Wagner: CA Cannot 'Substantiate' $8.9B Refund Claim

The state of California's persistent claim that it's owed $8.9 billion for electricity overcharges during the May 2000-May 2001 period "has not and cannot be substantiated," said Chief Administrative Law Judge Curtis L Wagner in his report and recommendations to the full Commission last week.

The amount of refunds due the state is in the "hundreds of millions of dollars, probably more than a billion dollars in an aggregate sum," he said, but at the same time there are "even larger amounts owed to energy sellers" by the California Independent System Operator (Cal-ISO) for unpaid power purchases. "Can a cash refund be required where a much larger amount is due the seller?" he asked, adding that he "thinks not."

The two weeks of settlement negotiations, which Wagner mediated, resulted in five settlement proposals totaling $703.6 million, he said. This was lower than his initial estimate of $716 million. A breakdown of the offers were: $510 million by in-state generators (Williams, Duke Energy, Reliant Energy, Dynegy and Mirant); $125 million by Powerex, the energy marketing arm of government-run BC Hydro in Canada; $49.6 million by 15 power marketers; $6.5 million by seven members of the California Municipal Utilities Association; and $12.5 million by load-serving entities located outside of California.

"The sellers' overriding concern is that they should be paid the amounts owed at the same time that [the] refunds are made," Wagner reported to FERC.

Although no settlement was reached between California and the power suppliers during the marathon talks, Wagner characterized the overall refund negotiations as "successful," adding that he couldn't "work miracles" in the 15 days that the Commission allotted him to settle this controversial issue.

Michael Kahn, the chief negotiator for California, indicated that the state wasn't giving up its quest for $8.9 billion. He noted that potential refunds for the period between May 2000-October 2000 were never even considered. "That's $3 billion right off the table." The state will now look to the full Commission to accomplish what the settlement talks failed to so, Kahn said.

But Brent Bailey, vice president and general counsel for Duke Energy North America, suggested that California's $8.9 billion estimate was too unrealistic. It was a "pie-in-the-sky number that nobody in there [the settlement room] believed in their right mind was a legitimate number to begin with," he told reporters.

In a related development, Wagner disclosed last week that Calpine was close to reaching a separate settlement with California, but neither he nor a Calpine official would give any details.

Because the dispute between California and power suppliers raises "material issues of fact," Wagner urged FERC to schedule a trial-type evidentiary hearing to settle the refund claims once and for all. "Because of the urgent need for an answer to the refund issues that hearing should be on a 60-day fast-track schedule."

Wagner recommended that FERC retroactively apply --- and alter --- its June 19 price-mitigation order to determine the level of past refunds owed in California, as well as the state's unpaid amounts for its energy purchases. The judge's suggested method for calculating refunds came under attack by power sellers last week, with some arguing that it was tantamount to retroactive ratemaking.

In calculating refunds for the period between Oct. 2, 2000-May 28, 2001, Wagner suggested that FERC use actual heat rates of marginal generation units, rather than the hypothetical heat rates that were favored in the mid-June order. A marginal unit routinely is the highest-cost generation facility, and as a result is the last bid to be accepted to serve the Cal-ISO market. Under FERC's price-mitigation order, the market clearing price is based on the bid of the marginal unit during reserve deficiencies.

Wagner further said "the gas costs associated with the marginal unit should be based upon a daily spot gas price," not the monthly bid-week prices (averaged for three delivery points) that the Commission ordered. He cautioned that "the calculated refund price for the refund period should reflect the gas purchasing practices of sellers during the refund period."

The spot gas prices should be tied to the location of a marginal unit --- northern California or southern California, he noted. "In the event that the marginal unit is located...North of Path 15, the daily spot gas price for PG&E Citygate and Malin [Oregon] should be averaged with the resulting gas price multiplied by the marginal unit's heat rate to calculate a clearing price for that hour," he said. If the unit is located South of Path 15, then "the daily spot gas price for Southern California Gas large packages should be multiplied by the marginal unit's heat rate to calculate a clearing price for that hour."

He agrees that a $6/MWh operational and maintenance adder should be included when estimating the clearing price, as well as a 10% adder to reflect the credit risks of suppliers when selling to the California market. But "demonstrable emission costs should be excluded from the market clearing price and treated as an additional expense that sellers may subtract from their respective refund calculation" Wagner said.

The judge indicated he did not think FERC's method for calculating the maximum price for power during non-emergency hours --- 85% of the highest Cal-ISO's hourly market clearing price established during the last Stage 1 alert --- would be suitable for computing retroactive refunds.

"On a retroactive basis, the 85% maximum price could distort re-creation of a competitive market," he noted. To illustrate his point, he noted that the Cal-ISO declared a Stage 1 alert on Sept. 20, 2000 and did not declare another until Nov. 14. During that period, power prices remained at the 85% level and the refund date (Oct. 2) went into effect. "If gas prices rose (or fell) significantly during the interval between Stage 1 emergencies, the maximum price could be significantly different, either higher or lower than the true competitive price. Therefore, to measure the amount that actual prices may have exceeded the refund price, every hour should be re-calculated," Wagner proposed.

"Re-calculating the hourly competitive price for purposes of a refund calculation would also permit the Cal-PX and Cal-ISO to re-settle all charges for the refund period. Amounts owed to sellers and outstanding amounts due from buyers would be re-calculated. Any refunds could then be offset against accurate amounts receivable without sellers netting out any of their purchases from the Cal-ISO and Cal-PX during the refund period."

Lastly, Wagner said "interest should not be charged against any refund amounts unless the refund amount exceeds the amounts that are past due to the seller."

As for potential refunds owed in Pacific Northwest, he said there wasn't enough time during the settlement discussions to address the issues raised by representatives from the region. "They did not have data on what they were owed, nor an amount of refunds due them." Wagner had indicated earlier last week that he expected to recommend refund settlement talks for Pacific Northwest customers, but he didn't follow through on this in his written report.

In comments filed last week, the Attorney General's Office in Washington State said it "strongly concurs" with Wagner's earlier pledge to propose settlement talks for the Pacific Northwest, but it said it didn't want the Northwest issues to be "separated totally from other consolidated proceedings, since that would make true equity between the regions very difficult to achieve."

The AG Office called on the Commission to appoint a settlement judge to convene settlement discussions on Pacific Northwest refund issues "no later than the initiation of the 60-day fast-track proceedings" for California power customers.

In separate comments, the Cal-ISO opposed the refund-calculation formula that Wagner recommended, especially the use of spot gas prices. The "very spot market gas prices" that Wagner proposes to use in calculating "just and reasonable" electric rates are the target of a separate proceeding at FERC to "determine if they are the product of price manipulation in the gas markets," the Cal-ISO noted. In that case, over which Wagner presides, El Paso Natural Gas and its merchant power affiliates have been accused of engaging in illegal practices to drive up gas prices in California.

"In addition, generators themselves acknowledge that a large portion --- if not the bulk --- of their gas purchases would be on month-ahead or longer term basis. Thus, it is entirely inappropriate to use spot market gas prices as a benchmark for all time periods and all sales at question in these proceedings."

The Cal-ISO also urged the Commission to order refunds from May 2000 forward, when "the exercise of market power through economic and physical withholding became rampant." Wagner put the effective date for refunds at Oct.2, 2000.

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