Bold plans by Southern California Edison and Pacific Gas andElectric Co. to transfer $2 billion in hydroelectric powergeneration assets to non-utility affiliates could threaten thecompetitiveness and profitability of the state’s emerging merchantpower business if allowed by state regulators. The proposals havesparked calls for a statewide investigation by the CaliforniaPublic Utilities Commission. Potential violations of market powerand utility affiliate transaction rules are being loudly raised bya growing number of opponents.

The major focus is on PG&E because it owns the largestcollection of private-sector hydroelectric generation assets in thecountry. At stake is PG&E’s $1.6 billion (net book value)hydroelectric system that includes a total of 4,000 MW produced at68 generating plants linked to 16 water basins. As part of thissystem, the utility operates 163 reservoirs in 16 counties,Edison’s hydro system is about a third the size and affects fewerwatersheds.

The utility proposals could threaten a growing number ofgas-fired merchant power plants in California because it would puthydro plants, with more than 5,000 MW of capacity-potentiallycontrolled by affiliates of the state’s two biggest electricutilities-in a position to dominate peak-pricing situations,particularly in the so-called lucrative ancillary services markets.Hydro theoretically might hold more longer term profit potentialthan the ubiquitous gas-fired plants now operating or on thedrawing boards.

“If PG&E hydro is spun off, it would have real implicationsin terms of market power,” said one Northern California-basedenergy consultant. “Ancillary services can be an important part ofthe revenue stream of these merchant plants.” During the first sixmonths of California’s restructured electricity markets (throughthe end of September), according to the same consultant, merchantand utility generators alike obtained 30-40% of their revenues fromthe ancillary services market.

At issue are legal interpretations of California’s requirementsfor non-nuclear power plant divestment under its 1996 electricitylaw (AB1890) and the traditional rules and procedures of the CPUCregarding the transfer of utility assets to nonutility operators.While merchant plant operators are weighing in, the main oppositionso far has come from public sector water agencies, many of whichwould like to purchase some of the hydroelectric assets andaccompanying water rights, along with CPUC staff and environmentalgroups. The state’s public sector water agencies through theirtrade group, Association of California Water Agencies (ACWA), isadvocating that the CPUC take a statewide look to determine “thefuture ownership and control of the utility hydroelectric assets,”which the water interests claim are inextricably linked to state’sfragile and highly politicized water supplies. “Whoever controlsthe PG&E utility hydro facilities will be able to dictateelectric market prices, and if it’s a non state-regulated entity,it will have unprecedented control over California’s water,” saidLon House, a consultant to ACWA. The CPUC is expected to takeinitial action in February whether or not the current two vacancieson the five-member panel have been filled by newly elected Gov.Gray Davis, according to CPUC sources.

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