From: miyung.buster@enron.com
To: filuntz@aol.com, liz@luntz.com, nicholas.o'day@enron.com, mike.dahlke@enron.com, jennifer.rudolph@enron.com
Cc: steven.kean@enron.com
Date: 2000-09-29 17:42:00+00:00
Subject: More on California Deregulation Nightmares

UB Comment 
More on California Deregulation Nightmares
Martin Rosenberg
  
09/30/2000 
Utility Business 
Copyright 2000 by Intertec Publishing Corporation, a PRIMEDIA Company. All 
rights reserved. 
What were California utility regulators and state legislators smoking when 
they devised California's so-called "pioneering" stab at electric 
deregulation? The flaws in the scheme they came up with are profound. They 
are also rather easy to identify. 
Simply put, California's deregulation gurus required distribution utilities 
to shed their generation and buy power ONLY through the California Power 
Exchange and predominantly on a spot basis. Generators had total market 
power. 
The utilities - and the millions of Californians that they serve - were 
captive customers. Whatever price the generators could generate, the 
utilities had to pay. They could not use the threat of dropping off the Power 
Exchange system if prices got too high. 
Second, the utilities were stripped of any of the powerful tools available to 
deal with risk. 
Doug Kline, spokesman for San Diego Gas & Electric, says his company had a 
limited ability to hedge - or protect itself against soaring prices - going 
into this summer. It could hedge 10 percent of its power needs up to three 
months in advance. "We could go into the block forward market if someone 
would accept our proposal," Kline said, but "it's thinly traded." 
This is where the California scheme borders on being criminally 
irresponsible. Why expose utilities to market risks without providing them 
with means of protecting their customers against wild swings in market 
prices? 
The futures market is complex. But there are some easy patterns to discern. 
Electric prices in many parts of the country peak in the summer when consumer 
demand for air conditioning peaks. They are lowest in the winter. Generally, 
futures prices track these seasonal fluctuations. A few years ago, some wags 
observed that New York Mercantile Exchange futures traders who felt snow 
falling on their necks going to lunch returned to work and bid up the futures 
price of natural gas. 
As one trading company official says, "It doesn't take a brain surgeon to 
know electricity is going to go up in the summer." 
This summer it zoomed to 19.3 cents per kilowatt hour, up from 4.2 cents a 
year earlier. 
Demand for power is not up sharply this summer and supply is about equal, 
compared to last year. "It is difficult to explain a five-fold increase in 
prices," Kline says. 
San Diego Gas & Electric in the winter time - when electricity futures prices 
tend to be low - should be able to buy a futures contract for electricity to 
be delivered the following summer. Then, if prices soar, the utility's 
exposure would be limited. 
In their wisdom, however, California policymakers decided to largely deny 
utilities access to the futures market. 
Furthermore, the utilities could not buy power outside of the California 
Power Exchange. 
San Diego tried. "We applied more than six months ago for authority to buy 
outside the California Power Exchange, and the California Public Utilities 
Commission denied it," Kline says. 
The rise of trading Large industries in California can strike a deal with 
competitive suppliers. However, major traders have stayed away from smaller 
users - and consumers - because the margins are too thin. So consumers are 
captive of the utilities that in turn are captive of the California Power 
Exchange. 
Meanwhile, a robust energy trade has been developing in the rest of the 
country. A recent study by the Yankee Group in Boston reports that $70 
billion in electricity and natural gas will be traded on electronic energy 
commodity exchanges this year, up from $25 billion last year. That's a 
healthy hunk of the $225 billion worth of electricity and natural gas sold on 
wholesale markets. 
"As energy-trading firms migrate to these exchanges, over 90 percent of 
wholesale natural gas and electricity will trade across commodity exchanges 
within three years...An expanding trading market will result in $450 billion 
of energy trading by 2005 - virtually all of it electronically," the Yankee 
Group's May study states. 
So far, marketers are sitting on the sidelines. Al Butkus, a spokesman for 
UtiliCorp United, says, "We don't deal in California," Butkus says. "It's not 
an important market to us." That is an indictment of efforts to deregulate 
the state. UtiliCorp owns Aquila Energy, which last year was the second 
largest wholesaler of power and the third largest wholesaler of natural gas 
in North America. 
The Federal Energy Regulatory Commission in late August announced it would 
investigate developments in the California market. The commission will try to 
determine if the market rules need fixing, and whether remedial action must 
be taken because rates are unjust. 
Stephen Baum, head of San Diego's parent, Sempra Energy, says, "We strongly 
believe that FERC's investigation opens the door for substantial reforms of 
the state's wholesale electricity market, which is not workably competitive, 
and will eliminate the extreme wholesale price spikes that we have 
experienced this summer." 
While announcing the investigation, as part of a national market review, 
James J. Hoecker, commission chairman, said, "We do not find finger-pointing 
to be helpful at this juncture." 
At some point, however, the following conclusions are likely to be drawn: 
- In deregulated markets, suppliers cannot be free to raise prices with 
impunity while consumers are naked to the howling winds of competition. 
Utilities must be able to hedge their risks. 
- If free markets are to work, the benefits of competition must flow to 
residential consumers and other small users. It is not sufficient to place an 
artificial "cap" on rates - since costs are still incurred that must be 
recovered at some later date. There should be a profit incentive for 
marketers to court consumers. Factors limiting the emergence of a competitive 
consumer market should be identified and eliminated. 
- California, as large as it is, is not an island. Utilities in the state 
should not be required to buy from the California Power Exchange. 
- California regulators, who declined several requests for interviews for 
this column, and legislators should apologize to traumatized California 
consumers. They should admit they were unequal to the task of devising fair, 
workable deregulation policies.