    [House Hearing, 108 Congress]
    [From the U.S. Government Publishing Office]

                 CALIFORNIA ENERGY MARKETS: REFUNDS AND REFORM

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

                                    HEARING

                                   before the

                     SUBCOMMITTEE ON ENERGY POLICY, NATURAL
                        RESOURCES AND REGULATORY AFFAIRS

                                     of the

                                  COMMITTEE ON
                               GOVERNMENT REFORM

                            HOUSE OF REPRESENTATIVES

                          ONE HUNDRED EIGHTH CONGRESS

                                 FIRST SESSION

                                   __________

                                 APRIL 8, 2003

                                   __________

                               Serial No. 108-14

                                   __________

           Printed for the use of the Committee on Government Reform

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

                          U.S. GOVERNMENT PRINTING OFFICE
                                 WASHINGTON : 2003
    87-231 PDF

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                         COMMITTEE ON GOVERNMENT REFORM

                         TOM DAVIS, Virginia, Chairman
    DAN BURTON, Indiana                  HENRY A. WAXMAN, California
    CHRISTOPHER SHAYS, Connecticut       TOM LANTOS, California
    ILEANA ROS-LEHTINEN, Florida         MAJOR R. OWENS, New York
    JOHN M. McHUGH, New York             EDOLPHUS TOWNS, New York
    JOHN L. MICA, Florida                PAUL E. KANJORSKI, Pennsylvania
    MARK E. SOUDER, Indiana              CAROLYN B. MALONEY, New York
    STEVEN C. LaTOURETTE, Ohio           ELIJAH E. CUMMINGS, Maryland
    DOUG OSE, California                 DENNIS J. KUCINICH, Ohio
    RON LEWIS, Kentucky                  DANNY K. DAVIS, Illinois
    JO ANN DAVIS, Virginia               JOHN F. TIERNEY, Massachusetts
    TODD RUSSELL PLATTS, Pennsylvania    WM. LACY CLAY, Missouri
    CHRIS CANNON, Utah                   DIANE E. WATSON, California
    ADAM H. PUTNAM, Florida              STEPHEN F. LYNCH, Massachusetts
    EDWARD L. SCHROCK, Virginia          CHRIS VAN HOLLEN, Maryland
    JOHN J. DUNCAN, Jr., Tennessee       LINDA T. SANCHEZ, California
    JOHN SULLIVAN, Oklahoma              C.A. ``DUTCH'' RUPPERSBERGER,
    NATHAN DEAL, Georgia                     Maryland
    CANDICE S. MILLER, Michigan          ELEANOR HOLMES NORTON, District of
    TIM MURPHY, Pennsylvania                 Columbia
    MICHAEL R. TURNER, Ohio              JIM COOPER, Tennessee
    JOHN R. CARTER, Texas                            ------
    WILLIAM J. JANKLOW, South Dakota     BERNARD SANDERS, Vermont
    MARSHA BLACKBURN, Tennessee              (Independent)

                           Peter Sirh, Staff Director
                     Melissa Wojciak, Deputy Staff Director
                  Randy Kaplan, Senior Counsel/Parliamentarian
                           Teresa Austin, Chief Clerk
                  Philip M. Schiliro, Minority Staff Director

    Subcommittee on Energy Policy, Natural Resources and Regulatory Affairs

                         DOUG OSE, California, Chairman
    WILLIAM J. JANKLOW, South Dakota     JOHN F. TIERNEY, Massachusetts
    CHRISTOPHER SHAYS, Connecticut       TOM LANTOS, California
    JOHN M. McHUGH, New York             PAUL E. KANJORSKI, Pennsylvania
    CHRIS CANNON, Utah                   DENNIS J. KUCINICH, Ohio
    JOHN SULLIVAN, Oklahoma              CHRIS VAN HOLLEN, Maryland
    NATHAN DEAL, Georgia                 JIM COOPER, Tennessee
    CANDICE S. MILLER, Michigan

                                   Ex Officio

    TOM DAVIS, Virginia                  HENRY A. WAXMAN, California
                           Dan Skopec, Staff Director
                              Melanie Tory, Clerk
                       Paul Weinberger, Minority Counsel

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on April 8, 2003....................................     1
    Statement of:
        Winter, Terry, president and chief executive officer,
          California Independent System Operator; Karen Tomcala, vice
          president, regulatory relations, Pacific Gas and Electric
          Co.; Gary Ackerman, executive director, Western Power
          Trading Forum; Jan Smutny-Jones, executive director,
          California Independent Energy Producers; and George Fraser,
          general manager, Northern California Power Agency..........    50
        Wood, Patrick, III, chairman, Federal Energy Regulatory
          Commission.................................................     6
    Letters, statements, etc., submitted for the record by:
        Ackerman, Gary, executive director, Western Power Trading
          Forum, prepared statement of...............................    76
        Fraser, George, general manager, Northern California Power
          Agency, prepared statement of..............................    90
        Ose, Hon. Doug, a Representative in Congress from the State
          of California, prepared statement of.......................     4
        Smutny-Jones, Jan, executive director, California Independent
          Energy Producers, prepared statement of....................    84
        Tomcala, Karen, vice president, regulatory relations, Pacific
          Gas and Electric Co., prepared statement of................    69
        Waxman, Hon. Henry A., a Representative in Congress from the
          State of California, prepared statement of.................    31
        Winter, Terry, president and chief executive officer,
          California Independent System Operator:
            Information concerning a review on LMP...................    51
            Prepared statement of....................................    58
        Wood, Patrick, III, chairman, Federal Energy Regulatory
          Commission, prepared statement of..........................     9

                 CALIFORNIA ENERGY MARKETS: REFUNDS AND REFORM

                                  ----------

                             TUESDAY, APRIL 8, 2003

                      House of Representatives,
      Subcommittee on Energy Policy, Natural Resources
                                and Regulatory Affairs,
                                Committee on Government Reform,
                                                        Washington, DC.
        The committee met, pursuant to notice, at 2 p.m., in room
    2157, Rayburn House Office Building, Hon. Doug Ose (chairman of
    the committee) presiding.
        Present: Representatives Ose, Sullivan, and Van Hollen.
        Staff present: Dan Skopec, staff director; Barbara Kahlow,
    deputy staff director; Melanie Tory, clerk; Yier Shi, press
    secretary; Paul Weinberger, minority counsel; Earley Green,
    minority chief clerk; and Christopher Davis; minority staff
    assistant.
        Mr. Ose. Good afternoon. Welcome to today's hearing of the
    Subcommittee of Energy Policy, Natural Resources and Regulatory
    Affairs. Today we are going to look at the California
    electricity markets' refunds and reform.
        We are going to discus two items. First, the actions taken
    by FERC on March 26th of this year regarding the California
    energy crisis, and second, the progress California has made in
    reforming its electricity market structure.
        As many of you know, on March 26th, FERC issued a report
    following its investigation of western energy markets. They
    concluded that an imbalance of supply and demand, coupled with
    a flawed market design, created conditions that led to market
    manipulation in California and other western markets.
    Consequently, FERC issued several show cause orders that will
    potentially result in prohibiting violating companies from
    selling electric power and natural gas at market-based rates.
        I support FERC's effort to punish those who have been found
    to manipulate the market. This sends a strong message to future
    would-be violators that if you break the rules, you not only
    will have to refund the money, but you also will not be able to
    participate in energy markets in the future.
        FERC also increased the amount of refunds due to California
    by taking into account the manipulation that occurred in
    natural gas markets. The Commission plans to continue to
    investigate specific acts of market manipulation and make a
    final ruling on refunds by the end of the summer. I encourage
    FERC to vigorously and promptly complete its investigation.
    California and its citizens deserve to get back every dollar
    that was overcharged during the energy crisis. It's been almost
    3 years since the crisis erupted. It's time to refund the
    overcharges so Californians can get the relief they deserve.
        The second purpose of this hearing is to discuss efforts to
    reform California's electricity market. While politicians from
    all corners can argue about who owes what to whom, we must not
    lose focus of one important point; that is, a leading cause of
    the energy crisis of 2000 and 2001 was a fundamental lack of
    electricity supply and a seriously flawed market design. Almost
    3 years later, California has failed to fix this problem and
    its electricity market still needs reformation.
        In February 2002, this subcommittee held a hearing to
    discuss the leading market reform proposal known as Market
    Design 2002. At that hearing, I made the following statement:
    ``In reality, California is not out of the woods yet, not by a
    long shot. As the witnesses at today's hearing will tell you,
    the fundamental factors that exacerbated the energy crisis are
    still with us today. California still lacks adequate energy
    supply. Our transmission system is old and overburdened, and
    most importantly, the structure of the electricity market is
    dysfunctional. The market suffers from inefficiencies in terms
    of pricing, transparency, transmission and settlement
    policies.''
        To my great regret, this statement is almost as true today
    as it was then. Since last year's hearing, the California
    Independent System Operator has introduced Market Design 2002,
    which we are hereafter going to refer to as MD02. It's CAISO's
    comprehensive proposal to reform California's electricity
    market. I applaud the efforts of CAISO to recognize the market
    flaws in the current system and attempt to solve them. However,
    I remain concerned that the reform process is moving too
    slowly. Time delayed is money lost for Californians. Already,
    several implementation deadlines have been pushed back.
        I am particularly concerned about the delay in the resource
    adequacy standards that are central to any market reform. One
    of the key regulatory failures of California's restructuring
    was the California Public Utility Commission's refusal to
    provide utilities with the ability to enter long-term contracts
    under safe harbor provisions. Resource adequacy would return
    the obligation to serve customers to the utilities by requiring
    utilities to produce adequate levels of power to serve its
    customers, plus a certain reserve amount. Utilities could meet
    these standards by signing long-term contracts with generators,
    thereby providing financial certainty and incentive to build
    more energy supply in California.
        However, this key component has been pushed back to the
    final phase of MD02. The CAISO is currently awaiting a
    rulemaking by the CPUC before it proceeds. We have been waiting
    for that rulemaking since April 2002, when this subject first
    came up.
        Given the abysmal history of the CPUC regarding long-term
    contracts, I am seriously concerned about the fate of this
    particular matter. In today's hearing, I have asked the
    witnesses to discuss the progress of MD02. I would like to
    direct the witnesses' attention to a January 2003 report
    produced by the Public Policy Institute of California entitled
    the California Energy Crisis: Causes and Public Options. This
    report does an excellent job of enunciating the need for
    electricity market reform. The report states that any market
    reform must meet the following goals: one, lower prices; two,
    system reliability; three, efficient use of resources; four,
    administrative feasibility; and five, environmental enhancement
    and protection.
        I wholeheartedly agree with these goals and ask the
    witnesses to keep them in mind today as we discuss the details
    of MD02. I intend for this to be an opportunity to discuss the
    details of reform and debate possible alternatives. But this
    process must go forward. It must. California cannot continue to
    live in an energy purgatory where we neither know right from
    wrong, up from down, or no power from power. The State's
    economy remains soft and today energy prices are low.
        But this will not continue forever. This is an opportunity
    we need to seize. We need to keep in mind that it takes years
    to propose, site and build a power plant. Up and down the
    State, power plant construction is being delayed and companies
    are scrapping plans to build more generation. Energy companies
    cite political and regulatory uncertainty as a principal
    obstacle to new energy supply. Wall Street refuses to invest in
    such an unstable environment.
        Yet experts predict that California will experience
    shortages again in a few short years. It is therefore essential
    that we get on with the reform process in order to encourage
    investments in energy generation and transmission. A stable
    marketplace with clear, rational rules is the only way to
    supply the lowest cost, most environmentally friendly energy
    that Californians deserve. We simply cannot afford to wait any
    longer.
        I want to welcome our witnesses today. They include Patrick
    Wood III, the chairman of the Federal Energy Regulatory
    Commission; Terry Winter, the president and CEO of California
    Independent System Operator; Karen Tomcala, the vice president
    of Regulatory Relations for PG&E; Gary Ackerman, the executive
    director for the Western Power Trading Forum; Jan Smutny-Jones,
    the executive director of the Independent Energy Producers; and
    George Fraser, a personal friend of mine who is general manager
    of Northern California Power Agency.
        [The prepared statement of Hon. Doug Ose follows:]
        [GRAPHIC] [TIFF OMITTED] T7231.001

        [GRAPHIC] [TIFF OMITTED] T7231.002

        Mr. Ose. I'd like to recognize the gentleman from Oklahoma
    for the purpose of an opening statement.
        Mr. Sullivan. Thank you, Chairman Ose, for holding this
    hearing. It is important that the causes behind the California
    energy crisis be considered. Coming from a State with an
    interest in energy markets, it is important to me that the
    truth comes out about the situation. Finger pointing by both
    sides does the consumer no good in the end.
        One of the recurring issues in the debate of California's
    energy crisis is whether or not generators physically withheld
    power in order to drive up prices. California has repeatedly
    claimed that generators did withhold power. In one case, where
    FERC staff has reviewed California's withholding allegations
    and found them to be overwhelming false and inaccurate, on
    September 17, 2002, the California Public Utilities Commission
    issued a report claiming that generators had withheld power on
    the 6-days when California suffered blackouts and brownouts.
    They claimed that had generators made this power available,
    blackouts could have been averted. The FERC staff analysis
    refuted the CPUC's allegations.
        I hope that FERC will look carefully to make sure that
    similar claims now being made by California are not equally
    false. I look forward to hearing Mr. Wood's statement and hope
    that it will shed light on the current state of investigations.
    I yield back the balance of my time.
        Mr. Ose. I thank the gentleman.
        As many of you may realize, this committee is an
    investigative committee. We routinely swear in our witnesses.
    So Chairman Wood, if you'd rise, please, raise your right hand.
        [Witness sworn.]
        Mr. Ose. Let the record show that the witness answered in
    the affirmative.
        Once again, we welcome to our panel the distinguished
    chairman of the Federal Energy Regulatory Commission, Patrick
    Wood III. Chairman Wood, you are recognized for the purpose of
    a statement for 5 minutes.

        STATEMENT OF PATRICK WOOD III, CHAIRMAN, FEDERAL ENERGY
                         REGULATORY COMMISSION

        Mr. Wood. Thank you, Chairman Ose, Mr. Sullivan. I
    appreciate the opportunity.
        I can't help but be struck by the juxtaposition of the two
    items before us today, which are a look at what happened in the
    past and then a view toward the future, and the importance of
    making sure that those two items are connected. Certainly a
    large part of the time I've spent since I think I saw you last,
    Mr. Chairman, is really trying to bring to a close our
    investigation on the activities in the western markets.
        Shortly before I even joined the Commission, the Commission
    had reviewed the underlying fundamental supply shortfalls as an
    issue and looked at the market design in December 2000, the
    prior Commission. We have one commissioner with us today on our
    Commission that was there at the time. But analysis showed that
    those two parts of the problem were a significant aspect of
    what went wrong in California.
        What we did after I joined the Commission and we began to
    explore these issues further was, we recognized that there
    were, in fact, those two conditions of significant supply
    shortfalls and flawed market design implementation, that those
    did create an environment in which market manipulation could
    happen. And, in fact, over the last year, a significant part of
    our staff, with resources spent for outside consultants to
    assist us in this effort, reviewing tremendous amounts of
    market data, actually concluded that in fact there have been
    instances, in fact some cases, very notable instances of
    manipulations in the power and gas markets that took advantage
    of this supply and market rules failure.
        So our report came out last Wednesday. As a consequence of
    that report, the staff recommended that the Commission take
    action on 31 different items relating from alterations of how
    we calculate refunds in the ongoing California refund case to
    recommendations to pursue causes of action against certain
    market participants for violations of the rules to a number of
    prospective fixes to make sure that these issues never show up
    again in California or in any other State.
        So the Commission is currently involved in implementing all
    those recommendations. We might change a few of them based on
    feedback from parties who have provided some commentary on
    this, and also based on our own assessment. But our staff
    pursued this effort independently, provided this report back to
    the Commission late last month. Actually, for most of the
    month, we had the opportunity to review this and digest it.
        And, I do have to say, I have some reservations about the
    activities that are reported here. I think it's without
    question that some of the behavior of market participants that
    was analyzed, identified and I think fairly balanced throughout
    the staff report is the kind of behavior that ought to be, if
    it's not illegal now it ought to be. So we are taking actions
    to make sure that our rules reflect, on a going forward basis,
    the type of things that I would have hoped good common sense
    would have kept people from doing. But quite frankly, it wasn't
    in some cases written down that some of these issues were
    wrong. And, it makes it difficult to tell customers that we are
    trying to do justice when in fact we cannot reach to activities
    that we all acknowledge are wrong.
        Looking forward, I do remember our visit back in Sacramento
    at the hearing we had last year with a number of our same
    witnesses today, Mr. Chairman. And, I, like you, am concerned
    that while we've had a lot of discussion, we don't have the
    Market Design 2002 implemented. It's my hope that, even in
    2003, that we could get Market Design 2002 implemented. But I
    am concerned that even that time line may slip.
        It is critical to get these issues addressed so that these
    types of opportunities for manipulation and fraud do not ever
    make themselves profitable again, even in a stressed market,
    which California has had, and may again have in the future.
    Good rules can prevent excessive behavior from manifesting
    itself.
        So it's my hope that certainly from the discussions today
    and the activities that the market participants are pursuing,
    which I think have been reported on in the witnesses'
    testimony, we can make a lot of progress to ensure this never
    happens again. Thank you.
        [The prepared statement of Mr. Wood follows:]
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        Mr. Ose. Thank you, Chairman Wood.
        I am asking unanimous consent to enter into the record the
    statement of the ranking member of the full Committee, Mr.
    Waxman. Hearing no objection, that will be done.
        [The prepared statement of Hon. Henry A. Waxman follows:]
        [GRAPHIC] [TIFF OMITTED] T7231.024

        [GRAPHIC] [TIFF OMITTED] T7231.025

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        [GRAPHIC] [TIFF OMITTED] T7231.028

        Mr. Ose. We are going to go to questions now. As usual,
    Chairman Wood, you are exactly punctual in your 5 minutes, for
    which we are appreciative.
        I want to go through a particular concept here, and that is
    that FERC, has investigated the issue of pricing of natural gas
    and the five indices that were used to calculate it. And, on
    the basis of that investigation, has ordered refunds in two
    cases and asked for additional information I think in eight
    additional, as to the activities of eight additional companies.
        The question I have is, if we are able to determine
    manipulation post October 2, 2000 in the drivers of pricing for
    natural gas, would that manipulation spread to all participants
    rather than just be constrained in the two, and would that
    necessitate a far grander view of whether or not refunds are
    entitled?
        Mr. Wood. Pre October 2nd or post?
        Mr. Ose. Post October.
        Mr. Wood. Post October 2nd----
        Mr. Ose. We'll get to the pre-October question.
        Mr. Wood. I want to make sure, because there are two
    different approaches we take.
        From October 2nd forward, which is 60 days after the
    utility from San Diego filed a complaint saying that they
    wanted FERC to take action in the California ISO and PX markets
    to do price caps or some other approach to address the concerns
    that were raised. From October 2nd forward the Commission has
    really looked at, with the refund case, and that's what we kind
    of call generically the refund case, the $1.8 billion plus
    extra that will fall from last week's action. We looked at all
    providers and said, we are not going to allocate fault or
    whatever, but we are just going to reset the price at what it
    would have been had a competitive market worked as it was
    designed to work in California, what would that price be, and
    anything above that has basically got to be refunded.
        So whoever charged that, we are not looking at intent or
    asking them what they were doing that day. It's just kind of a
    de facto calculation, here's what the numbers are. So we don't,
    for that reason, we have not looked at individual players as to
    refunds, because in fact everybody that is over the threshold
    has given it back.
        Now, the items you referred to, there's a couple of baskets
    of things that fell out of last week's order. One of them was,
    there were I believe four companies that were electric and
    eight on the natural gas side that we went ahead last week and
    moved forward with proceedings to consider revoking their
    market-based rates based on some activities that are outlined
    in the report.
        There are different kinds of baskets. We are doing further
    work on three other large baskets of items. One is what we call
    the Enron gaming strategies, people that participated in those,
    some 30 some odd companies, 16 that had business relationships
    with Enron, that's a separate basket of orders, and then 9
    companies that may have engaged in economic withholding. This
    is pre October 2nd.
        If any of those things spilled over into post October 2,
    2000, then those would be actually available for additional
    refunds if we haven't already received them. But our remedial
    authority under the law, as it currently is, is focused on a
    time period 60 days after a complaint is filed. So that's where
    the October date comes from.
        And actually, because we do not have penalty authority yet,
    we can seek disgorgement of profits from certain transactions
    that violate the law or violate the tariff. So we are kind of
    in the middle of the stream with a number of these proceedings.
    But the ones you referred to are just part of the total.
        Mr. Ose. The question I am trying to get at is that you've
    made a determination as it relates to two cases that there was
    market manipulation. And, I can't remember the companies. I
    know we can get that in the record if you like.
        It would seem to me that if there is market manipulation
    practiced by these two companies, it has unavoidably spilled
    over into additional companies, whether innocently or
    otherwise, having their prices affected. I don't see how
    logically that can be avoided.
        Mr. Wood. Correct.
        Mr. Ose. If that's the case, the question of how much to
    refund is far greater. Now, in the report that FERC did, there
    is a reference to rules, or the protocols or the tariffs, I
    don't remember the exact word, but the rules that govern
    behavior in markets. There are provisions, in some cases vague,
    in some cases not, preventing gaming strategies of the like
    that you have found.
        If that is what you have found, pre October 2nd, does that
    give FERC the ability to go and seek refunds for that period of
    time prior to October 2nd?
        Mr. Wood. Yes, with a caveat. The hook that we've got to go
    back on, and the staff identified some tariff language that
    they think is the hook, we've got to say that you actually,
    you, company, were notified that this behavior was prohibited,
    or violated a rule. Then, we prove that they've done that. They
    don't have to excuse that, well, you know, I did it because the
    lights were going to go off otherwise, or what's a good
    mitigating excuse that certainly we would provide that
    opportunity to make that.
        And then, if those two things are met, if the law was clear
    and you violated it, then you get refunds for that. We are in
    the process now, because the parties did have the opportunity
    to file on March 20th, which was kind of close to the date of
    this meeting, their rebuttal to claims that were made by a
    number of the California parties and State agencies that a
    number of these violations had happened. We indicated at our
    March 26th meeting we want to look at the he said and the she
    said. So the overlap between the staff report and the parties'
    investigations that came to a climax in March, we are looking
    at that this month and anticipate for those issues that go
    backward to issue orders on those by the April 30th meeting
    that our Commission has scheduled.
        Mr. Ose. Now, you referenced in, if the gentleman will just
    yield a couple more minutes, you referenced in your testimony
    the ability to assess penalty and the lack of FERC authority to
    do that to date. In the last Congress, I put in a bill to
    provide FERC with authority to assess penalties from the date
    of filing, and I am advised, having put that same bill in again
    this year, that it's been rolled into the Energy Bill that
    should be on the floor later this week.
        Does FERC support being given the additional authority
    envisioned in that legislation?
        Mr. Wood. Absolutely. Yes. And we appreciate it. In
    addition to moving the date back to the date a complaint was
    filed, you also allowed the Commission, in your law from last
    year and the one that was put back in the hopper this year, to
    not only get disgorgement of profits, but actually assess
    penalties, in some cases up to, let me make sure I get it
    right, $25,000 per event. It was $500.
        Mr. Ose. $500?
        Mr. Wood. Per event.
        Mr. Ose. Right.
        Mr. Wood. And, it is over a broad, over the entire Federal
    Power Act electricity title that we live under. So those three
    things together, the refund date, the broadening to include the
    entire electricity title, and the elevation of the penalty
    amount does give the Commission a much stronger tool chest to
    use in overseeing markets.
        Mr. Ose. I appreciate the chairman's comments on that. My
    last question would be, if you found companies that have
    engaged in this behavior in violation of the terms of their
    certificate or violation of what you call tariffs, what I call
    rules, what the proposal has been is to deny them the ability
    to sell power or gas at market-based rates. It seems to me that
    such companies frankly ought to be put out of business, period.
    They ought to get the death penalty, if you will, as a clear
    and unequivocal message about this kind of behavior not being
    tolerated.
        Could you share with us why, if you would, you're only
    going halfway? My words, not yours.
        Mr. Wood. Well, we've got, I mean, the two tools we've got
    are taking away the privilege to do business at market-based
    rates. I think, I haven't actually given a lot of thought to
    can you just take them out of business altogether and revoke
    their license to even have cost-based rates. Can I get back to
    you on that one?
        Mr. Ose. Yes.
        Mr. Wood. We honestly have not looked at that. I think the
    perception in the outside world has been that the loss of
    market-based rates in a world that's dominated by markets is a
    significant penalty, and is one that we certainly have. Again,
    it's one of the two things that we have, get the profits back
    and yank your market-based rates. To have something on the
    intermediate scale, which the penalties would provide, is
    certainly something we welcome.
        Not all behavior is worthy of putting people out of
    business. Certainly errant employees, bad management, you know,
    if there is something rotten at the core, certainly that's a
    different issue. I think there are gradations, just as a judge
    in a criminal case gets to look at. There are gradations of
    punishment that a jurist ought to have. And, I'll have to think
    about that.
        Mr. Ose. Let me show you a flip side of that. The flip side
    of that is people in my district who process food, paying two
    or three or four times what they had budgeted or expected for
    electricity and having to shut down processing lines and lay
    people off. Or people in the business that use hot water
    basically can't buy the natural gas to heat the water that they
    need in their business. And, in effect, they are being shoved
    out of the position of being profitable into a position where
    they cannot survive. And, if someone is engaging in
    inappropriate behavior that creates that, it seems to me that
    maybe they ought to share the same fate. Just a different
    perspective.
        The gentleman from Oklahoma.
        Mr. Sullivan. Thank you, Mr. Chairman.
        Chairman Wood, I'd like to talk about a FERC staff report
    that has not gotten much attention. In 2002, the California
    Public Utility Commission alleged that generators had
    contributed to the blackouts experienced in California by
    deliberately keeping plants shut down rather than running them.
    If true, this would be extremely disturbing.
        Yet, as I understand it, your staff's investigation found,
    ``No evidence that any of the generators withheld any material
    amount of available power during the hours of the service
    interruptions.'' Is this correct?
        Mr. Wood. Yes, sir, it's correct. The staff did look at the
    days identified in the California PUC's report from last year.
    They looked at exactly the days of firm service interruptions,
    i.e., when there were blackouts in California due to inadequate
    supply. And, I will admit, it was difficult to kind of go
    through the, for our staff spent several months going through
    the data that the ISO had to actually look at what generators
    were available, what they had scheduled, what they had not
    scheduled, what was committed elsewise to some other customer.
    And, concluded that for 87 percent of the power, the megawatt
    hours, that in fact the firm service interruptions happened
    when the power was actually not available. It was legitimately
    not available through the ISO's records.
        Now, admittedly, the ISO does not keep records specifically
    for this point. So to give the CPUC, I guess the fair side of
    the analysis is, the records weren't just sitting there ready
    to be written up. It took a lot of digestion and analysis and
    that was really what our staff did at our direction to really
    get to the bottom of this. Because whatever the answers are,
    we've got to deal with them. If nothing happened and people
    should be exonerated, then that ought to be done. And, that's
    in fact what we did.
        If there is something going on, and again, we are looking
    at other hours today, we are looking at other hours than just
    these ones in this report to make sure in fact that this didn't
    happen in some other period. But in looking at the blackout
    periods, which were the crucial times when Mr. Winter and his
    colleagues at the ISO were scrambling around the whole west to
    keep the lights on, we did look at the claims here and chased
    them all the way down.
        Thirteen percent of the hours we are unable from the
    records to account for. But in total, they did not add up to
    the amount that would have prevented a blackout. So while we
    don't have a complete answer on the 13 percent, I think the
    takeaway is that the, while those megawatts may in fact have
    been withheld, they were such significantly small amounts that
    they would not have enabled the ISO to keep the lights on.
        So that's what our conclusions were on this report. And, as
    I mentioned, we are continuing to look throughout all the
    records. Some claims have come in as of last week about
    physical withholding, which is a really bad practice, if
    engaged in for the purpose of elevating market prices, and we
    will continue to chase those all the way down as we did these.
        Mr. Sullivan. Not only was there no evidence of
    withholding, the report goes on to conclude that the evidence
    actually refutes the CPUC's allegation that power was withheld.
    The report says, ``Approximately 87 percent of the power that
    the CPUC concluded was available power not generated was in
    fact available.'' Isn't this right?
        Mr. Wood. It was actually not available. Yes, sir.
        Mr. Ose. Could you clarify that for me, please? Run through
    that again. I just want to make sure we get it.
        Mr. Sullivan. The full question again?
        Mr. Ose. Yes.
        Mr. Sullivan. Not only was there no evidence of
    withholding, the report goes on to conclude that the evidence
    actually refutes the CPUC's allegation that power was withheld.
    The report says, ``Approximately 87 percent of the power that
    the CPUC concluded was available power, not generated, was not
    in fact available.'' Isn't this right?
        Mr. Wood. That's correct.
        Mr. Ose. Thank you. Keep going.
        Mr. Sullivan. While I am concerned because I think this
    report directly calls into question the credibility of the
    allegations made by the California parties, according to your
    staff report, the CPUC was wrong at least 87 percent of the
    hours it questioned. Eighty-seven percent is not a small error.
    In my view, that report was more of a political document than
    an objective analysis.
        Now I read of a new or recycled allegations being made by
    California where companies have told me the allegations have no
    merit. Is the FERC staff going to examine the reliability and
    merit of these allegations and eliminate the incorrect ones
    before issuing show cause orders to the companies? Giving that
    show cause orders tend to assume a company is guilty until
    proven otherwise, shouldn't FERC determine how accurate these
    latest allegations are?
        Mr. Wood. We are, and that is the reason, Mr. Sullivan and
    Chairman Ose, that we did not issue the show cause orders in
    the other 30 or so companies last week. In fact, the parties I
    mentioned a moment ago have the opportunity to respond to the
    claims by California parties by March 20th. And, it's about 3
    feet high worth of responses. So needless to say, we couldn't
    digest those and give both sides proper weight in 6 days. So we
    are in the process of doing that now. And, in fact, may indeed
    winnow down that list to just focus on not only the specific
    companies but the specific companies with specific claims that
    appear to have violated tariffs or rules at the time, rather
    than just broad brush complaints.
        Mr. Sullivan. Thank you.
        Mr. Ose. Chairman Wood, I want to make sure I've got this
    straight in my head. Under the rules that FERC operates under,
    people who are selling in the interstate market come to you for
    certificates that dictate the manner in which they can market
    their power. Is that accurate?
        Mr. Wood. Correct. Prior to 1992, they just came to us to
    set their rate. We did cost-based rates for everybody.
        Mr. Ose. Now, those licenses, if you will, are called
    market-based certificates?
        Mr. Wood. Right. And, since 1992, people have come in and
    asked for and in most cases been granted the authority to sell
    power at market-based rates, i.e., what the market will bear.
        Mr. Ose. OK. Now, in November 2001, let me back up here a
    bit. The Federal Power Act says that FERC cannot go prior to
    October 2, 2000 to order refunds unless sellers violated their
    market-based certificates.
        Mr. Wood. Or the CAISO tariff or FERC, Federal Power Act or
    FERC rules.
        Mr. Ose. The question I have has to do with getting the
    rules that the certificates are issued under, sufficiently
    strengthened so that there is no question, there is no
    vagueness, there is no ability to equivocate, everybody knows
    what the rules are. Now, FERC recognized this same problem in
    November 2001 and has been attempting since then to reform both
    the natural gas and electric power tariffs. And yet, the
    Commission hasn't been able to come to closure on that to date.
        Mr. Wood. That is correct.
        Mr. Ose. The question when I go home is, you know, when are
    you going to fix this, my constituents say to me. My question
    to you is, when are you going to get closure?
        Mr. Wood. On the market-based certificates, we actually a
    year ago this month, we were at that point a four-member
    Commission, came to two-two vote on how to refine the market-
    based rate tariff conditions. And, our two-two condition
    honestly existed until the end of last year.
        Knowing that Mr. Gelinas, who is in charge of putting this
    report together, was going to recommend changes to a number of
    aspects of market-based rates on both power and gas, we
    beforehand had not looked at the gas certificates because I
    think we had focused probably unduly on the electric only, but
    at that point, we now, it's 1 of the 31 items that we've got to
    punch through in the next series of weeks.
        So you are correct, sir, to point out that we have not
    tightened up this, I don't want to call it loophole, but
    tightened up this certificate. But we have not completed that
    work yet.
        Mr. Ose. In the summary that you, we are going to use the
    summary because I can hold it up here, it's not 400 pages, in
    the summary you have a number of recommendations that are
    enunciated relative to the changes that need to be made. For
    instance, in the reporting process, look at page ES6, chapter
    3, traders attempted to manipulate price indices through false
    reporting. Now, there's a number of recommendations here under
    the bullet points that I am willing to go through one by one or
    in aggregate send to you in writing. But I am trying to get at
    what kind of rules changes you are presently considering to
    prevent this market manipulation from occurring again.
        Mr. Wood. I could go through these, in fact, because we
    have just recently discussed those among my colleagues. They
    are all summarized on ES14.
        Mr. Ose. All right.
        Mr. Wood. The first four under ES14 are basically as we
    just discussed, conditioning certificates of electric and gas
    companies. It's our intention to get that done. We've got the
    open proceeding that you referred to that we had locked two-two
    on. That's the vehicle for doing that on the electric side, and
    we've got to initiate a new proceeding, as mentioned there,
    actually amending our regulations, and they're referenced there
    in the first bullet, to do that on the natural gas side.
        But that would be, for example, that is the one to provide
    explicit guidelines and prohibitions for trading natural gas.
    The manipulation of the indices and the behavior that led to
    inaccurate price reporting, which shows up elsewhere in the
    next series of bullets, actually the fifth, sixth, seventh and
    eighth bullet relate to the specific gas price index issue. The
    Commission is having a workshop on that on the 24th, I guess
    the week after next, on what to do about these natural gas
    price indices that a lot of people in the marketplace rely
    upon, but which have been called into question not only by this
    Commission staff report, but by market participants probably
    over the last 6 months.
        Mr. Ose. I especially want to go to the eighth one there.
    Encourage standard product definitions for published natural
    gas and electricity price indices and standard methodologies
    for calculating the price indices. This would seem to me to
    kind of be at the core of variability in how you calculate
    costs versus what's going to be charged. Of the five indices
    that were used to calculate natural gas price, if you don't
    have a standard product definition for what is or isn't a
    market-based product, how do you find that someone's not giving
    you square data?
        Mr. Wood. I think you've kind of hit the nail on the head.
    It's for that reason that we really, as of last week, just
    said, we cannot rely for the purposes of calculating the
    California customers' refund, we cannot rely on a weighted
    basket of these price indices for gas. They might have been
    directionally correct, and I'll say certainly, the indices have
    the potential to be right on target. But it's not a number that
    we on the regulatory side of the fence could really hang our
    hat on and say, this is what we know the actual market price of
    gas was on that day.
        So we went back to a much more regulatory approach to
    figuring out what should the input for gas price be and then
    provided opportunities for suppliers to show us their receipts
    basically, and get their money for what they actually spent.
    But you're right, the lack of standardization in the index
    reporting definitions and in the collection and computation of
    the data do leave some potential for variation that it's hard
    to get real comfortable with, from our point of view.
        Mr. Ose. In terms of defining a standard product or a
    standard methodology, has it gone beyond merely identifying the
    problem in the 400 page report, or there is actual effort to
    come to conclusion on that?
        Mr. Wood. As I mentioned, we teed up an all day workshop
    with different people in the industry across the board,
    including the current publishers of price indices, which are
    all trade press organizations, a committee of chief risk
    officers, which are the CROs from all the energy companies and
    their customers, the current exchanges, NIMEX, ICE,
    Intercontinental Exchange and I believe one other are also on
    the list, and some customers and users that are also involved.
        So it's my expectation based on the questions we ask them
    to respond to which are these, the ones here and broader. The
    definition of the product I don't think is going to be that big
    of an issue. I think the gas market today has pretty much a
    level maturity as to what the product is. It's what you do with
    the price as reported for purchases of those products or sales
    of those products, how are they averaged, how do you throw out
    the high numbers and the low numbers, what statistical sampling
    technique is used. I think it's those types of things that
    parties may want to explore, and will be exploring, I expect,
    on the 24th.
        Mr. Ose. Now, similarly, there's clear indication that
    there were gaming strategies being employed at some point in
    this marketplace. Similar to a definition of a standard product
    or standard methodology for fixing price or calculating price.
    I am not aware of any clear or definite tariffs, rules, that
    say this gaming strategy is illegal, this one's illegal, this
    one's approved, that one's illegal. What progress is FERC
    making on that?
        Mr. Wood. Well, we published last summer our standard
    market design rulemaking on the electric side. Just to say up
    front, we've made no progress at all on any of these relating
    to the gas side, other than indicating we are going to take
    action in the first two bullets proceedings on the gas gains
    and the gas reporting. But on the electric side, primarily
    based on our experience in the California market, we did put
    forth, well, not 10 commandments, I think there were 7.
        But in the proposed rule that is not being commented on and
    that the Commission is actually shifting its focus to, to
    really finalize that rule. But there are a number, I mean,
    certainly looking at wash trades, looking at false reporting,
    misreporting load for the purposes of gaming the congestion
    management system. I think there were four more, I'd have to
    look those up and report those back. But we have kind of laid
    those out for the electric side. I think the real lesson from
    this report is, we need to attend to the gas side as well.
        Mr. Ose. At the end of the day, I don't know whether
    history will show this got dropped in your lap or otherwise. I
    mean, that you came into something midway through and it just
    blew up, just by chronological coincidence or otherwise. But I
    have to say, I just find it amazing, given the volume of
    natural gas and electricity that transacts on a day-to-day
    basis or in the forward markets and the like, that we don't
    have any clear definition of what a market product is, a
    methodology for factoring it into these prices, what is or
    isn't a legal trading strategy and the like.
        We have to get to the bottom of this. We have to have
    defined rules so that we can stop this gamesmanship. Because I
    can tell you, for every 10 good traders out there, people who
    are trying to do the responsible thing and abide by the tariffs
    and the rules for FERC and CAISO and everybody else, there's
    one out there who's going to try and game it. I just know that.
    And, until we get to a defined set of rules, we are going to be
    chasing our tail. And, it's very frustrating up here,
    especially as someone who has to pay for all this stuff, living
    in California.
        Mr. Wood. Again, I could not agree more. It wasn't
    certainly with my eyes closed that I knew this was going to be
    a big part of the job, was cleaning up the mess. But I do think
    it's very important for these two critical infrastructure
    industries as we go forward to have very well defined rules of
    the road. I think it's, I am sure everybody's sick of me
    talking about it, but it's the only way to come and get this
    thing back on track.
        I should add, on the gas side, because it has worked, I
    think almost spectacularly well over the last 16 years that
    it's been more market based, there's been, the conservative
    estimate is $200 billion stayed in customers' pockets that
    wouldn't otherwise have been there. The high end is $600
    billion over a 16 year period. It has worked very well in many
    instances, in most instances. In fact, in probably all
    instances except when you had the major use for incremental gas
    in California for an electric market that was on the edge.
        And, I think any commodity market is going to be pushed
    against a tremendous amount of stress when you have kind of a
    fundamental market structure design flaw, which relying on the
    spot market was, in the California power market. And, when you
    also have really severe stress on the supply side, with the
    absence of significant amounts of hydro from the grid that
    year, it really shifted tremendous reliance to these old, 40
    year plus, natural gas plants.
        And, I do think that those conditions, as we concluded in
    the report, the staff did, made it very fertile ground for
    manipulation. But recognize that when those conditions, when
    the balanced market rules and the sufficient infrastructure are
    in place, it's very difficult to profit from manipulation.
    Because if you get manipulation, then someone undercuts you and
    takes your customer away. That's how it's supposed to work, and
    it has worked very well.
        So I share your concern. I am committed, and we will,
    before I am done with this job, get these market rules all the
    way down and put forth. But recognize that it's not a whole
    festering pot of garbage. It is a few bad actors that we are
    going to identify and remove, and let the rest of the people
    that are participating in this good marketplace continue to
    serve customers and serve them well.
        Mr. Ose. The gentleman from Oklahoma.
        Mr. Sullivan. No questions, thank you, Mr. Chairman.
        Mr. Ose. The press reports you're struggling with have to
    do with the difference between a short-term contract and a
    long-term contract, relative to the pricing of the natural gas
    that goes into the formula for calculating the price of
    electricity. Your point being that there may be an influence
    that the spot market price for natural gas has on the longer
    term markets, but there is some point at which that influence
    ceases to be material.
        And, the question I have is, at what point in the future,
    in your opinion, are forward prices for natural gas divorced
    from spot market price influence?
        Mr. Wood. One of the things that we have seen in the gas
    market actually, and I think the staff has a name for it, it's
    backwardation, is today where the spot prices are right around,
    say, a month ago, they were in the $6 range, they've fallen
    closer to $5 and hopefully will stay in that range or lower.
    But the forward price, I think the expectation that the market
    has been having is that in 2 years from now, even I think the
    expectation has become, we will pick back up and we will kind
    of get back on track and demand will be up. But in 2 years from
    now, I think the forward curves are looking like they're $1.50,
    $1.75 lower than they are today. I think we saw the same thing
    in the power markets in California, that the supply crunch of
    today will not be perpetuated years and months on end in the
    future.
        I think that happens. I think in commodity markets you can
    have short-term increases but recognize that over time they
    will settle back down to a lower level. We've seen that, and in
    fact, the last time, last week I looked at the forward curves
    on gas, it was still, it wasn't as high as $6, it was closer to
    $5. But there was still a forward curve that was lower in the
    future months than it is today. I hope that's correct.
        Mr. Ose. You have the difficulty of calculating just and
    reasonable prices on short-term and long-term contracts. So how
    do you factor in the price curve that you've just described on
    a long-term contract? If you're going to order a refund on a
    long-term contract, how do you know whether the price curve on
    natural gas or electricity is appropriate or not?
        Mr. Wood. One of the things that we asked our staff to do
    in this report, the fat one, was to look at the correlation
    between spot market and, which is defined as the 24 hour or
    less market, and the longer term markets. And, in chapter 5 of
    that report, they in fact looked at all the contract data and
    had a statistical consultant from the outside, let me see who
    it was. I'll have to look up his name later. Actually he
    compared all the costs of all the contracts that were entered
    into in the California market. And, on page D-17, did actually
    pull together a relationship chart, demonstrating the
    relationship between spot market prices and contracts based on
    the length of various contracts. As I think your question
    anticipated, had a much more pronounced linkage in the 1 to 2
    year timeframe than it did in the 3 to 4 or in the 5 to 8 year
    timeframe.
        So it is one factor that we've got to take into account in
    looking at any sort of contract claims. And, we do have some
    before us, as you know.
        Mr. Ose. Is it your opinion, then, that the relationship
    between the spot and the forward market breaks at some point?
    That irrespective of whether there's been manipulation at some
    point chronologically into the future it washes out?
        Mr. Wood. That's what I've got to think, what I think about
    it, because quite frankly, we are in the process now of, with
    the pending cases, grafting this together. But I would say that
    the staff analysis that I referred to in chapter 5 there does
    indicate a tapering off, really, after the 1 to 2 year
    timeframe.
        Mr. Ose. I have to express some reservations about that. My
    rationale being is that if the spot market is manipulated so
    that the price is elevated from what it would otherwise be,
    then at some point or another beyond a 1 or a 2-year timeframe
    you're going to have that reflected in the price curves at the
    out years. And, if that's the case, if that manipulation in the
    spot market in fact does go into those out years, then does
    that constitute rationale for refunds?
        Mr. Wood. If in fact it does, it could, Congressman. But
    again, I am just reporting back here, they have actually looked
    at the actual contracts that were entered into during this
    period. This isn't a hypothetical exercise. They actually
    looked at all the contracts. We required under subpoena all
    these contracts to be provided to the Commission so the
    statistical correlation runs could be done, and in fact came up
    with a much more attenuated view of the link in the 3 to 4 year
    category and the 5 to 8 year category.
        Mr. Ose. All right.
        The gentleman from Maryland.
        Mr. Van Hollen. I yield back my time, Mr. Chairman.
        Mr. Ose. You're yielding back for the moment?
        Mr. Van Hollen. I am yielding back.
        Mr. Ose. All right, we are just going around and around
    here.
        Mr. Van Hollen. All right.
        Mr. Ose. The gentleman from Oklahoma?
        Mr. Sullivan. I yield back, Mr. Chairman.
        Mr. Ose. I tell you what, I sure like freshmen. [Laughter.]
        Commissioner, the market monitoring ability that you have
    been able to put in place over at FERC, we've had this
    discussion a number of times as to what kind of tools you now
    have as opposed to what you didn't have. What is the status, or
    can you give us an update on your market monitoring programs so
    that we can in turn share that with the public, so that they
    can get some level of comfort that we've got the tools to do
    the job, or if we don't have the tools to do the job, what we
    do need to have in order to be able to do the job?
        Mr. Wood. Three things you need to have to make a market
    work: infrastructure, rules, which I know we are talking about
    on the next panel, and third is vigilant oversight. While we do
    have in the different regions of the country, as California
    does, as we do here in the Pennsylvania, Maryland, New Jersey
    interconnection, as my home State of Texas has and others, a
    market monitoring unit on the ground that looks up front at
    what is going on with the market, what we were missing at FERC
    was really a centralized, professional, experienced cadre of
    people who could look at the national perspective and do that
    well.
        So thankfully Congress did give us appropriation right as I
    took over as chairman in September 2001, and we did start at
    that point a nationwide search for an office director, senior
    staff, and we also had some existing staff at the Commission
    who moved to the new office. We've got about 90 people now who
    not only enforcement and remedial activities, but the kind of
    work like you saw that Mr. Sullivan asked about from the
    staff's review on the CPUC fiscal withholding report. Those
    folks are here behind me today.
        We also have people that look at the health of markets,
    these forward curves, we look at where there are interruptions
    in gas pipeline service, when there are escalations of gas
    price as we saw in the past 2 months, investigating that not
    days later but minutes later. And, the ability to do that is
    something our agency did not have and does now and acts on it
    very quickly. Market participants hear from us often. We
    monitor not only electric data and gas data but also oil data.
    We regulate, kind of the untold story of FERC is we have
    regulated the large oil pipeline industry for their rates for
    quite a while. It's one of those aspects that we are really
    proud of.
        In addition to that, we've now got employees from the FERC
    that are out in the marketplace. We have three employees, for
    example, at the ISO that----
        Mr. Ose. On the floor of the ISO?
        Mr. Wood. No, we actually are not allowed to be on the
    floor of the ISO. But there are three employees there. We lease
    office space from the ISO and our folks there interact closely
    with the market monitoring unit as well as with market
    participants in the California market. They've been there since
    October of last year, when we put in the new market power
    mitigation measures that we changed to at that time.
        And, we also now just recently announced that we are
    putting two in Carmel, IN, to monitor the midwestern markets
    which are in the process of being established and are kind of
    going through their startup and growth period. So I expect we
    will see more of that as the markets mature and develop around
    the country. We will make sure that we don't just sit here but
    we have folks that are our front line out there as well.
        Mr. Ose. My recollection is that you also took the step of
    hiring one or two professional traders to come to work for
    FERC, the purpose of which is to get not so much the scientific
    side but the trader seat of the pants sense of what's
    happening. Is that still the case?
        Mr. Wood. It is, and actually more than one or two just
    came to work at FERC from the industry side. And, it's not just
    the trading, but all aspects of both production, on the
    production side, on gas, we have some good gas expertise as
    well as some electric expertise from different parts of the
    industry. It's been, certainly we would rather not have the
    downturn in the industry, but it has allowed us to be a more
    attractive employer than we otherwise would have been, and have
    been able to attract certainly hopefully for longer than short-
    term some good, diverse talent to the agency. So I am again
    very grateful for the funding and the FTEs from Congress, but
    doubly grateful that we've been able to actually attract the
    quality people that we've been able to get.
        Mr. Ose. One of the things you have in the market
    monitoring area is you have a large map of the United States.
    And, up on that map you can visually see the, if memory serves,
    the path by which power gets to the markets. Now, the purpose
    of the map is to identify where you get roadblocks or
    impediments or congestion or what have you. How often do you
    tweak, if you will, the formula by which you identify where
    congestion occurs or where a problem arises?
        Mr. Wood. Well, we do rely on certainly the NERC, which is
    the North American Electric Reliability Council, does set forth
    the criteria under which interruptions would happen. Those are
    called transmission loading relief, which means you just
    basically take transactions off the grid and say, you can't
    send your power that way. Those happen every day. Some of them
    are like, I guess, bronze, silver and gold. You've kind of got
    a lot of bronzes, maybe a silver every day somewhere and every
    so often, a full curtailment of loads. Curtailment doesn't mean
    blackout, it just means that commercial transactions don't
    happen and customers end up paying more money. So congestion
    basically is a money issue.
        At extreme times, as we've seen in your home State, it can
    be a reliability issue as well.
        Mr. Ose. I just want to share, that's not why we are called
    the Golden State. [Laughter.]
        Are all of these resources we are putting for market
    monitoring, will they alone prevent higher prices or blackouts
    in the future?
        Mr. Wood. No. And, I hope I haven't promised that they
    would. But for example, California, let's look at that. In May
    2000, the prices in the wholesale market started to rise. We
    got a complaint 3 months later from a utility that was paying
    these prices and thinking, gosh, I am going to go bankrupt if I
    have to sell at this retail price and pay at this wholesale
    price.
        Sixty days later than that, so a good 150 days after the
    fact, customers had some remedy. I just find that unacceptable.
    So we want to make sure that if there are issues, that we
    identify them the day they are happening, so we can take action
    that day so if there is some violation, if it's the normal
    forces of the market working, then they should be allowed to
    work. And, people curtail their use or buy alternate products,
    switch from gas to fuel oil, perhaps, and do economically
    rational things.
        But if they're the result of somebody taking advantage of
    the rules or creating a situation that is illegal or unlawful,
    then that ought to be able to be remedied, not 150 days later,
    but that day. And, I think, if we continue to maintain the
    approach that we've got, in relying on our extensions in the
    regions, then that can be very quick activity and not extended,
    as we saw in the California crisis.
        Mr. Ose. Do you now have the ability to act on an immediate
    basis? Or are there things you need from Congress yet?
        Mr. Wood. You've got it. As you mentioned, your bill does
    that for us. We do not have that ability on the natural gas
    side. In our prior discussions, we focused on electricity. But
    the Commission, in my testimony to our oversight committee, did
    indicate a request to have such authority on the natural gas
    side as well, similar to what we just talked about in bill 964.
        But I think what we've found, and I think it's certainly
    the case, is when market participants know that not only are we
    looking, but we have capable, qualified, bright people who are
    doing that looking, not politically motivated looking, but
    people who are interested in the long-term health of the
    markets looking, then those behaviors get remedied pretty fast,
    if they get tried at all. It's hard to know what caused the
    California markets to kind of settle down, but I think a
    substantial number of people have credited the fact that now
    they knew that the cop was looking, not parked at Dunkin'
    Donuts but actually out there looking.
        And, we will continue to do that.
        Mr. Ose. Dunkin' Donuts is based in his district. No, just
    kidding. [Laughter.]
        Mr. Wood. I just think that the ability to be nimble and
    quick and smart is 90 percent of what is needed to oversee the
    market. The other 10 is to have a tool chest that gets
    attention.
        Mr. Ose. I do want to thank you for the work you do. I may
    continually nag at you to come on, come on, faster, more,
    sooner, frankly, because I've got 35 million people of which
    600 odd thousand live in my district, and they're concerned
    about this. I know Mr. Sullivan and his constituents are
    concerned about this. I do want you to know that, we do not
    believe this issue is over. Excuse me, I don't believe this
    issue is completed. I do think we are going to have a
    continuing issue in California relative to supply and price.
        The ability to bring to the rulemaking process some
    definition on methodologies for pricing and marketplace
    behavior is critical to what we are going to do successfully in
    California. We are going to talk a little bit about that in the
    next panel. I do appreciate FERC's willingness and interest to
    stay on this, because I will continue to watch and if
    necessary, have additional hearings. Because I know you love
    coming up here.
        Mr. Wood. Let's go to Sacramento again.
        Mr. Ose. Yes, maybe someday. I will tell you, I am
    troubled, I fail to see the logic between being able to find
    evidence of manipulation and moving to order refunds and then
    finding similar evidence of manipulation and being reluctant to
    order refunds. You haven't made that case to me yet, that there
    is a break between those two. Manipulation is manipulation.
    And, frankly, my people suffered accordingly. To the extent
    that they did suffer, they are entitled to refunds over and
    above a just and reasonable price. We'll come back to that
    issue in future hearings if necessary, and you'll probably get
    endless letters from me accordingly.
        But I do want to thank you for coming down here. I am
    appreciative of the fact that you've accommodated our next
    panel and will participate in that too. We are going to take a
    3-minute break here. Commissioner Wood, thank you for joining
    us.
        Mr. Wood. Thank you, Mr. Chairman.
        [Recess.]
        Mr. Ose. All right, we are going to go ahead and reconvene
    with our second panel. Joining us on our second panel are the
    following individuals. We have Terry Winter, who's the
    president and chief executive officer of the California
    Independent System Operator; Karen Tomcala, who's the vice
    president of regulatory relations of Pacific Gas and Electric
    Co.; Gary Ackerman, who's the executive director of the Western
    Power Trading Forum; Jan Smutny-Jones, who's the executive
    director of the Independent Energy Producers; and we have
    George Fraser, who's the general manager of the Northern
    California Power Agency.
        As you know, we swear in all our witnesses. Commissioner
    Wood is joining us also. We are going to ask him to rise and be
    sworn in again. If you'd rise, please.
        Commissioner Wood does not need to be sworn in a second
    time? All right. Well, he's volunteering. [Laughter.]
        [Witnesses sworn.]
        Mr. Ose. Let the record show that all the witnesses
    answered in the affirmative.
        Now, we have an order here, we are going to move from my
    left to my right. Commissioner Wood having given his testimony,
    if he wishes to add anything, will be welcome to do that. Each
    witness is going to be provided 5 minutes. We've received your
    testimony in advance. I have in fact read it. And I have
    numerous questions. We'll get to those as we move through.
        So Mr. Winter, you're first for 5 minutes.

       STATEMENTS OF TERRY WINTER, PRESIDENT AND CHIEF EXECUTIVE
    OFFICER, CALIFORNIA INDEPENDENT SYSTEM OPERATOR; KAREN TOMCALA,
    VICE PRESIDENT, REGULATORY RELATIONS, PACIFIC GAS AND ELECTRIC
     CO.; GARY ACKERMAN, EXECUTIVE DIRECTOR, WESTERN POWER TRADING
        FORUM; JAN SMUTNY-JONES, EXECUTIVE DIRECTOR, CALIFORNIA
       INDEPENDENT ENERGY PRODUCERS; AND GEORGE FRASER, GENERAL
               MANAGER, NORTHERN CALIFORNIA POWER AGENCY

        Mr. Winter. Thank you. I appreciate the opportunity to come
    and talk to the group. As normal, I have to say that as the CEO
    and president of the ISO, I am representing myself here today
    and would not want to represent that my comments deal with the
    board, any State agency or the Governor's office. So with that
    disclaimer, you're going to get whatever you see.
        With your concurrence, I would like to submit for the
    record an opinion from our market surveillance committee, which
    consists of Dr. Wolak, Dr. Bushnell, Dr. Hobbs and Dr. Barber.
    I had asked them to do a review on LMP. They got that to me
    yesterday. So if I could put that into the record.
        Mr. Ose. Without objection.
        [The information referred to follows:]
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        Mr. Winter. Thank you.
        I think the first question, why MD02, you've defined what
    it is, and for the record, that's Market Design 2002. And, one
    of the things that we've heard loud and clear is that the
    California market is broken, and I certainly agree with that.
    We no longer have a PX, we no longer have the ability to get
    supply. We certainly have seen high prices, and even though
    they have moderated considerably over the last year, they were
    still astronomical and we are concerned about those continuing.
        Actually, the redesign by different names started in 2000
    when we started having market things that we were concerned
    about. And, it's been over the last 2 years, we actually were
    ready in about January 2001, we received a new board. They
    wanted to get familiar with it. So the final MD2002 was filed
    with FERC in May 2002. And, this was a result of untold hours
    of stakeholder meetings, searches for best practices among the
    other ISOs, and recognizing the constraints of the California
    market and the situation the transmission system was in.
        The end result is MD02. And, it is our proposal to solve
    the six major concerns that we have. One, it addresses and
    prevents gaming and market power abuse. Two, it's to help us
    reliably operate the system. Three, it allocates scarce
    transmission resources fairly and provides open and non-
    discriminatory service. Four, it provides a day ahead market
    and removes from real, as much from real time as possible, the
    decisions that we have to make. Five, it provides transparency
    to market participants so that they can better manage their
    costs and exposures. And, six, we are hoping that it will
    return confidence to the marketplace, so that the efficiencies
    gained can benefit the consumers.
        Until this is in place, I feel that we are still vulnerable
    to all the things that have happened to the market in the past.
    So we feel we need to move rapidly to get this done.
        You've asked me to address four areas: resource adequacy,
    mitigation, LMP, and seams issues. Each of those subjects you
    could literally write books on. But I will try to capture in
    one or two sentences where we stand on each of those.
        Resource adequacy. The ISO feels as a very bare minimum
    that load serving entities should provide an amount equal to
    112 percent of their peak load. This will meet operational
    reliability concerns and ensure a competitive market. The ISO
    did not file this with FERC at the request of the State, which
    is working to provide a procurement policy for the utilities
    and the needs of the State. They have moved somewhat rapidly
    and in terms of getting hearings started, the PUC, the CEC are
    all working on these. They have told us that they will have
    results by November 1st.
        I think it is the State's prerogative to be able to say, we
    are going to meet this capacity with demand programs, with
    efficiencies, with additional generation, renewables. I feel
    that is a State prerogative. So we are waiting. But again, I
    think the ISO, from our standpoint, we have to be guaranteed
    that you have at least 112. The State is looking to give us
    more than that at the 115 to 120 percent level, which I am
    encouraged by.
        Mitigation. FERC has in place three things that they gave
    us at the end of, or the fall of last year. One of those was a
    must offer requirement, which ensures that generators will bid
    into the market. Second, a bid cap of $250. And third, an
    automated mitigation procedure that checks for prices versus
    the cost of gas.
        And, while those are absolutely necessary and helpful in
    the market, I would ask for two additional things. One of those
    is a method to mitigate local market power, because we see that
    when we have transmission lines out, we see it in pockets where
    the transmission service is not adequate.
        The second is, as much as I would dislike having to enforce
    penalties, I feel that the market, to gain confidence and also
    control some of the activities that we have seen, that we need
    penalties for things such as uninstructed deviations, when
    people do game the market. We've got to have a clear set of
    rules and say this is unacceptable and a way to stop that
    behavior.
        LMP. LMP has been much discussed, but merely, I think if
    you look at what it is, LMP is just a way of allocating
    transmission resources. The drawback, of course, to some is
    that it gives you a different price at different locations. If
    you happen to be in one of those high priced locations, then
    you're very anxious to make sure that you don't get stuck with
    a high price. We think it's absolutely essential for the
    generators and the wholesale purchasers to understand what
    price they are paying at a particular location, and so we are
    recommending that we go with the LMP, and I'll stop in just a
    second. But we are going to average the price over PG&E, Edison
    and SDG&E's territories, so that the retail customer will see
    one common price.
        Seams issues, we are working on those and I am sure you'll
    have a question for me on that. Thank you.
        [The prepared statement of Mr. Winter follows:]
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        Mr. Ose. I thank the gentleman for his time and his
    testimony.
        Our next witness is Karen Tomcala from Pacific Gas and
    Electric. Welcome. You have 5 minutes.
        Ms. Tomcala. Thank you, Mr. Chairman. I am Karen Tomcala,
    vice president of regulatory relations, of Pacific Gas and
    Electric Co.
        I appreciate the opportunity to testify before you here
    today, and I would ask that my full written testimony be
    submitted into the record.
        Mr. Ose. Nobody is going to object to that.
        Ms. Tomcala. PG&E supports the ISO's MD02 efforts, because
    a well functioning wholesale power market is necessary for
    utilities like PG&E to provide the reliable service our
    customers require. We should all recognize that the MD02
    related tasks before the ISO are both technically complex and
    politically sensitive, and the ISO must move forward respecting
    both of those facts.
        With this in mind, I'd like to emphasize the processes
    necessary for the ISO to achieve a successful MD02 program.
    First, the ISO must coordinate its market redesign activities
    with State efforts. Fixing California's energy market requires
    both Federal and State regulatory attention. The California
    PUC, under new leadership and in coordination with the other
    California energy agencies, is beginning to construct a
    coherent model for the State's energy future. The ISO's
    activities must proceed in synchronization with these efforts,
    so that its ultimate MD02 product supports the emerging model.
        Second, the ISO must provide an effective process for
    stakeholder participation and input in developing MD02. The
    energy crisis has shaken the confidence of everyone involved.
    Redoubled efforts to ensure that stakeholders' concerns are
    heard and addressed in the MD02 process are necessary to
    establish confidence that California will have a fair and
    stable market design on which participants and consumers can
    rely. Creating such stakeholder buy-in can provide the
    additional benefit of minimizing litigation, both during the
    design process and down the road. Our collective resources are
    better dedicated to fixing California's market and bolstering
    the State economy.
        Third, the ISO must develop, as necessary, and engage in
    regional coordination processes that recognize the regional
    nature of the western market. As has often been discussed, the
    seasonal exchange of power in the West has benefited customers
    across the entire area. To retain these synergies, the ISO must
    work cooperatively with the region to provide appropriate
    mechanisms for addressing seams issues between the Pacific
    Northwest, California and the Desert Southwest. Such a regional
    approach does not require that the market designs in western
    States be identical, only that they be consistent enough to
    permit the regional cooperation and coordination that have been
    the hallmarks of the western market for years.
        Examples of issues that should be coordinated across seams
    include operational and commercial rules, market mitigation and
    resource adequacy, all of which are more appropriately
    addressed in the regional footprint of the market and discussed
    further in my written testimony.
        Finally, by engaging in the processes I have just
    described, the ISO can do much to create a well functioning
    wholesale power market in California. The ISO, through its role
    as a non-discriminatory grid manager, is positioned to provide
    a range of transmission related benefits to the regional
    electric power market, including more efficient and reliable
    operations, transmission pricing that eliminates so-called
    ``rate pancaking,'' improved congestion management, improved
    reliability through application of its open access transmission
    tariff, and more coordinated planning of transmission
    investment. All of these activities will result in a robust
    transmission system for the benefit of consumers.
        In tandem with transmission benefits, getting essential
    market rules right will ensure that MD02 provides the most
    reliable service and the greatest protections available for
    consumers. One example of getting it right would be using MD02
    to craft mitigation rules targeted to address specific market
    problems. The crisis demonstrated that inappropriate or
    uncoordinated mitigation is a potential source of gaming. When
    price caps in California were low relative to neighboring
    States, some suppliers were motivated to export power from
    California, thereby making the supply situation in the State
    worse.
        Another way in which the ISO can use MD02 to get it right
    is to implement stable, transparent market rules, an essential
    precursor to investment in new infrastructure. The upheaval
    associated with the California crisis, which is not yet fully
    resolved, has chilled investment in the State, leading to
    projections of supply shortage recurrence in the 2007-2008
    timeframe. Implementing stable rules on which investors can
    rely can reverse this trend and ensure fully adequate
    resources.
        The fact of the matter is that doing all these things may
    take some time. But doing them right is the most important
    objective. Taking the extra effort to coordinate, strive for
    consensus, plan and implement MD02 properly is the only way to
    provide customers with the stable, reliable service that they
    deserve.
        Thank you, Mr. Chairman. I'd be pleased to answer any
    questions.
        [The prepared statement of Ms. Tomcala follows:]
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        Mr. Ose. Thank you for your testimony.
        We'll go right to Mr. Ackerman for 5 minutes. He joins us
    from the Western Power Trading Forum.
        Mr. Ackerman. Thank you for getting the name right, Mr.
    Chairman. My name is Gary Ackerman, and I am executive director
    of the Western Power Trading Forum, a non-profit trade
    association dedicated to enhancing competitive energy markets
    in the western States.
        I appreciate the opportunity to offer my comments in
    addition to the written testimony I have submitted to your
    subcommittee regarding the efforts of the California ISO and
    the Federal Energy Regulatory Commission to redesign
    California's restructured market.
        First, let me say that the people I represent are the folks
    providing the key ingredient to making our homes and businesses
    safe and secure; that's electric energy. They provide the
    energy to light the dark spaces, and connect folks into the
    21st century. They are the people who build alternative energy
    projects that emit fewer pollutants, sustain our vital natural
    resources and lessen our Nation's dependence on foreign oil.
        Notwithstanding the negative press that has surrounded our
    industry of late, we have a vision whereby consumers enjoy
    lower average energy costs through competitive markets. And, we
    remain steadfast in our desire to show you and the Nation what
    can be achieved. Without competition, consumers are stuck with
    a single energy provider, and costs are passed through to the
    ratepayers.
        With competition, private companies battle for the right to
    serve consumers, thereby lowering average prices, with all the
    financial risk borne by the companies, not the ratepayers. For
    example, my group updated a comparison of the average monthly
    wholesale prices in California since deregulation began in
    California in 1998. We compared it to the pre-deregulation just
    and reasonable generation component of retail rates.
        The outcome is clear. The deregulated average for the full
    5 years since competition began is lower than the utility's
    cost to provide the same even with the bumps and perturbations
    of the well documented wholesale price spikes that occurred
    during the crisis.
        Had Californians the opportunity to pay competitive
    wholesale prices, as opposed to paying the just and reasonable
    price, then California consumers would have saved $3.7 billion
    that otherwise went to paying their electric bill. If one adds
    to that savings the proposed refund amount announced by FERC 2
    weeks ago, then the total 5 year consumer benefit would be $7
    billion. That's not a bad value in either case for 70 percent
    of the consumers in your State.
        Market design in the West, particularly in California, is
    moving forward in fits and starts. The worst design will
    suffice amid abundant energy supply. The best design may falter
    in a shortage. I would encourage this subcommittee, the
    Commission, and the California ISO, rather than getting all the
    elements of the design perfect, to spend more time on the
    elements of the design that affect private investment in new
    generation plant and transmission. There is a common belief
    that getting the rules just right will eliminate market
    manipulation and the abuse of market power.
        But the other side of the coin is that suppressing market
    forces to the point where markets don't exist any more will
    further exacerbate the looming shortage that will occur when
    the economy rebounds and if there is a drought in the Pacific
    Northwest. In short, no one is going to care how hard we tried
    to get the market rules right in 2003 when the lights flicker
    in 2005.
        My written testimony covers the specific items the
    subcommittee has posed to the panel and I won't repeat those
    answers here. However, I look forward to answering your
    questions, and again, thank you for the opportunity to appear
    before you and provide our point of view.
        [The prepared statement of Mr. Ackerman follows:]
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        Mr. Ose. Thank you for joining us, Mr. Ackerman.
        Our next witness is Jan Smutny-Jones. Mr. Smutny-Jones, you
    are recognized for 5 minutes.
        Mr. Smutny-Jones. Thank you, Chairman Ose. My name is Jan
    Smutny-Jones. I am the executive director of the California
    Independent Energy Producers. I also previously served as the
    Chair of the ISO from until June of probably January 2001. I
    would like to submit some written comments for the record and I
    am just going to summarize them here today, in the interest of
    time.
        Mr. Ose. We'll accept them without objection.
        Mr. Smutny-Jones. Mr. Chairman, in the beginning of today's
    hearing, you characterized California as continuing to live in
    an intolerable state of energy purgatory. I share that view,
    although I believe that California is on the road to recovery.
    Hopefully the road to recovery is not like the road to hell and
    just paved with good intentions. I think our purpose today is
    to make sure that the primary work before us with regard to
    market restructuring actually takes place.
        Key to the infrastructure development that you indicated is
    necessary in California is stability. Stability requires
    clearly articulated market rules, which I think you and
    Chairman Wood talked about previously. Second, a coherent
    procurement process, which I think several of the previous
    witnesses have suggested is underway in California. There have
    been some positive developments on the part of the State with
    developing procurement roles. And, last, but certainly not
    least, a redesigned market structure, which is currently
    underway in California ISO.
        What I'd like to focus on here is the need for resource
    adequacy. IEP is in the resource adequacy business. Our members
    build and operate power plants, both gas-fired and renewable.
    There's over 10,000 megawatts added to California since
    restructuring, and have been added to California's resource
    mix. Importantly, these facilities are not only reliable, but
    have shifted the development and operational risks from
    basically ratepayers to private sector developers and operators
    of these plants. That's a huge benefit to the people of
    California.
        An ancillary benefit of this modernization also has very
    real, significant environmental benefits. The Calpine plant,
    for example, in Sutter County, produces electricity with 98
    percent fewer emissions than the average plant would in terms
    of the fleet in 2000. So that's significant.
        The resource adequacy component of the CAISO is currently
    being held in abeyance until the State completes their work in
    November of this year. I want to underscore this point. It is
    absolutely critical that the work that the State is doing is
    fully integrated into the ISO's tariffs. Otherwise, this is not
    going to work and we are going to revisit the problems that
    we've previously experienced.
        Some other specific market rules that I think we need to be
    going forward with here is, the market redesign in California
    needs to be based on sound economics and markets that work
    elsewhere. There is a significant debate going on about why
    California is different and why the West is different and
    whatever. Fine. Let's identify where we are different and move
    on. I for one used to hold that view very religiously, but I
    think we need to just recognize the fact that there are other
    markets that do seem to work elsewhere and now is not the time
    to reinvent the wheel.
        We need a day ahead market so people can actually trade
    electricity. As I indicated earlier, a resource adequacy
    component is absolutely critical to overall market stability.
    And, we need a stakeholder advisory committee that basically is
    able to address issues that are coming up in a way that
    provides people a meaningful opportunity to basically impact
    the outcome of rules that are under development.
        Last, but not least, the seams issue. This is a regional
    market. California is not an island, has not been for a very,
    very long time. We need regional rules that are monitored and
    basically enforced on a regional basis. We think that's of
    critical import.
        And, so in closing, I would just like to conclude that the
    energy crisis was a convergence of a serious supply and demand
    imbalance, poor market design and inadequate regulatory
    response. It need not and should not be repeated. We need to
    encourage infrastructure investment providing new supply,
    implement meaningful market redesign and ensure that our
    regulatory institutions are reformed in a manner that is
    responsive to modern market realities. It is time for action,
    because quite candidly, Mr. Chair, we cannot afford another
    failure.
        Thank you very much.
        [The prepared statement of Mr. Smutny-Jones follows:]
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        Mr. Ose. Thank you for joining us today.
        Our final witness is Mr. George Fraser, who's the general
    manager of the Northern California Power Agency. Mr. Fraser,
    you're recognized for 5 minutes. And, by the way, his
    grandchildren are in the audience today.
        Mr. Fraser. Thank you, Mr. Chairman. We are a different
    segment of the market, as opposed to folks who are in the
    business to make a profit. I represent numerous community-owned
    utilities in Northern California. We are not merchants, we are
    integrated utilities in that we provide the generation, we
    purchase and sell power, to the extent that it's surplus, and
    we serve our retail customers.
        Our point of view regarding the Market Design 2002 is that
    it will not, as it's currently been described to us and
    designed, facilitate bilateral contracts. And, we live on
    bilateral contracts. We are encouraged by what Mr. Winter said,
    because we believe that meaningful resource adequacy is
    absolutely essential. And, before you start changing a new
    design and getting involved in a new experiment in California,
    we need to make sure that we have sufficient generation and
    especially transmission, so that we don't have to deal with
    congestion throughout California.
        There is no reason from what we can see right now to
    believe that Market Design 2002 will provide incentive for
    investment either. Standard market design is supposed to
    encourage voluntary bilateral contracts. We are very encouraged
    by the words we hear, but what we see in the detail of the
    design doesn't appear to support bilateral contracts.
        When a detailed proposal is put forth that truly supports
    voluntary bilateral contracts, I think you'll find us
    supporting such a plan. We think it's more important to do this
    design right rather than doing it fast, so we are urging that
    this thing be carefully put together and not rushed. The
    current process seems to be geared toward managing
    stakeholders, and moving toward a pre-ordained outcome rather
    than actually including the input from stakeholders as we go.
        Just to reemphasize my point of view about transmission, I
    believe Spencer Abraham has been quoted as characterizing the
    existing transmission in California as Third World. We don't
    see any fundamental elements of Market Design 2002 that
    addresses transmission construction and transmission adequacy.
        Let me move ahead and talk about market incentives and
    resource adequacy. Let me summarize my verbal comments here and
    they're consistent with the written comments we've turned in.
    Market Design 2002 is inconsistent with the stated goal of SMD
    to encourage and facilitate voluntary bilateral contract
    arrangements.
        We believe that resource adequacy must precede market
    design, that the plan with Market Design 2002 is a serious case
    of putting the cart before the horse. We are not starting out
    with resource adequacy, we are starting out with a new design.
    In its current state, we see, and we've studied Market Design
    2002, we believe it lacks sufficient detail concerning such
    critical elements as the ones I've described, as well as
    congestion management and market power mitigation. We would
    like to, as I said, support the design when we see more detail
    and see it tested in the relatively near future.
        Thank you very much, Mr. Chairman.
        [The prepared statement of Mr. Fraser follows:]
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        Mr. Ose. I thank the gentleman for his testimony.
        As we said, everybody's statement, we've received it, we
    are entering that into the record. There's a couple things I
    want to go through in particular. The January 2003 report
    produced by the Public Policy Institute of California, which is
    entitled, ``The California Electricity Crisis: Causes and
    Policy Options,'' lays out a series of goals that any market
    structure should achieve. And, these include lower prices,
    system reliability, efficient use of resources, administrative
    feasibility and environmental protection.
        These are significant issues and many times very difficult
    to resolve, let alone grasp in total. I want to make sure that
    as we go forward through this hearing that those particular
    five contexts be the basis for the feedback you give us.
    Because that's essentially where we've got to go, is we've got
    to figure out how to stitch this all together. So with that
    particular thing in mind, I do want to proceed.
        Now, you've all talked at one point or another in your
    testimony, either because we've asked you to or otherwise,
    about resource adequacy. The proposal for California, for its
    Market Design 2002, has pushed off the adoption of resource
    adequacy standards until the last phase. I happen to think that
    most if not all of the dysfunction we suffered in California
    was due to an inability of the utilities to enter into safe
    harbor, long-term, bilateral contracts. And, it seems to me
    that whatever we do in market design, we ought to make sure
    that we incorporate the ability to enter into short, medium and
    long-term contracts into that market design for our utilities.
        Now, as I understand, Mr. Winter, CAISO has not been able
    to move forward on that because the California Public Utilities
    Commission basically hasn't taken up the challenge of resolving
    that issue. Am I correct in that?
        Mr. Winters. That is correct. They came before our board
    and our chairman gave them until November 1st to come up with a
    plan and then he made it very clear that if they did not have a
    plan put together by that time, that he would continue with the
    request that we had made to FERC for the 112 percent.
        Mr. Ose. That raises an interesting question, because when
    we had the first of these hearings, and this I am going to
    direct to Ms. Tomcala, when we had the first of these hearings,
    I asked a specific question whether or not the PUC had adopted,
    from a regulatory standpoint, safe harbor provisions for the
    investor-owned utilities to enter into long-term contracts. In
    other words, go ahead and do it, we are not going to second
    guess you.
        I was told under direct questioning by Loretta Lynch that
    the PUC had adopted safe harbor provisions for the investor-
    owned utilities to go ahead and enter into long-term contracts.
    And yet, if that's the case, why are they now considering
    whether or not to do that? It seems to me there's a
    disconnection. The question is, has the PUC provided the
    investor-owned utilities the ability to enter into safe harbor,
    long-term contracts for the provision of power to their
    customers?
        Ms. Tomcala. The PUC has divided that question into two
    time related segments, the short-term, the intermediate, to get
    us over the hump, and the long-term procurement proceeding,
    which they're engaged in right now. So the PUC has provided us
    the ability to enter into contracts for the time being, but is
    still pursuing an integrated, long-term procurement proceeding
    that will look at the combination of some of the elements that
    you identified earlier, contracts, demand response, efficiency,
    those sorts of things and how they fit together for the long-
    term.
        Mr. Ose. So you have the ability to enter into a long-term
    contract?
        Ms. Tomcala. We have the ability to enter into contracts.
    We would probably quibble over whether we have a safe harbor
    provision.
        Mr. Ose. How important is a safe harbor provision to your
    ability to enter into those contracts?
        Ms. Tomcala. Tremendously important, not only for the
    ability to enter into those contracts, but also to return us to
    investment creditworthiness, which we feel is essential to
    provide the service that we must provide to our customers.
        Mr. Ose. When you say you don't have the safe harbor
    provisions, what do you mean?
        Ms. Tomcala. What we mean is we are not in a position yet
    where our contracts won't be second guessed after the fact.
        Mr. Ose. By whom? Why would anybody second guess your
    contracts? I mean, you're the utilities.
        Ms. Tomcala. Because we are still working out the standards
    for the long-term and the long-term procurement proceeding.
        Mr. Ose. So this issue arose, I mean, I broached this issue
    in April 2001. And, you still don't have any definitive rules
    from the CPUC about what is or isn't acceptable for long-term
    contracting for power delivery.
        Ms. Tomcala. That's right. That procurement proceeding is
    continuing as we speak.
        Mr. Ose. And, Mr. Winter, you're saying that the board of
    the ISO has given the PUC until November 1st to get their act
    in order?
        Mr. Winter. Correct.
        Mr. Ose. Chairman Wood, under MD02 or any market structure,
    if people operating in the market can't get regulatory or
    political certainty until the last of the process, what does
    that mean for resolving all the--it seems to me that the
    delivery of power is what this is all about. What does that
    portend?
        Mr. Wood. It means you won't invest. And, that's what I
    think, honestly there's, I think all five of these folks have
    said the exact same thing on this issue from a different
    perspective. There's got to be, if California is going to
    regulate the retail customer, I think that's a choice that the
    legislature now has made. Kind of return to a more, to a
    traditionally regulated retail environment.
        The approach has got to be one very similar to that taken
    in other States, that if you do a very organized process, which
    I understand from our staff's visit with the CPUC staff 3 weeks
    ago they're looking at, you do have to basically say, if you go
    through an open solicitation for power contracts and you take
    the best bid or lowest bid or whatever you define it to be,
    that will be de facto granted, that is the best choice, before
    you actually sign the contract.
        These folks have to have that kind of certainty. Then these
    folks can go ahead and build and trade on that and it all
    works. But if you don't have that build-ahead component of this
    market, which we still don't have there today, then you do
    have, I think, what Mr. Winter pointed out, I guess I am going
    to put words in your mouth, but kind of a problem down the road
    and it may not be a very long road.
        Mr. Ose. Mr. Fraser is a public agency, but Mr. Ackerman
    and Mr. Smutny-Jones have private side producers. Some of your
    members actually generate power, or at least would like to, and
    would like to sell it for a profit. And yet, you don't have a
    customer that you could enter into a long-term contract with.
    Do you have any input on this? Mr. Smutny-Jones.
        Mr. Smutny-Jones. I would say the No. 1 problem in
    California right now is that there is not a long-term contract
    that you can take to a bank and get financed that basically
    comes out of a procurement process where PG&E or the other
    investor-owned utilities will know that they'll get cost
    recovery later on. It's a very significant problem.
        The second point I want to make here, because even if the
    PUC comes up with, and I don't by the way think that this is
    rocket science, it shouldn't be that hard, but even if they
    come up with a perfect rule that applies to the investor-owned
    utilities, resource adequacy will also have an impact on Mr.
    Fraser's community, which is about 30 percent of the market in
    California. And, there is an additional group of load serving
    entities that are neither municipal utilities nor publicly
    regulated utilities. These are load serving entities servicing
    the retail market.
        So how to pull this all together I personally believe that
    the connective tissue is the ISO tariff. So basically we
    determine how much can be determined by the State of California
    and the municipal utilities that they have to respond to, who
    provides it is obviously an open question. But more
    importantly, how it's ultimately enforced is going to be
    through an ISO tariff and ultimately I think through
    Commissioner Wood's Commission.
        Mr. Ackerman. Mr. Chairman, I think you're looking at part
    of the problem. The whole problem also includes aged power
    plants in the State of California which could be shut down and
    a lot quicker if they don't see the kinds of markets that would
    facilitate being used at all. So we have to look not only at
    the new construction which might not take place, because the
    certainty isn't there, but the additional megawatts that might
    be taken off the table because people are looking at the costs
    of continuing to run those power plants and saying, the
    economics aren't there, putting more pressure on the supply
    demand imbalance, if you wish to call it that.
        Mr. Ose. You've identified two questions. There's the
    capital necessary to keep existing plants running on a
    maintenance and repair basis.
        Mr. Ackerman. That's right.
        Mr. Ose. Then there's a second question having to do with
    creating, generating power for the growth in the market.
        Mr. Ackerman. That's right. And, we can add to make it
    complicated a third element, which is new transmission
    facility. I'll give you a specific example. Let's take the
    generation that's being built in Arizona and along the Mexican
    border. It doesn't have enough transmission to get in to help
    serve the needs of California and the Pacific Northwest.
        So we have inadequate transmission to bring some of this
    currently stranded new-asset power into the State of California
    and the Pacific Northwest. There's the chance that we might
    lose some existing power plants, because they can't sustain
    themselves and add new environmental requirements in order to
    keep producing power.
        And, then of course, we have the fear of new generation not
    being built because they don't have the market certainty. Other
    than that, things are going pretty well.
        Mr. Ose. You're an optimist.
        Mr. Winter, it seems to me that we've got enough power for
    this summer. But I am not very optimistic about the out years,
    if you will, 2 or 3 or 4 years downstream, as it relates to any
    potential shortages or significantly higher prices. Now, I know
    ISO is working on a report to forecast power supplies for this
    summer and the near future, which seems to be prudent, and I
    want to compliment you on that. Do you have anything you can
    share with us to summarize what appears to be the case, both in
    the immediate term and in the near term beyond that as it
    relates to power supplies for California?
        Mr. Winter. I have the advantage of having the draft report
    that you're referring to. It's 3,246 megawatts that we have
    ``in excess'' of the identified needs. That would portray that
    for the summer of 2004, we would have adequate power.
        Now, I always qualify that with, if I lose a couple of
    nuclear units, suddenly some transmission lines are down, or if
    we have a situation where there's a local hot spot that we just
    don't have sufficient transmission to serve it, that we of
    course would have to take whatever action was necessary for
    those. But for that period of this summer, it looks like we
    will be able to make it.
        That also takes into account a reduced import from the
    Northwest. During the summer, we usually see somewhere between
    5,000 and 6,000. In our studies we have projected only 3,500,
    because we expect the Northwest to be somewhat drier. My
    understanding in talking to them last week was that they have a
    very good March as far as snow and rain is concerned, but we
    don't know what the impact of that will be.
        Looking beyond that, I have considerable concerns, many of
    the things people have mentioned here. We have old plants, many
    of them are under a requirement to add significant capital, to
    add SCRs or catalytic converter type things to clean up the
    air. People are just not going to make that investment unless
    they know they've got a market that they can play in.
        The other is that we have many old units. The other thing
    that I am seeing that, one of the advantages of being rather
    old is, you see things tend to repeat themselves quite a bit.
    And, I am seeing the utilities now getting caught up in the
    economy is down, the load is not growing as it has in the past.
    And, my experience in the utility was, we were very, very good
    at predicting nice, steady growth or nice, steady leveling off.
    But we could never quite hit it right when things either
    started growing fast or they started going down.
        I see this trend to try and lower things because of the
    economy. If our economy turns around, especially with the
    activities we have in Silicon Valley, where so many of them
    have reduced their consumption, they can add that back in
    literally months. And then, I think we are going to very
    quickly get into a concern.
        My guess is that if things go normally, the economy doesn't
    rapidly recover, we are probably good until 2006, 2007. If
    things don't go well or if they go well and the economy picks
    up but we have less additions and there's no more added
    generation, I think as early as 2005 we could be getting back
    into a problem. And, if bad weather in 2004, we could get into
    trouble.
        So I know that's not a clear answer, but forecasting load
    is not a real science. My feeling is, we need more generation.
    But even more than that, we need some transmission. And, one of
    the things that George said that troubles me a little bit,
    mainly because maybe I don't understand it, was the
    identification that the MD02 design was not friendly to
    bilateral. I think what he's referring to is that, the design
    does not guarantee, if you will, transmission for bilateral
    contracts. And, I would certainly agree with that. But as far
    as bilaterals, with the design, bilaterals are done completely
    outside the market and are just a way of getting resources in.
        So now we get to the point of do we have sufficient
    transmission. And, the answer to that is clearly no. But that's
    not a market design that can provide that. That's something
    that we've got to sit down, and while MD02 tries to indicate,
    through the nodal identification of constraints and power costs
    that you need a transmission line, I don't think it will ever
    be sufficient to be the total driver for the addition of
    transmission.
        So while MD02 is a portion of it, there's all kinds of
    other parts of the procurement of power, the addition of
    transmission, the building and adequacy of the generation,
    demand side, distributive generation, that all has to be pulled
    together. I feel MD02 gives us a basis to work on those. But it
    by itself cannot solve all the problems.
        Mr. Ose. So you have a draft report that indicates using
    what I would describe as conservative assumptions from power
    transfers from the Pacific Northwest, that in the summer of
    2003 we have 3,200 more megawatts available under ``normal
    circumstances'' than we have demand for?
        Mr. Winter. Correct.
        Mr. Ose. Which is about 6 or 7 percent of the total market?
        Mr. Winter. Right. But now realizing that I've already
    added my reserves, which are 6 to 7 percent, so if you put
    those together, you're about the 12 percent that I've talked
    about. But next year, if load growth occurs and we don't have
    any new generation, which I am not seeing being built in
    California, then I think we start cutting into that 6 percent
    very rapidly.
        Mr. Ose. So if the total, I just want to make sure I
    understand this from a generic standpoint, if the total market
    is around, let's say, 50,000, total market load is 50,000
    including the reserves 6 or 7 percent, you've actually got
    around 53,000 megawatts available against a market demand of
    around 47,000. Those aren't the exact numbers, I know that, but
    I am trying to get it clear it my head.
        Mr. Winter. Right.
        Mr. Ose. And then, you've accounted in your out years using
    some assumptions that we will be short in 2005 or 2006, again
    depending on how fast the economy grows and whether something
    goes down and what have you. But in any case, it's not a
    particularly optimistic scenario.
        Mr. Winter. And again, that's not our study. We look at the
    short term. But that was just my feelings based on the
    experience I've had in utilities.
        Mr. Ose. Well, I came to Congress from business, so the
    economy is at the heart of what I pay attention to. I want the
    economy to come back. Trust me, I want it to be just
    percolating like crazy. If my objective and that of so many of
    my colleagues here is achieved, that is, if we get economic
    growth of 2.8 or 2.9 or 3 percent per year, what I hear you
    saying is that we are going to be in a box, so to speak.
        Mr. Winter. I would certainly concur.
        Mr. Ose. OK. That's kind of where I am at. That's one of
    the reasons I want to get the design done. I want to get these
    things aligned and in place and moving.
        Mr. Winter, you and I have had this discussion about
    whether or not the CAISO is independent. We are not going to
    rehash that today. I do want to talk a little bit about the
    stakeholder process, whether or not the people, for instance,
    sitting between Mr. Wood and Mr. Fraser have been part and
    parcel of the deliberations that CAISO is undertaking. For the
    stakeholders, let me just make sure I've got it correct. Are
    you guys being consulted with relative to the design of MD02?
    Is that consultation taking place on a satisfactory level?
        Mr. Ackerman. I don't think that my members would agree
    that consultation is taking place. There's an education process
    that's going on, whereby the ISO staff educates the market
    participants, who I represent, and Jan represents as well, as
    to what the ISO is thinking. We have some limited amount of
    input. It has not been the feeling expressed to me by my
    members that they are part and parcel, they are somehow
    partners in terms of designing this marketplace as it was once
    upon a time, let's say, back in 1997 or 1998.
        Mr. Fraser. I would agree with that. I would support what
    he said. To illustrate that, I believe there's an RFP out for
    software to basically run the MD02 system put out before our
    input has been entirely included in the design process.
        Mr. Ose. Mr. Smutny-Jones.
        Mr. Smutny-Jones. I think that there is a great deal of
    concern of how well the stakeholder process has been working. I
    would concur with what Mr. Ackerman suggested with respect to,
    it's more educational than anything else. We have put together,
    with some other parties, a formal stakeholder advisory
    committee proposal to the ISO and ISO board for their
    consideration. That is crafted along the lines of other
    stakeholder advisory committees that currently exists in other
    successful markets, like PJM, for example, where there's a much
    more, a process we believe takes input from the marketplace.
        We think this is important for a couple different reasons.
    One is obviously getting input from people who are affected by
    the market, I think, is a positive thing. Two is, it does
    reduce the amount of things we ultimately then need to litigate
    before Chairman Wood's commission. If we can resolve these
    things in California before they get to Washington, we can save
    an awful lot of time and a lot of money. So we basically
    believe there needs to be stakeholder reform in California.
        Mr. Ose. Mr. Winter and Mr. Wood, I direct this question at
    you. The stakeholders are saying they'd like to have some
    direct line of input into this process that's formal in nature,
    with voting and all this other stuff. What's your reaction? Mr.
    Winter first, apparently it doesn't exist now to their
    satisfaction? Is there another view to this?
        Mr. Winter. Well, certainly I have another view. Not to
    debate what they have said, because what your customers, all of
    them say is reality, whether you feel it's the truth or not. I
    guess after probably 5 years of sitting through more meetings
    than you can ever imagine with input from everybody I can also
    imagine, having agreements then filing your filing and having
    people contest it at FERC anyway because your decision was not
    to agree with them, has kind of left me a little bit less than
    willing to accept that we didn't have a process. I forget how
    many hundreds of meetings, how many manhours we've spent trying
    to bring people along.
        I think it is a fair criticism that after input for a
    couple of years we move forward. But trying, and this is what I
    am going to pass to Pat a little bit, because during the summer
    of 2002, we were concerned about this very fact. Because we had
    put together the design, we had modified it constantly with
    people's input, we had tried to go to chat rooms, we had tried
    to do everything we could to get information from folks.
    Finally, somewhat in frustration, we asked FERC to come out and
    hold some technical working conferences on MD02, so that if for
    no other reason, they could see that we at least had tried to
    get the input in some rational way.
        They held those meetings, I guess, Pat, I don't think they
    were all that successful, but nonetheless, we had them and got
    input. And, so we have moved forward.
        Now, let me also address the problem, if the example is
    that you've gone out for an RFP, let me tell you that four
    Senators from California sent me a letter and said, you will
    not move forward on----
        Mr. Ose. California has four Senators?
        Mr. Winter. Well, four of them that sent me a letter. The
    State, they have--it feels like 100. But nonetheless, they had
    requested us not to go forward until we had done an LMP study.
        We sat down with representatives of those folks and clearly
    laid out that the reason we needed to go forward was to keep
    things on schedule, and that we needed input from the designers
    of the system to No. 1, give us schedules, No. 2, give us
    alternatives that we could put into the design so that we could
    determine whether or not we could accommodate many of the
    things that people were asking us to do.
        So we proceeded with that. Nothing is cast in concrete. The
    board has committed to the State Senators that they in fact
    will not go forward until we have reviewed all the issues.
        So I guess I feel we've made quite an effort to do it.
    You're never perfect on getting everything to everybody's
    satisfaction. But the idea to slow down, slow down, kind of
    disturbs me, because most of the things we are doing are either
    in place in other ISOs and where markets are well running, and
    certainly I think there are some issues around FTRs or CRRs as
    to how we are going to allocate transmission. But one of our
    major problems is, we don't have adequate transmission and
    we've got to come up with a way to allocate that to people and
    some of them have existing contract rights, which we have to
    carve out and protect.
        So we are where we are, and we are trying to do the best we
    can to get that input. We are modifying the design every day as
    people come in. We just spent 4 days or 3 days last week
    walking everybody through every step of the process of the
    design and how it's going to work, so that they could give us
    input.
        Mr. Ose. Commissioner Wood, how valuable is the stakeholder
    process that you utilize over at FERC? I don't know if it's
    institutionalized or otherwise.
        Mr. Wood. We certainly, in setting up all the other
    markets, and just to take an example, one that's going on right
    now in the Southeastern United States, have a formal
    stakeholder committee, which is not just everybody showing up
    in a room with their designated representatives from each kind
    of constituent group who comprise the committee. So it is a
    manageable, diverse group that does not, is not mandated to
    agree on everything, but is mandated to get to, as close to
    consensus solutions on major issues as you can get.
        It is very valuable. It ultimately goes through the ISO
    board up to the Commission. It's very valuable to know that a
    proposal has been vetted through the stakeholder process. Those
    stakeholders do have the right, which you can't deprive them
    of, to directly address FERC on their concerns about the ISO
    solution. I don't think that anything would ever really change
    that. But certainly folks in my position, including me, do look
    at whether a process has been, or a new procedure has been
    vetted through a stakeholder process. I think these are too
    important not to do that.
        But on the other hand, an independent view has to be looked
    at as well. That's why we do value an independent board's
    review of what stakeholders come up with, to make sure that it
    not only advantages stakeholders, but ultimately is good for
    the public, it is good for the broad industry. And, there will
    be at times proposals that can make it through a stakeholder
    process that are not in the best interest of the public. And,
    we've got to always be able to say no to the stakeholder
    process. But that's what I think Terry and his folks are going
    through. It's probably the most difficult place in the country
    to do a multilateral negotiation on issues related to
    electricity that I could ever imagine. So I don't know that
    it's a necessarily textbook example.
        Mr. Ose. All right. I want to move on to the seams issues
    here. We have 11 different States, we have Canada, we have
    Mexico, we have plans to generate in each of these 11 States.
    We have transmission lines, we get a lot of power from Power X.
    We have facilities south of our border with Mexico that are
    under construction, if not already producing. And, the sum of
    that is that on any given day, we may import a significant
    amount of power from outside the State and then on any given
    day, when we have surplus, we may export power outside the
    State.
        The issue here is how do the market places interact with
    each other? In other words, if the rules in one area are
    different than the rules in another, how do you stitch them
    together? That's that seam between the issues. Now, Mr. Winter,
    in your testimony, you talk about a working group, the SSIWG. I
    can't remember what the acronym is. Seam Steering something or
    another Dash Working Group. And, you talk about how they
    interact.
        My concern is that we don't create a market design in
    California that makes it impossible to import from other areas
    or export when we have surplus. So what are the leading
    concerns on that particular aspect that you're dealing with?
        Mr. Winter. Well, I think first off that group has been
    tremendously successful in at least identifying the problems.
    It's one of the reasons that we tend to support FERC's SMD as
    it makes these different issues, somewhat gives you a framework
    to work off of.
        I would say probably the No. 1 contention is going to be
    how are you going to handle congestion, management of the
    transmission system. We've chosen locational marginal pricing
    because it has worked in the Northeast and PJM and New York
    models. I don't think that the others are quite there yet. But
    at least we are talking to them about it.
        I think a bigger concern oftentimes that I have is, I think
    there will be ways to work out the market issues. But some of
    the timing issues around the real time operation get to be
    major. In other words, if one market is accepting changes and
    bids up to 20 minutes before they dispatch the power----
        Mr. Ose. As opposed to 10 minutes.
        Mr. Winter. Right, as opposed to 10 minutes or 5 minutes or
    wherever we get, those are the kinds of issues that have to be
    resolved in the design phase, so that the operators don't have
    to try and deal with that in real time.
        So you know, I can't list all the things they've gone
    through, because they've been going through an evolutionary
    process of whether they're going to use flow gates or they're
    going to use LMP or they're going to use zonal or how they're
    going to divide their markets up. I think the main thing
    California has to do is stay flexible so that we can
    accommodate most of those. I think if we get the operational
    time lines, then we can work out the others as long as there's
    transmission capacity to bring the power in. That's a real
    time, every 10 minute issue of whether or not you have
    sufficient transmission to get the power in.
        Mr. Ose. Do you think you can handle this through agency
    action, or do you need direct legislation?
        Mr. Winter. My 'druthers is, I don't like to push anybody
    into joining the ISO or having to live with the market. So one
    of the things we have done a tremendous amount of is trying to
    make it flexible enough to accommodate everyone. On the
    municipal side, we've developed what we call metered subsystems
    that allow them to operate their systems pretty much away from
    what the ISO does and what the markets do. I think we would
    offer the same type of opportunities to the regions outside.
        Mr. Ose. This brings me to one of the things as a consumer
    that I am most interested in seeing effectively implemented.
    And, that is when you get to this interaction or this interface
    between, if you will, the RTOs from different geographic areas,
    how do you ensure that the behavior at that point of interface
    is properly occurring? In other words, do you need a market
    wide monitor, so to speak?
        Mr. Winter. Yes. Clearly one of the things at the ISO, we
    identified many of the gaming activities that were going on
    inside our borders and we could suspect them on the outside.
    But once you went outside the State, we really couldn't
    determine whether someone was behaving according to the rules
    or not. So I clearly support the FERC's West-wide market
    monitoring activities.
        I would say that I think there is a need for the local
    monitors also because they're sitting there, right there
    watching the market every day, move up and down. Therefore,
    they can identify problems more quickly than somebody at a
    regional area who has to then monitor the interfaces and may
    not see the data for several days or even weeks.
        Mr. Ose. Mr. Wood, if I understand this particular concept,
    FERC would be the agency to whom this independent market
    monitor would report?
        Mr. Wood. Correct.
        Mr. Ose. And, the tool that they would use perhaps would be
    the, either the reports from the field, from these people
    deployed into the different markets, or the data gathering
    machinery or equipment you have over at the headquarters?
        Mr. Wood. Or their own independent analysis. They could
    depend on the folks that work at Terry's shop or in the
    Northwest or in the desert Southwest. Again, we are pretty
    flexible in how the different regions want to set up the market
    monitoring function. But we do require that there be a
    component of it that answers directly to us that's not
    responsible to Terry to tell him he's doing good, but could
    actually talk directly to us and also to the appropriate State
    regulatory authority at the same time. They could use a variety
    of tools, ours, theirs, and a third set, their own.
        Mr. Ose. Ms. Tomcala, in the context of an IOU, whether it
    be you or San Diego Gas and Electric or Southern California
    Edison, is a West-wide market monitor a necessary component of
    making these different RTOs operate efficiently?
        Ms. Tomcala. Absolutely.
        Mr. Ose. So just from an industry perspective, obviously
    you're not speaking for anybody other than perhaps PG&E, you
    would support having an independent market monitor to govern,
    if you will, the interactions?
        Ms. Tomcala. Yes. And, we have supported that in written
    comments to the FERC, both associated with Order 2000 a couple
    of years ago and associated with the SMD proceeding.
        Mr. Ose. Mr. Ackerman, do you share that opinion?
        Mr. Ackerman. Yes, we do. The three most important points
    that have to be done on a regional analysis, and I just want to
    emphasize that the members of my group are of course trading
    across all the Western States, not just in California, is
    resource adequacy, which we've talked about a little bit.
    That's the bean counting function--do we have enough supply in
    order to meet demand under various conditions?
        Second is market monitoring, which you're asking about
    right now, we do need a West-wide monitor. We want to have it
    under an apolitical, to the extent that's possible, an
    apolitical umbrella so we don't feel as we do today that what
    occurs in California is under the guise and under the direction
    of an ISO governing board that's quite biased, quite biased
    against us.
        And, finally, congestion management of the transmission
    system. Those are the three most important things.
        And, I'll reserve specific recommendations after that.
        Mr. Ose. Mr. Smutny-Jones.
        Mr. Smutny-Jones. Yes, we obviously believe that there
    needs to be regional market roles. I'll even go one step
    further. I am not necessarily advocating an ISO amongst the
    entire Western United States, but there needs to be basic rules
    that are understood on a regional basis. It's important that it
    not only be monitored regionally but also enforced regionally.
    And, I think here's an area that probably requires some further
    exploration, given the fact that this is interstate commerce
    and you do have different States that have obviously very
    different views on how this might work.
        But we are very supportive of the concept that if, you
    know, we have a regional market, an interstate market, and
    those rules need to be both monitored and enforced by a
    regional market monitor.
        Mr. Ose. Mr. Fraser, what's your input on this?
        Mr. Fraser. I totally agree. We both purchase in the
    Northwest and Southwest and sell into both markets, and have
    the same concern that we not get way out in front of the
    designs in those other areas, so that we move ahead in concert
    with them, rather than way ahead of them.
        Mr. Ose. Anybody else want to offer? Mr. Winter. Ms.
    Tomcala.
        Mr. Ackerman. Could I just add one thing? Chairman Wood
    reminded me of one element that's also important on a regional
    basis, which is transmission planning. I was thinking it, but I
    didn't say it. So add that to the list. That would make four
    essential elements.
        Mr. Ose. Just a moment here. Mr. Winter, you brought up the
    issue of local market power. What I believe you were attempting
    to convey is concern about the ability of a sole source to
    control pricing and availability and the like under a certain
    set of circumstances where transmission into an area may go
    down and the like, so that there is no alternative means of
    providing power.
        You said something that I don't quite understand. You
    stated that there was a need for additional mitigation measures
    for plants that have local market power. The question I have is
    that under a normally functioning market, the competitors for
    that particular producer would move into that market and
    attempt to sell or create power generation. And, it would seem
    to me that at least under a pure theory of markets, putting
    artificial constraints on local market power would serve as an
    adverse incentive to bringing that power in.
        Can you reconcile that?
        Mr. Winter. Clearly it is going to put the impact of not
    wanting people to generate or build new generation in that
    area. On the other hand, no one is going to build a new
    generator if in fact the line outage is for 2 weeks during the
    year and that's the only time you need to mitigate it.
        So if you have a generator who is located in a very
    isolated spot, you have two transmission lines going into the
    area, one of them goes out, therefore you can't get any power
    from outside the area, the only guy you can call on is the guy
    located right in the area. He has no restraint on his prices
    now.
        Mr. Ose. So how would you deal with that?
        Mr. Winter. Well, the way I would deal with it is as much
    the method that PJM has of dealing with it. What they do is
    they have established a price that the generator is entitled
    to. If something happens to the system so that they clearly
    have market power and the prices start going up, they just
    mandate that the person operates at that cost.
        Mr. Ose. Mr. Wood, under a scenario like that, how do you
    ever bring new generation to that marketplace? Who would ever
    put their capital at risk?
        Mr. Wood. It would be difficult if that were the only tool.
    One that the New England market redesign has proposed is to
    let, local pockets happen. They just do, because you've got
    industry that for 100 years was encouraged to be concentrated.
    So now we are trying to disaggregate it to get competition to
    work. So it may be transitional, you know, a couple of years to
    get transmission built or until you sell generation plants to
    various companies, so there are competitive forces at work.
        But I think of southwestern Connecticut as kind of that
    constrained example. Probably the north peninsula in San
    Francisco down to probably Palo Alto area, is similarly
    constrained. What they have proposed in New England, and just
    adopted in March, was to set the price cap, basically, at the
    cost of what a new entrant would charge to recover his costs
    fully. So that could in fact be higher than the formula Terry
    was just talking about.
        But it is one that I think we've heard from both generators
    and regulators and customer groups alike, that seems to
    probably hit the right balance. Because I think everybody
    recognizes that local market power exists and really can't run
    unabated. But the really bigger debate at our level so far has
    been, so what's the right way to address that local market
    power. Do you do it through a cost plus formula or through a
    proxy for the new power plant, what he would cost to enter into
    the market.
        Mr. Ose. Ms. Tomcala, how does PG&E deal with situations of
    this nature?
        Ms. Tomcala. Well, in the past we've had RMR contracts to
    deal with this. Going forward----
        Mr. Ose. Share with us----
        Ms. Tomcala. I am sorry. Reliability Must Run contracts, we
    use the acronym so often it's hard to get out of them. There
    are mixed reviews about how well that has worked in the past
    and whether that approach fits in with a fully competitive
    market going forward. So we have some proposals at the ISO
    through the MD02 process that we are addressing as possible
    alternatives for RMR.
        Mr. Ose. And, those would be coming out of the deliberative
    process some time after November?
        Mr. Winter. Good question. I am not familiar with exactly
    what proposal she's talking about. But clearly it would have to
    be coordinated with the November procurement and whatever the
    State came up as the requirements.
        She mentions RMR, and I think that's a perfect example,
    where you just can't look at the cost of generation, because in
    the example I gave, you could build a third transmission line,
    and that may be the least expensive alternative. So all these
    have to be coordinated. I am sorry, I don't know exactly what
    her proposal was in the program.
        Mr. Ose. Mr. Ackerman, how would your members react to this
    kind of thing?
        Mr. Ackerman. Well, they agree that it's a thorny problem
    in terms of identifying where market power exists and how to
    mitigate it. But here's what's really far more scary. When I
    was at the 4-day MD02 workshops ISO conducted last week, the
    scary part was, they said, we are going to apply this
    mitigation measure for local market power everywhere except for
    points where power comes into the State and interconnects with
    the ISO and in the middle of the State, where we have Path 15,
    that's south of your district, and south of that, Path 26.
        But everywhere else, the ISO will assume that local market
    power exists and we are going to apply these market mitigation
    rules. So your supposition is absolutely correct. Why would
    anybody invest in an area where we have this difficult load
    pocket to deal with, but now apply it to a much broader area,
    that includes the whole Bay area, Humboldt County, Round
    Mountain, Los Angeles, San Diego, the eastern part of
    California and on and on. And, they are going to start there
    because the ISO doesn't believe that there's sufficiently
    competitive markets in order to take off these ``mitigation''
    shackles, as it were. So people are not going to invest.
        And, when we get into the definition of partnering with the
    ISO to say, well, where do we start solving this problem, I
    think the first question is where do these problems truly
    exist? We will have to come to some compromise solution.
        Mr. Ose. Well, let me flip it around on you. There's a
    price cap of $250, if I understand it. Are you saying that $250
    is not a sufficiently high price for a power generator to come
    in and build a plant?
        Mr. Ackerman. I would say for a power plant that only
    intends to operate 1,000 hours or less a year, $250 is nowhere
    near enough.
        Mr. Ose. To cover that gap?
        Mr. Ackerman. To cover that gap. Now, we are not talking
    about a cap of $250 when we talk about local market power
    mitigation. We really don't know what number it might be.
    There's no dollar number floating out there. But I'm darned
    sure it's less than $250/mwh. We wouldn't be spending time
    talking about this topic if it weren't.
        Mr. Ose. Mr. Smutny-Jones, any input on this?
        Mr. Smutny-Jones. Well, it's certainly not a new problem.
    Obviously it's being handled elsewhere. I think the
    Northeastern approach actually is a variation on something that
    was looked at in California a while back to deal with San
    Francisco, because San Francisco is a load constrained area. At
    the time we were looking at a, I guess it was a bid cap at a
    level of the new entrant or the closest adjacent competitive,
    what's called a node, or substation. In other words, there may
    be other reasons why the prices in the market are high that
    have nothing to do with the location of the unit. And, the
    person who owns that unit shouldn't be harmed by that.
        We also had a large number of RMR contracts when we first
    set the market up in California. And, it was a great deal of
    effort. We took a great deal of pride in the fact that we
    removed a significant amount of these RMR contracts, both in
    northern and southern California. So that is yet another way of
    dealing with this issue.
        I share the concern that market power and concerns about
    market manipulation have sort of tainted everything. So what we
    are doing is, we are spending an inordinate amount of time
    focused just on market power and not on designing a market that
    I think Commissioner Wood talked about, or Chairman Wood talked
    about earlier, that if you have adequate resources, and there's
    real competition, the market power problem really doesn't
    arise.
        Mr. Ose. Mr. Fraser.
        Mr. Fraser. Well, I'd like to add another level of
    complexity to all this. I suppose one of the paradoxes in our
    business going back to the earlier comments about the need to
    have sufficient resources to meet all the load plus a 10 or 12
    percent reserve, the paradox is that you have a power plant and
    you hope never to run it.
        So you've got to, within your market design, figure out
    some way to accommodate that. In many cases, it might be an old
    plant that used to run efficiently but nowadays is held in
    reserve. And, ideally, if nothing goes wrong, it is not run. So
    you've got to have a market design that would accommodate the
    owner of that plant, so that he or she would keep it in
    operation and ready to start when needed.
        Just to support what Mr. Ackerman said, we have a number of
    combustion turbines that when things are running well, they are
    not operated, other than maybe 40 or 50 hours a year. In the
    bad old days in 2000 and 2001, they were run right up to the
    limit of their resource availability. But in normal years, if
    you look at the cost on a per kilowatt hour basis, if you judge
    it on per kilowatt hour, it's very high. So the capacity
    adequacy issue is indeed pretty complex when it's essential
    that we have a very reliable electric system.
        Mr. Ose. I am sitting here listening, and I have to say I
    am somewhat confused. The argument that was just made regarding
    local market power would serve to protect if you will the
    oldest, most inefficient producers that are doing the most harm
    to our environment, producing the highest cost power in our
    marketplace. That is the net result of this particular
    potential policy, is that the dinosaurs of our industry end up
    getting protected in lieu of replacing them with far more
    efficient, far lower cost producers.
        And, I have to sit up here balancing the different
    objectives we have of power for our people and capital
    allocation that produces plants and protecting our environment.
    I am sitting here scratching my head, how do you reasonably
    come forward with a policy, the net result of which is that we
    have dirtier air than we might otherwise if we replaced that
    old plant with a more efficient plant in the first place? Would
    any of you care to comment on that? Commissioner Wood.
        Mr. Wood. I think it clearly points out the need for
    sufficient transmission. The best solution to a clogged up
    local market power plug is to have more highways into that
    congested area. Now, there are parts of California, as there
    are in any other State, that are very, very difficult to build
    in. So there will be places like New York City, probably like
    San Francisco, we've got an upper Wisconsin, southwestern
    Connecticut, where you've got significant environmental
    pushback.
        And, I think what we are seeing certainly with the rate
    design changes that were introduced in Connecticut is, OK, then
    the people that live there see the price impact of those
    choices. So the choices to run an expensive unit and not to
    have transmission result in the bill not being paid by everyone
    in New England, but now by people in that part of Connecticut
    getting paid. So that's one of the harsh realities, but good
    realities of some of the changes in MD02, which I think Terry
    indicated they're able to mute. But with locational marginal
    pricing, we start to see the costs of these environmental
    choices or non-choices that then get paid by the folks who make
    those choices as opposed to spreading the costs to everyone
    else.
        Mr. Ose. Well, if I understand the investor owned utility
    structure in California, which delivers a significant
    percentage of the power, those costs are aggregated and then
    spread to the entire ratepayer base.
        Mr. Wood. They are.
        Mr. Ose. So in effect, it's----
        Mr. Wood. It's muted.
        Mr. Ose. Yes.
        Mr. Wood. But nonetheless, those signals are identified so
    that these transmission planners and the utilities who will go
    fix the problem will know exactly where it is and can make the
    case to the PUC, who's got to prove it on need and on cost
    benefit, that in fact this is costing PG&E in the aggregate $80
    million a year. This is a $200 million line. It pays for itself
    in whatever, 2\1/2\ years. That's something that a regulator
    can say, yes, hard as it is to site, it's worth doing.
        Mr. Ose. I have to tell you, this is an amazing argument,
    but I find myself beginning to subscribe to this issue of
    environmental justice. Because what you're laying out is
    someone who makes a conscious decision to not build
    transmission and not build generation for whatever reason,
    basically shifting the responsibility to somebody else
    accordingly. And, I can't see that's very good policy.
        Mr. Wood. Plus the environmental point.
        Mr. Ose. Plus the impact. I mean, my air quality is bad so
    somebody else doesn't have that issue.
        Mr. Ackerman.
        Mr. Ackerman. There are two other creative elements that
    would allow people in a load pocket to reduce demand. One is
    demand bidding, of course, which allows large users of energy
    to every day, maybe even every hour, to enter bids as to how
    much they would be willing to be paid in order to shut down
    operations. And, the other one is real-time pricing.
        But here's the problem. Jurisdictionally, those items are
    on the State side of the line, not on the Federal side of the
    line. It becomes somewhat messy in terms of how to coordinate
    those two sides so that you have a coherent policy. It's not
    possible for FERC, for example, to go to a State and say, you
    know, you really ought to be doing demand-side bidding.
    Although they can give it lip service, and they have in many of
    their polices and many of their orders. But they can't go all
    the way. The States must pick up the slack.
        Mr. Ose. And, Mr. Winter, in your testimony, you talked
    about some of these permutations, if you will, on the demand-
    side. Are these part and parcel of the design that you're
    talking about?
        Mr. Winter. That is certainly one of the ways of meeting
    your capacity requirements. So if the State decides that they
    want to identify demand-side reduction, let's just take San
    Francisco, for example, because that is, as Pat Wood said, a
    constrained area. So if you look at that particular area, in
    regard to being constrained, and I am sorry, what was the
    question? I lost you.
        Mr. Ose. Whether or not these demand-side reduction
    provisions are part of the market design discussion.
        Mr. Winter. Right. They are not part of the design, but
    they would meet the requirement. And, at such time as those
    particular areas became constrained, then they would use the
    demand reduction to allow the sufficient generation to get into
    the area.
        Mr. Ose. I believe you just told me it's one of the tools
    that would be available.
        Mr. Winter. Correct. But not through the design itself. It
    just has to be, everybody keeps saying, put that in the design.
    I think they're talking more broadly of the design of how
    energy is going to be provided in the State as opposed to MD02,
    which is really the design of how the market would work.
        Mr. Ose. All right. Mr. Smutny-Jones, do you want to add
    anything on this, on local market power?
        Mr. Smutny-Jones. Only to emphasize that we do share your
    observation and concern with respect that the cure is worse
    than the disease here. In using San Francisco, not just to pick
    on them because I am from Sacramento, but there is a
    significant constraint there, we've debated this now for 6, 7
    years. It seems to me that we can resolve this. If you set your
    price gap but also allow people to bid into the closest
    competitive node, you need an LMP to do this. Then you remove
    the problem that I think you're observing, which is you're not
    giving people any incentive to basically build there.
        I also think it does in fact send signals to policymakers,
    even if you peanut butter as they say, the rate impact of this.
    It does give the utility and the policymakers real information
    in terms of what it's really costing to serve a particular
    area. That is absent right now.
        Mr. Ose. Mr. Fraser, any input?
        Mr. Fraser. No, thank you, Mr. Chairman.
        Mr. Ose. My last question here, I am concerned about the
    market design being such as to prevent the gaming that occurred
    such as Death Star and Fat Boy and all the others that have
    gotten such play in the modern lexicon. Mr. Ackerman, how do we
    embed in market design the structures that prevent that kind of
    gamesmanship?
        Mr. Ackerman. I think that moving to a system that's been
    given the initials of ``LMP,'' which means the locational
    marginal pricing, goes a big step toward preventing the type of
    gaming you saw previously. And, I don't want to go into so many
    details that I lose the point here.
        I think that the Market Design 2002 is heading toward
    several positive charges; one of them being locational marginal
    pricing, another trying to specify how they're going to
    mitigate prices globally, and third, how they're going to
    mitigate prices on a local basis. Those three things alone will
    do a lot to remove the worry that I think consumers should have
    that they're being subject to the kinds of games that were
    identified in previous hearings in the State of California and
    many, many other reports.
        But to answer your question more broadly, I believe the
    whole industry has matured, because we've been exposed in the
    public light. There's a lot of public anger about what has
    occurred. With MD02 or without MD02, trading is not going to
    look like it was before.
        So I wouldn't rest upon MD02 to solve all the problems and
    assure people that everything is going to work cleanly. If
    there is a charge, it comes right down to the individuals who
    are making decisions on the trade floors. How are they going to
    make those decisions? I think now they understand that what
    they do, what they say and who they report to has the light of
    public review. I don't think anybody ever considered that or
    dreamed it, way back when.
        Mr. Ose. Commissioner Wood, same question. How do you use
    MD02 to prevent market manipulation in the future? What
    specific tools need to be in it?
        Mr. Wood. I think it was the most clear consensus item I
    heard from my fellow panelists here today, is get that resource
    adequacy requirement in place as soon as possible. I heard that
    from the folks who would build and trade, from the man who
    operates the grid, from the utility that both public and
    private view, have customers and who also have generation. I
    think it is the cleanest way to hop over all the noise about
    the California being a bad place to build, etc.
        If you have customers who have authority and ability to
    pay, which is an important issue with the large IOUs,
    certainly, to be dealt with hopefully soon, then all the rest
    of this work, the ability to manipulate again is exacerbated
    when you have insufficient supply and I think the market rules,
    certainly I can't pass that up. We clearly have to get
    congestion allocated in a better way. The price signal is being
    sent to not only builders of power plants, but to customers and
    to transmission builders about where investment is needed.
        But clearly steps to keep the supply bubble ahead of that
    kind of tight level that Terry laid out for 2004. That's not
    just jump up and down kind of news for me. Any steps that can
    be taken in the very near future to send that buy-ahead signal
    to developers of all sorts, to come into California and start
    building again, would be very welcome.
        Mr. Ose. Mr. Winter, how do you use Market Design 2002 to
    prevent the manipulation?
        Mr. Winter. First off, I agree both with Pat and Gary.
    Clearly if you have plenty of resources there, people don't do
    things that they normally do. On the other hand, I don't think
    any generator is going to build based on his ability to try to
    game the market, if you will. And, clearly, the LMP allows me
    as the operator to quickly identify the problem and get right
    on it.
        Because the dilemma we had with the old design was that
    people could actually in the day ahead congest lines. Then,
    when we got to real time, I had to solve it because the models
    didn't tell me that it was congested until I got to real time
    and saw the line overloaded. Then I had to take action. And, it
    was just a beautiful opportunity to game things by scheduling
    loads such as to cause congestion.
        So I think that will help. Clearly, getting more generation
    and transmission, it isn't just generation, because right now I
    sit with power in Northern Mexico and power in southern
    Arizona, and because of transmission constraints, I can't get
    it in. I've got to have a way to increase that capacity and
    make it available.
        And, I look at the transmission system as an enabler for
    the markets, and it's really a rather small percentage of the
    cost of energy. Therefore, let's try and get some lines built
    that will relieve it, then you allow the generator to build in
    more places he would like to where he's got water, transmission
    service, etc. And, then, we can move forward. But if we keep
    constraining it, even if you build all the generation in the
    world, if I can't get it to the load, it doesn't do me much
    good.
        Mr. Ose. Ms. Tomcala.
        Ms. Tomcala. Yes, we can all agree, I think, on this area,
    and that's a nice thing. Adequate resources, clear rules,
    independent region-wide monitoring, and the ISO has done some
    things already in the MD02 process in conjunction with FERC
    that help. There are some screens in place now, an impact
    screen, a conduct screen, and a reference price, all of which
    give the monitor something to look at, to give a quick check to
    see if everything's in place or if there's a problem. And then,
    FERC's ability to act when they do see a problem coming out of
    those screens.
        Mr. Ose. Mr. Fraser.
        Mr. Fraser. I couldn't agree more. Resource adequacy has
    got to come first, I think I made those comments earlier.
    Particularly transmission, and I think you've got to look at
    transmission a little bit different from the traditional least
    cost planning, and view it from a strategic point of view that
    transmission brings more than just the cost in the cost benefit
    analysis. It brings reliability as we've discussed, it's a very
    effective tool in mitigating gaming, and certainly not the
    least of which it facilitates inter-regional transfers,
    particularly in the West, where we have major temperature
    differences between California and the Northwest that we at the
    NCPA have taken advantage of for some 15 years.
        Mr. Ose. Mr. Smutny-Jones.
        Mr. Smutny-Jones. I think what the other speakers are
    saying is very similar to my observations here. I think it's
    important that we learn lessons from what happened in
    California but we don't learn the wrong lessons. Unfortunately,
    there's a lot of people who I will call neo-monopolists that
    sort of want to go back to some other model that frankly didn't
    work all that well either. I think as we move forward, the
    market redesign that's being proposed here needs to parallel
    other markets that we have real world experience in. And, I
    think we are almost there.
        But that real world experience is based on using the LMP,
    which does have a very high level of transparency associated
    with it. I think all the people on the panel have indicated a
    set of regional rules that are monitored and enforced
    regionally that basically, whether you call it megawatt
    laundering or arbitrage or ricochet or whatever, the rules are
    the same in Sacramento as they are in Portland as they are in
    Phoenix, people will behave according to those rules.
        So we need to basically, I think, move in that direction so
    we actually do have, that we do in fact learn from what
    happened in California and we do not have a repeat of that in
    2005 and 2006.
        Mr. Ose. I want to thank you all for coming today. This has
    been educational, to say the least. I am not particularly
    comforted by what we talked about relative to the current
    market design that exists in California. I still happen to
    think we can do better. I think the current design leaves us
    vulnerable to manipulation. And, I am not convinced that we as
    a State, that is California, have yet to address the
    fundamental flaws in its market.
        I don't believe we are done with this situation. I don't
    think we are going to have rosy markets forever. I think we've
    got maybe a year to get this thing under control before we have
    another crisis. Frankly, I don't think we can afford to let
    that happen. To the extent that, Mr. Winter, you can expedite
    the market design and the rest can provide input to get us to
    closure on that, I think that's a critical piece of the pie
    here, to getting the California market fixed.
        Absent a fix, we are not going to have any investment,
    whether it be generation or transmission, whether it be public
    or private, whether it be munis or utilities or third party
    merchant generators. We'll be stuck with old plants at high
    cost and high pollution and that's not a future that I really
    want to have come to pass.
        This Member of Congress is going to stay focused on this.
    You have a basic piece of the economic puzzle that you're
    working with. My objective is to get lower prices for
    ratepayers and have it delivered in a fashion that allows
    people to have power when they turn on the switch and clean air
    when they want to breathe. I hope CAISO's Market Design 2002
    works out. I am here to tell you I am going to be watching, and
    if necessary, we will have you all back here again, because I
    know you enjoy it.
        Thank you all for coming. I appreciate it. This hearing is
    adjourned.
        [Whereupon, at 4:54 p.m., the subcommittee was adjourned,
    to reconvene at the call of the Chair.]
        [Additional information submitted for the hearing record
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