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
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
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