From: ken.skilling@enron.com
To: all.worldwide@enron.com
Date: 2001-03-13 16:17:00+00:00
Subject: California Energy Crisis

California,s power crisis has generated heated debate over the last several 
months.  Unfortunately, this debate has generated more heat than light.  We 
want you to know what the facts are and what we are doing about the crisis.  
Please spend a few minutes reading the following overview on the situation 
and our position on California energy issues.

What happened in California

The source of California,s current problem is as straightforward as supply 
and demand.  California,s economy grew 29 percent since 1998.  This increased 
the demand for electricity by 24 percent.  At the same time, regulatory 
restrictions prevented new generation from getting built in the state.  So 
demand grew but regulations prevented supplies from being added.  The result, 
predictably, is a shortage.  This summer, peak capacity will be about 10 
percent shy of peak demand, leading to further blackouts in the state.

In addition to the supply and demand imbalance, there are two other related 
factors that led to the current crisis.  First, the state,s regulations 
forced all sales and purchases into the spot market.  The spot market for 
power is extraordinarily volatile.  The way firms behave in a free market 
when faced with such volatility is to construct a portfolio of purchases long 
term, medium term and short term, to reduce exposure to this volatility.  In 
California, state regulation prevented this strategy.  This would be the 
equivalent of putting the entire state on an adjustable rate mortgage in the 
most volatile interest rate environment imaginable.  Everything was fine 
while the power surplus persisted, but when shortages ensued, every megawatt 
was purchased at the sky rocketing spot price.

Second, retail markets were not deregulated.  Regulated retail rates remained 
in effect, and stranded cost recovery charges were structured to keep 
competition out.  This meant that utilities were forced to pay high wholesale 
prices in the spot market but were only able to recover costs at the 
regulated retail rate.  They are now nearly bankrupt.

In short, California,s problems were caused by regulation, not deregulation.  
Regulations prevented competitors from entering the market, prevented new 
generation from being built, and prevented prudent hedging against volatile 
spot prices.

At the time California was developing its restructuring plan, Enron warned 
the state,s policy makers about these risks and proposed alternatives, which, 
if adopted, would have averted the current crisis.

Enron,s Role

Many political leaders in the state have elected to fix blame rather than fix 
the problem.  Power sellers, including Enron, have been vilified by the 
politicians and the media.  Here are the facts:

? Other than a small amount of wind power, Enron is not a generator in the 
state of California.  Every megawatt we sold in California we bought in the 
same market available to other California purchasers.  Because we are a 
market maker, not a generator, we are not biased toward high prices.  We are 
interested only in having a market that works so that we can package products 
for our customers.
? As a seller to end-use markets in the state, we provided protection from 
the problems the states, utilities, and their customers, now face.  We 
protected, and still protect, our customers from price volatility.

You may have read that EES recently elected to have the utilities supply 
power directly to its customers in California instead of procuring power on 
the open market.  Early reports mischaracterized this as a &turnback8 of our 
customers to the utilities.  Here are the facts:

? As a result of a variety of factors existing in the current California 
market, it made more sense for EES to source power for its customers directly 
from the utilities.  This decision reduced EES,s market price risk by 
allowing EES to access lower utility rates.
? EES did not terminate any customer contracts, and our customers continue to 
receive the financial benefits of their contract prices.
? EES is continuing to work with its California customers to provide them 
with other energy-related products and services, including assistance in 
reducing the demand for power, particularly at peak times.

Enron is currently proposing solutions to help California work out of its 
crisis; Enron continues to sign up customers in the state; and Enron 
continues to actively manage its risks and capture opportunities in Western 
power markets.  Enron,s primary business is managing risk for our customers 
with solutions customized to meet their needs.  There has never been more 
demand for our products and services.

The Solution

The solution to California,s crisis is also straightforward.  In summary, the 
state must increase supply, reduce demand, reduce reliance on the spot market 
and shore up the financial stability of the state,s utilities.

Increasing Supply

California,s process for siting and permitting new generation is nothing 
short of Byzantine.  Enron has built plants elsewhere in the country in less 
than a year.  In California, it often takes 5 to 7 years.  California simply 
must streamline this process.  Ironically, while many of the regulations 
generators must overcome are aimed at improving environmental quality, the 
regulations are preventing new clean technology from coming online and 
displacing current plants, which emit 40 times as much NOx.  California can 
have abundant power and cleaner air by expediting the permitting of new 
facilities.

Reducing Demand

Customers in California today have no incentive to reduce or shift demand.  
They pay the same rate no matter what the market price is.  An open retail 
market would trigger demand responses, which would balance supply and demand 
at lower prices than today.  California should fully open its retail market.

Reducing Reliance on the Spot Market

In a truly deregulated market, customers would protect themselves from 
volatile spot prices by purchasing some of their requirements on a longer 
term, fixed-price basis.  The state has instead left procurement in the hands 
of the utilities, which it has forced to buy exclusively in the spot market.  
Opening the market at the retail level will give customers control over their 
price risk.

Restoring the Financial Integrity of the State,s Institutions

The utilities in California are not paying their bills.  This has led to 
greater uncertainty in the market, higher costs, and reduced flexibility to 
arrive at lasting solutions.  California must permit its utilities to recover 
their costs so they can pay their bills and invest in the transmission and 
distribution assets necessary to get power from where it is to where it is 
needed.

Just as important as doing these things, the state must avoid policies that, 
while politically attractive, do not fix the problem or even make matters 
worse.  Price caps have been proposed.  They don,t work; have never worked; 
and they will not work here.  Price caps succeed only in creating shortages, 
which then have to be allocated among competing users.  Imagine how 
ineffectively the government would be in determining, for example, whether it 
is better to make its limited power supplies available to the Imperial Valley 
or Silicon Valley.  Price caps are a surefire way to make the current 
shortage worse.

The state has also proposed to take over generation and transmission in 
California.  There is no reason to believe, and every reason to doubt, that 
the state will be more effective than free markets at investing in, 
constructing, operating and maintaining assets.  This will also result in 
California tax revenues being spent on power transmission and power 
generation -- which the private sector can do -- instead of education, roads 
and other public goods -- which the private sector cannot do.

As you are approached by people outside the company or are learning about the 
crisis from the media, it,s important for you to know this:  We at Enron will 
continue to serve our customers and we will continue to propose real 
solutions to the state.