The issue of whether to reform or abrogate $16 billion in long term electricity contracts signed by California in the midst of the western wholesale market meltdown two years ago now rests with the Federal Energy Regulatory Commission’s three current commissioners, following oral arguments last Thursday. A key will be how broadly the regulators want to view the case.

While the oral argument from the state was decidedly arcane and legalistic, the regulatory decision ultimately comes down to questions of whether FERC commissioners agree with California’s governor that the contracts were signed with a proverbial gun held to its negotiators’ heads.

The three FERC commissioners have given little indication on how they are leaning, although the lone Clinton Administration holdover, William Massey, said he is concerned about a separate FERC staff report pointing to massive western market manipulation as being relevant to the contract case.

The federal regulators heard starkly different arguments from opposing attorneys for California officials and wholesale power sellers on the long-disputed electricity supply contracts with the state’s Department of Water Resources (DWR). The subject of the arguments was on the question of whether the dysfunction of western spot power markets in 2000 and early 2001 impacted futures contract prices. At stake are seven major contracts with Sempra Energy ($6.4 billion), Allegheny Energy ($4.3 billion), Dynegy ($2.4 billion), Coral ($2.3 billion), Mirant ($516 million), El Paso ($273 million), and Morgan Stanley ($188 million).

State officials noted that the Mirant contract has expired, but they still wish to gain refunds for the portion of the per-megawatt-hour price that they consider “unjust and unreasonable.” As an example, the Coral and El Paso contracts are for an average price of $169/MWh and $120/MWh, respectively, compared to current spot prices in the $40-$60/MWh range, the officials said.

California argued that on a “public interest” basis alone FERC should overturn the disputed power contracts because the state contends the deals were adversely influenced by a dysfunctional spot market that other “evidence” has shown was manipulated, allegedly in some cases by some of the sellers with the contracts in question. Further, California argues that if FERC doesn’t reform or abrogate the deals it will be allowing some of the alleged manipulators to profit from their supposed misdeeds.

Attorneys for the sellers countered that California got what it was seeking: “competitively priced” long-term power supply contracts as substantiated by a long-term marginal price analysis submitted in evidence, and the issue of alleged market manipulation is not part of this case. Noting that California has the burden of proof, the sellers’ argue that the state has not proven its case and the so-called “Mobile-Sierra doctrine” does apply to what they say were “freely negotiated” deals.

Citing an “undisputed record” that the long-term contracts’ charges were going to be directly borne by the public, California attorneys argued this public impact sets their case apart from the Mobile-Sierra case which involved two private utilities. “If the wholesale market is out of whack, and that’s your only choice of the forward (price) curves, and you must keep the lights on, it doesn’t follow that it is an imprudent decision to go ahead (as the DWR did) and pay that amount,” said William Kayatta, an attorney for the state Electricity Oversight Board (EOB).

With the seller having FERC-authorized market-based rate authority, the contracts were pre-authorized as being “just and reasonable,” one of the sellers’ attorneys, Mirant America Energy Markets’ Debra Raggio Bolton told the FERC commissioners. “As being just and reasonable now, [these contracts] may be overturned only upon a finding that they have now become unlawful or unjust and unreasonable, and that they are no longer in the public interest.”

“If you believe the FERC staff report, then you know that California consumers today are paying above just and reasonable rates to the very people that according to the staff report have contributed to those [higher] rates,” Kayatta said. “Any court in the world would say that it is darn well in the public interest to moderate that. When we come back to the Federal Power Act it is about protecting consumers in the long run from unjust and unreasonable rates.”

Two days before the oral argument, California officials in Sacramento laid our their case to news media. EOB attorney Erik Saltmarsh said the FERC staff report on Price Manipulation in the Western Market and other evidence “clearly show” a linkage between manipulated market prices and the terms of the long-term contracts that the state signed in the midst of its energy crisis in the first half of 2001.

Richard Katz, a senior advisor to Gov. Gray Davis, said the evidence shows “massive gaming and manipulation” of the wholesale energy markets, so now the question appears to come down to how FERC “defines the ‘public interest.'” However, in reference to the now-infamous Wall Street conference call with two FERC commissioners, Katz said, “We now know that at least one of the FERC commissioners has thought that preserving outrageous, improper contracts is more in the public interest that doing what’s right by the ratepayers.”

In Thursday’s hearing, suppler attorneys countered that there will be a chill in the market if the contracts are overturned by FERC, making sellers unwilling to enter long-term deals whenever prices spike. Thomas McCormack, an attorney for Allegheny Energy Supply, said there is probably not a “risk premium big enough” to cover future long-term contracts if the commission abrogates or reworks these deals.

As expected, FERC Commissioner Massey tended to ask tough questions of the suppliers, while Chairman Patrick Wood and Commissioner Nora Brownell zeroed in on the narrower, tougher to prove questions for the state, concerning whether it was clear the spot prices had major impact on the forward prices in the contracts, or the applicability of what to do with the much-cited FERC staff report pointing to manipulation of the wholesale energy markets in the crisis period.

“Evidence induced by the state of California contemporaneously with the process and a part of the [FERC case] trial shows that this portfolio was priced at or below marginal cost,” Allegheny’s McCormack said. “They went into the marketplace wanting competitive power, and guess what — they got it.

“Each seller was duly authorized [by FERC] to sell power in California at market-based rates,” he added. “Moreover, certain of the contracts were filed with FERC with no opposition by California. Thus, all of the contracts are lawful and binding.”

Originally, California’s DWR signed more than two dozen, mostly long-term power supply deals totaling about $43 billion, and within less than a year it was back renegotiating many of the deals, and has, in fact, reworked more than half of them (in terms of total market value), the largest being deals with San Jose, CA-based Calpine Corp. On average, the costs of the re-done contracts have been reduced about 20%, the state officials said, although in its FERC arguments the state said it would be seeking to lower the costs of the outstanding contracts by an average 33%.

“California got what it wanted at the time of the contracts, and at a competitive price,” McCormack said. “The facts show that the contracting process was highly dynamic with hundreds of bids. Tens of thousands of megawatts at various prices, terms, lengths and risk allocations. Indeed, California was able to get exactly what it set out to do at the start of the process.”

As added color to support its arguments against FERC doing anything with the contracts, McCormack read quotes in the spring and summer of 2001 just after the long-term deals had been signed by DWR, quoting Gov. Gray Davis and his chief contract negotiator, S. David Freeman, as praising the deals (see Daily GPI, March 9, 2001; NGI, June 18, 2001; Power Market Today, Oct. 12, 2001). He cited California officials generally praising the contracts in news media reports at the time as being “fair and negotiated in hard-fought deals.” The officials said they “tamed the spot market and changed the market psychology,” McCormack told the federal regulators.

Other quotes included Davis saying the contracts “significantly reduce the future cost of electricity to the state.” And Freeman: “The only insurance against prices going back up again is to have a bunch of long-term contracts.” In June 2001, Freeman, the current head of the state power authority, told news media he was “proud” of the contracts.

In July 200l, Freeman was quoted by McCormack as saying in news media reports: “We didn’t just fall off a turnip truck. I’m not saying we took the shirt off their backs, but I am saying these were fair negotiated and hard-fought deals.”

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