[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:]
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    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:]
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    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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