California Gov. Gray Davis on Friday signed a short-term measure(AB 7X) to allow the state to get into the bulk power spotpurchasing business immediately. He also ordered the state waterresources department to begin setting up a power auction processanticipating it will be authorized by another new state law thatwill be finalized this week to seek long-term electricitycontracts. Observers and market participants, however, say themeasures probably are inadequate to solve the state’s currentsupply crisis.

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

The governor expects “a great deal of interest” among suppliersin doing business with the state, which he characterized as muchmore credit-worthy than the state’s two principal investor-ownedutilities. He expects suppliers to be more than willing to sellpower at prices in the 5 to 5.5 cent/kWh range.

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

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

“We haven’t said that we would” sell power at that price, saidDuke Energy spokesman Tom Williams. “What we’ve said is we wouldparticipate in an auction process… But if it comes out that theauction process is not a good thing for us to do, [we will just sayno]. We have our own bills to pay. You don’t just say ‘I want powerand 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 isthe fuel, and right now the five-year strip for natural gas inCalifornia would make the price of power between 8 and 8.5cents/kWh. The price goes down if the term is longer.

“We offered 5-cent power in August,” he added, “but due to theprice 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 shortterm. It has sold 90% of its power in the forward market and left10% in reserve to compensate for outages. Duke, with 3,351 MW atfour power plants, represents 5% of the state generation market.

Reliant Energy offered to the state last week five- to 10-yearcontracts in which it would supply power at 2 cents/kWh. There’s acatch, however: the state or the utilities would have to supply thenatural gas, which as Duke’s Williams noted makes up the majorityof the cost of the power. Spot gas prices at the SouthernCalifornia border are about $11/MMBtu.

“We’ve got a couple of other proposals that we are discussingconfidentially with the state officials today for long termcontracts under different price structures,” said Reliant’s RichardWheatley. “The best thing I can tell you is one of the mostworkable solutions is the 2 cent/kWh charge; that’s if they bringthe gas to our plants. [The gas cost] is a heck of a priceescalator. No it [won’t come out under their 5.5 cent/kWh capunless] they supply the gas. In effect it would get around that[price cap] requirement. Whether or not they want to bring the gasto the table or not is another matter.”

Wheatley said Reliant was spending $5 million to $15 million aday on gas to fuel its own California power plants, which produce3,800 MW in-state. He predicted the $400 million allocated to theDWR to buy power would last only about seven days under recentdemand scenarios. “You have to question the ability of the DWRsubsequently to go out and try to sell $8 billion to $10 billion inrevenue bonds given the uncertainty of the marketplace and theinstability and volatility out there. There are a lot of questionsout there and very few answers.”

The utilities should continue to have the gas required thanks toan order by Energy Secretary Bill Richardson on Friday that forcesgas suppliers, many of whom have cut off or are about to cut offsupplies to Pacific Gas & Electric, to continue supplying gasto the state’s utilities (see related story this issue). Heindicated Reliant might not be subject to Richardson’s orderbecause it cut off PG&E weeks ago. Reliant already has”hundreds of millions” of unrecovered costs of its own inCalifornia, he said.

Merrill Lynch analysts expressed hope that the state SenateEnergy Committee may make “constructive enhancements” to its planthis week to garner at least a little more support from generators.”First we expect support for more contract price flexibility and anear-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 thatthe state’s power generators are going to be willing to sign on thedotted line, “and that’s crucial.” The state’s plan as it standsdoes little to fix the short power supply situation if generatorsaren’t on board. She said Assembly Bill 1-X probably will nottrigger an upgrade in the utilities’ credit ratings because toomany questions remain unanswered. The utilities still could beforced into bankruptcy and that could make matters significantlyworse.

Rocco Canonica

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