Noting that California’s energy markets are “markedly more stable” than only a few years ago, Standard & Poor’s Ratings Services released an analysis last week that warned that a return to instability is possible, given the state’s continued power transmission grid limitations and the prospect for a shortfall in generation in the next few summers. “A measure of uncertainty remains in the California markets,” S&P concluded.

The focus of the analysis was on the California Independent System Operator (CAISO) and its long-advocated market redesign MD 02 that is aimed at preventing market manipulation, lowering congestion and generally lowering the costs of the grid operator’s real-time balancing market, which represents only about 5% of the state’s power supplies, but a good chunk of the most expensive, peak-demand power. But S&P stressed that the combined efforts of the California Public Utilities Commission, Federal Energy Regulatory Commission, and CAISO will be needed to bring more permanent stability and certainty to California’s energy markets.

“It is critical to understand that the CAISO’s markets form only a small portion of California’s power supply and that other credit factors are perhaps more material to overall credit quality of the utilities,” S&P said in its report, “Makeover for California’s Power Markets,” by David Bodek in New York and Swami Venkataraman in San Francisco.

With the corporate governance issue at CAISO now resolved in the state operator’s favor and resignations of its CEO and executive in charge of strategic planning, S&P thinks the grid operator will remain committed to the slow implementation of MD 02, but with further modifications. One may come from Gov. Arnold Schwarzenegger’s advisers in the form of the creation of a capacity market similar to what the New York Independent System Operator has instituted.

“Such a capacity market is expected to ensure resource adequacy on the part of the load-serving entities (LSEs, such as utilities),” S&P’s report said.

Earlier this year CAISO’s five-member gubernatorial-appointed board agreed to push back the first phase of its market redesign (MD02) until the fall. Previously, the state’s grid operator was targeting this summer for the revisions in the wholesale real-time power market. Involved is the integration of 17 different software applications to make changes in what CAISO has designated as “1-B” (second sub-phase of first phase) work.

It was attempting to get the work done concurrently to meet an original Spring deadline, a CAISO spokesperson said.

“What we have learned is this is not the best, nor even the fastest way to get things done,” the spokesperson said. “The problem with concurrent work is that if you need to make a change in one thing, it affects work you may have already done somewhere else, so we think it is better in these complex project to work sequentially.”

A report to the CAISO’s board last month said it is “clear” that the attempt to develop, test, train and support market simulation in parallel “has not been successful.” The report noted that four areas require additional time before the grid operator can be ready to launch Phase 1B of its massive redesign: (1) hands-on operator training, (2) market simulation that meets pre-established exit criteria, (3) load and performance testing, and (4) a final integration of the 17 system applications.

S&P stressed that while this is important, there are four other critical projects in various stages of development at the CPUC:

Although S&P was silent on it in its report, California last week has a surviving state legislative proposal (AB 2006) for future electricity reform pitting utilities against large commercial/industrial customers. With amendments, the proposal cautiously moved out of a state Senate energy committee on a 5-2 vote last Tuesday, but the committee chair indicated the proposal will undergo further revisions before it returns to the policy committee in August for its final political run. In the meantime opponents and proponents are locked in a high-profile media battle.

Negotiations over AB 2006’s final language and emphasis are expected to heat up with Gov. Arnold Schwarzenegger personally getting involved in August after the state lawmakers take their customary July recess. Based on his past statements, the governor leans more to the side of large energy users who argue that private sector investment in new power infrastructure and increased direct access retail choice need to be encouraged.

While Southern California Edison helped write and promote AB 2006, the other two major private-sector electric utilities — Paciifc Gas and Electric Co. and San Diego Gas and Electric Co. — have remained neutral so far. PG&E’s utility last Tuesday sent Senate energy committee chairperson, Sen. Debra Bowen, a letter expressing support for the bill’s goals of incentives for building new generation, more regulatory certainty and no cost shifts among customer groups, but it drew short of supporting the bill as currently written.

PG&E supported Gov. Schwarzenegger’s earlier suggestion to the CPUC that AB 57, the existing law, be fully implemented to give the utilities more certainty going forward. The utility told Sen. Bowen that some of AB 2006’s provisions don’t fully address the stated goals and some are even in contradiction to those goals.

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