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Enron's Lay: Rules for Power Market 'Aren't Right'

Enron's Lay: Rules for Power Market 'Aren't Right'

Although the focus of last week's "summit" in Ohio was spiraling winter gas prices, Enron Chairman and CEO Kenneth L. Lay used the opportunity to take a few shots at deregulation in the electric industry in general, and the California market specifically.

While he conceded some of the problems plaguing the power market are due to the fact that it's in the "early stages" of deregulation, Lay also blamed federal and state regulators. "The rules aren't right on interstate transmission.....and obviously they're still not right at the state level as you get down to the retail [market]," he told an over-flow crowd of gas executives and regulators at the "Governors' Natural Gas Summit: Responding to the Looming Energy Crisis" last Wednesday in Columbus, OH.

This has led to much higher margin spreads for trading electricity, he noted. While margin spreads in natural gas markets have dropped 75%, resulting in average trading spreads of "about a penny" at the Henry Hub, the margins in the electricity market have reached as high as 17 cents, he estimated. "That is mainly because the system isn't working." The difference between a penny and just a 10-cent spread is about $2.5 billion a month, or approximately $30 billion a year, of "lost efficiency" for the electricity industry, Lay said.

He was critical of the California power market's dependence on the spot gas market. The state's electric system was designed under "the conclusion or assumption [that] the spot market would always be the cheapest market...It even was set up in a way to greatly discourage people like Sempra and others from trying to hedge [gas] prices," said Lay, who noted that gas could have been hedged at $2.79/Mcf earlier this year. He believes utilities should be encouraged to hedge because it removes much of the "volatility" from the gas-buying equation.

At the core of California's problems is its shortage of generation capacity. During the past four years, power demand has risen about 12% (by 5,500 MW), while new generation capacity has only increased by about 672 MW.

But "the lack of capacity is not because people are not proposing to build plants." Lay said about 11,000 MW of new capacity has been proposed for California by various companies, including Enron. But "it's very slow in getting the permits to build," he said, adding that it takes about 3 1/2 years to get a new generation facility constructed in California.

In contrast, Lay noted Enron was able to build 1,300 MW of new generation capacity in less than a year in other markets in 1998, and 1,600 MW in less than a year in 1999. "That shows what you can do if the rules are right."

He made clear his distaste for any kind of price regulation or price caps for electricity and natural gas, referring to such action as the "regulatory death spiral" for the markets. "When we start off with a tight supply, resulting in a price surge or increase, we put on price caps, [then] we get less supply and more demand, leading to regulated shortages, and then to brownouts and blackouts. It's a very predictable cycle," Lay said.

"It behooves all of us...to make sure that doesn't happen, to make sure, in fact, that we do continue to let the market for wholesale natural gas work, and it is working well.....and [that] we get the improvements in the wholesale electricity market that are needed, particularly on open-access transmission....., and [that] we not go back to try to re-regulate."

While he believes there's the potential for a backlash by residential customers to the high gas prices this winter, Lay said that gas - once prices are adjusted for inflation - still will be one of the best buys around (see related story). On a real-price basis, "the price that we're looking at for this winter for residential consumers of about $8.80 [at the burner-tip] is back to just about where the price was in 1986."

Overall, he noted that all classes of natural gas consumers have saved about $174 billion since 1984 when deregulation got underway. But the cost savings to consumers would have been only $350 million to $400 million if the price controls that were enacted under the Natural Gas Policy Act in the late 1970s were still in force today, Lay said.

He noted that industry experts anticipate that wellhead gas prices will moderate over the next two years, providing further relief to customers. They expect prices to "probably drop from about $5.30 this winter to $4.30 next winter, [and] to $3.75 the winter after. That's a 30% reduction in two years."

Lay said experts also anticipate the tight supply situation "probably will bottom out this winter," and then begin to rise in response to the increased drilling activity, "probably growing at least a Bcf a day or more.....[over the] next several years."

Susan Parker

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