California Energy Market On the Brink
The good news is the lights are still on in California. But Wall Street will be watching closely this week as California legislators on one coast and the Clinton Administration on the other attempt to stop the train wreck in the California power market and rescue the traditional "widow and orphans" investments in PG&E Corp. and Edison International from the junk pile.
The President, taking time out for Mideast peace talks for a crisis closer to home, has summoned California Gov. Gray Davis to meet with Energy Secretary Bill Richardson, Treasury Secretary Lawrence Summer and FERC Chairman James Hoecker, possibly as early as Tuesday. Details of the meeting, which will be jointly hosted by the departments of Energy and Treasury, remained sketchy at press time Friday.
In California a special session of the legislature was meeting to consider emergency measures, including a state bond issue to pay off the more than $11 billion debt of the two utilities, which represents the difference between wholesale rates paid and retail rates collected. A number of California legislators and the state treasurer also were aggressively calling for the state to take over the power system and run it. The legislators also have the power to raise directly raise rates (see related story this issue).
The actions came at the end of an almost unbelievable series of events last week, which started with the California Public Utilities Commission's approval of a band-aid penny a kWh interim surcharge on power rates to California consumers. The action or lack thereof touched off a firestorm on Wall Street as Moody's and Standard & Poors lowered the credit ratings of PG&E and Southern California Edison to a notch above speculative grade and Fitch dropped them to junk level. At the same time stocks of major energy companies that supply power in California tumbled by up to 20% before rebounding somewhat on assurances by the companies (see separate stories this issue).
As the week ended, the U.S. Court of Appeals in D.C. rejected SoCal Edison's plea for a writ of mandamus directing FERC to reinstitute cost-based rates to tame power prices in the out-of-control California bulk market. In a one-page decision, the court also refused to order FERC to decide rehearing of its now-famous Dec. 15 order limiting action in the California market to a soft cap, saying "We anticipate that the Commission will rule on the rehearing petition in a timely manner" (see NGI, Dec. 18). Meanwhile the California Power Exchange has refused to implement provisions of the order and has taken FERC to court, filing an appeal with the 9th U.S. Circuit Court of Appeals last Thursday.
FERC's Hoecker, in a concurring opinion issued three weeks after that decision, offered an olive branch of sorts. He acknowledged that since then the "western energy shortage has metastasized into a financial crisis of major proportions." He said while he regarded price caps as "arbitrary and potentially confiscatory," he could support them 1) to offer "a short 'time out' within which parties could negotiate better ways to make the market work for consumers, such as bilateral forward contracts, demand response programs or equitable relief; or 2) if they were employed as 'damage caps' to prevent clearly unwarranted price explosions, such as the $1,000 cap used across all three northeastern ISOs."
Hoecker moderated his stand on the issue of retroactive refunds for California power customers, saying that while FERC did not have broad authority under the Federal Power Act (FPA), Section 309 of the FPA provides the Commission with remedial authority that "could approximate" refunds.
This law "allows us to craft whatever equitable remedies are necessary to remedy the impacts of [market] manipulation, including (in my view) disgorgement of unlawful gain," he noted. "I fully expect the Commission to employ Section 309 to do justice" for customers in San Diego and elsewhere in California.
Citing the "general level of vituperation and lack of constructive discourse" to resolve California's woes, he invited parties to offer "a price cap proposal in the context of a comprehensive settlement of the issues." As part of a "Workout Plan for California" that he proposed last week, Hoecker called for DOE's Richardson and top economic officials to convene a conference to work out a comprehensive solution. To succeed, "the state must be willing to help implement our Dec. 15 order and support longer-term reforms.." Hoecker still believes that order "offers the best opportunity to begin rehabilitating the wounded California power market."
The chairman's decision to back price caps under limited conditions can be viewed in part as a concession to California's governor and the state's investor-owned utilities, which have been lobbying FERC for caps for months. It also is a departure from the Commission's Dec. 15 order in which it enacted a series of reforms for the California electric market, excluding hard price caps.
Agreeing to limited price caps was a big step for Hoecker, who in his concurring opinion said they "create uncertainty for investors, discourage entry into the market, or even drive resources elsewhere, thereby fostering future scarcity." They are the "ultimate non-market solution that will work to disincent policymakers from undertaking more important reforms." However, he conceded caps "can lower prices, at least temporarily," and that's why he will support them on a limited basis.
In the long term, though, California "cannot 'price cap'" itself out of the problems with its bulk power market, Hoecker noted. "A responsible course of action is to attack the current market meltdown on several fronts over a period of time --- in California's case, three to five years."
Hoecker remained steadfastly opposed to cost-based rates for California. "Reimposition of cost-based wholesale rates, notwithstanding its surface appeal, would not necessarily reduce current problems for consumers or their utility suppliers."
Hoecker urged California's political leaders not to try to reinvent the state's electric industry once again. "There is no doubt in my mind that the powerful economy of the state can extricate itself from this crisis if its leaders do not jump from the frying pan into the fire," he said. While "competition is the solution," he conceded "it was not well-conceived or well-executed in California and for that, we all share blame."
A "serious and little-discussed structural flaw" in California's market that requires immediate attention is the lack of adequate generating reserves, Hoecker wrote. As a potential remedy, California "should impose on load-serving entities and other 'customers' an obligation to build or buy sufficient capacity to serve expected requirements." This is "admittedly a quasi-market approach," but it "will be a small price to pay to avoid a cycle of boom and bust."
Hoecker noted California's talk of "electrical secessionism" could be disastrous for the state and the entire western region. The state "once again wants to go it alone in finding ways to correct what is a regional problem." He believes the current crisis facing California and the problems in other western power markets underscore the need for a regional transmission organization (RTO). "Therefore, I strongly recommend that the Commission mandate a West-wide RTO and publish its own requirements and timetable for achieving that end."
Susan Parker, Ellen Beswick, Rocco Canonica
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