasonable prices by requiring parties to settle a multitude of 
issues with a price tag of billions of dollars without at least 
2 cents' worth of guidance.
    Third, I do not agree with the rhetoric in this order that 
characterizes cost-of-service pricing as irrelevant and perhaps 
even downright harmful on the theory that it would discourage 
new supply. I do not understand the need nor the logic of this 
language. We have made a choice in the order to strike a 
balance between strict generator-by-generator cost-of-service 
regulation and a blind reliance on the market. The mitigation 
program puts in place important cost-based price caps while 
relying on market-based pricing. The order sets out reasons for 
this balanced choice and articulating them is all that is 
needed to support our decision. Make no mistake, this is a 
cost-based program. The maximum price is limited to the costs 
of the last generator dispatched.
    I strongly disagree with the statement in the order that a 
cost-based inquiry alone would not be sufficient to fulfill our 
statutory duty under the Federal Power Act. I do not read the 
Federal Power Act and the relevant court decisions so 
restrictively. I have aggressively supported this movement to 
markets, and I still do, but there is still an important role 
for cost-of-service regulation where markets melt down and 
prices are not just and reasonable.
    What is curious about this aspect of the order is that the 
concern is to avoid discouraging new supply. However, as well 
respected economist Alfred Kahn recently said of our long 
reliance on cost-of-service regulation, and I believe he said 
it before this Committee, ``If the literature agrees on 
anything about that experience, it is that cost-based 
regulation as traditionally practiced has encouraged the gold-
plating of service and the very excess capacity that seems to 
promise such enormous benefits to consumers during the past 
decade if rates were deregulated.''
    Mr. Chairman, I notice the red light is on. May I have 2 
more minutes, please?
    Chairman Lieberman. Indeed. Go right ahead.
    Mr. Massey. Thank you. Dr. Kahn, therefore, believes that 
cost-of-service regulation may lead to too much supply. Thus, I 
do not understand the order's logic concerning cost-based 
regulation discouraging supply adequacy. There may be 
legitimate reasons against cost-based regulation, but 
discouraging new supply is not one of them, at least according 
to Dr. Kahn.
    These concerns notwithstanding, I supported the order and 
the price protection plan it puts in place. To ensure that this 
price protection plan is successful, the Commission must 
exercise all of its statutory powers to keep natural gas prices 
in the West at just and reasonable levels. Virtually all of the 
formula, all of the formula except a $6 O&M adder, is tied to 
the cost of fuel. For the marginal unit, that will be natural 
gas. Thus, the success of the plan we adopt in lowering prices 
depends in large part on fluctuations in the price of natural 
gas. If natural gas prices stay reasonable, our plan will 
provide reasonable price mitigation.
    Today's price protection plan gives California and the West 
breathing room while the markets are brought back to health. A 
number of items need to be addressed in the next 15 months. 
There must be substantial amounts of new generation capacity 
brought on-line, a more balanced supply portfolio must be 
developed as California moves away from over-reliance on the 
spot markets, a robust demand response program must be 
implemented through demand bidding and accurate price signals, 
the transmission constraints must be relieved.
    Without these measures, which must be implemented over the 
next 16 months, I would be concerned about whether the markets 
in the West can be brought back to health. Thank you, Mr. 
Chairman.
    Chairman Lieberman. Thank you, Commissioner Massey.
    And finally, Commissioner Wood, welcome to you.

   TESTIMONY OF HON. PATRICK H. WOOD, III,\1\ COMMISSIONER, 
          FEDERAL ENERGY REGULATORY COMMISSION (FERC)

    Mr. Wood. Thank you, Chairman Lieberman and Senator 
Thompson. I would just ask that my written comments represent 
my views here. I am the fifth guy of five, so I won't belabor 
you other than to say, from my own experience as a State 
regulator in Texas, I share a lot of Commissioner Brownell's 
perspective on these issues and recognize that it is so 
important that the Federal Commission be perceived and be in 
reality a co-player in regulating these very important 
infrastructure industries, electricity and natural gas.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Wood appears in the Appendix on 
page 504.
---------------------------------------------------------------------------
    One of the important aspects of competition, the only 
reason that competition works, and as we have seen the counter 
case in California, is that there are good market rules in 
place and a sufficient infrastructure, infrastructure being a 
broad word, meaning supply side and demand side, resources 
meaning the delivery that gets them there, whether that be gas 
transportation pipelines or electric transmission lines. It 
doesn't work well--it doesn't work at all if the infrastructure 
is not in place.
    I think one of the lessons learned by this Commission is 
that our historic reliance on individual States or on private 
industry organizations to oversee that sort of reliability is, 
I think, a thing of the past. I do think that is a role now 
that clearly ought to move to this Commission and ought to be a 
constant oversight for us as we determine that the competitive 
infrastructure is in place before we move to a deregulated era.
    So that is what I hope we will do. I think we probably are 
going to need some resources to do that and we will be, I 
think, reviewing that in the appropriate way with the Chairman 
and with our oversight committees, as well.
    But in addition to people and financial resources, I think 
also one of the things that are important for regulators to 
have are big sticks, not that they ever need to be used, but 
when they hang from your belt, the people who you are trying to 
regulate understand. Certainly, the ability to revoke a 
certificate, or as my colleagues here recommended, at times to 
go from a market-based certificate to a cost-based certificate 
may be perceived as a penalty of sorts. I think administrative 
fines, certainly ordering refunds is one issue, but to order 
refunds with an administrative penalty attached to those would 
be perhaps a useful tool for the Commission to have in its tool 
shed.
    I think perhaps we were asked if there were treble damages, 
much as exists in antitrust lawsuits. We found that we did not 
have the statutory authority to do that in this order that was 
issued yesterday, but that again may be an important tool for 
the Commission to have. Those do not exist today, but I think 
if we are going to be a vigilant market cop, we need to make 
sure that our bite can match our bark.
    So I look forward to working with you, Chairman Lieberman, 
Senator Thompson, your Committee, Committee staff, and my 
colleagues on making sure that this Commission is fully 
equipped to do the job that I know you want us to do well.
    Chairman Lieberman. Thanks, Commissioner Wood, for that 
statement, very interesting statement.
    I have been thinking as I have been listening to the 
testimony today. This picks up a thought that you just 
articulated, which is that the market is a magnificent 
mechanism for stimulating, facilitating economic growth, 
thereby general well-being, and through competition getting 
people the goods or services they want at the best possible 
price.
    I am paraphrasing somebody, maybe famous, maybe not. The 
market, notwithstanding its great attributes, its positive 
attributes, has no built-in conscience so that if there is not 
genuine competition, then there arises in a market without the 
pressure of competition, the genuine need--you just uttered the 
word, for what I would say a cop on the beat, to bring back the 
conscience, to bring back a sense of right and wrong, and 
limits. Otherwise, people will suffer.
    And I do think in the environment we are in now, both in 
terms of deregulation of certain elements of the energy 
industry and then more broadly the grave national concern about 
fluctuations in energy pricing, that this is a role that 
various agencies and departments in the Federal Government have 
to play. And I appreciate what you said. I think that there 
will be a way in which this Commission, I hope, has crossed a 
bridge to a new chapter in its history through this period of 
time. So I appreciate what you have done.
    As I said this morning, I think the order that was issued 
on Monday was a real step forward and I appreciate it. I have 
some questions about it, both in terms of the formula chosen 
and the means chosen as well as questions about refunds which, 
in part, Mr. Hebert, you answered.
    But let me go to the formula. Once you decided last 
December that the rates in California were not just and 
reasonable, and I gather on Monday in the order made the 
similar decision for the rest of the Western grid. The question 
then is what relief to provide.
    I am from a State Government background. I was Attorney 
General. My office represented the Public Utilities Commission, 
control authority as we call it in my State. So the notion of a 
cost-of-service-plus--some reasonable profit seemed much more 
simple and certain, and I suppose easier to administer to me.
    As I look at the system you have chosen, I want to ask this 
question. It seems to, as one of you said, peg the acceptable 
price in California to the last price offered during the period 
of time, the highest price, and, therefore, arguably the least-
efficient price, the least-efficient company setting the price. 
Then they can charge up to 85 percent of that in the off-peak 
hours.
    So there is no question that this system will impose some 
constraints on pricing to the benefit of electricity consumers, 
energy consumers in California and now throughout the West. But 
considering that the standard of law is just and reasonable 
rates, how can you feel comfortable that this system will 
guarantee just and reasonable rates? In other words, you have 
put on a ceiling here, but because it is being set by the 
highest price, the last price charged, the highest price, it 
can be a pretty darn high ceiling and there still can be a lot 
of latitude for unjust and unreasonable pricing underneath that 
ceiling.
    Mr. Hebert. Let me speak to that as quickly as I can, and 
that is really the crux of what we are trying to accomplish 
here. One, and I know you understand this, while we were trying 
to put this together, our goal was to bring prices to a 
reasonable level while at the same time attracting adequate 
investment so we can get the supply there, we can build the 
deliverability up so that we can deliver that supply, therefore 
keeping prices down in the long term for consumers.
    We weren't really looking for the easiest way to get there. 
We were, in fact, looking for the best way to get there. I 
think that is what this plan is.
    I have heard many people on this Committee, Mr. Chairman, I 
have certainly heard you speak on green issues and making 
certain that we have a green environment. Through driving the 
efficiency, we do two things. One, we bring down prices. Two, 
we strive to never make our air dirty through bringing in the 
cleaner units. If the most inefficient unit that clears the 
market is setting the price at which other people may take, 
then you are going to drive everyone's efficiency, and the 
secret is this. As they enter the bid stack, no one knows which 
units are going to be called and which is going to be the last 
unit, so there is no way to predict or manipulate which is the 
most inefficient unit and which one is going to be called last.
    There would be some people who would suggest, well, it is 
going to keep the dirty units on for the long term. Well, that 
is not true, because if they are what is clearing the market 
and if their costs or their market inputs is what is setting 
that price, then their profit is much lower than anyone who has 
got a 7,500 heat rate system as opposed to a 40,000 heat rate 
system. So what they are trying to do is, hopefully, we will 
retire these dirty systems. They will go away. We will bring in 
the newer 7,500, and even under compressed situations, 4,500, 
heat rate systems. They will be much more efficient and they 
will clean the air.
    Now, that is better for consumers in two aspects and it 
meets the balance of bringing prices to a reasonable level 
while at the same time attracting investment and providing for 
clean air.
    Chairman Lieberman. Let me ask you and any other 
commissioners who want to respond, why is that better than 
having gone to a more traditional cost-plus-reasonable-profit 
system, such as has existed traditionally at the State level?
    Mr. Hebert. I will give you the brief answer and I would 
like to give each of my colleagues an opportunity to answer it. 
One, we have come up with a plan that I think we are going to 
be able to move forward with as we move towards cost-based. We 
have seen the litigious nature of that, the appellate review of 
it, the indecision that ever comes from it. We need something. 
California and the West needed immediate results. They needed a 
problem solved today. Cost-based does not do that.
    And the other thing that cost-based does is it does exactly 
the opposite. It would guarantee a profit at maybe 10, 12, or 
13 percent return on these inefficient units and you would keep 
them around a very long time and we need those units off.
    Chairman Lieberman. Do any of the other commissioners wish 
to respond? Yes, Commissioner Breathitt?
    Ms. Breathitt. Mr. Chairman, I would like to make a point, 
that this plan is only covering 20 percent of the electricity 
sales occurring in California. The number that we have gotten 
from State officials in California is that they have been able 
to secure 80 percent of their sales in fixed price contracts. 
So we are only talking about this plan mitigating prices for 20 
percent of the energy purchases, and I think that is an 
important factor. It is not 100 percent.
    The plan also is a market-oriented plan that has incentives 
as we believe that will incent new investment, but at the same 
time, you can call them price caps, you can call them price 
controls, you can call them a price mitigation, it does put in 
price controls that have proven to be effective from our March 
29 order, and if this continues to hold forth, it is going to 
be effective all hours, all the time.
    Chairman Lieberman. I do want to note for the record that 
two of you have used the term ``price control.'' I was 
expecting Groucho's duck to come down from the ceiling. 
[Laughter.]
    Ms. Breathitt. I will say price cap.
    Chairman Lieberman. You are truly bold.
    Chairman Thompson. I wish the governor had stayed around to 
listen to this. He ought to be here.
    Chairman Lieberman. Commissioner Brownell, do you want to 
add anything?
    Ms. Brownell. I will try and dodge the issue of calling it 
anything as long as it works, frankly.
    Chairman Lieberman. Yes.
    Ms. Brownell. I would add simply that I think it is pretty 
clear from other markets that you do not get innovation when 
you have monopolies and cost-based kinds of pricing, that the 
kinds of opportunities that capital flows to are created by 
markets where people can make economic choices and to make 
choices based on other kinds of preferences. We saw almost 20 
percent of the market in Pennsylvania choose green power. For 
the first time, we actually had investment in a number of green 
plants, many examples of economics that work, but an example, I 
think, that will prove true over time.
    I also think that the commentary by the investment 
community yesterday and this morning would indicate that it 
also satisfies some of their concerns, so you will have 
stability both for the incumbents to the extent that they deal 
with their other issues and the market players. I think that is 
important, as well.
    Mr. Massey. Mr. Chairman, my preference was to return 
temporarily to a system based upon the cost of each individual 
generator in the market. I think that would have been a more 
effective time out and I would have exempted any new generation 
from that. I hope my colleagues are right that a cost-based 
system tied to the least-efficient generator will actually 
encourage the retirement of those generators. A lot of 
economists believe that it will. Others believe that it may 
provide an incentive to keep some of those old dogs around so 
that the market clearing price can be pegged rather high.
    So I don't have 100 percent confidence that this is the 
right approach, but it seemed to me that it was a dramatic step 
forward.
    Chairman Lieberman. Commissioner Wood, I thought I heard 
you say in your opening statement that you have left the door 
open to situations where the Commission might want to 
temporarily order a cost-of-service-plus rating system.
    Mr. Wood. I think that is always an option, Senator. Some 
perspective on this. The State in 1996 put forward a plan that 
FERC approved that said they wanted to move away from it as 
part of their restructuring plan. The Commission, wanting to 
work with the States, in fact, approved that. That moved the 
procurement of almost all the power by the major investor-owned 
utilities to the spot market mechanism where you take the last 
unit's price.
    Back in that day of surplus and prior to the drought, that 
incremental unit was cheaper than the average unit, and I think 
had that world continued for forever, people would have 
continued to be better off under the deregulated plan than the 
regulated plan. But the drought, which hydroelectricity is a 
big part of the energy picture in California and in the 
Northwest, the drought and the lack of investment in anything 
new caught up with the State and with that region last summer, 
and in the fall, the Commission moved in its December order to 
really preempt the State plan and say, this will not work 
anymore. We have got to get you guys out of the spot market and 
move you to a contract-based market. So that is when, as 
Commissioner Breathitt pointed out, we are now down from 100 
percent to 20 percent of the power plants playing in this 
hourly marketplace, and so that has meant quite a bit of 
difference.
    As I mentioned yesterday, and I am sorry I do not have my 
crude drawing skills as at the Energy Committee, but in 
response to Senator Feinstein's proposed legislation with 
Senator Smith, what we have found is that the units that are 
playing in this spot market pool are largely the older gas-
fired plants, we call them the old dogs, and they are largely 
about the same heat rate. They are about the same level of 
inefficiency.
    So because of that unique situation, it seems to me that 
cost-of-service ratemaking in that spot market might actually 
cost the customers of California more than what the Commission 
adopted. Now, that may not always be the case, and it is a 
tool, as your question asked, Senator, that is a tool in the 
regulatory toolshed, that if a cost-of-service rate is the best 
way to get to a just and reasonable rate, it certainly is in 
the statute and it is certainly something the Commission can 
do. I do think for the reasons stated that it may be advisable 
to move toward ones that are more incentivizing than we have 
had in the past.
    Chairman Lieberman. Thanks. My time is more than up. I 
appreciate your answers. I think I understand better why you 
made the decision you did on Monday.
    I must say that I am left with a question about whether the 
system you have chosen will ultimately fulfill the statutory 
responsibility to maintain just and reasonable rates, but I 
think the answer to that is that we are not going to know until 
we see for a while how this system you have chosen works. So we 
will all, hopefully, be following it with open minds and learn 
from the experience.
    Senator Thompson.
    Chairman Thompson. Thank you, Mr. Chairman.
    I appreciate the Commission being here and the work that 
they are doing. I imagine you feel somewhat like a center on a 
football team. Nobody notices much what you do until something 
goes wrong. But I think people are beginning to realize more 
and more the work that you have been doing, the 50 to 60 orders 
that you have put out, the addressing of this issue. Just 
because you do not do what people want you to do, one side or 
the other or both, does not mean that you are not addressing 
the issue. I think, if nothing else, you have disabused the two 
extremes, and these are the people who say that FERC has no 
role in this and the others who say all you need to do is cap 
retail prices and wholesale prices and prices will be low and 
everybody will be happy.
    So, hopefully, we have moved away from both of those. I 
think one thing that we have learned is that if we have prices 
that wind up driving the demand up and the supply down, you are 
going to have problems. And we can't just look at the problem 
today and what we do about it in the short run because we run 
the risk of exacerbating an already troublesome situation.
    It does seem to me like this is, in many cases, short-term 
versus long-term consideration. Something that might be helpful 
in the short term and pleasant, or more pleasant, might not be 
the right thing to do in the long term, and those are the 
balances that you have to make. I think the more we learn about 
it, the more we see the complexities of it.
    I do not think, for example, you can talk about the March 
order and whether it is successful or not. Until we get a way 
down the road, you may have gone not far enough, you may have 
gone too far. I don't think anybody knows. I mean, that is the 
nature of the situation, and especially the nature of 
electricity, it seems to me. If there was an answer--we have 
brilliant people here now for the second day on both sides of 
the issues. If there was an answer, we probably would have 
discovered it. So we have to do the best we can and learn as we 
go along.
    One of the things that puzzles me is what are we going to 
do, and I know the tremendous pressure that this Commission has 
been under, but the Department of Energy, Senator Murkowski 
testified today and he pointed out that the Department of 
Energy has pointed out that, as I understand it, that there 
will be blackouts in California. Now, you know what is going to 
happen. There is going to be a hue and cry that the Commission 
didn't go far enough. That will be definite proof that the 
Commission didn't go far enough, and the pressure that you see 
today will be magnified many times over.
    My question is, what are you going to look at? I know you 
are not going to just respond to the public opinion polls. What 
are the factors that you will look at when that happens? Are 
you going to look at what has happened since this order and 
conclude that that can tell you what the sound policy is for 
the future, or will your analysis at that point be the same 
analysis that you have today. That is, you consider all of the 
factors that you ought to consider and you put this down for 
time enough to see whether it works, however long that might 
take.
    But it seems to me that from a, I do not want to use the 
word ``political'' standpoint, but that is something we have to 
consider if you do not, but you are buying into a tough hand 
here because you are coming up with a policy in your considered 
judgment--some of you have some reservations about it, but in 
your considered judgment is the way to, knowing that if it 
works as well as it can possibly work, you are going to have 
blackouts. How are you going to handle that when the time 
comes?
    Mr. Hebert. Senator Thompson, I will tell you that you are 
exactly right as to the politics and the pressure, there has 
been a lot of pressure applied by the Senate and the House and 
State leaders. The important thing is that this is an 
independent agency, hopefully not susceptible to pressure. I 
want to thank my colleagues for taking a bold move by believing 
in this and saying we believe this will work.
    We cannot, ``we'' being FERC, control blackouts. It is 
outside the realm of our ability to change. The reason for that 
is we can't site generation. We can't build generation. We 
can't cite intrastate gas pipelines that supply fuel that, 
quite frankly, is constrained right now in California. There 
are things that are outside the realm of opportunity for us, 
and that means we need help and we need California to help.
    We will just have to continue to believe in what we need, 
and that is to call balls and strikes. Part of the beauty, I 
think, of this Commission of five, Commissioner Wood brought it 
up about two State Commissioners. Actually, you have four State 
Commissioners, previous State Commissioners, I think three of 
which, including myself, that were previous chairmen of State 
Commissions. So we are sympathetic to the needs and plight and 
understand the political pressures that are on State leaders, 
as well, in this regulatory environment.
    There are mechanisms that we are going to continue to pay 
attention to. This plan stays in effect through the end of 
September 2002. There have been lots of questions come up, is 
that long enough? How long should you go? Well, the end of 
September is an educated guess based on what we are being told 
is going to be brought to the marketplace in California and the 
West as far as generation.
    Now, there was a release in April of this year by the State 
of California, perhaps it may have been the governor's office, 
I can't recall, that there was going to be around 5,000 
megawatts brought on-line by the end of this summer, which is 
very important to this Commission and certainly important to 
the people of Commission.
    Chairman Thompson. By July.
    Mr. Hebert. Right. The newest numbers that are out are 
suggesting to us that 2,309 megawatts are going to actually be 
what is going to be what is on-line. That is less than half of 
what we are told. If those megawatts are not brought on-line, 
the blackouts will continue and they will be harsher because 
demand is increasing. We have no control over droughts. We have 
no control over outages, although we are trying to inject 
ourselves there to make sure we understand the schedules.
    The short answer is, I don't have an answer for you, 
Senator Thompson. I wish I could tell you that politics are not 
going to play a role in this and I wish I could tell you that I 
know and I am willing to bet my life on this plan. This is an 
evolution that we are going through. We are learning this 
process. I think right now it is the right move and I believe 
it will bring down prices and at the same time bring in new 
supply. But I remember when I got this job on January 22, the 
California crisis was right in the middle of our face and I was 
asked about it by some reporter, ``What are you going to do 
about it?'' and I said, ``Well, we are going to work hard and 
we are going to be committed. I did not start this fight, but I 
am going to try to finish it.'' And that is what we are doing.
    Chairman Thompson. Does anyone else have a different 
observation or additional--Mr. Massey?
    Mr. Massey. Senator, my view is that this order does about 
all that we can do at the Federal level, this order and 
previous orders, to prevent blackouts this summer. The ISO is 
skillful and has adequate tools to keep the system in balance 
if there is enough supply. There is a ``must offer'' provision 
that requires all generation in the Western interconnection 
that is not committed to native load or wholesale contracts to 
be offered in every hour of every day. The ISO in California 
will supervise maintenance schedules and outages within the 
State to ensure that the maximum supply is available.
    We have, by imposing these price controls, I think, 
eliminated any incentive to withhold generation to drive up 
price. That strategy is simply not available anymore because it 
won't work. So that is about all we can do.
    There will still be blackouts this summer in California 
because there is just not going to be enough supply in some 
hours, and I am not sure what this agency can do about that at 
this point.
    Chairman Thompson. Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you, Senator Thompson. Senator 
Collins.
    Senator Collins. Thank you, Mr. Chairman. Mr. Chairman, 
before I question our witnesses this afternoon, for the honor 
of my State, I have to correct a wrong statement that was made 
this morning by Senator Torricelli after I had left. It is my 
understanding that the Senator from New Jersey made comparisons 
about Maine's per capita energy use versus California and 
implied that Maine was much higher. That is incorrect, which 
does not surprise me. And I would also note, though I am sorry 
he is not here to hear this, that the residents of New Jersey 
use 35 percent more electricity per household than do the 
residents of conservation-minded Maine.
    I thought it was very important for the record that I set 
that straight, and I would ask unanimous consent that a table 
doing a State-by-State comparison of average monthly bills be 
included in the record.\1\
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    \1\ The chart entitled ``Average Monthly Bill By Sector,'' appears 
in the Appendix on page 744.
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    Chairman Lieberman. Without objection.
    Chairman Thompson. How does Connecticut fare? [Laughter.]
    Chairman Lieberman. Actually, I think we do pretty well, 
don't we? You don't have to give me the answer now.
    Senator Collins. I am sure that you would be interested in 
that----
    Chairman Lieberman. The thrifty New England Spirit.
    Senator Collins. That is right.
    Mr. Chairman, I very much appreciate the opportunity to 
discuss with our FERC Commissioners this afternoon some issues 
that are of great concern to the people of Maine, and since I 
have been in touch with many of them on the issue I am about to 
raise, I am sure it will not be a surprise to them.
    I first want to congratulate the two new members, 
Commissioners Brownell and Wood, on their recent appointment 
and tell you that I checked you out with the members of the 
Maine Public Utilities Commission, on which a former counsel to 
me serves. They speak very highly of you and I am confident 
that coming directly from State regulatory commissions that you 
will be especially sensitive to how your decisions affect 
consumers, particularly those who have little or no control 
over what they pay for electricity.
    I would like to pose some questions about the charges for 
installed capacity, the so-called ICAP fee, which has been a 
very controversial issue in my State. I realize there may be 
some limits on your ability to respond, and I will respect 
those limits.
    To provide some background to my colleagues, Maine leads 
the Nation in the percentage of its electric load served by 
competitive providers with numbers that recently passed those 
for Pennsylvania and that continue to grow. Unfortunately, what 
appears to be good news on the surface is the result of a less-
happy development, mainly that our consumers pay very high 
prices for standard offer or default service. This is because 
of the interest in promoting competition. We have done more 
than any other State to expose our consumers, especially our 
business consumers, to current market prices for power. That 
obviously contrasts dramatically with the approach taken in 
California.
    And it is a tribute to the people of Maine that they have 
largely accepted these price increases with stoicism, if not 
silence. But it would be unfair and unwise to abuse their 
patience with additional government-imposed costs that cannot 
be absolutely justified. The market is already making them pay 
dearly for energy, and in my judgment, the Federal Government 
should not be adding to this burden through high capacity 
charges.
    I appreciate the importance of providing incentives for new 
generation, but unlike California, it is difficult to see that 
New England has any kind of problem on that front. More 
significant, we should be very careful that in our eagerness to 
create incentives for new generation, we do not want to create 
incentives for voters to pull the plug on electric competition.
    Against that backdrop, I have two questions. First, to what 
extent has FERC considered the appropriateness of using a 
deficiency charge for capacity that was developed during a time 
of fully regulated, vertically integrated utilities in a time 
when power is sold in a competitive market? To be more 
specific, in the prior world, utilities sold each other energy 
based on their actual costs. Most owned substantial generation, 
and government could ensure that the proceeds of any capacity 
charges were used for new construction or otherwise benefitted 
consumers.
    Now in States like Maine, energy prices are based on what 
the market will allow. Companies that sell power to consumers 
often have to buy all of their capacity in the market and 
capacity charges are simply another cost imposed on consumers 
with no guarantee that they will be used to improve 
reliability.
    Should these dramatic changes in the nature of the industry 
alter how FERC sets deficiency charges for capacity and how the 
proceeds are allocated, and if so, how? Mr. Hebert.
    Mr. Hebert. You are well-educated on an issue that you 
should not be required to be educated on.
    Senator Collins. I agree with that. [Laughter.]
    Mr. Hebert. I want to remind my colleagues that this is a 
pending matter. This is a remand back to us from the First 
Circuit, so, therefore, we have jurisdiction of it at this 
point. I would ask the Senator's permission to very carefully 
draft you an answer in writing as opposed to giving you 
anything orally that may cause me to recuse myself. That is a 
pending matter. Mr. Welch and I are friends, as well, and I 
hear you, heard him, and we will be acting.
    Ms. Breathitt. Senator, I think that is why you saw us all 
sort of shifting back and forth and talking among ourselves. We 
have had this before us for a while. It went to the court. The 
court remanded it back and I hope we will be acting soon.
    Ms. Brownell. Senator, I would just like to add that you 
asked the right questions. The questions are not only being 
asked in New England, but in PJM and throughout the country, 
both by the market participants and the ISOs. So it is an issue 
that we will be dealing with and I think we are cognizant that 
a transforming market requires new looks at everything.
    I would also like to suggest it would be a great thing if 
you could lead a conservation competition among all the States. 
It would be the fastest way to get demand-side management to 
the market that I could think of.
    Mr. Massey. Senator, I have no idea whether we got that 
$8.75 charge right or not. I think our decision was reasonably 
well motivated. We want load-serving entities to come to the 
market meeting their requirements plus some measure of reserve, 
and if they fail to meet that reserve capacity requirement, the 
question is, how do you create incentives for them to meet that 
capacity reserve requirement and should they be penalized if 
they fail to meet that requirement? That is really what this is 
all about. And if they should be penalized, what should the 
level of penalty be? That is what is before us.
    The Court of Appeals said to us, you can retain the $8.75 
per kilowatt month penalty if you choose to, but if you choose 
to, you have to provide a much better explanation of why you 
made that choice, or you can move off of that choice. We now 
have before us a new proposal from New England about how to 
calculate that fee, and I won't comment on the wisdom of it 
because I haven't reviewed it, but I know it is before us.
    But I do think one of the issues this Commission is 
struggling with generically, and frankly, it rose out of the 
California debate, there was no capacity market in California 
and no reserve requirement and not enough generation being 
built and----
    Senator Collins. But New England is not California, and 
that is part of our----
    Mr. Massey. That is true, but one of the reasons New 
England is not California is there is this capacity 
requirement, and the question is, if the load-serving entities 
don't meet it, to what extent should they be penalized? That is 
really the issue before us. I am sensitive to your concerns. I 
am glad you raised it and we will try to do the right thing on 
rehearing.
    Senator Collins. Mr. Wood, did you want to add anything?
    Mr. Wood. I think, as kind of a general matter, because 
this was really the last piece of unfinished business on the 
agenda when I left the Public Utility Commission of Texas, 
which like New England and unlike any other place in the 
country both have in excess of 20 percent excess capacity 
looking at this summer and next, one would think in a market-
based scenario, in a market that is slightly overbuilt, that 
the costs of buying social insurance for excess capacity would 
be relatively low, if not zero. In a market that is really 
tight, if you were buying social insurance for capacity, like 
in California, maybe that would be a relatively expensive 
purchase.
    So philosophically, the answer to your question is that a 
market would price things different than a regulated area. How 
it does so is going to be, again, subject to this proceeding 
that is coming up. But I think it is a critical question to get 
right, because as I mentioned before, relying on external 
sources to make sure we have enough capacity in future years is 
something that the Commission can no longer do. We have to 
ensure that mechanism is something that is ordered by this 
Commission, if it doesn't already exist.
    Senator Collins. Mr. Chairman, I am wondering if you would 
indulge me with one more question----
    Chairman Lieberman. Go right ahead.
    Senator Collins [continuing]. Since it involves New 
England.
    Chairman Lieberman. That was a very craven appeal to my 
partisan, or my regional, parochial, regional interests. There 
are only three of us, so you should see the red more as a 
cautionary yellow light.
    Senator Collins. Thank you. [Laughter.]
    My second question is this. The independent system operator 
of New England recently submitted a proposal to FERC which 
provides that sellers of capacity must agree to bid their 
energy into the market at a price that is capped at $1,000 a 
megawatt hour. I earlier talked about a situation we had in New 
England last May when there was a price spike that went to 
$6,000 per kilowatt hour, more than 100 times the usual rate.
    I won't ask you to comment on the specific proposal, 
because I understand the constraints you are under. But in 
general, should a generator who receives capacity payments have 
any limits on the prices that it charges for energy? Mr. 
Hebert.
    Mr. Hebert. As you know, we do have a matter pending before 
us and, therefore, I am going to be precluded from answering 
that. I will tell you that this Commission, I think, has been 
very clear that we are conscious of rising prices, we are 
conscious of problems that markets that are not fully designed 
and fully functioning create, and that we are willing to do 
what is necessary to make certain that those markets are 
working and on their feet.
    Senator Collins. Let me ask just one final question that is 
not related to a matter that is pending before you. But I have 
to tell you that those matters that are pending before you are 
of extraordinary importance to my State and have caused a great 
deal of consternation, and whenever I go to a manufacturing 
plant, it is the first issue that comes up. In fact, you would 
not believe the number of people in Maine who know what ICAP 
means. That is really frightening.
    Let me switch gears for a moment. It seems clear to me that 
given the short-term inelasticity of electricity markets, that 
there are periods when at least some sellers can know with 
certainty that their output will be purchased no matter what 
the price. Now, during these periods, what steps do you think 
we can take to constrain prices--I know the $1,000 cap has been 
one approach--that will preserve public confidence and still 
provide sufficient incentive for capital investment in 
generation?
    And one particular matter I would like you to comment on, 
in addition to price mitigation or price caps that could be 
imposed, is whether or not we should be looking to develop a 
real-time demand response, and whether you have any thoughts on 
how such a response could be incorporated into the market 
structure. When we had that $6,000 spike, consumers didn't know 
that at that time they should turn off their air conditioners 
or delay doing laundry or curtail their use of electricity. 
They don't have any way of knowing when we have hourly 
electricity markets what the prices are for that particular 
time. Mr. Hebert.
    Mr. Hebert. Actually, what the Commission has done is we 
certainly, I believe, have a full understanding that we have to 
be committed to a wholesale marketplace that works. What you 
are talking about is fluctuations in a marketplace from time to 
time that get price spikes.
    I will tell you, individually myself, not speaking for the 
entire Commission, I understand price spikes, but what 
consumers truly feel are average prices. A price spike every 
now and then may give some certainty to the investment 
community as to where they need to send their dollars to 
invest, to build new generation, perhaps to deal with 
congestion or bottlenecks.
    Through our Order 2000, this Commission believes that if we 
set up regional transmission organizations, which we are in the 
middle of right now, we can somehow get the free flow of 
electrons. The end state hopefully will be flow-based rates 
that will give us some opportunity to make certain that all 
consumers get the benefits of a market that works. We are not 
there yet. We are in the middle of that process. It is a part 
of the evolution, but we are continuing to go down that road.
    We are working with State regulators. I mentioned to you 
Mr. Welch. We are trying to make sure that all State regulators 
understand the need in us working together with the regional 
transmission organizations to get these grids to work. Ideally, 
we would love to have one North American grid. That is not 
going to happen. We have got the interconnection difficulties, 
but we are trying to get it down to a lower level than we have 
currently got. We need investment in infrastructure. We need 
investment in supply. And the Order 2000 will bring about that, 
I believe.
    Senator Collins. Commissioner Breathitt.
    Ms. Breathitt. Senator, I would like to add that if there 
is sufficient supply in your area, in your State, that that 
expensive bid for power may not ever be needed to be called 
upon by your grid operator. So one thing that can be focused on 
in your area is if there is the right planning process to site 
new needed generation, and because of the installed capacity 
program in your area, there should be the incentive in place to 
ensure that there always is a reserve margin.
    The other thing that is in place in the area that 
Commissioner Brownell comes from, and we have seen it in ISOs 
to the north, Pennsylvania, New Jersey, Maryland, is the 
circuit breaker concept that you mentioned of $1,000. The few 
times it has been used in the PJM control area, I think we 
asked recently and they have only gotten up to $1,000 under six 
times. So it is rare that it gets up there, but it is a circuit 
breaker if sales do reach it. So adequate infrastructure, 
climates that allow for that, and a circuit breaker approach 
works.
    Ms. Brownell. Senator, I would simply add that another 
issue is you have to have the rules in place that make sure you 
know what is going on in that market and why that spike took 
place, and you have to have appropriate things like congestion 
pricing that is responsive to the market. So I think those are 
things that we are working on and they are important. We do 
have a $1,000 cap in PJM and I think it just sends a signal. 
But critically, you have to know why that spike was there.
    On demand side management, in our order on Monday, we 
called for a technical conference in two phases. The first 
phase will actually bring in technology providers--it is really 
extraordinary what is out there--and learn what is available, 
and then in the afternoon probably talk about implementation 
issues.
    The reality is, I think customers are a whole lot smarter 
than we think they are and I think if we can encourage the 
development of technology, we can bring down costs and let 
everyone from large business to small business to homeowner 
begin to use the tools that are available. So we are committed 
to doing that and we do understand that is a reality, an 
important reality, in any market.
    Mr. Massey. Senator, I think it is a wonderful question. 
You have really put your finger on an issue that I think we 
have grown to believe is extraordinarily important in any 
electricity market. Electricity markets aren't like other 
markets where a purchaser simply decides not to purchase if the 
price gets too high. In other markets, that has a substantial 
price dampening effect, as you point out. But in electricity 
markets, we simply don't have that yet, but we are working on 
it. It requires, I think, a strong Federal role and an even 
stronger State role to make that happen. But because of the 
nature of electricity, I think it is important that price 
volatility be minimized to the extent possible. It is simply 
not acceptable in electricity markets.
    We need to implement demand response programs, working with 
State Commissions. It will require a substantial portion of the 
load actually seeing a price signal in real time, I think, 
having the tools to respond to that price signal to cut back on 
usage. I think the technology is available to do that. This 
conference that Commissioner Brownell played a leadership role 
in establishing, I think could be a watershed event in this 
Commission moving forward to understand the relationship 
between the wholesale markets and the retail markets, 
particularly as they relate to the demand side, so I very much 
appreciate your question.
    Mr. Wood. I guess the only thing I would add, Senator 
Collins, is that unlike buying gasoline or milk or a new car, 
you get a bill 30 days later and it is a little hard to change 
your behavior because it has already happened. The big 
customers tend to have real-time meters on their premises, and 
when, as we move to hourly markets, as you all have in the 
Northeast, hourly prices are then corraborated with the usage 
of the plant, the manufacturing plant that you mentioned in 
your question, that those folks are pretty cognizant of what 
the prices are, as you know, and have the ability to respond to 
them.
    Actually, 30 percent of the market, which would be the 
commercial and industrial, the large guys, if those people have 
the ability to react in real time by cutting off their power 
usage in whole or in part and getting paid for it, which is 
what the demand side mechanism that Nora and Bill just talked 
about are all about, i.e., if you are going to pay $6,000, I 
will take $3,000 to shut off. This guy will take $2,000. This 
guy will take $1,000. We will get down below that $1,000 cap 
pretty quick. These people will take some money to get shut 
off. Interruptibility has a price. Then that really becomes 
another player in the market, just as good as building a new 
power plant.
    So it is a critical silver bullet to solving this market-
based transition that we are in and I am glad to hear you are 
interested in it, too.
    Senator Collins. Thank you. Thank you, Mr. Chairman.
    Mr. Hebert. If I might add one thing on the demand side, 
Mr. Chairman----
    Chairman Lieberman. Sure.
    Mr. Hebert. Senator Collins, a couple of things. The demand 
side issue is something that has certainly been in front of 
FERC, that we have been engaged in. Actually, the first time I 
think we supported it together was March 15. We had it in our 
March 15 order. We had it in our April 26 order. And now, the 
5-0 vote of the Commission the first time we have been able to 
get together on it.
    But I will tell you, understanding, and this is, again, 
where I think it is important to have four former State 
Commissioners engaged in this, the demand issues are State 
issues and they extend beyond our jurisdiction here at the 
FERC. But what this Commission, through removing obstacles and 
impediments, is willing to do is complement the services of 
States that are willing to get into demand issues. We are 
willing to help them when and where possible in looking for 
ideas and answers. Thank you.
    Senator Collins. Thank you very much. Thank you, Mr. 
Chairman.
    Chairman Lieberman. Thanks, Senator Collins.
    I have a series of questions about the order on Monday, 
just to clarify on some questions that have come up. The first 
is on the question of refunds, which there was a lot of concern 
about this morning. I think I understand, Mr. Hebert, what you 
established and what your understanding is regarding the 
California--the 15 days before the administrative judge--
parties will discuss the settlement, the judge has 5 days or 7 
days thereafter then to recommend to the Commission, and there 
is some latitude there to begin a process.
    You also indicated, I was pleased, that there is some way 
in which Oregon and Washington can become parties to that 
process. Additionally, those two States expressed a concern, 
and the letter that I mentioned before is from the four 
Senators from the States, Senators Wyden, Smith, Murray, and 
Cantwell, to the Commission, which undoubtedly will be waiting 
for you when you return.
    The question is the law and the fact that they need to wait 
60 days after the investigation is opened to enjoy any benefits 
of refund, which would not in this case, in their case, occur 
until early in July of this year, and that is the law. Because 
that seems like an inequitable situation to me, and my question 
is, is there any way to work around that within the law?
    Mr. Hebert. I like that question.
    Chairman Lieberman. The reason I ask that is----
    Mr. Hebert. As a lawyer, I love it, but----
    Chairman Lieberman. The Attorney General of Washington 
suggested that if there is not, one of the things the Committee 
ought to do, working with the Commission, is to see if we 
cannot find a way to change the law, and I do not mean with 
regard to these cases, but in the future.
    Mr. Hebert. Well, obviously, the Federal Power Act is the 
law that we go by in regard to this, and certainly Congress can 
amend and change and whatever law is passed down to us, we will 
follow. We have to follow the law and that is what we are 
doing.
    Sixty days after the notice is exactly right. That is why 
it is July 2, and I think that is the case you are talking 
about. As I told you, there is a pending matter before us in 
dealing with Puget Sound and we will have to be very careful in 
any comments we make due to that, because I nor anyone else 
wants to be recused. We all want to sit on that case.
    But I will tell you at the same time, as I shared with you 
a little bit before, I think that is the beauty of the 
settlement process that we set up through this order that we 
issued on Monday, and that is that there are entities from the 
Northwest, the Pacific Northwest, that are parties to this 
California settlement.
    Chairman Lieberman. Because they are suppliers into 
California.
    Mr. Hebert. And I will tell you that we have, I believe, 
one of the best settlement judges around, our chief judge that 
is going to handle this matter. Now, this Commission felt it 
was important to leave the uncertainty there. What this judge 
ends up doing within the confines of that hearing room, I don't 
know nor can I give direction to, legally or ethically. But I 
will tell you, I believe that is the beauty of the settlement 
process.
    My guess is that through this settlement process, there are 
many issues within our jurisdictional grasp--``we'' being 
FERC--that will be settled. As with most settlements that I 
have ever seen or been a part of, my guess is there are some 
issues that are outside of our jurisdictional grasp that will 
be settled, as well. What are those? I have no idea.
    Chairman Lieberman. I appreciate your answer. It was 
artfully done.
    Mr. Hebert. Thank you.
    Chairman Lieberman. I am not going to push any further. I 
think it does leave some hope here for the folks in Oregon and 
Washington that there may be some possibility of refunds, but 
that is my conclusion, not----
    Mr. Hebert. I am not going to draw any conclusions, but you 
are certainly welcome to, sir.
    Chairman Lieberman. Thank you. Let me ask this question by 
way of exercising our oversight function. For the moment, let 
us assume that--well, we do not have to assume anything. The 
fact that the ability to obtain refunds is contingent on the 
date on which an investigation is opened obviously puts a 
premium in that way and many other ways on a swift response to 
complaints.
    One of the criticisms of FERC in this matter, and I will 
ask it now as a question, the criticism generally is that the 
Commission has acted too slowly here. Price increases began in 
California last spring or summer. I guess the Commission pretty 
quickly opened an investigation in July, but it was not until 
December that the decision was made that the rates were not 
just and reasonable. Then, incidentally, no investigation was 
opened until the end of April regarding non-California States 
on the Western grid, particularly in this case, Oregon and 
Washington.
    So the question is, or the allegation is, that until 
Monday, in some sense, until last Monday, that the Commission 
has been sort of dragged along more by events and rising 
anxiety about economic impacts of prices in California than it 
has taken control of the events--until Monday. So I want to 
pose that question to you, Mr. Hebert. How would you respond to 
it? How would you defend the Commission's behavior? And then 
particularly that question about Oregon and Washington and why 
did you wait until late April to get into that?
    Mr. Hebert. I will defend it by my record, Mr. Chairman. I 
would tell you that I think the record of this commission since 
January 22 has been solid.
    Chairman Lieberman. In fairness--excuse me--you did not 
arrive until January 22.
    Mr. Hebert. I did not become chairman until January 22.
    Chairman Lieberman. I am sorry. You didn't become chairman 
until then.
    Mr. Hebert. I was a commissioner, and actually, if you talk 
about proceedings and the ability to get proceedings before 
this Commission, under the previous chairman, the El Paso case 
has been one of the big cases that so many people have talked 
about and questioned about why we moved so slowly. I actually 
issued a concurrence in the El Paso case under the previous 
chairman that we had made enough procedural and discovery calls 
and it was time that we made decisions on the substance of the 
matter with the El Paso case and moved forward. And one of the 
first things we did when I became chairman of this Commission 
is to move forward with the El Paso case. A lot of people said, 
why did it take you a year? Well, it was the same question I 
was asking, and I actually issued in a concurrence prior to 
being chairman.
    We did study not only California and look at and try to 
make good balls and strikes calls when it comes to the 
Northwest, as well. I think if you look at January 22, getting 
through that process, getting what we had to be done at the 
staff level to get adequate information, to call the right 
balls and the right strikes, I don't think April is that bad, 
actually. I think that is actually pretty good. And if you, and 
I know you do, know as much about a government as anybody, that 
is a pretty quick call.
    And at the same time, most people do not understand, we 
were working with a commission of three that, quite frankly, 
was left with a backlog of 2,000 cases. We have reduced that 
backlog by about 25 percent now while at the same time dealing 
with California, issuing refunds that had never been done 
before.
    So I feel very good about our record and I think we are 
going to continue to move in a strong, fast, and furious, but 
reasonable and legal, manner.
    Chairman Lieberman. I want to yield to my colleagues in a 
moment. I could ask this as a question, but I am just going to 
make a statement on it. Just when you mentioned the backlog it 
came to mind that under Monday's order, FERC is taking on some 
very significant responsibilities to monitor energy markets in 
the West on a 24/7 basis. The question, and it is a larger 
question for another day, is how are you going to do it as a 
matter of process and organization? Do you have the personnel 
that will enable you to carry that out?
    Mr. Hebert. I would like to quickly try to answer it, if 
that is all right, Mr. Chairman, because I think I do have an 
answer for you.
    Chairman Lieberman. Yes.
    Mr. Hebert. Several things. One, this Commission saw that 
early on, actually through our Order 2000. We believed it was 
important through the regional transmission organizations to 
give them a monitoring role, to try to give them some shared 
responsibility. So that is a part of Order 2000 and that will 
help us monitor those markets.
    At the same time, and I don't want to speak for my 
colleagues, I want to give them an opportunity, but if I recall 
correctly, there were some organizations, one including one 
division of FERC that was put together, that we all disagreed 
with. When I became Chairman, I reassessed our resources. I 
looked at those resources and I split that division back up, 
which was the litigation division. We had around 150 people. We 
needed at least half of those people, the technical people, to 
be involved in monitoring those markets. So we sent them to the 
division that properly would handle that through those markets 
and we sent the others to OGC to handle the legal situation at 
hand.
    So I think we have taken our resources. Do we need 
additional resources in the future? We will see. Again, we are 
in an evolution mode, but I will tell you, we are moving 
forward with monitoring efforts. We probably don't have 
everything we need at this point. What will that include in the 
future, I will be glad to keep you abreast of.
    Chairman Lieberman. Yes, I would appreciate that, because 
that is part of our oversight role, as well.
    One last final question, and a quick answer, I hope. We 
have talked about the order that you issued on Monday being 
effective through September of next year, 2002, which would 
take us, as a few of you have said, through the two summers, 
give time for this to settle out, and I think that is all good.
    There is another perspective on it, not negative to what I 
have just said, which is that the folks in California have 
projected that supply will not be in any equilibrium with 
demand until about a year later. I will ask if any of you want 
to comment on it, but real quickly if you would, in deference 
to my colleagues, will you be open to extending the order 
beyond September of 2002 if that seems appropriate?
    Mr. Hebert. I think it is important that we set a deadline, 
and as I said earlier, there are things out of our control--the 
siting of generation, making certain that generation comes on-
line, dealing with Path 15, dealing with the intrastate network 
on natural gas. All these things are problems in California. If 
they get resolved, and they should be, then yes. If not, 
perhaps they do not get in 7 percent reserves. Perhaps they 
stay within 10 or 11 percent. My suggestion will be that, yes, 
the plan should change. To what extent, we can't make that call 
at this point.
    Chairman Lieberman. Does anybody else want to add to that? 
Mr. Wood.
    Mr. Wood. I think if the market rules are fixed and the 
infrastructure sufficient, then competition can work. 
Deregulation can follow from competition. And I think it is our 
job to make sure that the infrastructure is in place.
    Chairman Lieberman. OK. Thank you all.
    Senator Carnahan, I think you were here first, if that is 
OK with Senator Carper.
    Senator Carnahan. Yes. Thank you.
    I have a question for Commissioner Massey. You said 
previously that you do not believe that FERC has met its 
responsibility to assure just and reasonable prices in the 
wholesale market. Given the experience in California, how might 
FERC reconsider its approach in the future to better reflect 
the current realities in the energy market?
    Mr. Massey. Senator, I have supported the movement to 
markets for electricity with one caveat, and that is it must 
benefit consumers. And so it seems to me that we have to ensure 
that the markets are structured in a way that they produce just 
and reasonable prices all of the time, and if they don't, we 
have to intervene.
    There are a number of things that we can do. First of all, 
we have granted market-based pricing to over 900 sellers using 
a screen that literally everyone passes. A market power screen 
that every seller passes is no screen. We may as well just 
issue a rule saying everyone passes. So I think we need to come 
up with a screen that is sensitive enough to actually measure 
market power in the marketplace and deny market-based pricing 
to those that have it.
    Second, we need to get very serious about market design. We 
need to ensure that the rules are in place in the market so 
that the market will produce just and reasonable prices in all 
hours. That is a big job in the California market right now. 
Perhaps the market should be redesigned to include an installed 
capacity market, a reserve requirement. We need to move 
dramatically away from over-reliance on the spot market. 
Progress has been made in that area. We need to do a lot of 
work to ensure that there is a robust demand response, in other 
words, consumers deciding not to consume electricity when the 
price gets too high. If we can achieve that goal, it will have 
a substantial price mitigating effect.
    And the markets need adequate supply. Our experience in 
California makes me wonder whether we should have markets where 
we know that the supply is inadequate. What should we do? What 
protections should we build in if we know it is a capacity-
short market and that prices will soar? So those are my 
thoughts on it.
    Senator Carnahan. When you think of beefing up FERC's 
enforcement, I have heard from many that SEC might be able to 
serve as a model. The SEC closely monitors the market and it 
proactively investigates anything that seems unusual. Do you 
think that is a good idea?
    Mr. Massey. It is a good idea if Congress is willing to 
fund it. It seems to me that to be the tough cop on the beat, I 
have come to believe that we need more resources than we have 
and we probably need more people involved in effective market 
monitoring. We need to attract--we have excellent economists 
and investigators, but we need to attract more, it seems to me. 
Perhaps we should look at the SEC model, but I think the SEC 
devotes about half of its staff to investigations. It is a 
large percentage. I don't know what percentage ours is, but it 
is probably a small percentage of our staff.
    So I think we perhaps will need to retool, because 
whenever--despite our best efforts to structure good markets, 
there may be problems, there may be market power, there may be 
abuses, and we have to be willing to investigate those 
effectively and step in.
    Senator Carnahan. Thank you. My next question is for Mr. 
Hebert. In your prepared testimony, you listed numerous actions 
taken by FERC over the past several months, and I understand 
that you have taken those actions based on your best judgment 
of how to help. In your view, have the prices in the wholesale 
market in California been just and reasonable?
    Mr. Hebert. I think the mitigation plan that we put into 
effect April 26, that actually was effective as of May 29, and 
I believe the plan that we put into effect on Monday that will 
actually take effect tomorrow, is and will bring down prices to 
more reasonable levels. This Commission has spoken in its 
December 15 order to say, in fact, that we have found and 
believe rates to be unjust and unreasonable at certain times 
under certain conditions.
    That was my belief then. That continues to be my belief, 
and that is why we have taken the action we have taken, to 
bring reasonable prices to the consumers of California and the 
West while at the same time attracting investment in supply and 
infrastructure that will continue to bring them better 
opportunities and, therefore, lower prices in the future.
    Senator Carnahan. In the future, how do you feel FERC might 
play a more constructive role earlier in the process to better 
meet its statutory obligation to assure just and reasonable 
prices when additional States now are undertaking deregulation, 
such as my home State of Missouri?
    Mr. Hebert. I have said before, and I will say again, that 
FERC probably made a mistake--not probably, FERC did make a 
mistake in giving too much deference to the State of California 
in waiting too long to intervene and step in. We hate for 
government to intrude in any time that they don't need to, but 
clearly, we had a dysfunctional market. We needed to step in. 
We have done so now and I think the record will speak for 
itself that we are doing a good job of that.
    So many people want to look in the rear-view mirror and 
talk about what happened last year and the year before. I 
wasn't the umpire at that point, so I am not going to go there. 
But I will tell you, I believe that we are moving in the right 
direction. Things are going to be better.
    In saying that, I think it is only fair to say right now, 
since the Commission has been trying to move California away 
from its reliance on the spot market, and we are very proud of 
where they have moved. They have got around 20 percent--
Commissioner Breathitt had talked about that--in the spot 
market at this point. Whereas we do want to move them away from 
reliance on that spot market, when we talk about forward 
markets and them moving towards the forward markets, I want to 
be very clear that there are forward markets that are 
reasonable and there are forward markets that, quite frankly, 
are very risky.
    It is my thought and my belief that once you start getting 
outside of 5 years, if you get beyond that on signing 
contracts, I would tell you that those are very risky 
contracts, especially given the volatility of energy.
    Senator Carnahan. Thank you very much.
    Mr. Hebert. Thank you.
    Chairman Lieberman. Thanks, Senator Carnahan. Thanks for 
your interest in this subject.
    Senator Carper.
    Senator Carper. Thanks. I was here earlier today, and I 
don't know if you folks were in the audience then or not, but 
these hearings are broadcast on C-SPAN. Sometimes they show 
them at night and people might be seeing this around the 
country around 3 o'clock in the morning someplace. They are 
waking up from a little nap and say, what is this all about, 
FERC? I just think, a month or two ago, most people had 
probably never heard of FERC, and now you are getting to be a 
household word, almost like Lieberman. [Laughter.]
    Mr. Hebert. We preferred, or at least I preferred the 
secrecy of FERC.
    Senator Carper. Well, you are a secret no more.
    Mr. Hebert, you were saying that you became the chairman 
back in January but you served on FERC prior. How long?
    Mr. Hebert. Since 1997.
    Senator Carper. All right. And Ms. Breathitt, how long have 
you been there?
    Ms. Breathitt. I joined the Commission in November 1997.
    Senator Carper. All right. And Ms. Brownell, you are pretty 
new, aren't you?
    Ms. Brownell. A week that seems like a thousand years, 
Senator. [Laughter.]
    Senator Carper. You are a brave soul to take this on.
    Mr. Massey, how long have you been on this team?
    Mr. Massey. Eight years, Senator.
    Senator Carper. Eight years, wow. Mr. Wood.
    Mr. Wood. Two weeks.
    Senator Carper. Two weeks. OK. Let me just ask, for people 
that might be watching this around the country and are waking 
up in the middle of the night wondering what is this all about, 
could you just explain for them and for this late-arriving 
Member of the Committee--and I am going to ask our newest 
members to do this--just explain to folks who might be tuned 
in, what did you all actually agree to and announce on Monday 
of this week?
    Mr. Wood. What we agreed to do, Senator, was to take 
action, perhaps a little delayed action, but action 
nonetheless, to help repair a broken market out West. There is 
an electricity market that was deregulated through State 
initiatives in 1996, or 1995 time frame.
    That worked pretty well at the beginning, but it quit 
raining and the State depends for about 30 percent of its power 
supply on the hydroelectricity. There was no new investment in 
new gas-fired plants or other kind of plants to keep the 
infrastructure in place. That confluence of bad weather and 
lack of investment and a deregulated market meant that prices 
went up.
    The step that the Commission took this week was what it 
could do to help mitigate the economic impact of those events, 
but unfortunately, no step we could have taken or can take will 
make up for the fact that there are more megawatts being 
demanded than will be available to be used this summer. So we 
did not promise that it would be a panacea.
    I think, quite frankly, we want to make sure that we 
mitigate not only the price, but mitigate the expectations that 
things are going to be rosy this summer in the West Coast. They 
will not. There will be blackouts. But I think what we wanted 
to take a step on was to make sure that those blackouts, the 
insult of those wouldn't be accompanied by the injury of a very 
high and unjust bill for the power.
    Senator Carper. Thank you. Ms. Brownell, do you want to add 
or take away anything from that?
    Ms. Brownell. I would never take away from my colleague, 
only to add----
    Senator Carper. Unlike us. [Laughter.]
    Ms. Brownell [continuing]. Just a little bit. And that is, 
I think that we laid out a road map. We took a number of steps. 
We laid out a road map that will give certainty to consumers, 
to the State of California, to the participants in the market 
there about what will happen through the next two summers so 
that we can begin to deal with the broader issues of a longer-
term plan of how to site more generation, create market rules 
that actually work, and that will provide for just and 
reasonable rates in the long term. We took the surprise of the 
day out of the market so that people now know what is going to 
happen.
    I think the second thing we did was respond very positively 
to the stakeholders from California's issues and reached out to 
the State of California to work with them, because we all have 
a role to play and it is critical that we each do our part.
    So I think we could give you 25,000 details, but most 
importantly, we took a lot of steps and we now have a plan, a 
map, and some certainty, and that is important.
    Senator Carper. All right. Ms. Breathitt and Mr. Massey, if 
I could ask you two the next question, and that is how do you 
know if what you have agreed on unanimously to do, how will you 
know that it is working or not working?
    Ms. Breathitt. We have a several-week trial of this plan 
having worked in what we call emergency conditions, when the 
grid operator in California says reserves have diminished to 7 
percent. Our plan kicked into effect in late May and we have 
evidence that that methodology worked. What we did was extend 
that methodology to all hours rather than just triggering when 
there was an emergency condition called by the grid operator.
    So we have some evidence that it worked the times that we 
were in an emergency, and we tweaked it slightly for the 24-
hour condition to actually even limit more the market clearing 
price for the non-emergency hours. So we think that it will 
work. We have some evidence that it is working and what we did 
was extended the plan to all hours and we covered the rest of 
the Western States. So we now have it in 11 States.
    Senator Carper. Mr. Massey, do you want to answer?
    Mr. Massey. Senator, I think the answer to your question is 
we don't know for certain whether it will work or not so we 
have to pay attention and----
    Senator Carper. What will tell you that it is working or 
not working?
    Mr. Massey. For me, the real question in whether it is 
going to provide substantial price relief is tied to the costs 
of the last generator to be dispatched. It could have been 
tighter than that, but we know the price won't be higher than 
that in the market.
    That last generator to be dispatched will probably be a 
natural gas-fired generator most of the time. About 95 percent 
of the dollars in the formula for determining the market 
clearing price under our order will depend upon the price of 
natural gas. That is it in a nutshell. If the price of natural 
gas remains reasonable, this plan will produce reasonable 
prices. If the price of natural gas skyrockets in California, 
the price for electricity will skyrocket. And so I think we 
still have a lot of work to do to ensure that prices for 
natural gas are just and reasonable, as well.
    Senator Carper. Mr. Chairman, I have one last question I 
would like to ask of Mr. Hebert, if I could do this as a 
follow-on. You have explained, and I think very nicely, what 
you agreed on and you have given us a pretty good notion of how 
you will know and maybe we will know if it is working. Let me 
just ask, when Governor Davis was here today, he described the 
unanimous step that you took, he described it as a step in the 
right direction.
    Let me just ask, and this I would ask of you, Mr. Chairman, 
if the kind of success you are looking for and hoping for 
doesn't occur, what would be an appropriate next step?
    Mr. Hebert. First, let me say that Governor Davis and I 
agree on that. It is a step in the right direction. What do we 
do from here? I think it depends on what we learn from here. My 
experience in government and regulation and energy markets, and 
I have been involved in legislating and regulating energy since 
1988, my experience is it is important to listen and learn 
before you lead and I think that is what this agency has done.
    I believe we have done that wisely, responsibly, and in the 
best interests of the consumers by looking at not only short-
term benefit of bringing down prices and making them 
reasonable, but at the same time focusing on supply and 
deliverability and making certain that we have got an 
infrastructure that will work and will, in the long term, bring 
better prices and more choices to the people of California and 
the West.
    What do we do beyond that? Some of it, as I have said, is 
outside of our control. We can't site one generating unit in 
California. The leaders in California can, and I believe and I 
hope that they are committed to that. We are going to look at 
this plan again on several opportunities. In the plan, we talk 
about looking to make certain that the generation that has been 
discussed and scheduled does come on-line in California, also 
that there is less and continued to be less reliance on the 
spot market.
    So we are going to continue to monitor these markets. We 
are evolving through that process. We have got additional 
people working on that right now, as I have said. I have taken 
the resources at our agency and moved them around and taken 
half of those 150 people who were doing nothing but litigating 
and got them now monitoring these markets. We are going to have 
the regional transmission organizations through Order 2000 
monitoring markets along with us. I believe we will be 
successful. If we have learned anything in the meantime that 
says we made a mistake or says that we need to change something 
we did, we will, in fact, do that.
    Senator Carper. Good. Mr. Chairman, I wish I could have 
been here for the whole hearing. This has been quite a hearing 
and we are grateful to each of you for being here today and for 
your service. You come to your positions, a couple of you, in a 
very exciting time, and Mr. Massey, for 8 years. For you, no 
purgatory, straight to heaven. [Laughter.]
    Chairman Lieberman. That was not a power of the Committee 
that Senator Carper was talking about. That is individual 
authority. [Laughter.]
    Thanks, Senator Carper, for coming back, and for your 
thoughtful questions.
    I thank the members of FERC for very good testimony. This 
has been a long day, very interesting to me and an important 
day, and I think ultimately an encouraging day. I mean, we have 
a real problem that occurred in California. There are a lot of 
reasons for it. I have the impression that everybody is now 
trying their best to make it better, and by your own judgment, 
last December, the rates for electricity were and are unjust 
and unreasonable and it required action by yourselves and, of 
course, other kinds of actions by the State.
    Though occasionally, because these are important matters 
and we are all in politics, there gets to be an edge to the 
back and forth. These are not ultimately partisan matters. We 
may have different ideological points of view. We may have 
different jobs to do. We may have different authorities. But 
these are real problems that cry out for solution and I 
appreciate the efforts you made.
    The Committee is going to remain involved here. We think 
this is important. We would like to work with you. As I said, 
we not only are going to press you and ask you why you did this 
or why you did that, but sometimes we are going to ask you, 
what do you need to do th things we are asking you to do? And 
then, we will try to become your advocates.
    I do think, as Commissioner Wood said earlier, the fact is 
that the Commission is at a new chapter in its history. The 
very fact that you have two new commissioners and you are now 
up to full strength says that. But also, I believe that, and 
you are more expert at this than I, but from what I know of 
FERC, that this has been a--we tend to use the term ``defining 
moment'' too much in our Senatorial lives, but it seems to me 
this has been one of those defining moments in the life of this 
Commission and that what follows will be different. And we need 
you to be actively involved because of the obvious central 
effect that energy pricing (that you have some authority over) 
has on the lives of individual Americans, but also on the 
vitality of our economy.
    So I thank you very much for your service, for your 
patience today, for your outstanding testimony, and we look 
forward to seeing you again soon.
    The hearing is adjourned.
    [Whereupon, at 4:20 p.m., the Committee was adjourned.]


  THE IMPACT OF ELECTRIC INDUSTRY RESTRUCTURING ON SYSTEM RELIABILITY

                              ----------                              


                        THURSDAY, JUNE 28, 2001

                                       U.S. Senate,
                         Committee on Governmental Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, in room SD-342, 
Dirksen Senate Office Building, Hon. Joseph I. Lieberman, 
Chairman of the Committee, presiding.
    Present: Senators Lieberman and Thompson.

            OPENING STATEMENT OF CHAIRMAN LIEBERMAN

    Chairman Lieberman. Good morning, and welcome to our 
witnesses and our guests. We thank all of you for being here.
    Two votes are going to occur in the Senate at around 9:50, 
so we can probably at least go until about 10 o'clock before we 
have to break for a while and then return, for which I 
apologize.
    This morning, I am pleased to continue this Committee's 
examination of the Federal Government's response to the 
deregulation of the energy industry. This is the third hearing 
we have held on this issue in as many weeks.
    In our first two hearings, we focused on the problems of 
electricity deregulation in California and the West and the 
need for more vigorous oversight and intervention by the 
Federal Energy Regulatory Commission.
    Fortunately, last week, the Commission did step up its role 
in addressing the Western power crisis. This Committee will 
continue to keep watch on those efforts to determine whether 
they bring adequate price relief to besieged energy consumers.
    Today we turn to a related concern, and that is the 
reliability of the electric grid. The grid is our energy 
lifeline, a vast network of transmission lines that carry 
electricity from a myriad of energy producers, large and small, 
to the utilities and ultimately into our homes and businesses. 
It is a lifeline that we take for granted every time we switch 
on the lights, sit down at a computer or open the refrigerator.
    The national electric grid is vital to our lives and to our 
livelihoods, and it has been greatly affected by the 
deregulation of electric utilities. So today, we are going to 
ask who is operating the grid, and who is watching what is 
happening on the grid on behalf of electricity consumers, and 
who is it that keeps the lights on--or, as people in California 
no doubt have been asking, who is to blame when the lights go 
off.
    Not long ago, that was an easy question to answer. Local 
electric utilities ran the show top to bottom. They produced 
the power for homes and businesses in their service areas, made 
sure there was enough of it, and saw to it that the electricity 
ran in the proper voltages and frequencies to be transported 
and used safely. Local utilities built and ran the transmission 
lines to get power from their plants to their customers, and 
they built interconnecting lines to neighboring utilities that 
allowed for modest trading in times of shortage.
    That diagram is roughly meant to show how neat things were 
before deregulation.\1\
---------------------------------------------------------------------------
    \1\ Chart entitled ``Bundled,'' appears in the Appendix on page 
819.
---------------------------------------------------------------------------
    But the deregulation of electricity markets has scrambled 
this picture.\2\ Utilities no longer make the power they sell 
to retail consumers. Instead, electricity generators compete on 
the market to sell to utilities and sometimes even directly to 
retail customers.
---------------------------------------------------------------------------
    \2\ Chart entitled ``A Fully Unbundled Electric Industry Model,'' 
appears in the Appendix on page 820.
---------------------------------------------------------------------------
    Nor do local utilities anymore always control the 
interstate transmission lines. In several regions of the 
country, independent system operators, known as ISOs, act as 
electricity traffic cops, routing power from sellers to buyers.
    That means that the ISOs are responsible for keeping the 
system up and running. So what was once a relatively sleepy, 
largely local network has been transformed into a fast-moving 
and extremely congested national electricity delivery 
superhighway.
    While deregulation obviously offers potential economic 
benefits, the new arrangements it has brought to the national 
electricity grid also pose some risks to the reliability of the 
grid. In fact, a Department of Energy task force concluded in 
1998 that the current configuration, devised in an age of far 
less usage of the transmission grid and far more regulation of 
the utility industry, is clearly ``unsustainable in the newly 
decentralized and competitive electricity industry.''
    In fact, problems have already occurred. A November 2000 
Staff Report by FERC describes a disturbing incident in July 
1999 when power was tight and prices were high. As I understand 
it, engineers monitoring the Midwest electricity grid noticed 
something unusual and troubling. Some of the electricity that 
should have been in the system just was not there. What 
happened? According to a later FERC report, Cinergy, a large 
Midwestern utility, just took power off the grid, which 
apparently it had no right to, in order to supply its own 
customers rather than disconnecting them or buying the extra 
power it needed, which would have been at significantly higher 
prices.
    Another account of the incident which appeared in the Wall 
Street Journal notes that the utility put power back into the 
system later, but only after demand and prices had dropped. The 
utility was never punished for this behavior because the system 
has historically depended on voluntary industry standards 
rather than a regime of Federal regulation and enforcement.
    Grid reliability has also been an issue in California, 
where the grid is managed not by the local utilities but again, 
by one of the new independent system operators.
    To fulfill its responsibility to keep the lights on in the 
spring of last year, the California independent system operator 
contracted to buy extra power in times of shortage from what is 
known in the industry as an RMR, ``reliability must run'' unit. 
But as an April 2001 FERC Order describes it, when the 
California ISO needed the backup supply last spring, some of 
these power plants did not cooperate. In other words, the 
``reliability must run'' units were not reliable and did not 
run. According to the FERC Order, to keep the lights on, the 
ISO was forced to scramble to fill demand on the spot market, 
obviously at much higher prices.
    FERC subsequently investigated that case and approved a 
settlement, with generators paying for the $8 million 
difference in price.
    Although FERC has jurisdiction over the interstate 
transmission system under the Federal Power Act, it has not 
historically regulated reliability. Instead, FERC has deferred 
this responsibility to regional voluntary Electric Reliability 
Councils, which include all of the electric systems in the 
continental United States, Canada, and part of Mexico. Industry 
has relied upon the voluntary standards set by these councils 
through their governing body, the North American Electric 
Reliability Council, or NERC.
    With the changing structure of the electric industry, 
however, we now need to ask whether the Federal Government 
should play a more active role in maintaining and policing the 
national electricity grid. Indeed, Congress has actively 
considered amending the Federal Power Act to require FERC to 
establish reliability standards and a system for enforcement, 
although no such proposal has yet been enacted.
    That is the issue that we are going to explore today. Some 
of the questions that I would like to ask include: Does the 
shift from heavily-regulated utility systems to deregulated 
competitive markets threaten reliability of the grid? If so, 
does FERC have adequate statutory and regulatory authority to 
protect the public interest in a reliable electricity 
transmission grid? And what is the proper division of 
responsibility between Federal and State regulators concerning 
electricity reliability overall?
    I look forward to hearing our witnesses answer these and 
other questions, and I thank them very much for joining us this 
morning.
    Senator Thompson.

             OPENING STATEMENT OF SENATOR THOMPSON

    Senator Thompson. Thank you very much, Mr. Chairman.
    Our topic today is less controversial than the two energy 
hearings that we held previously, but this one is important. We 
have seen demand for electricity grow across the country, and 
we are watching as new generation is being built to try to keep 
pace.
    What may be lagging behind, however, as you point out, is 
the new transmission and proper enforcement of standards to 
maintain the reliability of our grids. Prior to restructuring, 
integrated utilities were responsible for generating, 
transmitting, and delivering electricity from the power plant 
to the consumer. The reliability standards in place have been 
voluntary, established by the North American Electric 
Reliability Council, and when there is a violation, there is no 
penalty, even if the violation threatens the integrity of the 
grid, possibly resulting in blackouts.
    In recent years, we have seen dramatic change take place. 
The electric power industry is dividing itself into different 
components. As a result, there is no single entity that is 
responsible for overall reliability. We have seen over the 
years instances, some of them serious, of individual actions 
that have adversely affected reliability.
    So, as the electric power industry restructures, we need 
someone made responsible for ensuring reliability and someone 
who has enforcement authority.
    We should note that the problem is not simply one of 
enforcement but also of investment. A greater demand on long-
distance sales will require more transmission. I am pleased 
that the President recognizes this fact and included in his 
National Energy Policy Report the need to streamline the siting 
process to allow for construction of more lines. While the 
country moves down the road toward restructuring and 
competition, it is important not to leave any key component of 
our electricity system behind.
    The good news is that we as a Senate have addressed this 
issue. The Energy Committee has held hearings on this topic, 
including one last month; I believe Mr. Cook testified at that 
hearing. In addition, in the last Congress, the Senate passed 
by unanimous consent a bill to establish an organization to set 
reliability standards and to take disciplinary actions when 
those standards are violated. That legislation did not pass the 
House, but it has been reintroduced this year.
    Earlier this year, Senator Lott had planned to have an 
energy bill ready for the President's signature by July 4. 
Unfortunately, despite the urgency and need we have seen for 
some action, it does not appear that there will be discussions 
about the timing of such a bill until after the July 4th 
recess. Perhaps at that point we will address the energy issues 
which are becoming more and more critical every day and which 
are the focus of your well-timed hearings, Mr. Chairman. They 
of course will include the issue of the reliability of our 
system.
    Mr. Chairman, I want to apologize in advance. As you know, 
we have the patient bill of rights on the floor, and my 
amendment is up as we speak, so I am going to have to break 
away. It has to do with exhaustion of administrative remedies; 
it is very exciting, and I am sure that you will want to be a 
part of that as soon as the hearing is concluded.
    Chairman Lieberman. And I am going to try not to be 
exhausted by it.
    Thanks, Senator Thompson, for coming by. I appreciate it 
very much.
    Let us begin with David Cook, who is General Counsel of the 
North American Electric Reliability Council, to which Senator 
Thompson and I both referred.
    This is one of those hearings for which preparation 
educated me greatly, and I think the hearing will continue that 
process.
    Mr. Cook, please.

TESTIMONY OF DAVID N. COOK,\1\ GENERAL COUNSEL, NORTH AMERICAN 
                  ELECTRIC RELIABILITY COUNCIL

    Mr. Cook. Thank you, Mr. Chairman and Senator Thompson.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Cook with attachments appears in 
the Appendix on page 509.
---------------------------------------------------------------------------
    NERC welcomes the Committee's attention to the critically 
important issue of the reliability of the bulk electric system.
    As you indicated, NERC is a not-for-profit organization 
formed after the Northeast blackout in 1965 to promote the 
reliability of the interconnected bulk electric systems. NERC 
comprises of 10 Regional Reliability Councils that account for 
virtually all of the electricity that is supplied in the United 
States, Canada, and a portion of Baja California Norte, Mexico.
    For more than 30 years the industry has followed a system 
of voluntary reliability standards. Those standards have worked 
very well, and we have had an extremely reliable electric 
system. As you indicated, the reliability standards have no 
enforcement mechanism. Peer pressure has been the only means 
available for achieving that compliance.
    As good as that system has been, the voluntary system will 
not serve us well for the future as the electric industry 
restructures. Here is why. The grid is now being used in ways 
for which it was not designed. There has been a quantum leap in 
the number of hourly transactions and in the complexity of 
those transactions on the grid.
    Transmission providers and other industry participants who 
formerly cooperated willingly are now competitors.
    Rate mechanisms which in the past permitted utilities to 
recover the costs of operating systems reliably are no longer 
in place or are inadequate given the increased risks and 
uncertainties they face.
    The single, vertically-integrated utility that formerly 
performed all reliability functions for an area is being 
disaggregated, meaning that reliability responsibilities are 
being divided among many participants. Some entities appear to 
be deriving economic benefit from bending or violating the 
reliability rules.
    Construction of additional transmission capacity has not 
kept pace with either the growth in demand or the construction 
of new generating capacity, meaning that the existing grid is 
being used much more aggressively.
    The result of all this is that the transmission grid is 
being increasingly stressed, and that stress shows up in two 
ways. NERC is seeing more congestion on the grid for more hours 
of the day, and NERC is seeing increased violations of its 
reliability rules.
    Not changing the way we deal with the reliability side of 
the business as the electric industry restructures would be 
like an airline switching to jet airplanes without increasing 
the length of the runways. Not having everyone follow a common 
set of rules for how the interconnected international system is 
operated would be like allowing individual airlines to choose 
their own routes and altitudes at which they fly.
    NERC and a broad coalition of State, consumer and industry 
representatives have developed and are actively pursuing 
consensus legislation to convert the voluntary reliability 
guidelines into mandatory and enforceable rules.
    The goal of that legislation is to set mandatory and 
enforceable rules for all operators and users of the 
international interconnected bulk power system in North 
America. It would be fairly developed and fairly applied by an 
independent industry self-regulatory organization with 
oversight in the United States by FERC and similar oversight by 
governmental authorities in Canada.
    It would have respect for the international character of 
the interconnected transmission system, and regional entities 
would have a significant role in implementing and enforcing 
compliance with those common reliability standards.
    Because of FERC's limited jurisdiction and authority, 
because of the international character of the North American 
grid, and because of the technical expertise required to 
develop and oversee compliance with bulk power system 
reliability standards, this is not a job that can simply be 
given to FERC.
    Nor can we simply have regional organizations set and 
enforce their own rules in their own way. Having an independent 
international industry self-regulatory organization develop and 
enforce reliability rules under government oversight recognizes 
the interconnected and international nature of the bulk 
electric systems, takes advantage of the huge pool of technical 
expertise that the industry currently brings to bear on the 
subject.
    That combination of industry technical expertise to work on 
the substantive reliability rules and government oversight, 
FERC and the United States, provincial regulators in Canada, to 
assure fairness in due process, is an effective and efficient 
way to address these issues.
    As you indicated, the Senate passed a version of the NERC-
supported reliability legislation last year. The bill died in 
the House. That legislation is before the Senate again this 
year, both in Senator Bingaman's bill, S. 597, and Senator 
Murkowski's bill, S. 389.
    Your letter inviting NERC to testify specifically asked us 
to address the issues of the role of independent system 
operators and regional transmission organizations in 
maintaining reliability as well as the role of State 
commissions.
    In the pending legislation, ISOs and RTOs are defined as 
system operators. As such, they must comply with the 
reliability rules established by the independent SRO. I would 
add that having the potential for RTO development is important. 
It is a positive development in being able to address 
reliability issues, because I think it will enable us to deal 
effectively with some of the issues that we are facing. If 
those RTOs develop all across the country, with the full scope 
and authority that FERC has envisioned for them, it will 
greatly facilitate dealing with some of the issues we face.
    Nevertheless, since the actions of any one system operator 
can affect the result of the interconnected transmission grid, 
RTOs will still need to follow a common set of reliability 
rules independently established and administered by an 
international self-regulatory organization.
    NERC commends the Committee for focusing on this critical 
issue of assuring the continued reliability of the 
interconnected bulk power system as the industry undergoes 
restructuring. Legislation now pending would allow for timely 
creation and FERC oversight in the United States of that needed 
industry SRO. The reliability of North America's interconnected 
transmission grid need not be compromised by changes taking 
place in the industry provided that reliability legislation is 
enacted promptly.
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thank you, Mr. Cook. That was very 
helpful and interesting testimony about the impact of 
deregulation on the grid, and I suppose I should say that it is 
not every day that we have a representative from industry 
coming to Congress, asking for regulation. So it is a measure 
of the new landscape in which you are operating.
    Thanks.
    Chairman Lieberman. Mr. Harris, welcome.

   TESTIMONY OF PHILLIP G. HARRIS,\1\ PRESIDENT AND CEO, PJM 
                     INTERCONNECTION, L.L.C

    Mr. Harris. Thank you, Mr. Chairman.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Harris appears in the Appendix on 
page 526.
---------------------------------------------------------------------------
    I have prepared testimony that I would like to submit for 
the record if I may.
    Chairman Lieberman. Without objection, your testimony will 
be entered in the record. I have gone over the testimony that 
each of you have submitted, and I appreciate it very much. It 
is very thoughtful and very helpful to the Committee, and all 
testimony will be entered into the record of this proceeding.
    Mr. Harris. Thank you, Mr. Chairman.
    As you know, the critical test of any law or economic 
concept is the test of use. I come to you today from the Mid-
Atlantic region where, for 4 years, we have been operating the 
world's most successful competitive wholesale energy 
marketplace.
    We have over 200 buyers and sellers and traders in our 
marketplace, and we have an arrangement with five States and 
the District of Columbia wherein the States are active in the 
participation of this market development.
    We have an arrangement where the environmental groups are 
active and participate in our marketplace and have meaningful 
input into the rules and practice and procedures that we follow 
in the Mid-Atlantic region.
    We also have active participation by all of those who have 
an effective interest in our planning. We have a total regional 
planning protocol. As a matter of fact, we are the only region 
in the Nation that has a regional protocol. That has resulted 
in over 40,000 megawatts of generation being planned. Currently 
in the Mid-Atlantic region today, we have nearly 7,000 
megawatts of generation under construction. Additionally, we 
have over $700 million of transmission under construction to 
support that generation, so that over the next 10 years, we 
believe that we will not have a reliability problem.
    We have many buyers and sellers and traders in our 
marketplace. What we have seen over 4 years of rolling up our 
shirtsleeves and actually doing it is that reliability has 
increased in the Mid-Atlantic region and that competition has 
worked.
    Mr. Chairman, we have had over 70 different countries visit 
our area to ask questions about why is it working here and what 
are some of the root elements that we are engaging in, what are 
some of the presumptions that we made several years ago that 
have born fruit today. It is from that perspective that we 
would like to share some thoughts with you today.
    I think the first and most important thing that this 
Committee should do for the Federal Energy Regulatory 
Commission is ensure that it keeps its focus.
    The second thing is to ensure that the Federal Energy 
Regulatory Commission achieves ``end'' solutions. As the 
Chairman mentioned, there are many needs that are important. 
You must meet the environmental needs. You must meet the State 
needs. You must meet the local needs. Having ``end'' solutions 
that achieve reliability and competition is what it is all 
about, ultimately.
    The third thing is to ensure that the Federal Energy 
Regulatory Commission promotes a national energy marketplace.
    If I may, I would like to talk about each one of these. 
First, ensure that the Federal Energy Regulatory Commission 
keeps its focus. The Energy Policy Act which was promulgated in 
Federal Energy Regulatory Commission Order 888 and FERC Order 
2000 had one purpose, and that was to ensure that customers 
have the benefit of competitively-priced electricity. If we 
lose sight of the fact that the customers are the ones who are 
supposed to benefit from this change in the energy marketplace, 
we lose sight of the objectives of the Energy Policy Act that 
this Congress established and what it is all about.
    We must ensure that we have the appropriate form over 
function. FERC Order 2000 delineates certain functions that are 
necessary to ensure that the customers will have the benefit of 
competitive price generation, and ensuring that the Federal 
Energy Regulatory Commission is true to those functions--that 
they do not ``dummy them down,'' that they insist on regional 
planning protocols, for example, so we can coordinate among 
regions to ensure that there is sufficient generation for 
reliability and ensure that the differences between regions are 
adequately addressed is absolutely imperative, and FERC should 
have that authority.
    Second, ensure that FERC truly achieves ``end'' solutions. 
As the Chairman has mentioned, electricity touches the very 
fabric of our lives. We know that price is important, and it is 
important that pricing be done appropriately. Electricity is a 
speed-of-light ecological system. It is the only product in the 
world that, at the very instant someone wants to consume it, it 
is produced. You turn on the light switch, and nominally, you 
are controlling a nuclear plant. That process goes far beyond 
just the bulk system. It affects the distribution system, which 
the States are responsible for; it affects local delivery to 
the home, because it is an instantaneous, speed-of-light 
product.
    In truth, there really are no pure reliability/economic 
principles. They all overlap and are intertwined. What we are 
seeing today with the wonderful network information 
technologies which PJM has employed quite successfully to 
enable these competitive marketplaces through technology is 
that these things are blending and merging. So it is very 
difficult to say this is reliability, and this is not. We would 
recommend that this Committee ensure that the Federal Energy 
Regulatory Commission assert its authority over all the things 
to achieve these ``end'' solutions.
    Third, we think that you have to have national energy 
marketplaces. We have seen competition work, but the 
electricity grid is like a giant synchronous motor. The Eastern 
connection is 650,000 megawatts; there is not another motor 
like that in the world. The West is a 125,000-megawatt motor. 
It needs to work well together, and the Federal Energy 
Regulatory Commission should take the lead in ensuring that we 
have a true national marketplace that can meet the focus of the 
Energy Policy Act, and that is to ensure that customers have 
the benefit of competitively priced generation.
    Thank you, Mr. Chairman.
    Chairman Lieberman. Thanks very much, Mr. Harris. That was 
excellent testimony.
    We will recess briefly now so that I can go over and vote, 
and then I will come back.
    The Committee stands in recess.
    [Recess.]
    Chairman Lieberman. The hearing is reconvened.
    I apologize to the witnesses and others here. We ended up 
having two votes on the Senate floor; hopefully, there will now 
be a reprieve from floor action for a while.
    Mr. Harris, thank you for your testimony.
    We will go on now to Kevin Kelly, who is the Director of 
Policy Innovation and Communication at FERC.
    Thank you, Mr. Kelly, for being here.

 TESTIMONY OF KEVIN A. KELLY,\1\ DIRECTOR, DIVISION OF POLICY 
    INNOVATION AND COMMUNICATION, FEDERAL ENERGY REGULATORY 
                           COMMISSION

    Mr. Kelly. Good morning, Chairman Lieberman.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Kelly appears in the Appendix on 
page 533.
---------------------------------------------------------------------------
    My name is Kevin Kelly, and I am Director of the Division 
of Policy Innovation and Communication within the Federal 
Energy Regulatory Commission's Office of Markets, Tariffs, and 
Rates.
    I am appearing here today as a Commission staff witness, 
and I do not speak for the Commission itself or for any 
individual commissioner.
    Thank you for the opportunity to speak on how the 
reliability of electric service is being affected by the 
industry's restructuring and the Commission's role in ensuring 
the reliability of electric service.
    The Commission's fundamental role in the electric utility 
industry is to regulate public utilities with respect to the 
sale of electric energy at wholesale in interstate commerce and 
the transmission of electric energy in interstate commerce. In 
short, the Commission serves as an economic regulator.
    Since the electric power industry began, reliability has 
been primarily the responsibility of the customer's local 
utility as overseen by State and local regulators. 
Increasingly, electricity trading over large regions leaves 
many matters affecting reliability outside the exclusive 
control of the local utility. So it is more important than ever 
to have reliability rules that everyone follows.
    But the Commission has no statutory authority to promulgate 
and enforce mandatory reliability rules.
    One approach to ensuring reliability is to enact Federal 
legislation. In May, the administration released its National 
Energy Policy Report, calling on the Secretary of Energy to 
work with FERC to improve the reliability of the interstate 
transmission system and to develop legislation providing for 
its enforcement by a reliability organization, subject to 
Commission oversight.
    I believe that a legislative approach is preferable to 
another approach that some have been trying in the absence of 
legislation, that is, to ensure reliability through contractual 
commitments.
    Congress should understand, however, that mandatory 
transmission reliability rules alone are not enough to ensure 
reliable electric service. Senator Lieberman, you asked who is 
watching the grid. We believe it should be RTOs, and partly for 
reliability reasons, the FERC has strongly encouraged the 
formation of Regional Transmission Organizations. These RTOs 
would eliminate many of the reliability problems caused by the 
highly Balkanized way in which the interstate transmission grid 
is now operated.
    In adopting its RTO rule, called FERC's Order 2000, in 
December 1999, the Commission set out at length the need for an 
RTO in each region to ensure reliability. The needs include 
coordinated operation and maintenance of interconnected 
transmission systems, improved determination of transmission 
system throughput capability, and unified regional planning of 
necessary grid additions.
    The Commission required in particular that a RTO must have 
the authority to ensure the short-term reliability of the 
regional grid and also must be responsible for planning and 
arranging necessary transmission expansions and additions that 
will enable it to provide efficient and reliable transmission 
service.
    But reliability requires more. It also requires adequate 
generating resources. A current issue, for example, is whether 
those who sell power to retail customers all over the country 
must maintain a specified level of generating reserves. 
Reliability also requires that generation support transmission 
in certain ways, and the Commission required in its ``open 
access rule'' of 1996, called Order 888, that all public 
utility transmission owners must offer generation-related 
ancillary services to their transmission customers, including 
the provision of minimum levels of generating reserves.
    Senator Thompson pointed out in his opening remarks that to 
further ensure reliability, we also need to find ways to 
encourage the construction of new transmission facilities.
    Market and regulatory rules must be designed to elicit 
sufficient investment in new transmission. For example, to 
provide transmission owners with an incentive to meet the needs 
of transmission users, the Commission could adopt performance-
based rates reflecting the reliability of a transmission 
owner's system. The Commission already had authority to adopt 
such rates under the Federal Power Act.
    In closing, restructuring of the electric power industry 
makes it necessary to consider new means of ensuring the 
reliability of electric service. The Commission has only 
limited authority to address reliability, and the need for new 
approaches is clear. Federal transmission reliability 
legislation is one such approach but alone is not sufficient. 
The Nation must also develop regional transmission 
organizations for reliable grid operation and must develop its 
transmission and generation infrastructure.
    Again, thank you for inviting me to testify this morning.
    Chairman Lieberman. Thanks, Mr. Kelly. That was very 
thoughtful and very helpful.
    Mr. Popowsky--how did you get the name ``Sonny''?

   TESTIMONY OF IRWIN ``SONNY'' A. POPOWSKY,\1\ PENNSYLVANIA 
  CONSUMER ADVOCATE, ON BEHALF OF THE NATIONAL ASSOCIATION OF 
           STATE UTILITY CONSUMER ADVOCATES (NASUCA)

    Mr. Popowsky. I think it is because the first two children 
born to my parents were both daughters, and my father was 
determined that the next child would be a son and was 
determined to call me ``Sonny'' regardless.
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    \1\ The prepared statement of Mr. Popowsky appears in the Appendix 
on page 545.
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    Chairman Lieberman. That is a good reason.
    Mr. Popowsky. The other reason it stuck is because my real 
name is ``Irwin'' and that speaks for itself. [Laughter.]
    Chairman Lieberman. Understood. Well, ``Sonny'' seems like 
a good name to have for someone in your line of work.
    Thanks for being here.
    Mr. Popowsky. Thank you, Chairman Lieberman.
    I am the Consumer Advocate of Pennsylvania. I am also past 
President of the National Association of State Utility Consumer 
Advocates, or NASUCA. From 1997 until earlier this year, I also 
served as the representative of small utility consumers on the 
board of trustees of the North American Electric Reliability 
Council. I am testifying today on behalf of NASUCA.
    NASUCA is an organization comprised of offices from 40 
States and the District of Columbia, charged by our respective 
State laws to represent utility consumers before Federal and 
State regulatory commissions and the courts. Our members' 
primary interest is the protection of residential and other 
small utility consumers.
    In your letter of invitation, you asked NASUCA to address 
``the challenges to electric system reliability resulting from 
the restructuring of the electric industry and its increasing 
reliance on competitive markets.''
    In my opinion, there is no more important issue facing the 
electric industry and its consumers today. There remains great 
disagreement across the Nation regarding the relative costs and 
benefits of electric restructuring, but I believe there is 
little disagreement that if the road to restructuring leads us 
down the path of severely deteriorated reliability, then we 
will have accomplished little as a Nation and will indeed have 
set ourselves back, both economically and in terms of basic 
human welfare.
    Today, I would like to discuss the role of the States, the 
NERC, the FERC, and the Regional Transmission Organizations in 
ensuring that the American public will continue to receive 
reliable electric service.
    In my view, each State must continue to play an important 
role in ensuring reliability for its consumers. In practice, 
most day-to-day outages and reliability problems that affect 
retail consumers occur on the local distribution system, which 
has been and remains under State jurisdiction. States have long 
experience addressing these issues, and Federal involvement 
here would be duplicative and less effective than the current 
State efforts.
    Nevertheless, it is obvious that electric reliability 
problems can affect more than one State. Indeed, NERC itself 
was formed in response to the blackout of 1965 that cascaded 
across the Northeast with no respect for State boundaries.
    In my opinion, NERC and its member Regional Reliability 
Councils have done an outstanding job of developing standards 
and tools to operate an extremely reliable electric network.
    But as you have already heard, NERC is a voluntary 
organization that has traditionally had no ability to enforce 
its rules through anything more than peer pressure. To its 
credit, I believe that NERC has done almost everything that it 
can do, first, to open its doors to organizations like NASUCA 
that are outside the traditional utility industry, and more 
recently, to establish a fully independent board of trustees.
    NERC and some of its regional councils have also attempted 
to develop contractual enforcement mechanisms to put more force 
behind their rules and standards.
    But NASUCA agrees with NERC that more is needed, and we 
fully support the legislation that would establish a self-
regulatory industry organization that would continue to develop 
reliability standards but whose standards would be fully 
enforceable and ultimately subject to the review of the FERC. I 
believe this proposal is essential in a world of increased 
competition. The players in this game can no longer also serve 
as the referees, and the referees must be able to do more than 
just issue warnings to the players who violate the rules.
    What else can FERC do? I hope that FERC will turn its 
attention as soon as possible to completing the task of 
establishing a set of Regional Transmission Organizations 
across the United States. These organizations will play a vital 
role in the reliable operation and planning of the electric 
network. These RTOs in turn must coordinate their activities 
closely with their respective Regional Reliability 
Organizations and with any new national reliability 
organization.
    Ultimately, every reliability standard will have effects on 
the economics of many transactions, and any economic 
transaction could have an effect on reliability. RTOs and 
reliability organizations must work together on wholesale bulk 
power issues, but ultimately, they must both answer to a single 
entity, which I believe for interstate purposes must be FERC.
    I would like to close with a personal observation if I may 
about the electric restructuring experiences in California and 
my own experience in Pennsylvania.
    Viewing the California situation from 3,000 miles away, I 
would have to say that even if wholesale prices had not spiked 
to absurd levels, and even if major utilities had not been 
thrown into financial disarray, the reliability impacts alone 
of the recent electricity crisis in California were totally 
unacceptable.
    I never thought I would see the day when such a large 
segment of the American public could not be confident that 
their lights would stay on from 1 day to the next.
    A few years ago, some people questioned whether there would 
be adequate generation supplies at reasonable prices in a 
restructured electric industry, but they were assured that 
``the market would provide.'' Well, the market did not provide 
in California.
    The question our Nation must face is whether the past 
year's failure of the California market was the result of a 
``perfect storm'' of events in which everything that could go 
wrong, including the weather, did go wrong or whether 
California was the ``canary in the mine shaft,'' giving the 
rest of the Nation a warning that we should turn back from this 
path as soon as possible.
    In contrast, when I look in Pennsylvania at the current PJM 
market, I generally see reliable service, supply keeping up 
with demand, and prices that, at least most hours of the year, 
are close to what one would expect in a competitive market. The 
PJM market still has several flaws and is far from perfect, but 
at least the staff and independent board of PJM, as well as 
many PJM members, recognize these flaws and are taking steps to 
try to remedy them.
    In closing, I am hopeful that our experience in PJM to date 
will turn out to be closer to the rule and that the recent 
California experience will turn out to be the exception. But I 
think we first need to ensure that entities such as the newly 
reconstituted North American reliability organization, the 
FERC, and the hopefully independent RTOs will have the tools to 
create enforceable reliability rules and market structures 
where the benefits of competition can be secured for all 
Americans in a reliable and economic manner. Thank you.
    Chairman Lieberman. Thanks, Mr. Popowsky, for your very 
interesting testimony.
    Let me begin my questions by following up on the questions 
that you raised at the end of your testimony. They join the 
first two hearings, that we held on the California crisis, to 
this hearing.
    How do you--and you have had some experience in this--
answer the questions that you raised? In other words, how do 
you explain why reliability of electricity has become in doubt 
for this summer; and even though the prices are now, 
fortunately, moderating, there is still concern about 
blackouts. How do you explain why it happened?
    Mr. Popowsky. It is easier for me to try to explain why it 
has not happened in PJM, so if I could start with that, I think 
that if you have rational market rules where people can come in 
and build power plants and know they can be interconnected to 
the system in a rational manner and that they will participate 
in a market that actually works, you do not need ridiculously 
high prices in order to get people to build power plants and 
have the supply meet demand.
    I think again, from afar, in California, it appears that 
for whatever reasons, generators whom one would think should 
have been flocking to California to build needed generation did 
not do so, and there was a fundamental mismatch of supply and 
demand.
    As I said, I do not see that happening in PJM, but I think 
you have to have the market structure and the rules in place, 
and they have to be understood in order for the market to have 
any chance of working.
    Chairman Lieberman. So if a big part of the problem was 
simply that the industry was not building new generating 
facilities, looking back at it, who should have done what to 
avoid the crisis that has occurred in California? That is a big 
question, but I am curious whether you see that there was a 
role for the government here. This part of reliability is the 
adequacy of supply, really, and what is coming onto the grid, 
if I hear you correctly, as opposed to whether the grid can 
handle it and whether it is being policed adequately.
    Mr. Popowsky. Yes, I think that that is right, and that is 
why I raised the question, which is in theory, the market 
should provide the incentives to build the adequate generation.
    In PJM, the theory gets a little thumb on the scale. If you 
would agree, Mr. Harris--there is a requirement in PJM that the 
parties which are called ``load-serving entities,'' the parties 
or companies that serve load, have to have enough generation to 
serve their load plus a reserve margin in terms of capacity 
that they must have in addition to what they think they might 
need in their peak hour.
    So there is actually a requirement within PJM that requires 
participants in the market to have additional capacity over and 
above what they think they will need.
    Chairman Lieberman. Who sets that requirement? What is its 
origin?
    Mr. Popowsky. I believe it is set by PJM in cooperation 
with the Regional Reliability Council, the Mid-Atlantic 
reliability council.
    Chairman Lieberman. Mr. Harris.
    Mr. Harris. I have just a couple things to add to Sonny's 
comments. I think we get back to some very elemental things 
here. In the Mid-Atlantic region, the questions you are asking 
were considered so important that we insisted that we had to 
have a regional planning protocol before we began commercial 
operations in our competitive marketplace.
    We spent the years 1994 to 1996 negotiating with five 
States and the District of Columbia, consumer advocate groups--
Sonny's group participated--and environmentalists to come up 
with a regional planning protocol. So we are the only area that 
has a regional planning protocol in place before we begin 
competitive marketplaces. This is absolutely crucial to ensure 
that you will have capacity to meet demand.
    Chairman Lieberman. Was that one pursuant to some 
governmental authority or requirement, or was it just done 
voluntarily within the industry?
    Mr. Harris. No, sir. To credit the political and other 
leadership in the Mid-Atlantic region, the States, they 
determined that this was such a crucial point that they wanted 
to have this in place. It took us 2 years to negotiate the 
protocol so that all five States and the District of Columbia, 
consumer advocates, environmentalists and others joined in this 
process. We filed that to begin operation as an independent 
system operator.
    The second thing is a point which you made, that prices are 
important, and it is important to get prices right. So we 
developed a system that would make public transparent spot 
prices. We publish prices, every 5 minutes, on the electrical 
grid, and everyone can see the price, and transparent spot 
prices enable you to have appropriate competitive behaviors and 
enable people to determine when and if they want to build 
generation.
    Chairman Lieberman. Just talk a little more about that. 
That is very interesting. So that every 5 minutes, you are 
publishing the prices in that period of time from the various 
sources of electricity coming onto the grid.
    Mr. Harris. That is correct. And if you want it, we can 
give it to you every few seconds. As a matter of fact, 
information transparency is so important to having a 
competitive energy marketplace that we have created a program 
which we call ``E-data,'' and your staff and yourself can get 
on that program, and you can see these prices. Any individual 
can see what the prices are at any point in time, and then you 
can make your decisions based on that price transparency.
    Chairman Lieberman. Do people actually buy--what is the 
smallest unit of time that you can buy? In other words, how 
quickly can you change your purchases?
    Mr. Harris. You can change with 30 minutes' notice, 
actually. We have hundreds of traders in any given hour. On hot 
days where the system is getting tighter, we have actually had 
400 to 500 changes an hour in the marketplace. So another thing 
you need to have in your market is many buyers and sellers, 
which gets you back to the importance of having regional 
solutions when you move forward.
    Chairman Lieberman. Let me step back a little bit and go 
back to what the problem is and see if you can illustrate it 
before we get to some of the solutions.
    As I hear you, and understand from what I have read and 
studied, part of the problem, or a big part of it, is the 
significant transition we have made to deregulated electricity 
markets, and the fact that the electricity grid, which was 
largely local or regional in the old model of a particular 
local utility building a power plant, arranging for the lines 
to get to its customers, creating some backup possibility where 
it connected a transmission line to neighboring utilities--now 
you have a very active deregulated market in which every 5 
minutes, even every couple of seconds if you want, buying and 
selling is occurring over this grid, which was for the most 
part not built for this kind of traffic, so there are both 
congestion and reliability problems.
    I cited two examples that we found as we were going over 
this. One was the Cinergy case, where they basically took some 
power which they were not entitled to; and the second was the 
California case where the backup units did not fulfill their 
obligation to come on in time of need.
    I would just like to ask all four of you if there are other 
examples that you have of the problems which have come with the 
transition we have made to deregulated markets, just as a way 
of illustrating what we are dealing with here. Mr. Cook.
    Mr. Cook. Another kind of situation--I think the congestion 
issue that you mentioned, with the limits on how much power we 
can transfer from one part of the country to another, is a very 
critical one.
    Chairman Lieberman. And of course, once that happens, it 
then goes to the very heart of deregulation, because it limits 
competition.
    Mr. Cook. It can limit competition. It means that power 
cannot move into an area that might be less expensive, so 
people need to resort to more expensive generation, and in some 
instances, transactions need to be curtailed, because there 
simply is not enough ability to serve that load. That is one of 
the things that we are seeing, and it gives rise to the need 
that we have talked about to have a more robust transmission 
system.
    Chairman Lieberman. Mr. Harris.
    Mr. Harris. Thank you, Mr. Chairman.
    First of all, the two problems that you elucidated could 
not have happened in the Mid-Atlantic region simply because we 
are administered by an independent entity that has no financial 
interest in the marketplace. We have 10 different transmission-
owning companies and hundreds of traders, and it is 
independently administered so it would not have occurred.
    Chairman Lieberman. Take those two cases and tell us how 
your region would have prevented them from occurring, or why 
they would not have happened.
    Mr. Harris. It would not have happened because the 
operation of the power grid is done by an independent entity 
that has no financial interest in the marketplace. We have many 
companies. Cinergy was one company, vertically integrated, with 
everything under its control. We operate and direct the 
operations of the power grid neutrally and independently from 
all market participants.
    Chairman Lieberman. So what would happen in the case where 
Cinergy took the power off the grid that it was not entitled 
to?
    Mr. Harris. Well, again, it would not have happened in our 
area. We saw the power change, because the frequency dropped, 
because there was not enough generation to serve load, and we 
were asking questions about who was not playing by the rules. 
That is how it came about.
    Chairman Lieberman. OK.
    Mr. Harris. Two things that I think are problematic and 
symptomatic that this Committee could certainly look into are, 
first, the fact that electricity does get consumed the instant 
it is produced. It does not say this is only wholesale. It does 
not say it is only retail. It does not say it is just in this 
State. It travels at the speed of light. So the solutions that 
FERC needs to have need to be ``end'' umbrella solutions where 
you look at the whole thing. As Sonny was saying, things are 
not pure--pure reliability or pure economics--they blend. So it 
is extremely important to have a holistic view of the problem.
    The second thing is in the way that institutions are 
getting approved. We have institutions now that have spot 
market authority. There are certain RTOs that do not administer 
spot markets, and that creates difficulties, as you saw. We 
need to come to the national energy market with common designs 
so that we can solve these problems much more quickly and 
robustly as we move forward.
    There are other things coming out--the gas industry 
recently proposed an energy industry standards board. Some of 
the things that they proposed are interesting. They recognize 
that there is a nexus between natural gas and electricity, and 
there must be ways to resolve those issues as we move to the 
future.
    So we are learning, and the process we have followed, we 
call ``little steps, little feet.'' It is very complicated. We 
take little steps. We learn, pilot, take the next step, learn, 
and increment our way to the future.
    Chairman Lieberman. Thanks.
    Mr. Kelly, do you have any examples of reliability problems 
on the grid that might help illustrate the problem that we are 
trying to solve?
    Mr. Kelly. There are many, but let me give you two--one, 
illustrating difficulties with incentives to build generation, 
and one with difficulties in incentives to build transmission.
    You were asking Mr. Popowsky about California earlier. One 
thing that is rarely mentioned that I think is very important 
is that the West Coast is heavily dependent on hydro power. You 
have the Cascade Mountains down through Washington and Oregon, 
and the Sierra Nevadas through California; and starting around 
the time of World War I, they started developing the hydro 
resources there heavily. I think California is about 30 percent 
dependent on hydro. They had unusually heavy rainfalls in 1998 
and 1999, that created a surplus of electric energy in the 
West, which created a disincentive for people to come in and 
build generation right away. And then, they had 2 years of 
drought.
    It is my personal belief that with or without deregulation 
in California, the West would have been stressed over the last 
2 years. With the old world of regulation, however, there were 
reserve margin requirements, as Mr. Harris has talked about. 
The California market design chose not to have such a 
requirement, at least of the old sort. It was not built into 
their system as it is built into the East Coast systems.
    The FERC asked the California ISO and the California 
parties last November to consider having such a requirement. It 
is my personal belief that a reserve requirement of some sort 
is needed to incent generation construction in a market 
environment and to prevent the cyclical boom and bust of 
inadequate and surplus generation that can cause price swings.
    Let me turn to a transmission story. We are seeing a lot of 
gas-fired generation being sited along the Gulf Coast right now 
in Mississippi, Louisiana, and Texas, probably much more than 
can be consumed in the area. Many of those generators, I am 
told, intend to sell up in the Upper Midwest, Chicago, and 
States to the east and west of that. There really is just not 
enough transmission capacity to move the power up there, and it 
is not being built, in part because many of the traditional 
utilities that own generation and transmission, I think, see 
themselves getting out of the transmission business--they would 
rather put their money into generation--but in part because 
there are old, antiquated grid rules that make things 
difficult.
    Just for example, somebody who wants to move power from, 
say, Louisiana up to Chicago is likely to look at a path going 
through Tennessee and find that there is no capacity available. 
So it will look for an alternate path and find one that exists 
on paper that goes up through Arkansas and Missouri and gets 
into Illinois through that route, and it will reserve that 
path. But unfortunately, the electrons still flow through 
Tennessee, tending to overload the grid in Tennessee.
    You might say, well, the solution is for the utilities in 
and around Tennessee, primarily TVA, to build more 
transmission. The trouble is they do not have a transmission 
customer. The utilities that have the customers are the 
utilities in the Arkansas-Missouri area.
    So those are two examples, Senator.
    Chairman Lieberman. Those are very interesting examples. I 
don't want to break the trend here, but it leads me to ask for 
the record for those who are watching, just to help us 
understand--in the normal course, who decides whether 
additional transmission capacity will be built? Is that totally 
a market judgment where somebody has to come along and see an 
opportunity and decide to build--because that is a fascinating 
example. Plants are being built in Louisiana, more generation 
than the region needs, big markets up North, and how do you get 
the electricity there?
    Mr. Kelly. In the old world, it was the individual utility 
that was building transmission primarily to distribute its own 
power around its own area, and it built some interconnection 
with its neighbors for reliability purposes.
    In the new world that I have just described, I do not think 
that model will work. You need a large regional organization 
that encompasses all the utilities along all the flow paths 
from Mississippi to Chicago to decide when and where 
transmission should be built to meet the aggregate needs of the 
region. Hence the RTO.
    Chairman Lieberman. OK. So the vision that FERC has of the 
RTOs is that the RTOs would play that role.
    Mr. Kelly. Yes.
    Chairman Lieberman. And how would they do it? Would they 
actually do the building of the transmission lines themselves?
    Mr. Kelly. They would certainly do the planning and come 
out with a plan that meets the needs of a large region and have 
some role in either directing or carrying out the building.
    In our rules, we allowed some flexibility to how an RTO 
would do that, because there are different flavors of RTOs. 
One, for example, might be a pure transmission company that 
would build and own it itself. But in another region, you might 
have utilities that are owned by government. TVA is one 
example, and the cooperative utilities in Missouri, for 
example, who feel that they cannot turn their transmission 
over, either by law or custom, to another entity. There could 
be protocols where those utilities could build transmission in 
response to a plan by the RTO and a compensation scheme devised 
by the RTO and subject to FERC approval.
    Chairman Lieberman. Mr. Cook, does NERC play a role, the 
reliability councils, in trying to make sure that there is 
enough transmission capacity to handle the electricity that 
wants to move?
    Mr. Cook. Not in actually building the systems. NERC does 
do an assessment on a regular basis of the generation adequacy 
and transmission adequacy so that information is available 
about where the problem spots are and the kind of things that 
need to be taken on.
    Chairman Lieberman. Mr. Harris, what about PJM; what are 
you doing with regard to the need for new transmission liens?
    Mr. Harris. As I mentioned, we do have a regional planning 
process which is independently administered. We believe that 
the person who is doing the planning should not own the 
transmission; it should be those who are in the transmission 
business.
    We look at things regionally and ask what is the least-cost 
solution to ensure that generation will meet load over all five 
States. That is why we have approved and now have $700 million 
worth of transmission under construction.
    Chairman Lieberman. Who is doing that?
    Mr. Harris. My office is doing that.
    Chairman Lieberman. I mean, who is actually building the 
lines?
    Mr. Harris. Each individual utility is building the lines 
that go through their particular territories.
    Chairman Lieberman. And how did you get to that point? In 
other words, you saw the need, and you planned, but how did you 
make sure they would go ahead and build the lines that were 
needed?
    Mr. Harris. I think it was the maturity and the development 
of our marketplace. The companies got together and said this is 
going to be the reality of the future, and if we have a neutral 
and independently derived plan from somebody with no financial 
interest in the outcome, we will obligate ourselves to build 
and construct in accordance with that plan. That is what they 
agreed to back in 1996, and that is what we are following 
today.
    Chairman Lieberman. In the new deregulated market, are 
those generating companies, or what I used to call the 
utilities that are actually selling to the customers, who are 
building the lines?
    Mr. Harris. They are the utilities. In our market, someone 
could come in in a merchant capability if they so desired and 
do it if they wanted to; they are not precluded.
    The intriguing question that Mr. Kelly raised does bring up 
an interesting point as to how you get the broad interregional 
needs. With RTOs that have the planning functions, the key is 
making information available to those who have a commercial 
interest and can achieve an appropriate economic solution. In 
many instances, transmission is competing with generation to 
come up with the same solution. The problem they all have is 
how do I get the information so that I can make an informed 
decision.
    Chairman Lieberman. Mr. Popowsky, let me come back to the 
earlier question about whether you had in your work, either in 
Pennsylvania or information from your colleagues, illustrations 
of what the problem is with the grid now as a result of 
deregulation.
    Mr. Popowsky. Again, in our area, we have not seen the kind 
of reliability problems arising as a result of market failure. 
I do think, however, that we have seen some instances where it 
would have been a lot better if we had had more and different 
generating companies on the system.
    For example, the market for capacity--as I said, capacity 
is very important in PJM to make sure we have enough available. 
On the other hand, it is not a very liquid market, and if we 
look at the prices this past winter, they went from zero to 
$177 a kilowatt-day and stayed at $177 for 2 months. And two 
summers ago when we had a heat wave, the energy price actually 
went up as high as $900, which is really unprecedented and, 
fortunately, I do not think has happened again.
    But as I said, in PJM, we are making strides so that when 
things like that happen, the PJM Market Monitoring Unit and the 
PJM board can look at those things and either try to reach a 
resolution itself or come to the FERC with resolutions, as they 
have done over the last few months, to try to correct these 
remaining market flaws.
    If I could just mention one other thing about the Cinergy 
example, as Mr. Harris indicated, it is not a question of what 
PJM would have done at that point if that happened; it is that 
if you have a truly independent system operator who is 
operating the system, that will not happen. And my recollection 
is that when it did happen, I think the NERC board and the 
regional council were able to basically send a nasty letter 
saying ``Do not do that again.'' That is why we need the 
legislation so that FERC can follow up on that nasty letter 
with a little more authority.
    Chairman Lieberman. ``Strong action to follow.''
    Mr. Popowsky. Yes.
    Chairman Lieberman. Just to summarize what you have said, 
as I recall in the statements you submitted, Mr. Kelly and Mr. 
Cook, you both indicated that the number of violations of 
reliability rules are increasing in the deregulated market 
nationally, and I assume nobody on the panel would disagree 
with that.
    Mr. Cook, did you want to add something?
    Mr. Cook. Just to reaffirm that statement, that we are 
seeing more of that as the system is being stressed more; yes.
    Chairman Lieberman. Let us talk now about what to do about 
it. As I listened to the first two witnesses, Mr. Cook and Mr. 
Harris, I thought that I heard a difference of approach, and 
please correct me if I am wrong. I thought, Mr. Cook, that you 
were talking about the desirable answer here being to establish 
independent authority through NERC, through the North American 
Electric Reliability Council, with some oversight from the 
Federal Energy Regulatory Commission.
    But I thought, Mr. Harris, that you were focusing more on 
having FERC do this themselves, without a separate, independent 
group overseeing. Did I hear it correctly, and if so, can I 
invite the two of you not to get into a crossfire here, but to 
elucidate your points of view.
    Mr. Cook. The first point is that the panel report that you 
quoted from in your opening statement--NERC had an independent 
panel of experts come in about the same time to look at how 
ought we be treating reliability as we go forward. Both of 
those groups came to two conclusions. One was that we needed to 
have the rules be mandatory and enforceable. Then the question 
is what is the best way to accomplish that? Both the Secretary 
of Energy's panel that you quoted from and NERC's own panel of 
experts came to the conclusion that the best way to do that was 
to use an industry self-regulatory organization modeled after 
the SROs that are presently in operation in the securities 
industry. That is a way to have the industry expertise brought 
together and have government oversight there to make sure the 
process is fair and open. It is also a way to deal with the 
international character of the grid.
    As Mr. Harris said, the interconnection is one big machine. 
The map that I attached to my testimony indicates the scope of 
that machine, including the provinces in Canada as well. It is 
necessary for that machine to operate under a single common set 
of rules. If FERC was to set the rules for that, in effect they 
would be dictating what the rules would be in Canada as well. 
Having the international organization set those rules, 
Canadians participate now extensively in NERC activities, and 
that would carry forward into this new organization. That is a 
way to deal with that international issue as well.
    Chairman Lieberman. I was going to ask you if there is a 
model existing for what you propose, and from what you are 
saying, I gather that it is in securities regulation.
    Mr. Cook. In the securities regulation area, where you have 
the stock exchange and the NASD take on the role of setting 
rules for their marketplaces and how the broker-dealers are to 
be handled, under oversight by the SEC. The exchanges develop 
their rules, they are filed with SEC, and that gives them the 
legal authority to enforce them. SEC has independent authority 
to carry out its own enforcement activities if it sees a need 
to do that.
    Those features are really built into the legislation that 
is before you now. It is the same model that we have used.
    Chairman Lieberman. Mr. Harris, what is wrong with that?
    Mr. Harris. What we have learned over 4 years of looking at 
how do you get to competitive marketplaces and ensure you have 
the reliability necessary is that it is a learning curve. I 
also served on the NERC board of trustees, and I am the 
regional manager of the Mid-Atlantic Council, so I am very 
close to these issues and the genesis and the development of 
them.
    But we have made over 110 changes to our rules since we 
started by incrementally learning and growing. What we are 
seeing now in this industry is that we really need to deal with 
the realities. I think you said it very well--we have to 
address all the needs. There are environmental needs, there are 
State needs, there are local needs. And how we develop those is 
going to be extremely important to ensure that we do not have 
any more huge unintended consequences and missteps.
    So as we look at what is necessary to make sure those 
things happen, it should definitely be this Committee's 
oversight of the Federal Energy Regulatory Commission to ensure 
that the total holistic solutions are met, and met reliably. 
FERC has to have oversight.
    We are also finding the convergence of industries. Gas is 
important to what happens in electricity, as you have heard 
today. We were somewhat intrigued by the gas industry's 
proposal to solve this problem with an energy industry 
standards board where the current NERC would have a meaningful 
role in that process. This needs to have more thought, and it 
needs to be looked through.
    So our suggestion is that it needs to have FERC oversight, 
and the simplest way to do it would be to have the Federal 
Energy Regulatory Commission determine what is a necessary 
reliability organization and have the Federal Energy Regulatory 
Commission determine the scope and extent of that organization. 
Then we can get into the details without bothering the 
Committee. But I think this Committee should ensure that the 
Federal Energy Regulatory Commission puts forth some 
organization that allows that to take place, and we should 
learn from our experiences as we grow.
    Chairman Lieberman. Interesting. So if I am hearing you 
correctly, you are saying that the Federal Energy Regulatory 
Commission ought to make this decision, and not to presume that 
NERC is going to play that role, but obviously, that would be 
one of the options that FERC would consider.
    Mr. Harris. Yes, sir, that is correct.
    Chairman Lieberman. Mr. Cook.
    Mr. Cook. I was just going to say that under the 
legislation, the Federal Energy Regulatory Commission would be 
making that decision. That is, FERC would make the decision on 
what organization is going to carry forward once that 
legislation passes. The organization would submit a proposal to 
FERC saying ``We propose to take on that function and here is 
how we propose to meet it, and here is what we would do.'' So 
that feature really is built into the legislation.
    Chairman Lieberman. Mr. Kelly, what is your reaction on the 
FERC to this question of how to best organize a legislative 
response?
    Mr. Kelly. In terms of the differences that Messrs. Harris 
and Cook have expressed, if there are real differences, I do 
not see them as 180 degrees apart; to me, they are 5 or 10 
degrees apart. Mr. Harris wants to put a greater emphasis on 
the coming RTOs than he perceives NERC is placing. NERC has 
drafted a bill that puts emphasis on NERC and regional 
councils.
    In my personal view, when we get right-sized RTOs and 
right-sized regional councils, the councils will be coincident 
with the RTOs, and most of the differences that they may think 
they have will disappear.
    Chairman Lieberman. Mr. Popowsky.
    Mr. Popowsky. I would agree, and I think that is what the 
legislation is intended to do. There is a discussion of what 
the role of the States is through a savings clause. There is a 
discussion of coordination with Regional Transmission 
Organizations.
    I think, though, the bottom line is that both of the final 
decisions should come down to FERC. But that does not mean that 
FERC staff have to be sitting there, trying to develop 
reliability standards. That is better done by the new NERC or 
NAERO group, I think. Even today, they have a tremendous staff 
who focus on reliability. That is their area of expertise, and 
they should be working with the RTOs, coordinating their 
activities, and then, ultimately, it should be up to FERC to 
make those tough calls as to how much to emphasize reliability 
versus economics and how to reconcile those.
    Chairman Lieberman. Do any of you want to add anything 
about the legislation that is before us? We have both the 
Murkowski and the Bingaman proposals.
    Mr. Cook. On the reliability piece, Mr. Chairman, those 
bills are the same.
    Chairman Lieberman. Right. So that, basically, your request 
would be to get one of them adopted, but certainly that part of 
them adopted, and there is no real difference between them on 
reliability.
    Mr. Cook. That is correct.
    Chairman Lieberman. Mr. Popowsky, the National Association 
of State Utility Consumer Advocates which you represent here 
today filed comments with the Department of Energy, as I 
believe you know, that argue quite forcefully that FERC needs 
to act on reliability whether or not Congress passes additional 
legislation, and also argue that FERC has the authority to do 
so.
    I wonder if you are in a position to talk a little bit more 
about that now and if so, prior to the legislation, since we 
know that is hard to predict around here, what would you like 
to see FERC do?
    Mr. Popowsky. In light of what has happened over the last 
several months starting with the realignment--in other words, 
in February 2001, NERC did turn over its trusteeship to the new 
independent board of trustees. In addition, they began to 
establish contractual enforcement activities.
    Our first preference is certainly to pass legislation. If 
legislation is not passed, then FERC can certainly go back and 
try to eke out whatever authority it does have to address 
reliability matters.
    I personally think that is by far a second-best or much 
worse solution to giving FERC the actual authority to review 
reliability rules that would apply to all actors in the market 
and not just those who are under FERC's jurisdiction already.
    So that would still be by far the lower priority, and as I 
look at it, a better use of FERC's resources now would be to 
really get the RTOs in place, because the RTOs also have a 
reliability role, and to make sure that we have a national set, 
a complete set of RTOs that also have reliability authority, 
and that, clearly, the FERC has the ability to do. That would 
certainly be my preference at this point.
    Chairman Lieberman. You kind of anticipated my next 
question. Mr. Kelly, one of the points you made in your 
statement is that FERC does not have jurisdiction over a number 
of the utilities that control parts of the transmission grid, 
such as Federal power administrations or municipally owned 
utilities.
    I was interested in the fact that the recent order that 
FERC set regarding the Western power markets includes 
conditions on every utility that sells into the federally-
regulated transmission system out West, including the Federal 
power administrations and the municipally owned generators. So 
I wonder, prior to the legislation, if it is possible for FERC 
to act on reliability concerns throughout the system, including 
both the Federal and municipal parts of the system.
    Mr. Kelly. I suppose it would be possible, Senator, with a 
great stretch on our authority, but there are difficulties. The 
California situation, I think, caused the Commission to desire 
to act quickly and forcefully and to put a solution in place, 
by interpreting its jurisdiction just about as broadly as it 
could, probably more broadly than it would going into a new 
area.
    There is a real question, I think, if you are building 
reliability for the future--such an important topic that 
affects all 50 States and our neighbors in Canada and portions 
of Mexico--if you would want to build such an important 
enterprise on what might be an untested legal foundation.
    In addition, I might add, we were imposing conditions on 
generators who were using the transmission system that was 
jurisdictional to us, and imposing those generation pricing 
conditions as a condition of using the grid that was 
jurisdictional to us--I am not sure we could quite use the same 
rationale to impose conditions on transmission systems that 
were not jurisdictional to us. And one-third of the 
transmission in the United States is not FERC jurisdictional.
    Chairman Lieberman. Say the last sentence again, please.
    Mr. Kelly. One-third of the transmission in the United 
States is not FERC jurisdictional. When you look at TVA, 
Bonneville, the Western Area Power Administration, and add in 
the State-owned systems like the New York Power Authority, the 
whole State of Nebraska, which has publicly-owned transmission 
and utility systems, and all the major municipalities, and then 
add in the large cooperative utilities that are financed by the 
rural utility service and hence, when so financed, are not 
subject to FERC jurisdiction, it is fully one-third of the 
transmission lines.
    Chairman Lieberman. That is interesting.
    Does everyone on the panel agree that one of the most 
important parts of legislation would be to make sure that there 
would be one set of standards and one enforcement mechanism 
since, if there is anything that I have learned from this 
hearing, it is that everything is interconnected. Do you agree?
    Mr. Cook. Yes, sir. The letter that I attached to the 
testimony that we sent to the members of the Senate Energy and 
Natural Resources Committee included a long list of folks who 
are supporting the legislation, and on that list are the coops, 
the public power people, folks that, normally, you would not 
think would be suggesting that jurisdiction be extended over 
their members. But for purposes of the reliability bill, they 
have all signed on, if you will, and are supporting that 
effort.
    Chairman Lieberman. Are there any other responses? Mr. 
Kelly.
    Mr. Kelly. Well, I would agree, maybe adding a footnote 
that NERC's rules themselves do recognize there may be regional 
differences; for example, some of the rules as applied in a 
hydro-dependent region might be different from the rules in a 
wholly coal-fired region.
    So NERC has a standard rule, but the rule itself allows for 
variation. So with that footnote, I would agree with the 
statement.
    Chairman Lieberman. Mr. Harris.
    Mr. Harris. One additional footnote is that we just cannot 
ignore the physics. It is consumed the instant it is produced; 
it is a speed-of-light product; it does not know State 
boundaries; it is the consumer from the generating plant and 
the fuel behind it. So we cannot just carve out the wholesale 
business from the retail business. You cannot just carve out 
the States. You cannot carve out the environmental. It is a 
separate problem.
    The Federal Energy Regulatory Commission needs to have 
holistic authority to ensure that this thing will work together 
as a single, synchronized motor.
    Chairman Lieberman. It is really quite remarkable, and I do 
not know that I fully understand it--one of you referred to it 
before--about the example of the Louisiana utility trying to 
get its power to Chicago. But in a regulated market where 
utilities, conceptually, should be able to buy from generators 
anywhere on the national grid--at one point, I remember having 
a conversation where it was suggested that customers actually 
might--that is, business customers or even residential, 
ideally--would be able to choose where they wanted their power 
to come from based on a competitive model. The conceptual 
difficulty is in visualizing how this happens. It is one thing, 
as I said to my staff the other day, for me to understand that 
if I want to buy shirts from a particular mail order house, I 
have a series of choices to make, and then I know that they are 
going to find their way, either by airline or by truck, to 
Federal Express or UPS or whatever, to my house. But how does 
one envision how those units of electricity get instantaneously 
from a generator that may be halfway around the country to my 
utility in Connecticut, let alone to me?
    What I have been told is that they do not--is that right? 
In other words, somebody is adding to the pool, and what my 
utility is taking out is probably not part of that even though 
I am paying at a rate based on what that generator has added to 
the transmission grid.
    Mr. Harris. I appreciate your comment. That is the 
beautiful thing about moving to competitive electricity 
marketplaces. We now have over 100 different companies trading 
on the market in any given hour, from Florida, Texas, and 
Canada, all trading into the PJM marketplace.
    The Federal Energy Regulatory Commission has approved a 
pilot program this summer where we have economic incentives for 
individual customers to buy and make choices based on the spot 
price of electricity.
    Chairman Lieberman. Not utility companies--but customers.
    Mr. Harris. No, sir. Individual customers to make economic 
decisions based on that spot price. What we are seeing is the 
beautiful things about network information technology--the 
power and speed of processors, the broad bandwidth capabilities 
that will enable competitive enterprise to work down to the 
individual level. While it may be complex in administration, 
one of the things that we have found, again through these 
technologies, is that we can actually make the life of the 
customer more simple and more convenient through the use of 
these technologies.
    It is also something, I might add, that the Committee might 
want to ensure that the Federal Energy Regulatory Commission 
has, and that is the appropriate technology and tools to have 
oversight over this vast network of process. That can happen; 
they can understand what is going on in prices to see if it is 
an anomaly over a broad scope, and technology will enable that 
today.
    Chairman Lieberman. And the truth is that without 
technology, you could not do it; you could not monitor it. Too 
much is happening too quickly.
    Mr. Harris. That is correct. We can do things now that were 
impossible a year ago, and the technology keeps growing rapidly 
so that we can take this speed-of-light product and really 
simplify the life of the consumer and add value to the economy 
in these ways.
    Chairman Lieberman. Now that we are on this fascinating 
subject, just very briefly, how is the individual customer 
going to tap into the information that will allow him or her to 
decide where they will buy the electricity to their--are we 
talking about to their house, or to their office building, or--
--
    Mr. Harris. If the individual customer wanted to do that to 
their house, they could. Remember that we are developing our 
program ``little steps by little feet,'' so we have a pilot 
program that we are running that we call an ``economic 
program.'' It is interesting--we filed the program, and the 
Federal Energy Regulatory Commission approved it for this next 
season, and in that program, we negotiate a way where 
individuals, customers or small businesses, can see that spot 
price and then make decisions on whether they want to isolate 
to the grid, i.e., buy megawatts, or where you would actually 
pay them to come off the grid at their choice----
    Chairman Lieberman. And they see it on their personal 
computers, for instance?
    Mr. Harris. It is seen through some type of networking tool 
that would allow that information to be there. Again, this is a 
pilot program, but what it shows is the promise of the future.
    I think that one of the sad things about the California 
situation is that it masks the wonderful opportunities that we 
now have in a networked information economy, and somehow, we 
need to get back to that.
    Chairman Lieberman. Yes. Mr. Popowsky.
    Mr. Popowsky. In terms of residential consumers, I think 
most of the participants will be larger commercial and 
industrial customers, at least initially.
    Mr. Harris. Yes, we have some small commercial, but there 
is nothing that precludes a residential if they wanted to play.
    Mr. Popowsky. But there are other things that can be done. 
To get back to your first example, I think one of the positive 
developments in Pennsylvania is that consumers who wish to do 
so can buy green power, that is, power developed from renewable 
resources. Now, as you indicated, it is not that you can get 
the power all the way from the windmill, two States away, into 
your toaster oven; but by patronizing with that market or with 
that company, that company will put more of the wind power onto 
the grid. So it is not that you get those kilowatt hours, it is 
that you contribute.
    Chairman Lieberman. People feel good about it?
    Mr. Popowsky. We found in Pennsylvania that people are even 
willing to pay more, like they buy recycled paper goods at the 
supermarket. They are willing to pay more, and I believe they 
understand that they are not literally getting those kilowatt 
hours, but they are contributing to getting more of those 
kilowatt hours onto the grid.
    Chairman Lieberman. Very interesting and very exciting. I 
thank all of you.
    From the testimony that you have offered, I would conclude 
that dramatic changes have occurred, both in the markets, in 
the deregulation of electricity markets around the country, and 
of course in the increasing demand generally as our economy has 
grown, and as a result of the extraordinarily developments in 
technology, the grid as it exists now has reliability 
vulnerabilities to it and that the market and government and 
private groups have tried to react to those. But the general 
feeling I get from listening to you is that the current 
approach does not adequately fit the new reality of competitive 
markets and technology. Also, there seems to be general 
agreement by one path or another that the buck has to stop at 
FERC, that this is an area in which FERC has to receive new 
authority, that the ideal is if Congress were to clarify FERC's 
role here.
    There are details that still need to be resolved about how 
the actual organizational structure will be built and will 
operate, and it is not clear, as I hear from you, in the 
absence of legislation, although some would argue on one side 
or another, what steps FERC should take except to continue to 
pursue its vision of the RTOs.
    So I think some things are happening here. I think we do 
have a problem, and California is obviously the extreme example 
of it for a lot of reasons. But it is also clear that unless we 
act to improve the national electricity grid, consumers will 
not be able to achieve the maximum benefit from deregulation, 
and at worst, the lights will go off occasionally, or there 
will be unfair practices along the grid because there is 
inadequate monitoring and policing.
    So I think it is critically important that we act on this 
legislation on which there seems to be general agreement. And 
Members of this Committee will do our part to make sure that is 
so, and we will continue to monitor FERC's oversight of these 
matters.
    For me, it has been a very informative hearing. I will 
continue to be interested in it. As Senator Thompson said at 
the beginning, it is not quite as controversial or dramatic as 
the current crisis in California, yet this is all about 
prevention. This is all about taking the steps necessary to 
make sure that we do not have more Californias, more blackouts, 
and more pricing of electricity that is higher than it would be 
if we had a grid that was up to handling the generating 
capacity that will be coming on and to the opportunities that 
technology provides.
    We will leave the record of this hearing open for a week if 
any of you want to submit additional testimony or if any 
Members of the Committee who could not be here today want to 
submit questions for you. But in the meantime, I thank you all, 
not only for your testimony, but for what each of you is doing 
to assure the reliability of the national electricity grid.
    I thank you. The hearing is adjourned.
    [Whereupon, at 11:40 a.m., the Committee was adjourned.]
                            A P P E N D I X

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