Initial Legislation in CA Gets Low Marks

California Gov. Gray Davis on Friday signed a short-term measure (AB 7X) to allow the state to get into the bulk power spot purchasing business immediately. He also ordered the state water resources department to begin setting up a power auction process anticipating it will be authorized by another new state law that will be finalized this week to seek long-term electricity contracts. Observers and market participants, however, say the measures probably are inadequate to solve the state's current supply crisis.

In its current form, Assembly Bill 1-X bars the Department of Water Resources from buying power for a price of greater than 5.5 cents/kWh ($55/MWh). The DWR would sell the power for the same rate to the utilities and they in turn would sell it to their customers at rates fixed a penny and a half or so higher. The difference in wholesale and retail prices supposedly would be used to slowly paydown the utilities mounting $12 billion in unrecovered costs.

The governor expects "a great deal of interest" among suppliers in doing business with the state, which he characterized as much more credit-worthy than the state's two principal investor-owned utilities. He expects suppliers to be more than willing to sell power at prices in the 5 to 5.5 cent/kWh range.

"I can assure you the prices will come down and reliance on the spot market will drop dramatically," said Gov. Davis. Observers, however, were not so sure. In fact few expressed much confidence in the state's plan in its current form.

Many power generators argue 5.5 cents/kWh ($55/MWh) is far too little unless contracts have significant terms of greater than 10 years. Short-term power supplies have been going for $35/kWh. "The $55/MWh threshold for power contracts and absence of any near-term credit support make AB 1-X unviable," said Merrill Lynch analysts in a research note on Friday.

"We haven't said that we would" sell power at that price, said Duke Energy spokesman Tom Williams. "What we've said is we would participate in an auction process... But if it comes out that the auction process is not a good thing for us to do, [we will just say no]. We have our own bills to pay. You don't just say 'I want power and I'll pay only this much' and have it appear miraculously. That's not the way things work."

Williams noted that about 90% of the cost of producing power is the fuel, and right now the five-year strip for natural gas in California would make the price of power between 8 and 8.5 cents/kWh. The price goes down if the term is longer.

"We offered 5-cent power in August," he added, "but due to the price of natural gas that went up to 6 cents/kWh in mid-November." Currently Duke has little or no power left to sell in the short term. It has sold 90% of its power in the forward market and left 10% in reserve to compensate for outages. Duke, with 3,351 MW at four power plants, represents 5% of the state generation market.

Reliant Energy offered to the state last week five- to 10-year contracts in which it would supply power at 2 cents/kWh. There's a catch, however: the state or the utilities would have to supply the natural gas, which as Duke's Williams noted makes up the majority of the cost of the power. Spot gas prices at the Southern California border are about $11/MMBtu.

"We've got a couple of other proposals that we are discussing confidentially with the state officials today for long term contracts under different price structures," said Reliant's Richard Wheatley. "The best thing I can tell you is one of the most workable solutions is the 2 cent/kWh charge; that's if they bring the gas to our plants. [The gas cost] is a heck of a price escalator. No it [won't come out under their 5.5 cent/kWh cap unless] they supply the gas. In effect it would get around that [price cap] requirement. Whether or not they want to bring the gas to the table or not is another matter."

Wheatley said Reliant was spending $5 million to $15 million a day on gas to fuel its own California power plants, which produce 3,800 MW in-state. He predicted the $400 million allocated to the DWR to buy power would last only about seven days under recent demand scenarios. "You have to question the ability of the DWR subsequently to go out and try to sell $8 billion to $10 billion in revenue bonds given the uncertainty of the marketplace and the instability and volatility out there. There are a lot of questions out there and very few answers."

The utilities should continue to have the gas required thanks to an order by Energy Secretary Bill Richardson on Friday that forces gas suppliers, many of whom have cut off or are about to cut off supplies to Pacific Gas & Electric, to continue supplying gas to the state's utilities (see related story this issue). He indicated Reliant might not be subject to Richardson's order because it cut off PG&E weeks ago. Reliant already has "hundreds of millions" of unrecovered costs of its own in California, he said.

Merrill Lynch analysts expressed hope that the state Senate Energy Committee may make "constructive enhancements" to its plan this week to garner at least a little more support from generators. "First we expect support for more contract price flexibility and a near-term auction process," Merrill Lynch said.

Susan D. Abbott, Moody's managing director of corporate finance, said just because the legislature passes a bill doesn't mean that the state's power generators are going to be willing to sign on the dotted line, "and that's crucial." The state's plan as it stands does little to fix the short power supply situation if generators aren't on board. She said Assembly Bill 1-X probably will not trigger an upgrade in the utilities' credit ratings because too many questions remain unanswered. The utilities still could be forced into bankruptcy and that could make matters significantly worse.

Rocco Canonica

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