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[Senate Hearing 107-183]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 107-183

                       ELECTRICITY AND GAS RATES

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                                   on

                                 S. 764

 TO DIRECT THE FEDERAL ENERGY REGULATORY COMMISSION TO IMPOSE JUST AND 
 REASONABLE LOAD-DIFFERENTIATED DEMAND RATES OR COST-OF-SERVICE BASED 
 RATES ON SALES BY PUBLIC UTILITIES OF ELECTRIC ENERGY AT WHOLESALE IN 
           THE WESTERN ENERGY MARKET, AND FOR OTHER PURPOSES

                                 S. 597

   TO PROVIDE FOR A COMPREHENSIVE AND BALANCED NATIONAL ENERGY POLICY

                               __________

                             JUNE 19, 2001

                       Printed for the use of the
               Committee on Energy and Natural Resources

                                 ______

                  U.S. GOVERNMENT PRINTING OFFICE
76-175                     WASHINGTON : 2001

____________________________________________________________________________
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               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii              FRANK H. MURKOWSKI, Alaska
BYRON L. DORGAN, North Dakota        PETE V. DOMENICI, New Mexico
BOB GRAHAM, Florida                  DON NICKLES, Oklahoma
RON WYDEN, Oregon                    LARRY E. CRAIG, Idaho
TIM JOHNSON, South Dakota            BEN NIGHTHORSE CAMPBELL, Colorado
MARY L. LANDRIEU, Louisiana          CRAIG THOMAS, Wyoming
EVAN BAYH, Indiana                   GORDON SMITH, Oregon
BLANCHE L. LINCOLN, Arkansas         JIM BUNNING, Kentucky
                                     PETER G. FITZGERALD, Illinois
                                     CONRAD BURNS, Montana

                    Robert M. Simon, Staff Director
                      Sam E. Fowler, Chief Counsel
               Brian P. Malnak, Republican Staff Director
               James P. Beirne, Republican Chief Counsel
                 Leon Lowery, Professional Staff Member
             Howard Useem, Senior Professional Staff Member

                                     
                                     
                                     
                                     
                                     

Note: Senator Bingaman assumed the Chairmanship on June 6, 2001.

                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Bingaman, Hon. Jeff, U.S. Senator from New Mexico................     1
Boxer, Hon. Barbara, U.S. Senator from California................    33
Breathitt, Linda Key, Commissioner, Federal Energy Regulatory 
  Commission.....................................................    12
Brill, Thomas R., Director of Regulatory Policy and Analysis, 
  Sempra Energy, San Diego, CA...................................    56
Brownell, Nora Mead, Commissioner, Federal Energy Regulatory 
  Commission.....................................................    15
Fetter, Steven M., Managing Director, Global Power Group, Inc., 
  New York, NY...................................................    52
Hebert, Curt, Jr., Chairman, Federal Energy Regulatory Commission     4
Henning, Bruce B., Director, Regulatory and Market Analysis, 
  Energy and Environmental Analysis, Inc., Arlington, VA.........    59
Massey, William L., Commissioner, Federal Energy Regulatory 
  Commission.....................................................    14
McMahan, Ronald L., Ph.D., Managing Partner, Enercap Associates, 
  LLC, Boulder, CO...............................................    48
Murkowski, Hon. Frank H., U.S. Senator from Alaska...............     1
Roberts, Geoffrey D., President and CEO, Entergy Wholesale 
  Operations, The Woodlands, TX..................................    43
Wood, Patrick III, Commissioner, Federal Energy Regulatory 
  Commission.....................................................    16

                               APPENDIXES
                               Appendix I

Responses to additional questions................................    71

                              Appendix II

Additional material submitted for the record.....................    73

 
                       ELECTRICITY AND GAS RATES

                              ----------                              

                         TUESDAY, JUNE 19, 2001

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 9:07 a.m., in 
room SD-106, Dirksen Senate Office Building, Hon. Jeff 
Bingaman, chairman, presiding.

           OPENING STATEMENT OF HON. JEFF BINGAMAN, 
                  U.S. SENATOR FROM NEW MEXICO

    The Chairman. This morning the Energy Committee has a 
hearing on the recent FERC order, and it is also a hearing on 
Senator Feinstein and Senator Smith's bill to impose just and 
reasonable prices in Western electricity markets.
    I have said from the beginning of the process that I 
believe that the Federal Energy Regulatory Commission is under 
an obligation under the Federal Power Act to assure just and 
reasonable rates in California and throughout the West. I have 
also said that in my view the Commission was slow to act in 
that regard, and that if action was not taken, Congress needed 
to step in.
    The Commission yesterday issued an order that addresses 
market issues in the West. We are anxious to hear an 
explanation of that order, ask questions about how it is 
expected to work, how the Commissioners themselves believe it 
will work.
    On hearing the testimony this morning and hearing from some 
other witnesses, I believe we will be better able to determine 
whether Congress needs to move ahead or await further 
information.
    We look forward to the testimony. I want to thank the 
Commissioners particularly for being here. I know that this is 
a very busy morning for them. They have a technical conference 
on issues at the boundaries of regional transmission groups, as 
I understand it, and I am told that they really do need to 
leave here by no later than 10:30. So, we will have a short 
statement by Senator Murkowski and then go right to the 
witnesses and hear from them. Their general counsel is able to 
stay after they leave, I am informed.
    Senator Murkowski, go ahead.

      STATEMENT OF HON. FRANK H. MURKOWSKI, U.S. SENATOR 
                          FROM ALASKA

    Senator Murkowski. Thank you, Senator Bingaman. Let me, 
first of all, congratulate you as chairman, and make my pledge 
to work with you and your professional staff.
    I think between us we leave somewhat of a legacy on the 
issue of energy. You and I have held 24 hearings. We have had 
164 witnesses with specific recommendations on how to address 
the energy crisis.
    As we look at the testimony that we are about to receive 
from FERC, I hope that it is enlightening relative to the 
action taken and the question of whether or not this action is 
sufficient.
    You know, California ordered its investor-owned utilities 
to divest their fossil generation, but exempted the municipal 
utilities. And California prohibited its investor-owned 
utilities from using long-term contracts for the power market 
and forced them to rely entirely on the spot market.
    It was not so long ago that we saw headlines that indicated 
that power deals exceed prices on the spot market. In other 
words, these long-term contracts that were recently signed in 
California were at a higher rate than the spot market, which 
gives you some idea of the volatility of the price of 
electricity.
    Now, that strategy worked for a short time until demand in 
California grew beyond the availability of out-of-State supply. 
The reasons included increased demand in other parts of the 
West, as well as unseen factors such as record droughts on the 
Western hydro resources. But the reality is that supply did not 
meet demand, so now we have California's situation of 
blackouts, brownouts.
    The California power shortages have been evident for years. 
Yet, neither the State of California nor previously the FERC, 
under the previous administration, did very much about it. They 
simply hoped the problem would perhaps magically go away or the 
responsibility would fall on someone else's watch.
    In the meantime, California bankrupted its investor-owned 
utilities and put the taxpayer of California on the hook for 
some $40 billion. It did not pass on the true cost of power to 
consumers because of retail price caps. As a consequence, 
little incentive to conserve. Now some of those costs are 
passed on but I think it is still in the area of about 50 
percent.
    I cannot help but be somewhat amused that there seems to be 
in the minds of some people in California, or at least the 
media, there is a significant difference between the taxpayer 
and the ratepayer. I do not see that.
    Are price caps the solution to California's problems? Well, 
I do not think so. Price caps do not build powerplants. Price 
caps do not encourage conservation. They seem to spin the web 
of assumed political relief from higher prices, but not real 
relief. They do not build new powerplants or increase supply. 
That is the bottom line.
    But if price caps are the answer, as some suggest, I ask 
why has the California government not imposed price caps on the 
power sold by municipally owned utilities such as the Los 
Angeles Department of Water and Power.
    It is interesting to look at some of these accusations. 
Private power, of course, must openly report its profit. Public 
power does not have to report its windfall profits to anyone. 
It can keep them secret if it wishes. Private power has to 
report to the Securities and Exchange Commission and is watched 
like a hawk by investors who own stock. Public power has no 
investors, no SEC looking over their shoulder. Private power 
pays income taxes. Public power pays no taxes.
    It should come as no surprise that the State of California 
and specifically Governor Davis' Department of Water Resources, 
who has spent billions in purchasing power for California, has 
been stonewalling a California Senate committee investigation 
of suspected price gouging and market manipulation, refusing to 
provide relevant documents. To accuse the private power of 
profiteering, but to say so little about public power in my 
opinion is shameful. But for Governor Davis to fail to stop the 
Los Angeles Department of Water from profiteering is also 
inexcusable.
    I think it is also important, as we look at the issue of 
protection for those consumers in the West to recognize that 
both new generation and maintaining existing generation is an 
important factor that treats both the investor-owned and 
municipal utilities alike. Without a firm commitment from 
investors, we are not going to see one shovel turned in the 
construction of new generation. California has plenty of 
permits, but how many of those permits is that financing 
conditional?
    I refer to a letter I received by Mr. Wayne Angell, Senior 
Managing Director and Chief Economist of Bear Stearns. I will 
introduce the letter in the record in its entirety, but it 
reads and I quote. ``When caps are imposed and prices pushed 
below the market level, three things happen. One, buyers seek 
to purchase more, overriding public conservation efforts. Two, 
sellers supply less by diverting scarce supplies to more 
rewarding markets. And three, new energy transportation and 
production facilities would continue to decline as the 
uncertainties created by the regulations drive investors 
elsewhere.''
    Finally, Mr. Chairman, I think it is fair to say that the 
FERC order is working. Electric rates are declining. I have a 
chart behind me that shows some idea of the volatility of the 
rate structure and the fact that there has been a leveling off. 
The megawatt rate is somewhere in the area of $45 to $46, but 
you can clearly see the trend.
    I think FERC should be commended for their April order. 
That April order is working, and yesterday we saw FERC issue an 
order that builds on the April 26 price mitigation order, 
expanding its price mitigation to apply to all Western States, 
not just California, and expanding its price mitigation order 
to apply all of the time, not just when California is in a 
stage 1, 2, or 3 emergency.
    Since January, the current FERC has taken numerous steps to 
address California's problems. Nearly 30 orders have been 
issued. Under the Bush administration, FERC has been very 
aggressive to try and solve the problem.
    I would ask that a letter be entered in the record from 
four Governors today, Jane Dee Hull, State of Arizona; John 
Hoeven, State of North Dakota; Mike Leavitt, State of Utah; Jim 
Geringer, State of Wyoming. The body of the letter and the 
paragraph appropriate says, ``We understand FERC has acted 
unanimously to further address the issue through the existing 
process. This further underscores the effectiveness of the 
existing regulatory process and eliminates the need for 
congressional legislation in this area.''
    I commend those Governors. I commend the President and Vice 
President Cheney who have urged that we stay the course on this 
and that we do not need legislation. That is basically why FERC 
was established.
    I ask what do we need before we are convinced on the issue 
that what we really need is an increased supply. If there is a 
milk shortage around here, you run out and get some more cows I 
guess.
    But I am convinced that the time for talk is behind us. 
Anyway, what we have here is an operational FERC that is doing 
its job. We need to move forward with the legislation that 
promotes energy production and that is the energy plan that was 
presented by President Bush. It extends Price Anderson. It 
opens up the 1002 area of ANWR. It expedites renewal of TAPS. 
It increases LIHEAP weatherization. It expands the scope of 
appliance standards, hydro licensing, comprehensive 
electricity, eminent domain, pipeline safety, reauthorizes 
hydrogen futures, and a number of tax items. I think it is 
important to reflect on this because there are accusations here 
and there that the administration has not done anything in the 
sense of coming up with some positive solutions to address the 
energy crisis.
    What I do not think we want to do is go back to 1992 where 
this committee had extended hearings and did very little. I 
think what we got out of it covered encouraging renewable fuel 
development, conservation, and increased LIHEAP. The American 
will not stand for that. In addition, I think we have got left-
hand turns on red lights, and I think we got low-flush toilets 
that you had to flush twice.
    [Laughter.]
    Senator Murkowski. We have got to do better this time. 
Conservation can help, but it cannot do the job alone. If 
conservation was the answer, California would be swimming in 
energy because it is the second most energy efficient State in 
the Nation. Yes, we should conserve, but we must also have 
adequate supplies and increase our supplies.
    So, as a consequence, Mr. Chairman, I look forward to the 
witnesses this morning. I want to commend them for the action 
they have taken, and I would encourage my colleagues to 
recognize that before we wander in and introduce legislation, 
we should allow this agency, created by the Congress, to do its 
job.
    The Chairman. Commissioner Hebert, why do you not go ahead 
and explain to us the action that FERC took yesterday? Then we 
will call on each of the other Commissioners to give their 
perspective on it, to the extent they want to add anything. Why 
don't you go right ahead.

           STATEMENT OF CURT HEBERT, JR., CHAIRMAN, 
              FEDERAL ENERGY REGULATORY COMMISSION

    Mr. Hebert. Thank you, Mr. Chairman. I certainly have an 
opening statement that will get into what the Commission has 
done, has been doing, and actually what we have done as 
recently as yesterday.
    The Commission's experience in regulating electric and 
natural gas utilities, indeed, the Nation's experience in 
pricing and allocating vital goods and services, has taught us 
an important lesson. Consumers are better off if supply and 
pricing decisions are based on market mechanisms rather than 
bureaucratic fiat. Thus, the Commission is committed to helping 
move this country toward open competitive energy markets.
    At the same time, we recognize we must ensure that broken 
and dysfunctional wholesale markets are fixed. This poses 
challenges, particularly in California and the West where there 
is a substantial imbalance of supply and demand.
    In response to these challenges, the Commission has been 
working aggressively to reform market structures and to enhance 
consumer welfare in California and the West. The Commission has 
not lost sight of the point that the best way to lower 
wholesale electricity prices and to keep them low is to promote 
investment in badly needed supply and delivery infrastructure 
and to encourage demand reduction. The Commission's task 
remains to balance these goals to ensure that short-term 
measures do not undermine long-term principles.
    Yesterday, by a unanimous vote of 5-0, the Commission took 
action that illustrates this balanced approach perfectly. It is 
the approach that has been working and that will now, I 
believe, even work better.
    The Commission has adopted refinements to a market 
monitoring and price mitigation plan that was first implemented 
on May 29 of this year. The plan strikes a balance between 
bringing market-oriented price relief to the California and the 
Western electricity markets providing greater price certainty 
to buyers and sellers of electricity, energy, promoting 
conservation, and importantly encouraging investment in 
efficient generation and transmission.
    The original plan established price mitigation for the spot 
markets--in other words, markets in which sales are arranged 24 
hours or less before delivery of the power starts--run by the 
California independent system operator when the ISO declares a 
reserve deficiency--in other words, when generating reserves 
are at or below 7 percent.
    Price mitigation has been triggered twice since the 
Commission's plan was first implemented on Wednesday, May 30, 
and Thursday, May 31, 2001, 2 days of record high temperatures 
when the ISO announced reserve deficiencies. Prices which had 
been up around $300 per megawatt hour before the ISO announced 
a reserve deficiency on May 30 fell to $120 and rose no higher 
than $135 during the rest of the day. On May 31, prices rose to 
$130 per megawatt prior to the announcement of a reserve 
deficiency, but fell to $108 when mitigation began and fell 
further to $64 a megawatt hour that day.
    Even more significant is the fact that spot prices 
continued to fall in subsequent days, even when system 
emergencies were not declared and have remained low. Spot 
prices which had been up over $400 per megawatt hour for much 
of the month of May, prior to implementation of the 
Commission's plan, now rest comfortably around $100 per 
megawatt hour. Put another way, spot prices in California and 
the rest of the West are lower than at any time in the past 
year and are coming close to spot prices in the rest of the 
country.
    In addition, the drop in spot electricity prices has been 
matched by related price drops in other markets. Prices for 
Western forwards contracts are also down significantly. For 
example, year 2002 forwards transactions have dropped from $127 
per megawatt hour to $68 per megawatt hour. And 2003 forwards 
transactions have dropped from $60 per megawatt hour to $41 per 
megawatt hour in this past month.
    On top of all this, natural gas prices have similarly 
plunged and are lower and hopefully leveling off in California 
and much of the West.
    Building on this success, yesterday this Commission, in a 
unanimous decision, voted to refine its mitigation plan to add 
price mitigation measures for spot markets during all time 
periods and for all other States in the Western Systems 
Coordinating Council. Now wherever there is a reserve 
deficiency and when there is one in California, a market 
clearing price will apply not only to the ISO spot markets, but 
also to all spot markets in the 11-State region covered by the 
WSCC. The market clearing price will be based on the bid of the 
highest cost gas-fired unit located in California that is 
needed to serve the California ISO's load on any day in which a 
reserve deficiency is announced. The bid will reflect a 
published gas cost plus, an adder for operating and maintaining 
expenses, and a credit risk. Sellers other than marketers will 
have the opportunity to justify individual prices above the 
market clearing price based on their cost. Therefore, not a 
cap. Marketers will not be allowed to charge more than the 
market clearing price. Marketers will be price takers.
    When a reserve deficiency period ends, the maximum price 
that can be charged for spot market sales in California and the 
rest of the WSCC will be 85 percent of the highest hourly price 
that was in effect during the most recent stage 1 reserve 
deficiency period, absent cost justification. For example, if 
the highest market clearing price during the most recent 
reserve deficiency called by the California ISO is $100 per 
megawatt hour, spot prices in all subsequent hours, beginning 
when the reserve deficiency ends, can as a general matter be no 
higher than $85 per megawatt hour. This $85 per megawatt hour 
maximum price will remain in place until the next reserve 
deficiency is announced and a new market clearing price is set. 
Again, sellers other than marketers will have the opportunity 
to justify individual prices above the market clearing price 
based on their costs.
    Yesterday's order also limits the ability of generators to 
exercise market power by withholding capacity by requiring that 
all public utilities and non-public utilities that own or 
control generation in California offer power in the California 
ISO spot markets. This requirement applies to any non-
hydroelectric resource to the extent its output is not 
committed for use or sale in the hour or necessary to satisfy 
local reserve or reliability requirements.
    The same requirement will apply to sellers throughout the 
rest of the WSCC, except that they may offer their power in the 
spot markets of their choosing.
    Also, the Commission has made clear that through enhanced 
monitoring and coordination of generation or generator outages, 
along with additional tools to act against withholding in other 
forms of anti-competitive behavior, it is committed to 
ferreting out and remedying any form of market manipulation and 
misbehavior no matter when it occurs, 24 hours a day, 7 days a 
week.
    I am very proud of the Commission's approach toward 
reforming California and Western electricity markets. The 
Commission's mitigation plan manages what many said could not 
be accomplished: restraining prices while encouraging 
investment. The key is that price mitigation is based on market 
forces. The market clearing price is designed as a cost of the 
least efficient unit that is called upon to dispatch energy.
    The mitigation price is not a blunt, arbitrary figure that 
bears no resemblance to market conditions and is subject to 
political pressures and whims. That is what was tried in 
California just this past summer. The ISO lowered the price cap 
last summer from $750 per megawatt hour to $500 and then even 
lower to $250 per megawatt hour. All this did was cause an 
increase in the average electricity price and a reduction in 
the ability of the ISO to procure emergency power.
    The point I would like to make there is that there are so 
many discussions about price spikes, and we certainly 
understand that. We certainly look for those, as does the 
industry. But we are concerned with what inevitably gets to the 
consumer most and that is the average prices, and that is why I 
believe this plan will work best.
    Indeed, last December, the ISO begged the Commission to 
allow it to remove the cap, explaining that it was impairing 
the ISO's ability to meet demand and undermining the 
reliability of the electricity grid.
    Also the mitigation price is not based on the cost of 
individual generators. A return to traditional regulation would 
entail months and perhaps years of administrative appellate 
litigation over cost structures and reasonable rates of return. 
This type of delay and uncertainty is simply unacceptable at 
this critical juncture. We need to be problem solvers now.
    Even more disturbing, regulation based on cost would 
provide no incentive for suppliers to become efficient and 
reduce their costs and thereby lower prices for consumers.
    Mr. Chairman, I do see the yellow light, but I am trying to 
explain the entire plan to you. It will probably take me 
another 2 or 3 minutes.
    The Chairman. Go right ahead.
    Mr. Hebert. Thank you.
    The Commission's plan, on the other hand, provides every 
incentive for suppliers to reduce their costs and improve their 
efficiency. Nothing is now guaranteed. A generator or a 
marketer now makes money by increasing the efficiency of 
production. Its profit is determined by how much of a 
differential there is between its own cost of production and 
the cost of the least efficient last dispatched unit. A 
generator is now able to recover its fixed costs, but to the 
extent of its recovery of capital and the size of its profit, 
it is determined by the efficiency of its operations. In this 
manner, a generator will find it profitable to retire old, 
dirty, inefficient units and replace them with new, cleaner 
burning, more efficient units. It is not only better for 
consumers for bringing down prices and driving efficiency, it 
is also better for consumers because we all understand the best 
way to clean up our environment is to never dirty it in the 
first place.
    Yesterday's order was just the latest of dozens of orders 
we have issued in recent months addressing California and 
Western energy markets. On the electric side, the Commission 
has done everything it can within its jurisdiction to extract 
every last drop of electricity out of existing resources and to 
free up additional megawatts from demand reduction initiatives.
    To accomplish these results, the Commission has removed 
various obstacles through waivers and other regulatory 
enhancements. It has provided various incentives to the 
development of new supply, including hydroelectric supply and 
the reduction of existing demand.
    Other Commission-led initiatives have reformed well-
intended but operationally dysfunctional market structures and 
have promoted contractual certainty.
    On the natural gas side, the Commission has been no less 
active. First and foremost, the Commission in recent months has 
significantly expedited its processing of applications to add 
badly needed pipeline capacity to California. Applications of 
the type that used to take many months or years for the 
Commission to process were acted on in a mere 3 to 4 weeks.
    On this point, the California Energy Commission recently 
identified the lack of pipeline capacity, particularly capacity 
inside California as the principal reason for the recent upward 
spikes in the price of natural gas. The Commission recently 
held a technical conference on this subject. We do not control 
intrastate capacity. It is controlled by the State of 
California, by their Commission, and by their people.
    The Commission has sought comment on whether to reimpose 
ceiling prices for capacity release transactions on pipelines 
serving California. And the Commission established an expedited 
hearing on alleged affiliate market power abuses by major gas 
pipelines serving southern California.
    In conclusion, the Commission has been doing a great deal 
of work, Mr. Chairman and members of the committee. The 
Commission's efforts have contributed to the recent decline in 
Western energy prices. Yesterday's order issued by a unanimous 
Commission, a Commission sitting as one, improves upon a plan 
that is good for California, good for the Pacific Northwest, 
and good for the entire West. It is a plan that respects market 
forces and that attempts to restrain prices while at the same 
time offering incentives for investment in supply and delivery. 
That is the only real solution to the West's immediate energy 
problems. It represents an effort to provide some relief now 
while making sure that mitigation is short-lived. The 
Commission's goals remain to fix dysfunctional markets and to 
ensure that markets regain their competitive footing as quickly 
as possible.
    Mr. Chairman, just quickly, many of us have understood that 
too much deference has been given to California in the past. We 
are acting to do what we can and what we should and what we are 
bound to under the law to protect the consumers in California 
and the West. In doing that, I would like to mention something 
that I think is important for you to know as we understand we 
cannot afford to pay too much deference when consumers may be 
harmed.
    It is my belief--and I am not speaking for the Commission 
here and what the Commission did. This is my personal belief as 
Chairman of the Commission--that when I speak of forward 
contracts and I speak of less reliance on the spot market, 
which we know is what damaged California, it would be my 
observation and my inclination that anything outside of 5 years 
of forward contracts is getting purely speculative and 
potentially harmful to consumers because, as we know, prices 
will continue to be volatile. I do not mean to, nor will I, 
endorse 10-, 15-, and 20-year contracts with the volatility 
that I know is ahead.
    I know there are so many questions that come up as to what 
the Commission should have done a year ago. Again, I will 
continue to say that I cannot answer what this Commission 
should have done a year ago. I became Chairman January 22 and I 
came to many of your offices. I certainly came to Senator 
Feinstein's office as well about 3 weeks after I had been named 
Chairman. I assured you and I assured others on this committee 
that we would act responsibly, we would act expeditiously, and 
we would correct the markets. I think we have done that.
    We have issued over 60 orders for California specifically. 
We have had a price mitigation for California in reserve 
periods. We have got the RTO filed with us now, which is 
important, understanding that it is not only about supply but 
deliverability of that supply. We have issued orders removing 
impediments, removing obstacles. We are doing things faster 
than they have ever been done before to help California and the 
West. We have got gas prices coming down. We are moving towards 
transparency with gas prices. We are seeking comments on that. 
We are seeking comments on the caps themselves, on the capacity 
release. And now we have price mitigation not only for 
California but also for the West in reserve and in non-reserve 
periods.
    I will close by saying this, Mr. Chairman and members of 
the committee. I believe in my heart and I know in my educated 
mind that we are on the right track and we are doing what 
should be done for California and the West with the principles 
that I think are endorsed by all of America.
    Thank you, sir.
    [The news release of the Federal Energy Regulatory 
Commission follows:]

Commission Extends California Price Mitigation Plan for Spot Markets to 
             All Hours, All States in Entire Western Region

    The Federal Energy Regulatory Commission today expanded its price 
mitigation plan for the California spot market sales to 24 hours a day, 
seven days a week. The curbs on prices in the spot electric markets 
were also broadened to cover the entire 11-state western region. Spot 
markets cover sales that are 24 hours or less and that are entered into 
the day of, or day prior to, delivery.
    Chairman Curt L. Hebert, Jr. said: ``The Commission's price 
mitigation plan works. Today, the Commission adopts additional 
measures, based on its original mitigation plan and which continue to 
employ market-oriented principles, that will ensure that the plan works 
even better.''
    Today's order retains the use of a single price auction and must-
offer and marginal cost bidding requirements when reserves are below 7 
percent in the California Independent System Operator (ISO) spot 
markets, as outlined in the April 26, 2001 price mitigation and 
monitoring order. The California ISO market clearing price will also 
serve to constrain prices in all other spot market sales in the Western 
Systems Coordinating Council (WSCC) during reserve deficiencies in 
California. Sellers in other spot markets in WSCC will receive up to 
the clearing price without further justification. Sellers other than 
marketers will have the opportunity to justify prices above the market 
clearing price during reserve deficiency hours.
    The California ISO market clearing price for reserve deficiency 
hours will also be adapted for use in all western spot markets when 
reserves are above 7 percent. Prices during non-reserve deficiency 
hours cannot, absent justification, exceed 85 percent of the highest 
hourly clearing price that was in effect during the most recent Stage 1 
reserve deficiency period called by the ISO.
    Building on the success of its price mitigation and monitoring 
plan, the Commission said that the key to bringing down prices in 
California still lies with signing a portfolio of longer term contracts 
and relying less on the more volatile spot markets, and attracting 
additional investment in badly needed supply and delivery 
infrastructure.
    Today's actions will ensure that wholesale rates in spot markets in 
California and the rest of the WSCC will fall within a zone of 
reasonableness. In rejecting a return to cost-of-service rates, the 
Commission said that cost-based ratemaking may penalize more efficient 
generators and does not provide proper incentives for generators to 
become more efficient. The Commission, in this order, as it has done in 
all its previous orders related to the California markets, has put 
procedures in place to prevent possible abuses that could lead to 
unjust and unreasonable rates.
    The Commission made clear that the abuse of market power will not 
be tolerated and sellers may lose their market-based rates if they 
engage in anti-competitive behavior.
    In adopting market-based rates for the Western energy markets, the 
Commission's use of a monitoring program is key to ensuring that rates 
are just and reasonable. The revisions made in this order are designed 
to provide a structure that will minimize potential abuses, ensuring 
reasonable rates for consumers, while also encouraging adequate supply 
in the market.
    Other elements of today's order are:

   all public utilities and non-public utilities selling into 
        the markets run by the California ISO or using Commission-
        jurisdictional transmission facilities, who own or control 
        generation in California, must offer power in the California 
        ISO's spot markets. This applies to any non-hydroelectric 
        resource to the extent its output is not committed for use 
        (energy or minimum operating reserves) or sale in the hour.
   the same requirement will apply to sellers throughout the 
        rest of the WSCC, except that they may offer their power in the 
        spot market of their choosing.
   power marketers will not be permitted to sell above the 
        mitigated prices.
   generators' bids during reserve deficiencies must reflect 
        the marginal cost to replace gas used for generation, 
        determined by the average of the mid-point of the monthly bid 
        week prices as reported in Gas Daily for all three spot market 
        prices reported for California.
   bidders will be allowed to invoice the California ISO for 
        the costs of complying with NOX and other emissions 
        standards and for fuel used for start-up. The ISO is required 
        to file a rate mechanism to bill those costs over the entire 
        load on the ISO system.
   the price mitigation will end September 30, 2002.

    Chairman Hebert commented: ``This is a plan that is good for 
California, good for the Pacific Northwest, and good for the entire 
West. It is a balanced plan that respects market forces and that 
attempts to restrain prices, while at the same time offering incentives 
for investment in supply and delivery that is the only real solution to 
the West's immediate energy problems. It represents an effort to 
provide some relief now, while making sure that mitigation is short-
lived. The Commission's goal remains to fix dysfunctional markets and 
to ensure that markets regain their competitive footing as quickly as 
possible.''
    Commissioner Linda K. Breathitt said: ``I support the mitigation 
approach adopted through this order because it contains the market 
features that I believe are critical to helping remedy the market 
design flaws while still encouraging new investment in infrastructure 
and protecting consumers.''
    Commissioner Nora Mead Brownell commented: ``It is my hope that 
this order lays out a road map which will bring certainty and stability 
to the citizens in the West and encourage the desperately needed 
investment in infrastructure.''
    Commissioner William L. Massey said: ``This order provides price 
protection in the entire Western interconnection 24 hours a day, seven 
days a week, it absolutely prohibits gaming and so-called megawatt 
laundering, and will last 2 summers. I have been advocating this 
comprehensive approach for quite some time, and am generally pleased 
with this order.''
    Commissioner Pat Wood, III commented: ``What we do today is about 
more than California. It is about the future of competition and about 
our resolve to make it a better world for energy customers in our 
country.''
    In a comprehensive December 15, 2000 order addressing problems in 
the California wholesale markets, the Commission found that the market 
structure and rules for wholesale sale of electric power in California 
were flawed and that, in combination with an imbalance of supply and 
demand, led to unjust and unreasonable rates for short-term energy 
during certain periods and under certain conditions. The December order 
provided a number of remedies for the California markets including 
elimination of the Power Exchange's (PX) mandatory buy-sell requirement 
price and establishment of penalties for under scheduling load.
    Following the December order and a series of related refund and 
investigation orders issued earlier this year, the Commission announced 
its prospective price mitigation and monitoring plan for California in 
an April 26 order. The Commission noted that the plan, which took 
effect May 29, has already produced results with western power prices 
dropping in both the spot and long term markets. California's reliance 
on the spot market has dropped from near 100 percent to about 20 
percent during peak hours since the Commission's December order.
    The Commission also announced today that it will hold a settlement 
conference before a FERC administrative law judge later this month. All 
parties in the California ISO investigation proceeding are directed to 
participate in the settlement discussions in order to resolve refund 
issues for past periods and help structure new arrangements for 
California's energy future.

     KEY QUESTIONS AND ANSWERS ABOUT THE FEDERAL ENERGY REGULATORY 
    COMMISSION'S JUNE 18, 2001 ORDER ADDRESSING PRICE MITIGATION IN 
                CALIFORNIA AND THE WESTERN UNITED STATES

    Question 1. Does the Commission's order put price caps on all 
California wholesale electricity prices?
    Answer. No. The Commission's order does not impose cost-based caps 
in any markets or on any prices. Rather, it establishes price 
mitigation, based on market-oriented principles, that will apply to all 
wholesale sales of energy in spot markets in the United States portion 
of the Western Systems Coordinating Council (WSCC). Spot market sales 
are wholesale sales that last no longer than 24 hours and that are 
entered into the day of, or the day prior to, the power being 
delivered.
    Question 2. What is the ``price mitigation'' that is being adopted?
    Answer. There are two types of price mitigation being put in place 
for spot market sales, depending upon how low generation operating 
reserves are at any particular time:
    (1) When generation operating reserves fall below 7% in California 
(called a reserve deficiency), a market clearing price will apply to 
all spot market sales in California and in the rest of the WSCC. All 
bidders in the ISO spot markets will receive the market clearing price 
without further price justification. All sellers in other spot markets 
in the WSCC will receive up to the clearing price without further price 
justification. The market clearing price will be based on the bid of 
the highest cost gas-fired unit located in California that is needed to 
serve the California Independent System Operator's load on any day in 
which a reserve deficiency is called. The bid will reflect a published 
gas cost plus an adder for operating and maintenance expenses. Sellers 
other than marketers will have the opportunity to individually cost 
justify prices above the market clearing price. Marketers must be price 
takers, i.e., they cannot charge more than the market clearing price.
    (2) When a reserve deficiency period ends and generation operating 
reserves rise to 7% (a non-reserve deficiency period), the maximum 
price that can be charged for spot market sales in California and the 
rest of the WSCC during the non-reserve deficiency period, absent cost 
justification, will be 85% of the highest hourly price that was in 
effect during the most recent Stage 1 reserve deficiency period called 
by the California ISO. An uplift charge for fuel used for start up of 
generators will not be included in the market clearing price, but 
instead, will be recovered through ISO charges to all California load 
on the ISO's transmission system.
    Question 3. How does the above price mitigation differ from that in 
the Commission's April 26, 2001 order?
    Answer. It differs in three major ways:
    (1) The market clearing price formula is changed in three ways: it 
adjusts the gas component to reflect replacement gas prices in the 
North or South of California, depending upon where the generating unit 
that sets the market clearing price is located; it adjusts the O&M 
expense from $2 to $6; and it eliminates emission costs from the 
formula. Emission costs will be recovered separately from the ISO and, 
ultimately, the ISO's customers.
    (2) The prior order did not provide for mitigation of spot sales 
prices in non-reserve deficiency periods. As described in the answer to 
Question 2, today's order does provide for such mitigation.
    (3) The prior order did not provide for mitigation of spot prices 
in the WSCC, other than the spot prices in the ISO's centralized 
markets, but sought comment on whether and what mitigation to adopt 
outside the ISO markets. Today's order applies price mitigation rules 
in California and all of the WSCC's spot markets, including to 
individual bilateral contract spot market sales in California and the 
remainder of the WSCC.
    Question 4. Do the above price mitigation rules apply to all 
sellers in the West?
    Answer. Yes. The same rules that apply to FERC-regulated public 
utilities (such as traditional investor-owned utilities, individual 
power generators and power marketers) that make spot market sales in 
the WSCC also apply to any non-public utility (such as Federal power 
marketing agencies, municipal utilities and electric power cooperative 
utilities) that chooses to sell in FERC-regulated power markets or that 
use FERC-regulated interstate transmission facilities.
    Question 5. How does the Commission's order apply to power 
marketers and potential market power abuse such as ``megawatt 
laundering''?
    Answer. ``Megawatt laundering'' refers to selling from California 
to other states, and later reselling into California in order to avoid 
price mitigation that may be in effect. Incentives for this will now be 
eliminated because uniform price mitigation rules will apply in 
California and in the remainder of the WSCC for both reserve deficiency 
periods and non-reserve deficiency periods. Further, power marketers 
(unlike other suppliers) will not be permitted to justify prices above 
the prescribed mitigated prices. Finally, all public utility sellers' 
market-based rate authorizations are conditioned on sellers agreeing to 
refund overcharges resulting from anti-competitive conduct and to 
potential revocation of their market rate authority.
    Question 6. Does the new mitigation adopted in the order apply 
retroactively? What about refunds for past periods?
    Answer. The mitigation in today's order takes effect the day after 
issuance of the order. The Commission will address refunds for past 
periods, if not resolved by settlement, in future orders. The 
Commission has directed public utility sellers and buyers in the 
California ISO markets to participate in settlement efforts before a 
Commission administrative law judge, with such efforts to begin by June 
22 and to be completed within 15 days thereafter. Among the many issues 
presented by these proceedings, the parties may address refund issues 
during the settlement proceedings.
    Question 7. Why hasn't the Commission imposed cost-based caps? 
Isn't the Commission required by the Federal Power Act to impose cost-
based rates if competitive markets aren't working the way they are 
supposed to?
    Answer. The Commission has broad discretion in setting rates, and 
is not required to use cost-based rates or any other specific method so 
long as the end result is within a zone of reasonableness. The 
Commission must balance two statutory goals: protecting customers 
against unreasonable rates and encouraging adequate supplies to meet 
those customers' power supply needs. Cost-based rates would squelch 
development of new supplies in the West and thus perpetuate the 
problems we are trying to solve. Thus, the price mitigation adopted by 
the Commission ensures that rates are not unreasonable for customers 
but also encourages new supplies needed in the West.

    The Chairman. Thank you very much.
    Let me just ask each of the other Commissioners to take two 
or three minutes and add anything they would like or give their 
perspective on this order. Commissioner Breathitt, why don't 
you start?

        STATEMENT OF LINDA KEY BREATHITT, COMMISSIONER, 
              FEDERAL ENERGY REGULATORY COMMISSION

    Ms. Breathitt. Mr. Chairman, I have a very short statement 
that complements what we have done yesterday, and I would like 
to read that and ask that it be entered into record.
    The Chairman. Go right ahead.
    Ms. Breathitt. Mr. Chairman and members of the committee, 
yesterday the Commission instituted market monitoring and price 
mitigation procedures for the entire Western United States. 
These new procedures build on our April 26 order which 
implemented similar procedures for California and initiated a 
section 206 investigation of bulk power markets throughout the 
West.
    The plan we announced yesterday is designed to produce 
prices in all hours that are just and reasonable and to emulate 
prices that would be present in a competitive market.
    The purpose of the plan is to stabilize the market in the 
short term and permit California and other Western States to 
repair dysfunctional market mechanisms. The mitigation plan is 
intended to provide breathing room for the markets to self-
correct.
    Importantly, the mitigation plan will apply to all sellers, 
including marketers and non-public utilities across California 
and the balance of the U.S. portion of the Western States 
Coordinating Council.
    I fully support the premise of the order, which is that all 
sellers should be treated alike to remove the incentive to sell 
in one area versus another when an emergency is called by the 
ISO, so-called megawatt laundering.
    While I wholeheartedly encourage conservation and embrace 
demand reduction mechanisms, we need to acknowledge that the 
natural gas and electric infrastructure in the West must be 
expanded and upgraded.
    I believe the market-oriented approach we have taken 
through yesterday's order will provide the price mitigation 
needed. It is also my hope it will not discourage necessary 
investment in supply.
    I would like to note that I attached a concurrence to the 
order to express my views about one aspect that I did not fully 
endorse. The order instructs the ISO to impose a 10 percent 
credit worthiness surcharge to the market clearing price. The 
imposition of such a surcharge virtually concedes to the ISO 
the issue of whether or not the ISO must implement our 
Commission's credit worthiness standards, an action that I 
believe may be premature.
    Finally, I would like to state my support for a settlement 
conference that will be established through the order. I am 
keenly aware of the difficulties that the parties face and that 
compromises will need to be made to fashion a comprehensive 
settlement. However, I have long been an advocate of negotiated 
resolutions and I encourage all the parties involved, including 
the State of California, to work together at the daunting task 
of settling past accounts and structuring new arrangements.
    In conclusion, I am confident that the Commission has taken 
the appropriate actions to address the market distortions in 
California, and I am pleased that our mitigation plan will now 
be extended to the other States in the WSCC. Our remedies have 
been designed to help alleviate the high prices borne by 
California citizens and others in the West, but they have also 
been designed to ensure that sellers have incentives to sell 
into those States and build sorely needed new generation and 
transmission necessary to provide reliable service in the 
future. Meeting these goals within a market-oriented framework 
is an approach that I endorse.
    The Chairman. Thank you very much.
    Commissioner Massey, why don't you go ahead with any 
comments you have.

         STATEMENT OF WILLIAM L. MASSEY, COMMISSIONER, 
              FEDERAL ENERGY REGULATORY COMMISSION

    Mr. Massey. Thank you, Mr. Chairman.
    Yesterday's order brings substantial price relief to a 
broken market. I supported the order because it adopts measures 
that I have been championing for the past 8 months. Price 
controls are now extended to the entire Western 
interconnection, thereby eliminating the megawatt laundering 
problem that has vexed the mitigation programs adopted by the 
Commission and the ISO. All sellers, both jurisdictional and 
non-jurisdictional, are covered. Cost-based price controls 
based upon the production costs of the last increment of 
generation dispatched are now extended to all hours, not just 
those of reserve deficiencies. We have long needed 24/7 
coverage and we finally have it. Price relief will remain in 
place for two summers, until September 2002, giving the market 
16 months to correct. I endorse these measures.
    Given that the Commission has now adopted measures that I 
have long advocated, I am tempted to declare victory and let it 
be. But I cannot. I have some concerns.
    First of all, why did we not implement this plan 8 months 
ago? Until yesterday, the Commission had stubbornly refused to 
implement full-time price constraints, despite rather clear 
evidence that prices were not just and reasonable. We could 
have avoided much of the economic carnage out West, the closing 
of manufacturing facilities, putting people out of work that 
has occurred over the past year. Of all of this, this committee 
is very much aware.
    No. 2, the 10 percent credit worthiness surcharge. I object 
to this. I do not see the need for it. The Commission has 
issued orders in the past few months instructing the ISO to 
abide by the credit worthiness requirements of its tariff. I am 
concerned that this 10 percent adder may diminish the ISO's 
enforcement of those requirements. Moreover, it is my 
understanding that recently all sales into the ISO's markets 
have been backed by a credit worthy party.
    Instituting this surcharge does have a modest bright side, 
however. Generators may no longer attempt to justify bids on 
the basis of credit risk above what is provided in the cost-
based clearing price methodology. This was a major flaw in the 
old, ineffective $150 benchmark in our earlier mitigation 
program. Eliminating that ground for high prices is perhaps a 
positive development.
    Third, we should have provided guidance, in my judgment, on 
the issue of refunds. We send all the parties to a settlement 
conference with absolutely no guidance whatsoever on this 
question. And it seems to me that it is up to this agency to 
make a determination of what just and reasonable prices should 
have been, extending back to last October 2. Instead, we punt 
that to a settlement. I certainly hope it works. I hope the 
parties can settle the matter, but I would have preferred some 
guidance on this question.
    Point four, the issue of the least efficient generation 
unit. Will it, as Chairman Hebert says, encourage the 
retirement of inefficient generators? Or will it, on the other 
hand, encourage the continued use of inefficient generators so 
that the market clearing price will be high? I do not know the 
answer to this question.
    Point five, whether this is successful depends in 
substantial part on whether spot gas prices are reasonable. The 
last increment of generation will often be an inefficient gas-
fired generator, and it may very well be that 80 percent of the 
cost of that generator will be natural gas. If gas prices are 
high, then the last increment of generation will be high. If 
gas prices are reasonable, the last increment of generation 
dispatched may be reasonably priced.
    Finally, Mr. Chairman, just one more minute please. Over 
the next 16 months during this time out, can this broken market 
be repaired, repaired by substantial new generation, repaired 
by eliminating over-reliance on the spot markets, repaired by 
the implementation of a robust demand response program 
implemented through demand bidding that can take a bite out of 
the crisis, repaired by dealing appropriately with transmission 
constraints?
    We must work with the State of California. We must reach 
out a helping hand and approach them in a spirit of good will 
to solve these problems. We now have 16 months.
    Thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Commissioner Brownell, why don't you go ahead.

        STATEMENT OF NORA MEAD BROWNELL, COMMISSIONER, 
              FEDERAL ENERGY REGULATORY COMMISSION

    Ms. Brownell. Mr. Chairman, thank you. Senators, I am 
pleased to be here today to talk about an order that I think 
represents an enormous step forward.
    I would like to share with you, since I have been here 
last, what I found when I came to the Commission, particularly 
working on this order. I found a shared sense of urgency, both 
in my colleagues and by the staff. I found enormous flexibility 
as we worked through the complex issues that are outlined in 
this order. I found honest and open communication, and I 
believe those are the elements that will allow us to 
effectively respond and continue to open markets. I think you 
could fairly say that this order represents the fact that 
everybody gave at the office, and I think that is why it works.
    What else does it represent? I think what we have done is 
to provide a comprehensive road map, a plan to get through the 
next two summers, a road map that will create stability and 
certainty and allow all of us to address market monitoring, 
structure, and policy issues to create a fully functional 
market.
    It is important to note also that this order responds 
affirmatively to the significant and helpful input from all of 
the affected parties. The stakeholders' interests are well 
represented.
    My colleagues have, I think, articulated the main issues 
that have been handled in this order, and of course, I know you 
have a lot of questions, so I am going to be brief. But I want 
to talk about a couple of elements that I think are critical.
    We have, in fact, established a call to action for all of 
the parties to join in joint settlement discussions to bring to 
closure some outstanding issues. And Commissioner Massey is 
correct. Perhaps we need to give more guidance. But in 
Pennsylvania, we found the settlement talks to be successful 
because we believe business people can manage their own 
business more effectively than we can. I urge the parties and I 
urge you to urge the parties to be serious and to be quick 
about addressing these issues. We will certainly do it for them 
and we will certainly do it quickly. But we hope to give them 
the opportunity to respond in ways that are most appropriate.
    We have also begun the process to ensure that the 
opportunities created by new technologies for demand response 
mechanisms are fully examined and brought to the market in a 
rapid fashion. Customers are smarter than we give them credit 
for. Customers will use tools to manage their buying habits if 
we give them those tools. We need to find more effective ways 
than shutting down businesses to manage demand response. I 
believe the technologies are there. I think with encouragement 
from policy leaders like you and us we can bring them to 
market.
    I think the most critical piece of this order is that it 
represents a real opportunity for the State and the Federal 
Government policies and the stakeholders to work together. No 
one of us can solve this problem. I wish it were that simple. I 
believe we have made an effort at outreach and we will continue 
to do so because I think together we can provide the leadership 
that is required and, indeed, demanded and owed to the 
consumers of the West and, frankly, the consumers of this 
country.
    I thank you and I look forward to your questions.
    The Chairman. Thank you very much.
    Commissioner Wood, why don't you go right ahead.

         STATEMENT OF PATRICK WOOD III, COMMISSIONER, 
              FEDERAL ENERGY REGULATORY COMMISSION

    Mr. Wood. Coming last, there is a cleanup job. There is not 
much to clean up after this. We did a lot yesterday.
    One of the things that we did not do that I think is 
relevant to the discussions that I know were scheduled for the 
committee today is move to a cost-of-service rate regulation 
regime. We have contemplated it. I am just personally not 
allergic to that sort of remedy, but I wanted to look to the 
facts and have had the staff at the Commission, who I have 
found to be very capable and helpful on this issue, research 
for me some of the relevant facts here so I could share those 
with you all today. So, if I could just step over for my 2 
minutes to this chart.
    The Chairman. Go right ahead.
    Mr. Wood. The spot market in California encompasses the 
last 20 percent of the total market. Due to the efforts of the 
California government to get into longer-term contracts since 
last December, a lot of the generation has been taken off of 
the spot market and moved, as we think appropriate and support 
certainly from the Commission's point of view, into longer-term 
contracts that are not dealt with by yesterday's order.
    Yesterday's order deals with in predominant part--and this 
is what the facts show--with the older units that have what we 
call the higher heat rates, the less efficient units. I know, 
Senator Feinstein, you have been concerned about the use of the 
least efficient units, but quite frankly what is in the 
leftover part of the spot market are very many inefficient 
units. So, one is not markedly more inefficient than the other. 
There is some spread.
    And this curve is representative--I will get some 
additional facts as we work the ISO to get those. The curve 
largely is a relatively flat curve that drops a little lower as 
you have some of the newer more efficient units participating 
in the spot market, and then the very old units that are 
dispatched at the very, very end and very high units which we 
could see this summer certainly setting the price.
    Unlike cost-of-service ratemaking, the Commission's market 
mitigation order does not add a profit. We do add this credit 
worthiness that we have talked about, but we do not add a 
normal profit that we would add to the cost-of-service. If we 
were to take the prices of these units and add some sort of 
cost-of-service, I know even the Governor of California has 
said perhaps even a 50 percent return would be better, but in 
general regulation is a 12 percent return after tax, or the 16 
percent once you factor in the taxes. If you were to add that 
on to the curve right here, you would set up a rate here 
(gestering). So, that is kind of what cost-of-service would do, 
taking these costs and add a profit like that.
    What the Commission's order yesterday does is on a normal 
first contingency emergency, which is when you have got less 
than 7 percent excess capacity available in the market, we 
would set the price at that level. Yes, that is the least 
efficient unit in that time frame, but this (gestering) is what 
you call the producer surplus. These producers have costs at 
that lower level. They receive a price at that higher level. If 
you have got a more extreme day, you would have the clearing 
price being set at a higher level, and again we will see that 
this summer undoubtedly.
    But I think it is important to compare just under cost-of-
service there is still some money out there that might be more. 
So, I think it is a close call as to which one is more money 
out of California ratepayers' pockets, but I just want to 
assure the committee that I was cognizant of that. We certainly 
looked at that, at the Commission's point of view as to which 
is better, and I do not think there is a dramatically different 
outcome as far as the bottom line, how many dollars are going 
out of customers' pockets under cost-of-service versus the 
Commission's order.
    So, I hope that is helpful, and we will continue to work on 
the refining that kind of data because I think it is important 
for you as policy makers to understand the difference between 
the impact of the Commission's order yesterday and how it 
treats the spot market and how those spot market prices would 
work were it to be a cost-of-service based regime, which quite 
frankly we have been good at for 80 years and we are trying to 
move away from. But we can still do it.
    The Chairman. Thank you very much.
    Since the Commission has indicated they need to leave by 
about 10:30, I am going to limit everyone to 5 minutes and try 
to get all Senators to have a chance to ask questions. Let me 
start.
    Commissioner Hebert, let me ask you what your thought is. 
You stated, in very eloquent terms, the pride you have in the 
order that you have entered and the fact that you believe that 
now this order is the right thing to be doing. There is a long 
period here of many months during which Commissioner Massey and 
others have thought that something similar to this should have 
been in place. For that period of time, is it your thought that 
the parties themselves should negotiate what they believe would 
have been just and reasonable rates had this order been in 
effect and settle out at that basis? Is that what your intent 
is at this point, rather than having the Commission act on that 
back period?
    Mr. Hebert. I really get two questions out of what you are 
asking me. One is why has this not been done sooner, and the 
second would be the settlement and how do we do the settlement.
    As far as why this has not been done sooner, I have said 
many times, Mr. Chairman, I cannot answer that. We can blame 
the previous chairman. We can blame the Governor. We can blame 
the previous administration.
    The Chairman. I am not trying to get into that blame game. 
I am just trying to figure out where do they go now. Should 
they try to figure out, had this been in effect from the day 
that the high prices started, what would be owed in refund? Is 
that what you are directing them to do in the settlement 
conference?
    Mr. Hebert. What we have done is the Commission has acted. 
As you know, we acted to issue refunds, close to $130 million 
worth of refunds. We also had a refund separate of that for 
about $8 million. The Commission has taken action and has moved 
forward on that. We have got those subject to rehearing at this 
point, and that is from the time periods of January actually 
through April. And the May numbers have just come in. We were 
delayed in getting the numbers from October to December because 
we did not have the filing requirement in at that point. So, we 
got the new information.
    It is certainly my belief, Mr. Chairman, that if we can 
throw all of that into one settlement conference, we can get 
the State of California to the table, we can get the generators 
to the table, the utilities to the table, we can all come up 
with some type of agreement.
    Now, as to the direction of the agreement, there are always 
those that would second guess what you do in a settlement. As 
an attorney, my experience is that there are only two things 
that settle settlements, and that is deadlines--and we have a 
deadline here, and the deadline is the administrative law 
judge, our chief judge, has 15 days. They have 15 days to 
settle this case. And if they do not settle these issues, then 
the ALJ, the chief judge, will make a recommendation to us 
within 7 days. Now, that is fast, but our belief is that the 
issues are known, the numbers are known, and they need to come 
to some type of agreement.
    Now, the other thing that makes a settlement come to a 
close is uncertainty. If you define the parameters of the 
settlement, then you cut off some opportunity to settle other 
matters. It is my belief that we should not do that.
    Due to the uncertainty, due to the deadline, I believe this 
will be settled, and at the end of the day, if it is not done 
so in 22 days, this Commission will see it again and we can 
make that call then. It will be much quicker than going through 
these rehearings.
    The Chairman. Well, I am not disagreeing with your decision 
to try to get the companies to settle. It strikes me, though, 
that in some cases uncertainty detracts from the pressure to 
settle because each side may have a very different idea about 
what the Commission's action might be if they fail to settle.
    Can you give this committee or anyone involved some 
indication of what the Commission is willing to do by way of 
orders for these back periods if settlement is not agreed to?
    Mr. Hebert. Well, I think this Commission--and I am 
speaking about the Commission I have been involved in as 
chairman--has been the only Commission that has acted in the 
form of refunds, has been the only Commission that has acted in 
the form of mitigation of prices twice and now to the West, as 
well as California. So, I think the record is clear that if 
this Commission does see those issues again, that it will make 
a call that I think in the end justice will be served looking 
after, for the most part, the consumers of California.
    The Chairman. Does anybody else have a comment?
    Ms. Breathitt. Yes. Mr. Chairman, we still have an 
obligation, upon rehearing, to resolve on rehearing the refund 
orders that we issued for January, February, March, April, and 
May, and we have got to do October, November, and December of 
2000. So, this almost omnibus settlement conference would seek 
to resolve those matters in that context. If it does not, I am 
presuming that we would, on rehearing, resolve those dollar 
amounts.
    The Chairman. Since we are short on time, I will just stop 
with that and defer to Senator Murkowski for his 5 minutes.
    Senator Murkowski. Thank you very much, Senator.
    We hear so much about price gouging, who is to blame, and 
so forth. But I am looking at some figures, relative to 
allegations on specific organizations that appear to have been 
able to take advantage of the shortage in California and the 
excess capacity that they had, particularly British Columbia 
Power Exchange. I am referring to a reference that indicates 
that in recent studies, it shows that the Canadian trading of 
BC Hydro reaped about $176 million in alleged excess profits, 
several times the amount collected by all but one of the 
private generators. BC Hydro officials acknowledged they did 
anticipate periods of severe power shortage and planned for 
them by letting the reservoirs rise overnight and then 
operating them to create hydroelectricity which could be 
produced inexpensively but sold at a premium, and BC Hydro had 
stashed hundreds of millions of dollars in so-called rainy day 
accounts to ensure that it had among the lowest rates in North 
America.
    Now, it would seem to me that if we are dependent by about 
one-third of the total estimated costs by the California 
independent systems operator, which was estimated at $5.5 
million in excess profits, and BC Hydro was a third of that and 
you folks have no control over BC Hydro, they simply have 
excess power and they can sell it to the highest bidder. But 
that is a significant factor in the allegations associated with 
pricing, and whatever they could get is whatever those that had 
to have the power were willing to pay.
    Since you have no control over them, I assume this is just 
out there and you would like to not have to depend upon that 
source. But if they have excess energy and are willing to sell 
it, you have to pay the price regardless of your regulatory 
authority.
    Mr. Hebert.
    Mr. Hebert. Well, as to the past, that may be true, but as 
to the future, because of what we have done through the price 
mitigation measure here, it would extend to them, and in the 
sense that they would be mitigated, it would apply to them as 
well.
    Senator Murkowski. Their alternative is simply not to sell 
into you now. Is that correct?
    Mr. Hebert. Well, if they have got anything available, if 
there is anything available trading through the ISO or trading 
on our tariffs throughout transmission systems that we have 
jurisdiction over, within that 24-hour period, the real-time 
spot market, they have to make it available. They cannot 
withhold.
    Senator Murkowski. Within that 24-hour period.
    Mr. Hebert. Correct.
    Senator Murkowski. Yes, but if they do not want to 
basically participate in this agreement, they are not bound, as 
others are where you have some control, because BC Hydro is a 
significant developer of power and they could simply contract 
in if it is outside the 24-hour limitation.
    The point I am getting at here--and I hope that members 
pick up on it--is it is a supply and demand problem. We do not 
have the supply. We are dependent on outsiders. As far as BC 
Hydro is concerned, they are a significant contributor 
particularly to the Pacific Northwest and ultimately 
California. You have to have it. And they are going to charge 
whatever they can get beyond the 24-hour period. Right?
    Mr. Hebert. Right. BC Hydro itself is----
    Senator Murkowski. And until you develop more power in this 
country, you are going to have to depend on those sources which 
are going to keep the rates high.
    Mr. Hebert. Right, and BC itself is non-jurisdictional. We 
do have jurisdiction over some of its affiliates, but you are 
correct.
    Senator Murkowski. And BC Hydro has clearly made some 
extraordinary returns on its operation of the Columbia River.
    Mr. Massey.
    Mr. Massey. May I make a point please?
    Senator Murkowski. Sure.
    Mr. Massey. If they want to sell in the Western 
interconnection, they have got to sell under this program that 
is set out in this order. They will receive the price of the 
least efficient generator that is dispatched in the California 
ISO, probably a gas-fired unit, which would have costs well in 
excess of their costs. They will still make a handsome profit.
    Senator Murkowski. Right. Thank you.
    The other point I want to ask is, Mr. Wood, you talk about 
cost-of-service. To me that is cost plus a profit. Tell me how 
that concept encourages efficiency in the utility industry. It 
seems to me it gives them assurance of a rate of return, but no 
assurance that they are necessarily going to be as efficient as 
they could be otherwise.
    Mr. Wood. I would agree with that, and I think that is why 
I think as a general philosophical matter, on really all ends 
of the spectrum, there has been a move away from that across 
the Nation.
    Senator Murkowski. My last question, since we are running 
short of time, is to all of you, and you can answer it yes or 
no. It is simply, should Congress legislate wholesale price 
caps?
    Mr. Hebert.
    Mr. Hebert. No, sir.
    Ms. Brownell. No, sir.
    Mr. Massey. I would let this plan work.
    Senator Murkowski. That means yes or no?
    Mr. Massey. That means no.
    Ms. Breathitt. No.
    Mr. Wood. No.
    Senator Murkowski. Well, we have somewhat of a consensus 
based on the fact that all five voted for what they believed 
was a workable plan. Thank you, ladies and gentlemen.
    The Chairman. Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Mr. Hebert, to follow up on Chairman Bingaman's question 
about a settlement agreement, how do you get a settlement 
agreement when one key party, California's largest utility, 
PG&E, is shielded from having to pay its creditors by 
bankruptcy protection? As I look at it, PG&E basically has got 
a one-way street going. They are going to get refunds from 
those who overcharged them, but do not have to pay back those 
who charged a fair price. So, I am curious about how you are 
going to go about getting a settlement agreement.
    Mr. Hebert. Senator Wyden, the issue is not so much that, I 
do not think. I think the issue is does it position PG&E 
differently than they would otherwise be positioned. In other 
words, is there anything that changes through the settlement 
process that would not apply to the Commission, FERC, itself. 
They are in bankruptcy whether FERC is handling it through a 
settlement process with its chief judge or whether we are 
handling it.
    But I think the proof will be in the pudding. It is my hope 
within 22 days of Monday, because Monday is when the settlement 
conference will start, that we will have a settlement if I hold 
true to the course that I have been trying to move in. If not, 
this Commission will move expeditiously on it.
    Senator Wyden. I hope you are right, but I am skeptical. It 
looks to me like they have got a very, very advantageous 
position going into this settlement discussion. That is why I 
have been concerned about it for many months.
    Let me ask all of you why you chose 15 months for the 
order. From the seat of my pants, maybe this is too long, maybe 
it is too short.
    But I guess the question illustrates why we cannot come up 
with a third path between the two we have got now. We have sort 
of got this one path that says caps are the answer and another 
path that says caps are going to be a disaster. I guess the 
question is why can we not come up with an approach that 
creates some marketplace incentives as part of this.
    So, my question for all of you is, why not look at caps, 
even in this emergency period, only until a certain number of 
megawatts come on line that are needed to meet demand? That way 
you could send a message to all concerned that we want to get 
generation out there as quickly as possible, and the sooner the 
new generation becomes available, the sooner everybody wins. 
Would that not be something that you could do now to modify 
your order and actually create some incentives that would be 
consistent with an approach that would allow for caps?
    You are shaking your head yes, Mr. Massey, and I probably 
ought to quit while I am ahead.
    Mr. Massey. Senator, I think that is a very good idea to 
create a generation reserve benchmark and keep these price 
controls in effect until that benchmark is met. That would 
certainly be another way to skin this cat.
    I think the 15 months is intended to be a proxy for that, 
but it is a blunt proxy because we have no assurance that there 
will be sufficient generation 15 months from now. We have a 
hope and a prayer, and we need to work with the State of 
California to ensure that that is done.
    Senator Wyden. Mr. Wood.
    Mr. Wood. That 15 months--and in the order we referenced 
that that was based upon what the State of California has 
indicated were new plants that were expected to be on line and 
by which dates. The Commission has put in a quarterly reporting 
requirement to ensure that we are meeting that benchmark. So, 
the 15 months, as Bill pointed out, was a blunt tool, but it 
was built upon just the data you are suggesting ought to be the 
trigger and with which I agree.
    Senator Wyden. I hope you will look at this again because 
it seems to me that there is a better way to go about doing 
this. I see my colleague, Senator Smith, is here, and I am 
going to discuss this with him as well. I am concerned about 
the gaming prospects of caps, always have been. Suffice it to 
say, I do think that there is a way, even during this emergency 
period, to say that we are going to structure these caps so 
that they stay in effect only until we have got those megawatts 
on line that are needed to meet demand and create incentives 
for powerplant developers to go out and do it as quickly as 
possible. So, I hope that you will look at it. I see Senator 
Smith is here and I am going to discuss this with him further.
    I thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Senator Domenici.
    Senator Domenici. Mr. Chairman, I wonder if I could let 
Senator Smith go and I will wait another turn.
    The Chairman. Well, yes, I guess that is according to our 
rules here. Go ahead.
    Senator Domenici. I do not want to do it if it is 
violating--are you concerned about it?
    The Chairman. Well, we just have other people in line after 
you.
    Senator Domenici. So, I will just do mine.
    The Chairman. Why do you not go ahead?
    Senator Domenici. Thank you very much.
    Let me say to Mr. Massey, you just answered a while ago 
that we should not pass a new Federal law, that we should let 
this order of yesterday take hold and see if it works. 
Thereafter, in some responses to Senator Wyden, you seemed to 
indicate that you were not sure it would work.
    Mr. Massey. I am not sure it will work.
    Senator Domenici. Nonetheless, you say we should do it.
    Mr. Massey. I am not sure it will work. I have hope that it 
will work. I think it is dependent on, frankly, whether gas 
prices stay reasonable.
    Senator Domenici. So we will all know that you are the 
Commissioners that would be getting some help if we thought we 
knew how to give you help through some Federal law and you were 
suggesting, this particular day versus yesterday's order, that 
you do not think it is the time to pass additional Federal law 
on the subject.
    Mr. Massey. I think it is always better for the regulators 
who have the responsibility to ensure just and reasonable 
prices to use that authority effectively. It is my hope that 
yesterday's order is an effective 24-hour-a-day/7-day response. 
My advice is to give it some time to see if it works.
    Senator Domenici. Could I ask the Chairman and any of you 
to, in a simple way, tell this Senator what is your goal with 
reference to the activities you are pursuing with reference to 
California prices and of the West. What do you hope your legacy 
will be in the next 18 months to 2 years?
    Mr. Hebert. I would hope that we improve upon a 
dysfunctional market in California and bring it to its feet, 
deliver reasonable prices to consumers, while at the same time 
making certain that we are attracting necessary supply, because 
we understand that there is an imbalance between supply and 
demand, but at the same time, it is not only about supply. That 
is why I think if you ask me about the legacy, it would be my 
thought that the legacy should be to straighten out California 
and the West--and I think this plan will do that--at the same 
time, understand delivery and deliverability of supply is 
essential to the Regional Transmission Organizations Order No. 
2000. Let us move forward with those processes so we can not 
only be concerned with California and the West in the next 18 
months, but we can be concerned with California, the West, and 
the rest of America for the next years and decades.
    Senator Domenici. Mr. Wood, what do you think your goal is?
    Mr. Wood. Similar to what Curt just said, Senator. I think 
we have got to put a cooling off period there while California 
gets its infrastructure to sufficient levels, while the market 
rules that were inadequate to stimulate long-term investment 
and customer benefits in the California market get revised and 
get implemented. Once that is done, then competition can come 
back, but they are not done yet. So, the cooling off period is 
necessary.
    Ms. Brownell. Senator, I would simply like to add that 
whatever actions we take need to communicate to the consumer 
that they can have confidence that the public policy makers are 
working together to ensure that the answers will be there and 
that investment will be there. And if we do nothing else in the 
next couple of weeks, I think that is a critical message.
    Mr. Massey. Senator, I think there is a fair degree of 
consensus about the long-term strategy, a Western 
interconnection-wide RTO, because this is one big machine in 
the Western interconnection, and it ought to have a single RTO 
operating it.
    The debate has really been about what to do in the short 
term, and I hope that we have a plan in effect that will 
protect consumers in the short term while we move to the long-
term implementation of RTO rules, demand side responses to a 
high price, effective congestion management, and so forth.
    Senator Domenici. Commissioner?
    Ms. Breathitt. Senator, I would add that my goal is to 
stabilize the market in the short term and permit California 
and other Western States to repair dysfunctional market 
mechanisms. In other words, the mitigation plan is intended to 
provide breathing room for the markets to self-correct, while 
protecting consumers.
    Senator Domenici. Could I just ask the Chairman or anyone 
to tell me what these four words mean? I have read your order 
and I thought I would take the opportunity to ask you what some 
of these mean. I would have to take an awful lot of time to 
understand your order.
    What is requiring all sellers to bid into the spot market? 
What does that mean?
    Mr. Hebert. Well, that means, Senator, that if they have 
available capacity--there was a huge question about withholding 
energy, letting prices run up, and then releasing the 
electricity to get the high prices. If they have anything 
available in that spot market 24 hours, they have to release 
it, put it into the market so buyers can buy.
    Senator Domenici. What about proxy price? What does that 
mean?
    Mr. Hebert. Proxy price is a price at which we establish 
what a market that is functional would otherwise deliver to the 
market during a dysfunctional period.
    Senator Domenici. Do you all agree with that?
    Mr. Massey. It is a cost-based price based upon the inputs 
of fuel, O&M, and other production costs.
    Senator Domenici. What does a single price auction mean?
    Mr. Wood. To use that chart that I had, Senator Domenici, 
it would be the point at which demand upon the X axis crosses 
with the price on the Y axis, and then that price--say it is 
$100--is paid to everybody whose generators dispatch. So, 
everybody who is to the left of that point on my little curve 
there gets paid that single price.
    Mr. Hebert. Senator, that is the issue that drives the 
efficiency that we were talking about, the single price 
auction.
    Mr. Massey. It is intended, Senator, if it works well, to 
incentivize generators generally to bid their costs. It frankly 
has not worked that way because there is very little risk of 
non-dispatch in the market, but that is what it is supposed to 
do.
    Senator Domenici. My last observation has to do with 
powerplants and the construction of powerplants in the State of 
California. I assume you have no jurisdiction over the State 
and the State's effort to license and/or permit and cause to be 
constructed new powerplants.
    Mr. Hebert. No, sir, we do not.
    Senator Domenici. Do you have some way of finding out what 
the State of California officially says they are going to be 
doing in the next 2 or 3 years?
    Mr. Hebert. We have actually got that in our order. It was 
released, I believe, by the Governor's office, and we are going 
to revisit that after, I think, the next quarter of next year. 
That may or may not be right as far as the specific date, but 
it is important that we keep them on track, that they do have 
less reliance on the spot market, and at the same time, that 
they add the supply they say they are going to add. It is one 
thing to talk about it; it is another thing to bring it on 
line.
    Senator Domenici. Mr. Chairman, I raise that issue and, in 
a way, give it back to you for further understanding before 
this committee, maybe tomorrow with the Governor.
    But many of us have heard California's story in terms of 
when and how they were going to produce new powerplants. For 
the most part, over the past decade to 15 years, 20, all of 
which time I must admit I have been a Senator, so I was not out 
there in the market understanding this, but it seems to me that 
clearly California has historically over-promised what they 
were going to build and they end up with powerplants that 
cannot be built because of intervention, because of lawsuits, 
because of regulations. I think it is really important we find 
out. If we are going to be players and go along with the 
Commission, it seems to me we ought to really know whether 
California is going to build these powerplants or are there 
going to be further delays as there have been in the past.
    I thank you for giving me the time and I yield.
    The Chairman. Senator Feinstein.
    Senator Feinstein. Thanks very much, Mr. Chairman.
    I just want to say that I view this action by FERC as a 
giant step forward, and I am very grateful to you. I also view 
the fact that Senator Smith and I have worked hard on this bill 
and perhaps has been helpful in urging you along, but I will 
not draw that conclusion. I just say perhaps.
    Mr. Chairman, I believe Senator Smith and I are prepared to 
ask you to withhold the markup for the time being. Let us watch 
and wait and see how this order works.
    I share the concerns of Mr. Massey.
    And I thank you, Mr. Woods, for the diagram on how this 
least efficient megawatt works. However, it still remains to be 
seen, I think, whether it can be manipulated or not. I think we 
should wait and see what happens.
    I think the fact, though, that you have expanded your April 
order to 7 days a week/24 hours a day and to the 11 Western 
States until September 2002 is extraordinarily important and 
just really a giant step forward. Whether you call this 
mitigation or cost control, as they say, a rose is a rose by 
any other name. I will leave that up to you. I am very hopeful. 
I will be very frank with you. I want to see it work because I 
think the problems there are extraordinary.
    I want to comment on one thing. The order seems to change 
the accounting standards for nitrous oxides, so that instead of 
allowing generators to count these as variable costs, 
generators will have to submit invoices from the ISO so that 
the costs will no longer vary and should be lower. Is that 
correct, Mr. Hebert?
    Mr. Hebert. That is correct, Senator, and let me tell you 
why. We found difficulty, when we used it in our April 26 
order, because they would administratively change it all the 
time, so we could never completely calculate how it would work. 
So, we figured it was better just to have an uplift charge, let 
them invoice it. That way there would be no playing around with 
it. It will be their actual cost and it will be placed in 
there.
    Senator Feinstein. Thank you. We will watch that very, very 
carefully.
    I wanted to make a comment and then ask a question on this 
15-day settlement conference. I am very concerned because, to 
the best of my knowledge, very little if any money has actually 
changed hands as a result of prior settlement conferences. I am 
concerned because the costs out there to be discussed could be 
up to $15 billion. I am concerned that there are no rules or no 
protocol for this settlement conference. I would like to ask 
that you watch it very carefully. From what Commissioner 
Breathitt just said--and I want to corroborate this--if the 
settlement conference is not successful in resolving these 
issues, the FERC is willing to step in and make that 
resolution. Is that correct?
    Mr. Hebert. Absolutely.
    Senator Feinstein. Well, I am really going to hold you to 
it----
    Mr. Hebert. You do not have to.
    Senator Feinstein [continuing]. Because with a successful 
settlement, you could have a real settlement that could move 
the utilities out of bankruptcy as well and certainly be of 
massive help to the consumers. So, I think these next 15 days 
and then the 7-day recommendation period for you are 
extraordinarily important.
    I would like to ask this question. Why do you believe, 
because of the size of the Western grid, that it is really 
necessary to put this 10 percent gratuity, so to speak, on any 
sale into California?
    Mr. Hebert. The problem with California right now, when you 
look at it from a business perspective, is several fold. 
Senator Wyden pointed out part of it earlier. Bad business 
environment. You have got a bankruptcy right there. Energy 
companies that are thinking about doing business and building 
new plants and moving forward certainly are skeptical. We had a 
lot of issues in the past in looking at the credit issue. This 
credit issue moves forward. It says we believe that there is a 
difficulty when it comes to business transactions, when it 
comes to energy needs in California. We are so concerned with 
that that, quite frankly, what we are going to do is we are 
going to put a 10 percent adder.
    But here is the other magic. Here is the thing that has not 
been talked about yet that I really think you will appreciate. 
When it comes to justification, we do not have a cap in place. 
We do have the proxy. We would rather them bring the energy in 
than set a price at which we are not going to allow energy to 
be delivered.
    But you have some that have had conversations and made 
comments and filed comments, that when they try to cost 
justify, they may, in fact, even suggest that their risk factor 
on credit is 10, 15, maybe even 100 percent because they have 
not been paid. This takes that justification away from them. 
They have an adder. Justification is not there. They cannot use 
it. So, it is really good for the consumers.
    Let met add one thing to it, something you said in the very 
beginning that I think is important.
    Senator Feinstein. Fast because I want to ask one more 
question.
    Mr. Hebert. You mentioned about the piece of legislation 
and the influence. There is always conversation about what is 
the political influence on an independent agency like FERC.
    Senator Feinstein. I know. You are not impacted by any of 
this.
    Mr. Hebert. No, no, but I think it is important to point 
this out. Whereas I will be fair and accurate with you, it does 
take this Commission time and it is somewhat tedious to come 
and testify before the Senate, testify before the House, deal 
with legislation. I do not know about the influence, but I will 
tell you what it does influence and that is good, open debate 
that brings issues out that allows us to make good decisions.
    Senator Feinstein. Thanks, Mr. Hebert.
    As I understand it, the price of natural gas at various 
delivery points in the West sets an average cost that gets 
plugged into the heat rate formula for the least efficient 
megawatt needed at any given time. It seems as though you have 
changed the natural gas delivery points that are used. Could 
you quickly explain the FERC's plan here for natural gas and 
why you decided not to do anything about the transportation 
cost?
    Mr. Hebert. Commissioner Wood wants to do it. Let me say 
one thing before he does that, and I will be glad to talk 
further with you about it later. It is almost identical to what 
the ISO itself asked for.
    Commissioner Wood.
    Mr. Wood. In fact, yes, ma'am. We built our recommendation 
off of what the California ISO recommended. Rather than using 
the daily spot price, which can be, as we know, pretty 
volatile, they suggested using a monthly price which is done 
the last week of the prior month. The last week of May, 
everybody bids for their June deliveries. It is a monthly 
price. It's a widely published benchmark used for financial 
purposes. It is used for many contracts. It also reflects more 
of a balanced portfolio. So, we agreed with them and used that 
as part of the proxy.
    We averaged, I believe, three delivery points. One is 
northern California exclusive, one is southern California, and 
one comes into both. That gives a weighted north/south average. 
By using an average, it might be a little higher than what the 
north experiences. It might be a little lower than what the 
south experiences since that seems to be the disparity.
    Anybody that does not feel like they got their costs 
compensated may be allowed to come in and justify a higher 
price, but we are going to look at their total portfolio of gas 
purchases. I personally think that was very important to me in 
this order to make sure that there is a dampening effect on 
relying heavily on the gas spot market, just as we had a 
problem in the last 8 months of people relying very heavily on 
the electric spot market. So, pushing people back to portfolios 
is kind of a recurring theme here.
    Mr. Massey. Senator, if I may comment very quickly on that. 
I think your question implies what I believe to be true, which 
is the transportation differential issue, high transportation 
differentials into California and high spot market prices, and 
high gray market prices. If those continue, this plan will not 
work well to dampen prices. So, I think my agency still has a 
lot of work to do with respect to the natural gas market in 
California.
    Senator Feinstein. Thanks very much, Mr. Chairman. Thank 
you, FERC.
    The Chairman. It is 10:30. We have two additional Senators 
who would like to ask questions, if you can stay and take 
those. Then we have your general counsel who has agreed to be 
available to answer any additional questions people have on 
this.
    Senator Smith, go ahead with yours.
    Senator Smith. Thank you, Mr. Chairman.
    I join my colleague, Senator Feinstein, in saying I believe 
this order goes a long way, and I congratulate you for it. I 
think it renders substantially moot the legislative effort that 
she and I were pursuing. I do believe that that effort would 
have won large majorities in the Senate and the House. So, I 
think what you are doing is reflecting the will of the elected 
representatives of the American people.
    I know, because as a Republican who believes in markets, 
that you will now be subject to the criticisms that have come 
my way which are that you are interfering in the market. That 
critique of your efforts, I tell you, I think you are safe to 
defend for two obvious reasons.
    No. 1, this market is not free. It is badly broken, and 
your intervention has been needed for some time.
    No. 2, the commodity of power is different than the 
commodity of peas or widgets or anything else. People expect 
power. They have a right to believe it is going to be there at 
a cost that they can afford, and frankly, it is a matter of 
public safety and a reasonable expectation of the American 
people, which is a reason why this has been so highly regulated 
an industry for so long.
    We are in a process of deregulation. Senator Murkowski 
cited the instance of BC Hydro. I suspect there are a lot of BC 
Hydros out there on this side of the border. I think BC Hydro 
needs our market just like we need their power. My hope is that 
they will not be gaming the system any longer and that any 
American generators are not gaming the system any longer. And 
they cannot now because of what you have done. So, for that 
reason, I thank you.
    I hope the American people understand that what you have 
done addresses the short-term problem of price gougers, but 
long term the problem is supply and demand and bringing those 
in balance. You cannot fix that, but ultimately investments 
which still have plenty incentive will fix that and 
conservation on the part of consumers will bring that also into 
better balance.
    I do have a couple of concerns, and they are this. Right 
now your order goes 15 months. That gives California two 
summers to get through this. That gives the Northwest one 
winter. We are opposite from them, as you know, in terms of our 
peaking load. I hope you be willing to look at this again if 
mother nature does not turn the rain on and we are in a 
situation where we just simply do not have the power.
    Mr. Hebert. If I may comment on that briefly. Your comment 
and question is indicative of the evolution that this 
Commission is going through right now. We certainly do not know 
it all. I have had conversations with all the Senators in this 
room, and what I have shared with you is that we are not done 
yet. We are continuing to learn. We are not done with the 
Northwest yet. There is more to do. We are seeking comments on 
that. We do not totally understand the northwestern market. It 
is very different than California. So, we are seeking comment 
on that, and there will perhaps be more work to do. We do not 
know that yet.
    Senator Smith. I appreciate that very much because, again, 
I would say to any of the public watching this, it is one thing 
to describe to people why the cost of their milk is at a 
certain price. It is something very different to go to a 
nursing home and say to seniors on fixed incomes or to an 
aluminum plant that has laid off all of their workers why their 
prices have gone up so exorbitantly. You cannot say, well, it 
has because there are some really smart people out there 
manipulating the market. That is not something this Government 
should tolerate, and I am grateful that you all have stepped up 
to the plate like this.
    Lastly, does the settlement process for refunds that you 
announced yesterday only apply to sales within California? The 
reason I ask that is because of my concern about the status of 
the rehearing on the Puget Sound energy complaint that was 
denied on December 15. Does this just apply to California or 
does it cover all the States in the West?
    Mr. Hebert. At this point we are applying it only to 
California.
    Senator Smith. I would ask you to at least think of that 
one more time because I think there may be cases outside of 
California that need your review.
    Thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Senator Cantwell.
    Senator Cantwell. Thank you, Mr. Chairman.
    I do want to thank the Commission for their hard work on 
this order issued yesterday. But I do have some concerns about 
how we are going to proceed and particularly the answer to that 
last question, but I will get to that in a second.
    I just want to remind my colleagues that even though this 
will, I think, provide some guidance in the future, the 
Northwest has already seen a 50 percent rate increase in some 
of its pricing at the home residential and industrial level. 
And because we have already had to buy very expensive power 
through BPA, some of those costs are going to continue to be 
passed on. So, I am not sure if we are saying to the people in 
the State of Washington whether this is going to be much 
relief, given the fact that some of those increases are already 
going to take place again this summer and later this fall. So, 
I would encourage my colleagues to continue to look at, as we 
move through the legislative process, conservation and 
curtailment efforts that might help in reducing some of that.
    It seems to me that there might be a couple of ``I 
gotchas'' here in the way that both under the deficiency of 
reserves and in non-deficiency times how this mechanism would 
work. So, I wonder if maybe one of the Commissioners, maybe 
Commissioner Wood, could address this. But it seems to me that 
when operating reserves fall below 7 percent and the bid must 
reflect a published gas cost plus an adder, that there is a 
basic mechanism where people can come back and justify a cost 
higher than that. And the same when a deficiency period ends, 
the same absent justification language.
    So, first I am curious when we are going to see the exact 
details of the order. I do not think that the full order has 
been made available, or at least made available to the public 
or via the web. At least we checked. When will we see the 
details in the language?
    And exactly how will this justification issue be resolved 
to make sure that we have a solemn guarantee here that we are 
going to be looking at a basic cost and knowing what that is 
during this period?
    Mr. Wood. The order should be issued today, which will make 
it effective at midnight tonight and all day tomorrow, going 
forward.
    Senator Cantwell. So, the public will be able to get a copy 
of the full order, the details.
    Mr. Wood. Yes, ma'am.
    Senator Cantwell. Which I am assuming is at least many 
pages.
    Mr. Wood. About 60.
    The answer on the justification, the difference between a 
hard price cap is you got no justification; soft price cap, you 
do. That is the general thought.
    Justification was important for us in the supply constraint 
scenario to make sure we get every megawatt on the grid that we 
possibly can. If there are extenuating circumstances that the 
mitigation scheme cannot apply to fairly, we still want their 
megawatt and are willing to pay them. We are just not going to 
let them set that market clearing price that everybody else 
gets paid.
    There might be somebody that has a high gas cost. We have 
put forward in that section that we will not only look at the 
cost you paid for that Mcf of gas, but we will look at all the 
gas prices, all the portfolio that you hold of gas to make sure 
that you are not just sending the highest price cost to this 
mechanism and keeping all the low priced gas that you have 
acquired under longer-term contracts for the rest of your other 
contracts.
    We have taken off NOX, the emissions credits 
that are more predominant in California I believe than they are 
in the Northwest. We have taken that out of the mechanism so 
that will not be dealt with. We have taken startup costs out of 
the mechanism. So, they will not be dealt with either.
    Senator Cantwell. These are detailed in your order.
    Mr. Wood. Yes, ma'am. Those things tend to inflate the 
market clearing price. We have taken those out, said you get 
reimbursed for them, but we are not going to let that inflate 
the price for the whole mitigation scheme.
    Mr. Massey. Senator, if I might. I think the key point to 
make here is the justification, if a generator comes in, has to 
be based on costs. He cannot come in with some inflated notion 
because we have taken a lot of that flexibility out. The gas 
proxy formula is intended to replicate costs. For the emissions 
allowances that are in an uplift charge, they have to submit an 
invoice detailing their actual costs for those and so forth.
    So, the formula is intended to be very tight. If they 
cannot recover all their costs under the formula, they have got 
to come in and show us what their costs were that they could 
not recover. So, it is a cost-based control.
    Mr. Hebert. Let me clear up two things that you may draw 
into question. One is----
    Senator Cantwell. Well, let me just point out since we have 
not seen the details of all of this, I think that's what my 
concern is. Obviously, there are numerous times when Federal 
agencies come out with a new ruling and then you see the actual 
details of that ruling and find that there are ways in which 
people can maneuver around it. So, I want to make sure that we 
have understanding from the Commissioner.
    Mr. Hebert. Right, but there are two things. One, the 
credit, because that is a California issue, does not apply to 
the West. So, the 10 percent surcharge credit does not apply to 
the West. The other thing that does not apply to the West is 
the uplift on the NOX. So, those are two things that 
would not apply in the West and are exceptions.
    Let me volunteer to the committee our staff to come over 
and brief the committee staff, as well as anyone from the 
Senators' offices that would like to be included. If we could 
do that all at one time, Mr. Chairman, that would be helpful. 
But I would certainly love to do that. I think it would be good 
for you and it would certainly be good for us.
    Senator Cantwell. One critical question left, please, if 
several of the Commissioners could address this, and that is 
the issue of the settlement agreement as it relates to the 
Northwest. Commissioner Massey, you have been excellent on your 
review of the previous order and section 206 that was not broad 
enough in its investigation. So, where are we leaving Northwest 
energy consumers in this payback scheme, whether we are going 
to be at the table or not be at the table, whether we are going 
to be able to see any refunds from this or not?
    Mr. Massey. That is an excellent point, Senator. I think we 
could have done better than just sending it to a vague 
settlement conference. I think it leaves too much uncertainty 
and I think it leaves uncertainty about what residents in the 
Northwest are going to get back, if anything.
    Now, there are matters on rehearing that I do not believe 
the Commission has dealt with that could provide relief, and I 
appreciate that point.
    Senator Cantwell. You still have your final decision on 
that to be issued. Is that correct? On the review, on the 206?
    Mr. Massey. I believe we do.
    Senator Cantwell. The Commission has not issued your final 
discovery on that?
    Mr. Hebert. The July 2 refund effective date is out there 
and the settlement process, as I have said, is applying to 
California only at this point. That is what was discussed. 
Actually we have not discussed anything outside of that realm.
    Senator Cantwell. But we have, in your previous appearance 
at this committee, talked about the fact that the West needed 
some relief, including the Northwest on this, and you brought 
up your section 206 investigation. At that point in time, I 
brought up the fact that I thought it was late in coming, and 
you said we are going to make a decision about the West.
    Mr. Hebert. Well, the comments that we received from that 
are one of the reasons that we moved forward to improve upon 
our mitigation plan.
    Senator Cantwell. I am not clear on that answer whether the 
Northwest will be at the table, and you are saying they are 
not. But yet, you are saying----
    Mr. Hebert. They are not in the settlement conference, but 
they are certainly a part of our price mitigation at this point 
in the reserve and non-reserve hours. But we are, as I said 
earlier, continuing to seek comment on what to do with the 
Northwest. So, we invite those comments.
    Senator Cantwell. I asked this question before and you were 
gracious enough to answer. Have you found that the Northwest 
prices are just and reasonable?
    Mr. Hebert. You and I bantered about a bit, and we have 
certainly had conversations in your office. I will tell you 
that prices are high. There has been no judgment on the 
reasonableness and justness of prices for the Northwest.
    Senator Cantwell. I am still unclear about your final FERC 
action on that.
    Mr. Hebert. We have not done anything final on it.
    Senator Cantwell. And when is that date?
    Mr. Hebert. I do not have a date.
    Senator Cantwell. Is it not a time span of like 60 days or 
something?
    Mr. Massey. The refund effective date set in the order for 
the Northwest would be July 2 of this year. So, if the 
implication of your question is that refunds could not go back 
before July 2 of this year, you may be right, and perhaps that 
is an issue for rehearing.
    Senator Cantwell. Thank you.
    Thank you, Mr. Chairman.
    The Chairman. Thank you very much, and I want to thank the 
Commissioners. I know that you have taken a great deal of 
valuable time here describing this order. We congratulate you 
on the action you have taken. We will be watching very closely 
to see how it is implemented, as I am sure you will be.
    Senator Boxer is here and would like to address the 
committee. I will call her forward as a witness at this point 
to give us her testimony on this issue. Then following that, 
Mr. Kevin Madden, who is the General Counsel, will be available 
to answer some additional questions that any of us on the 
committee have, and I will call on him next.
    Senator Boxer, welcome to the Energy Committee. We are 
anxious to hear your views on the action FERC has taken or 
action you believe they should take.

         STATEMENT OF HON. BARBARA BOXER, U.S. SENATOR 
                        FROM CALIFORNIA

    Senator Boxer. Thank you so much, Mr. Chairman. Thank you, 
Senator Murkowski. I know what a hectic schedule you have, and 
I am going to try to complete my remarks in 5 to 6 minutes. I 
think I have some definite opinions and I hope you will 
consider them.
    First, I want to say that the committee has been very 
helpful. There are those who say there was some pressure put on 
FERC to act. I think a nicer way to say it is we have 
encouraged FERC to act. Senators Feinstein and Smith had a good 
bill on the cost-plus pricing. Congressman Bob Filner and I had 
a similar bill, but it included refunds. I think frankly 
without help from outside California, we would not be at this 
day. I think it is a very important day today. I cannot tell 
you the feeling I have and the relief that I feel that we are 
moving in the right direction.
    I still believe we have more to do and I am going to 
comment on that today.
    The first point I want to make, Mr. Chairman, is really to 
set the record straight. Many have said that FERC had nothing 
to do with this crisis in California; that in fact, it came 
from California. There have been jabs at our Governor, although 
I think it is intriguing because the fact of the matter is that 
this whole deregulation occurred before. He had nothing to do 
with it. He is one of the few who had nothing to do with it. It 
was bipartisan. It was Governor Wilson who recommended it and a 
Democratic legislature and Republicans in the legislature who 
embraced it. So, to blame this Governor is absolutely wrong.
    I have had the opportunity to talk to Vice President 
Cheney, and I appreciated the meeting that he took with the 
California delegation. I wanted to correct the record because 
Vice President Cheney has said, when we said we need help in 
California, ``Go back and talk to whoever it is that blocked 
the development of additional supplies in the past because they 
are the ones who are responsible for the high prices.''
    Well, I want to correct the record. Mr. Chairman, FERC does 
bear some of the responsibility for stopping the supply, and I 
want to make the case this was under a Democratic President. 
This is not a partisan jab in any way.
    In the early 1990's, the California Public Utilities 
Commission ordered our utilities to build more powerplants. 
Now, what did the utilities do? They appealed the order to a 
State administrative law judge who ruled against the utilities 
and said, you must build these 1,400 megawatts.
    So, what did the utility companies do? They appealed to 
FERC. Now, what was interesting was FERC sided with the 
utilities in 1995. They said, you are right. You do not have to 
build these 1,400 megawatts. Therefore, we do not have those 
1,400 megawatts. And you can really say that those megawatts 
may have well saved us from the rolling blackouts.
    So, let me just say I was very pleased with yesterday's 
about-face by FERC. I believe that they have a new tone. I 
believe that they finally recognize that we needed action 
throughout the entire Western region.
    But I do have two unanswered questions, and the reason I 
raise them is I think your committee could play a central role 
in just following these issues.
    One, will FERC enforce the cap or will they allow companies 
to use loopholes to escape it? I think that is key and I hope 
that your committee and Senator Lieberman's committee and my 
Environment and Public Works Committee will take a look at 
this.
    Two, will the cap be set too high since it is pegged to the 
least efficient producer rather than to the actual cost of each 
company? I think we need to keep monitoring that.
    Now, my big disappointment with the order, Mr. Chairman, is 
along this line. I believe the Commission should be issuing 
refunds to those who have been paying these outrageous prices. 
I really do. I think maybe we will watch a settlement 
conference. But I do believe it is FERC's responsibility. It is 
in fact in their charter to protect against unjust and 
unreasonable prices. I think that if they do not do it and if 
the settlement conferences do not work, I believe Congress 
should do it, and I am going to be introducing legislation that 
would do just that.
    Let me show you why this is so important, Mr. Chairman. I 
think when you see this--you may already know this, but it will 
reinforce my point. The chart on the generator profits that we 
have seen. Mr. Chairman, profits increased on average by 508 
percent between 1999 and 2000. I want to make a point here. 
Demand increased only 4 to 5 percent, and profits increased an 
average of 508 percent.
    Now, you might say maybe the whole energy sector enjoyed 
those kind of profits, but if you look at it, the energy sector 
got a 16 percent increase in profits in the electric and gas 
industry. 16 percent average profits compared to 508. One 
company, Reliant Energy, saw its profits increase 1,600 
percent.
    Could I have that ad from the Roll Call? There is an ad in 
the Roll Call, plus there are ads in all the newspapers, I 
would say, except in California for obvious reasons, that show 
Reliant as saying, ``Helping California keep the lights on.'' 
Yes, they did at 1,000 percent profit, at gouging prices. And 
that is the problem that we are facing. I think the headlines 
should say, ``Keep the lights on while gouging California 
consumers.'' So, again, 1,000 percent increase in profits; 4 
percent increase in demand.
    Now, I used to be a stock broker and I know that profits 
are crucial for every business. But there is a difference 
between responsible corporate behavior and irresponsible 
gouging.
    I want to show you one other chart, Mr. Chairman and 
Senator Murkowski, you may not have seen, which is the 
maintenance schedule for these companies. In the blue, you see 
last year the energy that was taken on line for maintenance. 
Here in the yellow, Mr. Chairman, you see the current year. 
Look at how many plants closed for maintenance. Now, it is hard 
to believe that this is a coincidence if you look at last year 
compared to this year. So, when you pull power off line, Mr. 
Chairman, it puts the squeeze on, and I think we have seen that 
occur. And all of this has happened at the consumers' expense.
    If the price of a gallon of milk had increased at the same 
rate as California's electricity prices, milk that now cost $3 
a gallon would cost $190 per gallon. Mr. Chairman, imagine 
where all of us would be if our consumers walked into the 
supermarket and had to pay $190 a gallon. It is no different as 
to what is happening to them.
    Let me tell you what is beginning to happen. We are 
beginning to get letters from small businesses, from individual 
consumers. I will read you just a teeny part of a letter I 
received from a constituent. The letter is from John Odermatt 
of San Marcos, California. He wrote to President Bush and sent 
me a copy. This is what he says and I quote. ``I'm a father and 
a husband in a single income family. My wife and I very 
carefully planned our family economics in order to give our 
daughter the benefits of having a full-time parent at home. 
We're currently spending money on electricity bills that should 
be going into family investments for college and/or our 
retirement planning.''
    Mr. Chairman, I know you care deeply about those who need 
help paying their bills. To help the 2.1 million low income 
Californians who qualify for LIHEAP, we need additional funds 
for this program, or only 10 percent of our people who need it 
will receive assistance. Imagine 90 percent would not get 
assistance. This summer, without air conditioning in certain 
parts of California, people will perish. I want to make that 
point. I worry so much about the elderly who are on fixed 
incomes withholding air conditioning. People will perish. 
Emergency funds for LIHEAP are needed, and I know you are 
working on that.
    Mr. Chairman, I support your position of $3.4 billion in 
the budget for LIHEAP. Again, I know this is important to you. 
You are our leader on this issue, and I stand ready to help you 
in any way I can.
    Now, there are those who say that LIHEAP does nothing to 
hold down prices. As a matter of fact, they say, well, wait a 
minute. If you make it possible for people to pay these high 
prices, they will stay high. But, Mr. Chairman, this is an 
emergency. We have to do all that we can.
    I have one quick suggestion and then I will sum up on the 
LIHEAP program. I think we ought to look at a special stream of 
money for LIHEAP. There are those who have recommended the off-
shore oil revenues. If an electric generating company makes 
significantly higher than average profits as compared to the 
industry as a whole, I do not think it would be a bad thing for 
that company to make a contribution into the LIHEAP fund to 
help those consumers who are being hurt by the high prices they 
are charging. I hope we can work together on this seed of an 
idea that I have here.
    In summary, the FERC's order was a step forward. My 
colleague called it a giant step forward. I think she is right 
on that.
    Let me reiterate, just the major points I have made.
    One, we need to monitor FERC's actions. If it is not 
working, we need to move to cost-based pricing.
    Two, we must see that refunds are provided to those who 
have paid excessive profits. That is the role of FERC, to 
protect against unjust and unreasonable prices. We need those 
refunds for the victims of price gouging.
    Three, increases in the funding of LIHEAP are in order and 
consider that those companies that have reaped an unfair 
windfall should pay into that program.
    Thank you so much to you and Senator Murkowski. This is 
really a much better day for us in California and we are most 
appreciative.
    The Chairman. Thank you very much, Senator Boxer. Thank you 
for your strong effort on this Senate issue as it affects your 
State.
    We now have the General Counsel of FERC.
    Senator Murkowski. I have one question.
    The Chairman. Oh, go ahead, Senator Murkowski.
    Senator Murkowski. I am glad to hear things are better in 
California today.
    Senator Boxer. Well, we feel better.
    Senator Murkowski. I think we all agree that the FERC 
action, if it is what it says and works as they hope, will give 
you some relief. Of course, I believe in the theory that if 
milk costs too much, we ought to get some more cows. If you get 
more cows, why, the price goes down unless the milk sours. Now, 
clearly we have had a souring within the energy market, but I 
think the point is to produce more energy.
    My only question to you--and I know of your interest 
relative to consumer affairs and the idea that we should have 
clear and full disclosure. But I wonder if you think that the 
Governor of California should order the Los Angeles Department 
of Water and Power to refund any of their windfall profits 
specifically.
    Would you recommend that the contracts between the State 
Department of Resources and the sellers of power to the State 
be open for public view?
    Senator Boxer. Absolutely. I think anyone who has gouged--I 
think that is against the law. If they are municipal, if they 
are private owned, whatever, I really do believe in that.
    By the way, Mr. Chairman, I agree we need more supply. We 
will have about 1,200 megawatts on line this summer. We need to 
do more there. The Governor projects there will be 13,000 
megawatts on line in a couple of years. I think we are going to 
be okay. I think we can do the supply. I think we can do it 
right.
    But it is a balanced program that I support. Energy 
efficiency is key. Conservation is key. A responsible expansion 
of the supply is key. I think if we do those things and if the 
FERC order works, I think we are going to see the light at the 
end of the tunnel and everyone can stand proud of that.
    Senator Murkowski. I draw your attention to the report that 
suggests that the top 10 in profiteering from California total 
about $505 million, and as I have indicated, Los Angeles 
Department of Water and Power is $17.8 million. And you would 
recommend a refund from the Los Angeles Department of Water as 
well.
    Senator Boxer. I say that any entity, private, public, that 
has gouged consumers and that FERC has made a judgment that 
that there is gouging, that is the law, and they must, in fact, 
make those refunds. Yes.
    Senator Murkowski. The British Columbia Power Exchange, 
which is BC Hydro, is about a third of the alleged price 
gouging. Of course, we do not have much authority in British 
Columbia, in a foreign nation. We are left simply to the 
exposure of them having the power and we having the addiction 
to the power. So, we have been paying the price.
    Thank you, Mr. Chairman, and thank you, Senator Boxer.
    Senator Boxer. Thank you so much.
    Again, that is why energy efficiency is so important.
    Thank you again.
    The Chairman. Thank you.
    Mr. Madden, why do you not come forward? Unless you had 
some statement you wished to make, we would just go right into 
questions, just to supplement what we had already asked to the 
Commission itself. Is that agreeable with you?
    Mr. Madden. That is agreeable, Mr. Chairman. I do not have 
an opening statement other than to say the Commission and its 
staff has worked extremely hard to get this order out, and we 
did it in lightening speed. The order was issued on April 26. 
We got the comments within the 30 days and we acted just 
yesterday. Thank you.
    The Chairman. Thank you.
    There are some States that are affected by your order which 
have not seen high prices for wholesale power, my State being 
one of them, New Mexico. Are you confident that nothing in your 
order, which takes the entire West and, in effect, puts in 
place a limit on what can be charged based on the highest price 
being charged out in California, is going to result in 
increased prices for wholesale power in these other States 
where they have not had the exorbitant prices for wholesale 
power?
    Mr. Madden. A couple points, Mr. Chairman. One, our order 
only deals with 24 hours or less. Most sales outside California 
are bilateral sales, more than 24 hours. So, in terms of your 
particular State--and I do not have the numbers--I would assume 
a great deal of the wholesale sales that occur are bilateral 
sales which are not even covered by our program.
    To the extent that it is, we have this price mitigation 
which mimics what the market is supposed to look like, and any 
agreements or any deals that want to occur below that price or 
even up to the price should not affect prices outside 
California in terms of how the market works.
    Another point to make is that the order will go out for 
comment and seek what other market-type approaches we should 
look at outside of California, recognizing there are 11 States 
in the WSCC. We are providing 60 days for comment to look at 
whether or not those ramifications to our price mitigation that 
is going to be in effect, if we issued the order today, 24 
hours after that. We are asking comment from everyone in the 
West whether or not there is a better approach outside of 
California.
    The Chairman. Are you confident that the order will not in 
any way deter the entering into long-term firm sales contracts 
for the future? One of the agreed-upon purposes or directions 
that California has been trying to move into is to get more 
long-term contracts in place in recent months. Do you believe 
that that incentive to do that will continue to be there even 
though this order is in place?
    Mr. Madden. In our December 15 order, we recognized the 
importance of California getting out of the spot market, and 
they were essentially 100 percent in the spot market. We 
recognized that they should really have only 5 percent in the 
spot market. They have been successful to date in moving a 
great deal of their portfolio outside the spot market.
    I believe our mitigation program that is in place now and 
our order, as of yesterday, will have no effect in terms of 
California negotiating longer-term contracts. In fact, that is 
the premise of our order. We want them to continue to enter 
into longer-term contracts and get out of the spot market.
    The Chairman. How does the monitoring and reporting system 
work for the rest of this WSCC? As I understand it, the ISO has 
gathered the cost information and reported prices in 
California. Who is going to do that in the rest of the West, as 
you see it?
    Mr. Madden. In our order, we propose that the WSCC serve as 
a clearinghouse, among others, for the prices. But I believe 
that outside of California, the entities, the sellers, will 
know the prices the ISO establishes for the particular hours of 
the day.
    The Chairman. Let me go ahead and defer to Senator 
Murkowski for any questions he has.
    Senator Murkowski. Thank you. I have no questions other 
than to indicate to you, Mr. Madden, that I want to compliment 
you and your professional associates for the manner in which 
you have been responsive. I think it was a very thorough 
effort. We will look forward to receiving the formal order very 
soon.
    The Chairman. Very good.
    Senator Cantwell.
    Senator Cantwell. Thank you, Mr. Chairman.
    Mr. Madden, I am trying to understand if we do not have a 
major flaw in this order. I am trying to understand the order 
as it relates to the section 206 investigation and whether the 
Northwest or, for that matter, all the other Western States are 
entitled to have overcharging investigated and be eligible for 
refunds. So, if you could clarify how this order applies to the 
rest of Western States and whether we, in fact, will be 
entitled to that or whether the Commission, just in haste, 
limited maybe unnecessarily this refund issue just to 
California.
    Mr. Madden. Senator, I think you have to go back to the 
April 26 order where we, as a companion to that order, 
initiated a 206 investigation outside California for the entire 
West. Under the law, under section 206 of the Federal Power 
Act, we cannot have refunds occurring earlier than 60 days 
after we have it published in the Federal Register. So, the 
refund effective date for the West, other than California, with 
respect to the rates is July 2, 2001. So, in terms of refunds 
occurring prior to that period, we have no statutory authority 
for that from a refunds standpoint.
    We can look at, however, whether or not there have been 
tariff violations. We can use our equitable remedies to see 
whether or not public utility sellers have, indeed, violated 
the tariff.
    Our mitigation plan for the West, despite the July 2 refund 
effective date, will be effective 24 hours after we issue the 
order.
    Senator Cantwell. What you are saying--and further explain, 
if you would like, why California will be able to be included 
in refund and possible investigation as this settlement process 
prior to that, but the Northwest or other Western States will 
not.
    Mr. Madden. Senator, last August 2000, we issued a 206 
investigation for California, not for the West. And we set the 
refund effective date to October 2, 2000. That order only 
applied to California. It did not apply to States outside of 
California. So, with respect to the issue of refunds, why is 
the West not entitled to the refund back to October 2, the 
answer is that the order that we issued back in August only 
applied to California and it established the refund effective 
date, October 2 forward, for California. We are on two separate 
tracks, California and the West, for refund periods.
    Senator Cantwell. Which I think I brought up. I do not know 
if you were at the last hearing with the FERC Commissioners. 
But we brought up this issue and the fact that this 
investigation of the Western States was, in fact, late. We can 
see now that we will be penalized in this order for that unless 
the Commission decides to take action otherwise in being able 
to recoup some of those costs and overcharging that has 
happened in the Northwest, unless the Commission does believe 
that the rates have been reasonable and just in the Northwest.
    Mr. Madden. Well, in our earlier order of April, we stated 
that the rates may be unjust and unreasonable in the West, and 
that is why we established the 206 investigation. And that is 
why we established the earliest possible date under the Federal 
Power Act, and that is July 2, 2001.
    Senator Cantwell. If the Commission did want to take action 
otherwise, how would they resolve this?
    Mr. Madden. If the Commission wanted to have refunds 
occurring prior to July 2, 2001 for outside the West? Is that 
the question?
    Senator Cantwell. Yes.
    Mr. Madden. We have no statutory authority to require 
refunds prior to July 2, 2001.
    Senator Cantwell. So, the Commission could not take action 
solely on its own.
    Mr. Madden. We have no statutory authority to do so.
    Senator Cantwell. Thank you, Mr. Chairman. This is 
something I think the committee should investigate because, 
obviously, we have seen this was a West-wide crisis in Western 
States, not just in California. The impact for consumers, as 
far as industrial users and residential users, has been real. 
We have not had a retail cap in the State of Washington. We 
have not had consumers who have been shielded from that, unless 
their utilities have gotten creative with their own financing 
and spreading that out over a longer period of time. So, we 
have seen a real impact.
    So, in this order, Mr. Chairman, to be left out without 
that recourse, given that again we have already seen a 50 
percent increase, we are likely to see another 70 percent 
increase, even given this order and its forward actions, 
because of the amount of power that has already had to be 
purchased through this process. So, Mr. Chairman, I think it is 
something that the committee should address. Thank you.
    The Chairman. Yes. Thank you very much.
    Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman. I want to thank 
you all for holding this hearing and thank you, Mr. Madden, for 
being here.
    First, I want to say that I thought the actions of FERC 
made a great deal of sense. You can call it what you will, 
price cap, price control, proxy price, price mitigation. The 
bottom line is that the market was broken and needed fixing.
    I have generally opposed price caps in general. One of the 
issues in my campaign was whether there should be credit card 
interest rate caps. Senator D'Amato was for them; I was against 
them. But there are occasions when the market is not working, 
when it is broken, when there is, in a sense, a monopoly which 
is what happened here. And then you have to act.
    I think some of my colleagues confuse and many people in 
the country confuse being pro business and being pro market. 
They often coincide. Sometimes they do not. When you do not 
have a market, it does not mean that you just help the company 
do whatever it wants. That is what was happening here.
    So, I am delighted that FERC did this action for the 10 
Western States and salute you for doing it.
    As we move on the road to deregulation, until you get a lot 
of suppliers and a lot of buyers, you are not going to have 
real competition, and that is what all of us have to be very 
careful about. I believe in deregulation. I put in a major 
deregulation bill with Phil Gramm, but again, it just does not 
happen at the snap of a finger.
    So, what I would like to ask you about is not the 
California market, but its implications elsewhere. I come from 
New York which, if you believe the pundits, what happened in 
California could happen in New York. My question is as follows.
    One, in general, what are the differences in the structures 
of the New York market and the California market? I know we 
have more long-term contracts in New York, but even there we do 
not have all long-term contracts. So, we could have the same 
kind of squeeze that California faced, should there be a lot of 
warm days.
    But second, why should what FERC did not become national 
policy? Why, if the same thing happens in New York and there is 
one supplier or two suppliers who are sort of doing price 
leadership, should the same types of--again, call them caps, 
call them controls, call them mitigation, call them what you 
will. Why should they not apply?
    So, my general question is how is New York different? 
Should these caps--should this policy--let us not jaundice it 
by calling it one thing or the other--be a national policy as 
opposed to just a Western policy, and if not, what could deal 
with a similar problem that might occur this summer in New 
York?
    Mr. Madden. Those are very good questions, Senator. Let me 
see if I can respond to them.
    The first question, how is New York different than 
California? Let me give you my particular thoughts. California, 
when it went through unbundling, told essentially the IOUs that 
they should get rid of their portfolios but for essentially 
hydro and nuclear, and that they sold those particular plants 
to producers, to the Reliants, to the Mirants of the world. And 
they did not have the IOUs enter into long-term contracts. They 
essentially said that they should buy through the spot market. 
As a result, they did not have either generation there to 
support their load or they did not have the buy-back provisions 
of a contract.
    Now, if you look at New York, for example, New York did not 
require all spot. It had a lot of the IOUs have longer-term 
contracts. They, in fact, had their generation. More 
importantly, New York is in the PJM region, and the reserves in 
the PJM area, which covers this region of the country, New 
York, Maryland, et cetera--they have reserves, 15, 20 percent 
of reserves for the supply in the most part. It is a better 
working situation here than it is in California.
    Even as an example, when there was concern earlier this 
year with New York being short on supply, there was an 
immediate response by the State of New York to add a 
substantial amount of generation to cover it. You also have the 
New York ISO, in terms of how they operate the rules and the 
market rules there.
    What we have seen in New York and, for the most part, the 
rest of the country is that the market really is working. The 
prices are $30 to $50 a megawatt hour in the most part. There 
are spikes, yes, but the volatility is nothing like it was or 
is in California.
    Now, why would you want to overlay, for example, a price 
mitigation scheme that we implemented to take care of the 
concerns, the dysfunctions of California and the West, when for 
the most part, what we are seeing is a well functioning, 
competitive market? Yes, there still have to be concerns, but 
my personal view is that you should not overlay with additional 
rules a situation where the market is operating very well.
    Now, we at the FERC are very concerned about New York, and 
a lot may happen to New York and other areas of the country. We 
just last week started asking for outage data. So, we will 
monitor that market, as we will the other markets in the 
country.
    Senator Schumer. Let me just follow up, if I have your 
okay, Mr. Chairman. It is true the New York market is not as 
bad off as California. First, the supply/demand equation is not 
as out of sync in New York, as you say. Second, we do have 
long-term contracts. And third, you are right, the PJM market 
is better than the Western market. But let me just make two 
points here.
    One, not all of our contracts are long-term. By the way, 
this tends to be at least immediately for the next summer or 
two a down-state rather than an upstate problem. But Con 
Edison, which I think supplies a third of New York power and is 
the main supplier overwhelmingly in New York City and in 
Westchester and in LIPA, Keyspan in Long Island--neither of 
them are totally covered by long-term contracts. So, you still 
have the problem at the margin you are similar to California.
    Second, as I understand it, while, yes, there are excesses 
of power in PJM and in New England, for that matter, in large 
part you cannot get the power from here to there, that the 
transmission lines are so overloaded and old that you just 
cannot get from here to there. So, even if you have an excess 
in those areas, they may not do the job.
    So, my question is, yes, the markets are different, but 
this policy is not designed to deal with the market in general. 
It is designed to deal with it at those peak times when 
ludicrous prices, way above what is needed to incentivize 
companies to build new plants, are asked and paid for. Why 
should we not have a policy that deals with that? I do not want 
to bring you back here in September and you said, well, gee, 
everything was fine except for 3 days in August, but now New 
York is in a position where we are $2 billion out because we 
are paying some wildly absurd sum. Could you answer that? 
Because I did not find your first answer totally dispositive.
    Mr. Madden. Well, Senator, unlike California, I think that 
the neighboring States have provided a substantial amount of 
supply to New York where it has been needed. I think New York 
needs to build more infrastructure, clearly transmission lines 
in New York City. There has to be the development of an 
infrastructure.
    Senator Schumer. Agreed, but that is 2, 3, 4 years away.
    Mr. Madden. If we have the right incentives, it could be a 
lot shorter. If we have the right incentives, we can have a 
streamlined permitting. I just do not think at this stage, 
based on what I know--by the way, there are pleadings before 
the Commission asking for a similar result, Senator, in terms 
of why not apply somewhat of a similar mitigation plan----
    Senator Schumer. If I just might interrupt you, sir, I have 
here the Energy Daily of June 19, today as it turns out. Con Ed 
says that FERC is leaving New York City residents exposed to 
unfair and unreasonable rates this summer by refusing to 
consider special market power mitigation measures proposed by 
the utility. So, it is not just me talking about this; it is 
the main distribution agency in New York.
    And your answer--we could be the quickest State in the 
country. We are not going to get power lines ready for not 
even--forget this summer--it is impossible--but for next 
summer. I supported the building of those ten little plants. I 
was one of the few elected officials who did, but that is not 
sufficient.
    Mr. Madden. Senator, we have the pleading by Con Ed and 
others before the Commission right now, which raises the same 
questions that you have asked me. We will be addressing that 
pleading in the near future. I cannot talk more about the 
specific merits of it because I am precluded, but I am well 
aware of the pleading.
    Senator Schumer. I would simply ask you to consider our 
problem, and I do not think saying either most of the contracts 
are long-term, surrounding markets do have some excessive 
power, or that we can build more transmission lines over the 
next few years, which I agree with--we have to--are sufficient 
answers if, God forbid, we have a lot of hot days this summer.
    Mr. Madden. I am not saying they are sufficient, but at the 
same time, I have to recognize we have to deal with a 
particular pleading by Con Ed. And we may have the relief you 
are requesting.
    Senator Schumer. I hope you will consider that. Thank you.
    Thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Mr. Madden, thank you very much. Let me just say that I 
know you and the Commission itself are very proud of the order 
you have entered. We hope very much that it does all that you 
intend. Based on the consensus view here on the committee, 
which I am sure you heard, we will suspend any effort to 
legislate in this area, at least in this committee, and watch 
and hope to continue to stay in close touch with you to 
determine whether you think your order is, in fact, handling 
the situation.
    Congratulations to you on the action you have taken, and we 
appreciate very much your staying behind and answering some 
additional questions.
    Mr. Madden. Thank you, Mr. Chairman, and thank you, Senator 
Murkowski.
    The Chairman. Let us get all of our additional witnesses up 
here. Our third panel is Mr. Geoffrey Roberts, who is president 
and CEO of Entergy Wholesale Operations; Mr. Steven Fetter, who 
is the managing director of Global Power Group; Dr. Ronald 
McMahan, who is the managing partner of Enercap; and Mr. Thomas 
Brill, director of regulatory policy and analysis for Sempra; 
and Mr. Bruce Henning, who is the director of energy and 
environmental analysis in Arlington, Virginia. If each of them 
would come up, we would appreciate it.
    Why don't we go ahead and hear from each of you? If you 
could summarize your comments, we will be glad to put your 
entire statement in the record. But why don't we start on the 
left-hand side, my left? Mr. Roberts, why don't you start out, 
and we will just go right across the table and hear your point 
of view of any of these issues. Mr. Roberts, thank you for 
being here.

 STATEMENT OF GEOFFREY D. ROBERTS, PRESIDENT AND CEO, ENTERGY 
            WHOLESALE OPERATIONS, THE WOODLANDS, TX

    Mr. Roberts. Thank you, Mr. Chairman, Senators. Thank you 
for allowing me to appear before you today.
    Entergy Wholesale Operations is the unregulated wholesale 
power arm of Entergy Corp. We have powerplants operating or 
under advanced stages of construction or development through 
the Gulf South, Midwest, and east coast of the United States, 
as well as in England, Spain, Italy, and Bulgaria. We currently 
have no projects operating or in advanced development in 
California or other parts of the Western States.
    I have been president and CEO of EWO for nearly 3 years, 
but I have been working in various parts of the energy industry 
for the last 18 years. My most recent experience has been 
trading and marketing electricity and natural gas and building 
the infrastructure necessary to serve these important markets 
in North America, Europe, South America, Australia, and Asia.
    Since joining Entergy, our focus has been two-fold. The 
first part has been putting together the development teams, all 
the necessary work that you need to get customers, land, water, 
permits, all the requirements necessary to build a powerplant.
    But it is not enough to put a powerplant in the ground and 
operate it well. There is a lot of risk, and it is not as easy 
as it might seem. All aspects of the business are fraught with 
risk. It is in understanding and evaluating these risks that 
places this all together. The choice between the potential 
powerplant project where we may choose to invest here or in 
another location is going to be entirely dependent upon how we 
assess those risks and the associated rewards.
    To put this in perspective, we currently have three 
different projects competing for each of the sets of turbines 
that we have. Our choice of one location or another is entirely 
dependent upon how we assess those risks.
    We have no special insights in to how to solve what is 
currently the enormous problem that is facing California today. 
Since the addition of new generation to California has to be 
part of the long-term solution, I hope to provide some insight 
as to how we approach the market and how we make decisions 
about where to invest. Perhaps that will help those who are 
confronting this problem in helping them to make decisions.
    Powerplant investment decisions come down to really two 
simple questions. First, does the potential return on 
investment justify taking the risks associated with the 
investment? Second, are there other projects available that 
provide either a greater return for the same risk or the same 
return for less risk?
    It is useful at this point to note some differential 
definitions between risk and uncertainty. Risk in the 
powerplant business comes from anything that makes earnings 
streams uncertain and is amenable to both measurement and 
management. Uncertainty refers to those hazards which are 
amenable to neither quantification nor management. Obviously, 
as a developer of power projects, we seek to measure and manage 
those projects and those risks.
    Uncertainties in particular projects, however, cause us to 
rethink our investment plans fundamentally, for we are in the 
business of taking calculated risk for the benefit of our 
investors. By definition, uncertainty is an exposure that 
cannot be calculated, where carefully developed skills may be 
of no benefit, an environment in which investment loss may be 
caused by arbitrary forces over which the investor has no 
control.
    There are two primary risks that we look at. One is 
obviously the capital, the impact on the cost side of the risk. 
Those were mentioned earlier today. Operating costs, ability to 
construct on time and on budget, environmental costs, et 
cetera. There are also risks affecting the revenue side: 
customer default, prices for power and related ancillary 
services, market supply and demand fundamentals, changes in 
market rules, and changes in regulatory structure. We spend a 
great deal of time trying to measure and quantify and manage 
the risks associated with these revenue and cost streams, and 
we keep a watchful eye on these uncertainties.
    All these factors go into the development of what we call 
forward curves or price forecasts. These take into account 
anything that we think might be significantly impacting the 
price of generation or our ability to operate. These forecasts 
with appropriate sensitivities provide the basis for developing 
the financial forecasts used to determine where and how we 
invest. We make decisions about investment, acquisitions, and 
divestment based upon these proprietary price curves. We 
believe, through our philosophy, experience, and actions, that 
price signals work. Price signals change behavior.
    As I discussed before, when economically feasible, we 
actively mitigate these risks. However, let us talk about some 
of those specific uncertainties.
    Significant uncertainties that cannot be anticipated in our 
forward curves or mitigated through various market tools, 
present very special challenges to any business, especially one 
that is as capital intensive as ours. Risks that are visible 
can be evaluated relative to expected returns and to other 
projects.
    Significant uncertainties that are unclear or unmanageable 
lead us to make decisions not to invest in projects affected by 
such uncertainties. One uncertainty that fits this description 
is the risk of adverse governmental laws or actions. In 
general, we choose to invest in markets where the regulator has 
made a commitment to develop rules that are transparent, 
stable, and fair. The rules do not have to be exactly what we 
want, so long as we can operate within their framework. During 
the past 3 years, we have exited from a number of international 
markets specifically because of regulatory and governmental 
uncertainties that would deny us the opportunity to apply our 
competencies effectively in pursuit of an adequate return for 
our investors.
    As you carefully consider the steps to address California's 
difficult power situation, it is important to consider not only 
how your decisions may affect generators and customers today, 
but also for years to come. The steps taken today will affect 
whether generators decide to build in California, or whether 
they perhaps choose to invest in other markets, or perhaps only 
invest at a higher return, or perhaps not at all. If steps 
taken today result in a perception by investors that the 
California market is not merely a market with normal risks, but 
one with uncertainties and market rules, taxes, and the general 
investment climate are seen to be unmanageable, they will 
either increase the required return on their capital that is 
higher or build elsewhere. Moreover, if the actions taken today 
reflect a trend for the broader generation market, it could 
negatively impact powerplant development decisions across the 
Nation.
    As I stated before, the market rules do not have to work 
perfectly. Electricity has the most complex physics of delivery 
of any major commodity, and the market rules governing the 
business of electricity tend to be complex as well. So, market 
rules tend to be a compromise between the requirements of the 
physical laws and the simplicity for market operation between 
the needs of the generators, the investors, the end users, and 
other market participants. As a market participant, we 
understand the give and take inherent in any system of market 
rules.
    Regulatory volatility, however, is an uncertainty we cannot 
tolerate. I will always choose a market with stable rules over 
one without, and I will guide my investment program 
accordingly. If I do build, it will require a much higher 
hurdle rate to ensure that investors' interests are reasonably 
protected. It is no different than how the capital markets 
work. If the particular market is more risky, the costs of that 
capital are higher to compensate investors for the increased 
risk.
    We are concerned with the energy situation in California. 
We are empathetic with the hardships being faced by its 
citizens. We hope this testimony helps those with 
responsibility for public policy so that California's situation 
does not become long term or affect the markets in other parts 
of the country.
    Thank you.
    [The prepared statement of Mr. Roberts follows:]

     Prepared Statement of Geoffrey D. Roberts, President and CEO, 
            Entergy Wholesale Operations, The Woodlands, TX

    Mr. Chairman, Senators: Thank you for allowing me to appear before 
you today. Entergy Wholesale Operations (EWO) is the unregulated 
wholesale power arm of Entergy Corp. We have power plants operating or 
under advanced stages of construction or development in the gulf South, 
Midwest, and East Coast of the United States, as well as in the England 
and Bulgaria. We have no projects operating or underway in California 
or other parts of the Western United States.
    I have been President and CEO of EWO for nearly three years. I have 
been working in various parts of the energy industry for over 18 years, 
with most of my recent experience being related to trading and 
marketing electricity and natural gas, and building the infrastructure 
necessary to serve these important markets in North America, Europe, 
South America, Australia and Asia. Since joining Entergy, our focus at 
EWO has been two-fold. One part was to build up our development, 
marketing, construction and operating teams. These are the teams that 
actively seek out, construct and operate the projects--seeking out 
customers, land, water, permits--all the requirements necessary to put 
a power plant into the ground, then to construct and operate it 
efficiently.
    It is not enough, however, to put a plant in the ground and operate 
it well. To be worthy of our investors money, we must be sure a project 
has a reasonable opportunity to provide at least a minimum return. This 
is not as easy as it might seem. All aspects of our business are 
fraught with risk. It is in understanding and evaluating these risks 
that management makes the choice between potential power plant project 
investments. To place this in perspective, we currently have over 3 
different projects internally compete for each set of the gas turbines 
that we have purchased. Some of these sites we will develop to become 
generating plants;others we might permit and then either retain for 
future development or sell to another developer. Yet others we will shy 
away from, either because the economics are not there relative to the 
risks or simply because there are better alternatives. Ultimately, we 
want to choose those projects that provide the optimal risk/reward 
profile. The second part of our focus at EWO has been in developing the 
analytics and processes necessary to identify, evaluate and manage the 
risks of our investments.
    It is this second aspect of our business I would like to discuss 
today. I have no special insights into how to solve what is currently 
an enormous, but we hope, short-term problem in California. Since the 
addition of new generation into California has to be part of the long-
term solution, I hope it will be helpful to provide insight into how 
generation companies make their decisions about where to invest. 
Perhaps this will help those who must confront this problem make 
decisions--and keep what is currently a short-term problem from 
becoming long-term.
    Power plant investment decisions come down to two questions. First, 
does the potential return on investment justify taking the risks 
associated with the investment? Second, are there other projects 
available that provide either a greater return for the same risk, or 
the same return for less risk. It all comes down to relative risk and 
return.
    It is useful, at this point, to note some definitional differences 
between ``risk'' and ``uncertainty''. Risk in the power plant business 
comes from anything that makes the earnings stream uncertain, but is 
amenable to both measurement and management. ``Uncertainty'' refers to 
those hazards which are amenable to neither quantification nor 
management. As a merchant developer, we seek to measure and manage our 
exposure to risk, but certainly not to avoid it entirely, for 
investment in a competitive marketplace inherently brings with it a 
measure of risk. Uncertainties in particular projects, however, cause 
us to rethink our investment plans fundamentally, for we're in the 
business of taking calculated risk for the benefit of our investors. By 
definition, uncertainty is an exposure that cannot be calculated, where 
carefully developed skills may be of no benefit, an environment in 
which investment loss may be caused by arbitrary and capricious forces 
over which the investor has no control. Risks and Uncertainties come 
from a myriad of sources, affecting both the costs of the project and 
the revenue stream. I'll start with the capital, or cost side risks, 
since as an industry, our capital costs are major factors in making 
decisions. Examples of some cost-related risks include:

   Operating and maintenance costs
   Fuel supply reliability and cost
   Ability to construct on time and on budget
   Environmental mitigation and regulatory changes
   Changes in transmission pricing and availability
   Changes in taxes
   Changes in financing costs
   Natural disasters

    Similar risks affect the revenue stream, including:

   Customer default
   Prices for power and related ancillary services
   Over- or under-development of the market (supply) relative 
        to demand
   Changes in demand, perhaps resulting from technology, 
        behavioral changes or other causes
   Changes in market rules
   Changes in regulatory structure

    EWO spends considerable time and resources to identify, value and 
manage the risks in these revenue and cost streams, and we keep a 
watchful eye on the uncertainties. We track generation development and 
customer load growth, regulatory and legislative changes,fuel supply 
logistics, transmission construction and constraints, to name a few, 
all to provide us the best possible view of the market and our 
projects. All these factors go into the development of what we call 
``forward curves'' or price forecasts. These take into account anything 
we can think of that might significantly affect the price of generation 
or our ability to operate. These forecasts, with appropriate 
sensitivities, provide the basis for developing the financial forecasts 
used to determine whether or not a power plant project would be a 
prudent investment. A fundamental assumption of these curves is that 
the market in which we compete is competitive and that economic forces 
drive rational decision-making. We make decisions about investment, 
acquisitions and divestment based upon these proprietary price curves. 
We believe, through our philosophy, experience and actions, that price 
signals work.
    As I discussed before, when economically feasible, we actively 
mitigate risks. For example, to mitigate the risk inherent in 
construction, we entered into a joint venture with the Shaw group. 
Similarly, fluctuations in fuel prices can be hedged in the derivatives 
market. We buy insurance for natural disasters (which might cover the 
cost of the hardware, but not the lost revenue), and we buy quality 
equipment to maximize reliability and reduce the risk of not operating. 
And now, even the risks of weather can be managed in the marketplace, 
through innovative transactions being offered through our affiliate 
Entergy-Koch.
    However, significant earnings Uncertainties that cannot be 
anticipated in our forward curves or mitigated through various market 
tools, present special challenges to any business, especially to one as 
capital intensive as ours. Risks that are visible can be evaluated 
relative to expected return and to other projects.
    Significant Uncertainties that are unclear or unmanageable lead us 
to make decisions not to invest in projects affected by such 
Uncertainties. One Uncertainty that fits this description is the risk 
of adverse governmental laws or actions. In general, we choose to 
invest in markets where the regulator has made a commitment to develop 
rules that are transparent, stable, and fair. The rules do not have to 
be exactly what we want, so long as we can operate within their 
framework. Consequently, we look for markets where the rules of 
competition are clear, encouraged and relatively stable. During the 
past 3 years, we have exited from a number of international markets, 
specifically because of regulatory and governmental uncertainties that 
would deny us the opportunity to apply our competencies effectively in 
pursuit of an adequate return for our investors.
    As you carefully consider steps to address California's difficult 
power situation, it is important to consider not only how your 
decisions may affect generators and customers today, but also for years 
to come. The steps taken today will affect whether generators decide to 
build in California, or whether they perhaps choose to invest in other 
markets, or perhaps invest only at a higher return, or perhaps not at 
all. If steps taken today result in a perception by investors that the 
California market is not merely a market with normal risks, but one in 
which uncertainties in market rules, taxes, and the general investment 
climate are seen as unmanageable, then they will either increase the 
required return on their capital, or build elsewhere. Moreover, if the 
actions taken today are perceived as reflecting a trend for the broader 
generation market, it could impact hurdle rates and power plants 
development decisions across the nation.
    As I stated before, the market rules do not have to be perfect. 
Electricity has the most complex physics of delivery of any major 
commodity, and the market rules governing the business of electricity 
tend to be complex as well. So, market rules tend to be compromises--
between the requirements of the physical laws vs. simplicity for market 
operation, between the needs of generators and investors and the needs 
of end-users. As a market participant, we understand the give-and-take 
inherent in any system of market rules. As long as they are reasonable, 
fair and predictable, we can figure out a way to work within their 
structure. Regulatory volatility, however, is an uncertainty we cannot 
tolerate. One cannot predict or mitigate the risk--the major outcomes 
are recriminations, and dissatisfied investors. I will always choose a 
market with stable rules over one without--and I will guide my 
investment program accordingly. If I do build, it will require a much 
higher hurdle rate to ensure that my investors' interests are 
reasonably protected. This is no different from how the capital markets 
view individual markets around the world. If the particular market is 
more risky, the costs of that capital are higher--to compensate 
investors for the increased risk.
    EWO is concerned with the energy situation in California. We are 
empathetic with the hardship being faced by its citizens. We hope this 
testimony helps those with responsibility for public policy, so that 
California's situation does not become long-term, or affect the markets 
in other parts of the country.

    The Chairman. Thank you very much.
    Dr. McMahan, why don't you go right ahead.

   STATEMENT OF RONALD L. McMAHAN, Ph.D., MANAGING PARTNER, 
              ENERCAP ASSOCIATES, LLC, BOULDER, CO

    Dr. McMahan. Thank you. I will digress from the remarks I 
submitted in light of the time squeeze and also the comments by 
the FERC.
    I do want to say that I have 25 years experience as an 
economist, mostly with the company I founded, RDI, watching 
these swings in cycles in the electricity market in particular. 
I think we should understand two things from the outset. First 
of all, nothing that has been done by the FERC today or 
yesterday will do anything to help with the chronic electricity 
shortages that are going to be faced in California and the rest 
of the West. And secondly, we will still see high prices in the 
West.
    On a positive note, all the pieces are in place to help 
mitigate these problems. There is a tremendous amount of 
generating capacity either under construction or having been 
announced in recent years given the opening of the market. 
There is clearly public awareness that has led to considerable 
conservation efforts, and clearly the regulatory authority does 
exist to deal with the pricing issues that people have talked 
about.
    So, while it is no surprise where we stand, and rather than 
sort of pound on the California issue and how we got here, let 
me just give some orders of magnitude of what we are looking at 
this summer and talk about the supply side.
    First of all, the hydro issue that people have been talking 
about. I included some numbers in my prepared remarks, but let 
me just give some orders of magnitude around that. Given the 
reservoir levels in the Northwest, even though we have been 
seeing some decent spring runoff and some relief in prices, 
given where we are now and according to a study by Henwood and 
Associates in Sacramento, we are going to be looking at chronic 
shortages in the middle of the summer and into August. The loss 
of about 4,000 to 5,000 megawatts of average generation due to 
just the hydro problem, the loss of about 8,000 to 9,000 
megawatts of peaking capacity. That is the equivalent of losing 
the entire PG&E system at noon on a hot summer day. It is a lot 
of electricity.
    Right now we are looking at deficits in August of about 
8,000 megawatts; 139,000 megawatts of demand and only about 
131,000 megawatts of effective capacity. Do not forget, a stage 
3 emergency, which is the highest level of emergency in 
California, is when they have a 1.5 percent reserve margin. We 
are projecting August reserve margins of minus 5.3 percent. 
There will be blackouts unless there is some relief in the 
weather, and there will be a lot of voluntary curtailment of 
load.
    I prepared a map that shows where the electricity plants 
are being constructed. I do not know if it is here. I have some 
copies if the Senators would like to look at them.
    The Chairman. Yes, we would like to see that. If somebody 
could go grab those for us, I would appreciate it.
    Dr. McMahan. Those are attached to the remarks that I 
brought.*
---------------------------------------------------------------------------
    * Retained in committee files.
---------------------------------------------------------------------------
    Essentially what this shows is all of the plants that have 
either been under construction, have been announced or are 
somewhere in the permitting process throughout the WSCC region. 
The dots that are fully filled in are those that are under 
construction. You can see, by the color, the red ones will be 
coming on in 2000; the green ones in 2002; and the others in 
2003. Some of the longer range ones are the bigger plants that 
have more lead time.
    But we see about 6,000 megawatts in the whole region that 
is under construction to come on this summer. As you know, that 
is still not enough to make up the kind of 8,000 megawatt 
deficit that I was talking about.
    Even if all of these plants that are completed, all the 
ones that are under construction, over the next 3 years, we 
would see about 17,700 megawatts of new capacity. That is 
encouraging, but that still does not even get us up to the 15 
percent reserve margins that people look for.
    So, what is going on with all of those other plants that 
you see on there that are not fully shaded? I think that those 
plants are in jeopardy for several reasons.
    First of all, now the analysts are going to all go back 
home at the development companies that are developing projects, 
break out their calculators, look at what they consider to be 
the proxy price going forward, and will make decisions, as my 
colleague has stated, about whether they should continue the 
development of these projects, whether they should postpone the 
development of those projects, or abandon them altogether.
    The second big question that arises is how are the 
financial markets going to react because, again, all of those 
plants that are not fully shaded in are still somewhere in the 
financing process, and how the markets and Wall Street react is 
going to be very important.
    The final technical point that I will make that sort of 
takes a little bit of the gloss off of this nice development 
picture is that natural gas is supplying 98 percent of these 
plants that are being built. As you know, there are tremendous 
strains on the natural gas system. If all of the plants were 
built in the West and in Texas, we would see about half again 
as much gas needed for that as all of the electricity that we 
generated in the United States last year. So, the gas 
infrastructure system and the gas replacement system is going 
to be very critical. It could be we will have all these plants 
and nothing to fire them.
    So, just in conclusion, as far as what should be done, I 
think clearly conservation, investing in renewables, 
development of new powerplants and reinforcing the pipes and 
wires infrastructure is very important.
    I think cost-of-service pricing mechanisms would be a 
disaster and would essentially wipe out most of the new 
development that is planned. I think that punishing the rest of 
the country for what is happening in California is kind of like 
picking out one student who has been bad and punishing the 
whole class for it. I think we need to be careful about what we 
do as far as sweeping legislation in order to be sure that we 
keep this pipeline of powerplants full.
    Thank you.
    [The prepared statement of Dr. McMahan follows:]

      Prepared Statement of Ronald L. McMahan, Managing Partner, 
                  Enercap Associates, LLC, Boulder, CO

    Mr. Chairman and Members of the Committee:
    I am pleased to be here today to summarize the findings of a study 
I recently completed addressing the electricity supply situation in the 
West. I will begin by saying that no matter what the Committee does 
here today, and no matter what actions the Congress takes in the coming 
weeks, this much is certain: electricity shortages will continue to 
plague California in the months to come, and high energy prices will 
persist throughout the region.
    There are no quick fixes for the current situation. However, I 
believe that all of the pieces are in place today to see us out of this 
problem.

   Enough new generating capacity is under construction and/or 
        planned to meet the West's projected needs by late next year.
          --This assumes that legislators do not take rash actions that 
        will cause developers to withdraw.

   Public awareness coupled with increasingly painful price 
        signals promise to deliver substantial conservation.
          --At the same time, innovative suppliers and buyers are 
        devising methods to better understand electricity consumption 
        patterns and to more carefully tailor usage--particularly at 
        the industrial and commercial level.

   The regulatory authority and mechanisms currently exist to 
        curtail price gouging and to deter suppliers from ``gaming the 
        system.''

                           ELECTRICITY SUPPLY

    The situation that we face today in the West should come as no 
surprise. Four years ago, in May, 1997, when I was invited to address 
this same Committee on the topic of electricity deregulation and 
stranded cost recovery, I pointed out that California's deregulation 
scheme would most likely lead to supply shortages, and recommended 
strongly that Congress not pattern a national scheme on such a model.
    The California approach was flawed from the outset for a couple of 
very basic reasons:

   First, it attempted to address the problem of inordinately 
        high electricity rates in the state by ``re-mortgaging'' 
        historic, high-cost power policies--these policies themselves 
        the product of short-sighted legislative and regulatory 
        constraints.
   Second, the state assumed it could take advantage of low-
        cost power then available in the rest of the Western grid from 
        states whose utilities had taken a more reasoned approach to 
        capacity development.
          --However, it did nothing to address the issue of developing 
        new supply to meet growing demand.
          --An unintended consequence of the stranded cost recovery 
        mechanism was the migration of capital away from new project 
        development, and largely out of the state.

    Unfortunately, the inevitable supply squeeze has been exacerbated 
by two factors--faster than anticipated economic (and, hence, 
electricity demand) growth, and two consecutive seasons of extremely 
low hydro availability in the region. To illustrate the severity of the 
hydro problem consider the following chart:

                 WESTERN SNOW PACK IS WELL BELOW NORMAL
------------------------------------------------------------------------
                                                                Peak
                                               % of normal    capacity
------------------------------------------------------------------------
Pacific Northwest............................      67%         30,600 MW
California...................................      78%          9,600 MW
Colorado River...............................      80%          8,400 MW
------------------------------------------------------------------------
 The loss of 4,000-5,000 MW of average generation
    --Equivalent to losing the entire PSCO and Colorado Springs systems
  for a year.
 
 The loss of 8,000-9,000 MW of sustainable peak
    --Equivalent to losing the entire PG&E or Pacificorp system at noon
  on a summer day.

    According to a recent study by Sacramento-based Henwood Energy 
Services, Inc., WSCC at the Brink: Disaster or Recovery, the West is on 
a collision course with disaster later this summer as projected peak 
demand is expected to exceed the region's total effective capacity of 
131,000 MW by 8,000 MW--a massive shortfall. For perspective, in 
California, a Stage 3 emergency occurs when reserve margins fall to 
1.5%. In August, the study projects that peak hour reserve margins 
could drop to minus 5.3%. Only drastic voluntary and forced cutbacks in 
load will avert what could ultimately be the worst shortage the region 
has seen.
    Developers are racing to bring new generation on-line as quickly as 
possible. In just the interconnected Western grid alone (WSCC), roughly 
6,000 MW of new generation capacity is under construction and scheduled 
to come on line by the end of the year--most likely too late to fully 
avert this summer's chronic shortages. But the good news is that over 
the next three years, significant new capacity is scheduled to come on 
line, as illustrated in the table below and on the attached map of 
power plant activity.

                                       NEW POWER PLANTS IN THE WSCC REGION
                                              [Net Capacity in MW]
----------------------------------------------------------------------------------------------------------------
                                                                       Under
                                                                   construction   Permits    Announced    Total
----------------------------------------------------------------------------------------------------------------
2001.............................................................     5,983          160         699       6,842
2002.............................................................     6,850        4,066       3,148      14,064
2003.............................................................     4,909        5,148       9,469      19,526
----------------------------------------------------------------------------------------------------------------
    Total........................................................    17,742        9,374      13,316      40,432
----------------------------------------------------------------------------------------------------------------
Source: Henwood Energy Services, Inc., NextGen Database.

    While this level of development activity is encouraging, we must 
temper our optimism in light of recent developments and public 
initiatives.

   The 17.7 GW of capacity under construction is helpful, but 
        not enough to insure safe capacity margins--even in normal 
        hydro years.
   The investment climate is cooling.
          --Much of the 22.7 GW of capacity currently in the permitting 
        process or announced is in jeopardy of not being built as 
        developers become wary of increased regulatory control and the 
        possibility of price caps.
          --The psychology of the market has turned around as 
        developers are ``demonized'' and inclined to wait this out or 
        invest their capital elsewhere.

   Natural gas supply issues--too many eggs in one basket?
          --Of the 17.7 GW of capacity under construction 17.3 GW (98%) 
        will be fired by natural gas.
          --Of the total 40.4 GW announced, 39.6 GW (98%) will be fired 
        by natural gas.
          --Between the WSCC and ERCOT (Texas), all of the natural gas 
        projects currently under construction or permitted will require 
        3.8 Bcf/d or 1.4 Tcf/y.

   For comparison, in 1999, in the entire U.S., total gas-fired 
        electricity consumption consumed 3.1 Tcf/y.

          --Current natural gas exploration is not even enough to 
        maintain supply.

   We need to find 8.5 Bcf/d just to stay even--10,000 wells/
        year.
   An ``all out effort'' can produce 9.5 Bcf/d--net +1 Bcf/d.

          --This level of development means further demands on a gas 
        pipeline system that is already operating at 85%-90% of 
        capacity with only minimal expansion under way.

                          WHAT SHOULD BE DONE?

    In April, I presented these findings at a round table in Denver 
chaired by Senator Craig with participation from FERC Chairman Hebert, 
the Governor of Montana, and numerous state officials including the 
chairmen of the California Energy Commission and the Texas Railroad 
Commission. At that time, when asked what we should do, I responded, 
``We need to do everything--we need to conserve as never before; we 
need to invest aggressively in promising renewable energy technologies; 
we need to encourage the development of new natural gas and clean-coal 
power plants; and we need to reinforce the `pipes and wires' 
infrastructure.''
    Today, I will make an emphatic addition to that response--i.e., 
what we should not do. We should not move toward sweeping cost-of-
service pricing mechanisms for electricity. This would be a giant leap 
backward to a time when cost-plus regulation created the very problems 
that we are trying to untangle today. It discourages innovation; it 
hurts productivity; it does nothing to check demand; and it sends all 
the wrong signals to project developers.
    In many ways the genie is already out of the bottle, and believe it 
or not, the system is working as a plethora of new power plants are 
coming on line to meet demand. If the market is left to work as it 
should, we will soon see a period of increasing supply and lower 
prices--especially on the spot market.
    The FERC already has the authority to check ``unjust and 
unreasonable'' prices, and in recent weeks has moved to implement 
temporary rules aimed at accomplishing virtually the same results as 
the proposed legislation. What is important is to be able to apply 
these rules judiciously and fairly without invoking the dreaded image 
of ``price caps'' that can send investors running.
    There is always the fear that if the federal government doesn't 
step in and provide price relief, the natural trend toward deregulation 
will suffer. This may be true, and it may fall to the FERC to navigate 
through the next few months until needed supply once again begins to 
build and the situation cools down.
    California continues to show us what can happen as a frustrated 
government thrashes about trying to impose quick fixes--going into the 
transmission business; signing high-priced power contracts at the peak 
of the market; and demanding federal intervention. If Congress were to 
react by implementing sweeping legislation at this time, it would be 
like punishing the whole class for the misdeeds of one pupil.

    The Chairman. Thank you very much.
    Mr. Fetter, why don't you go right ahead.

STATEMENT OF STEVEN M. FETTER, MANAGING DIRECTOR, GLOBAL POWER 
                GROUP, FITCH, INC., NEW YORK, NY

    Mr. Fetter. Thank you, Mr. Chairman. I must say I came 
prepared for a brawl over price caps and ran into a love fest 
regarding regulation. As a former regulator, I am honored to be 
here.
    The Chairman. Which side are you on on this issue? I am not 
clear from your statement if you are for regulation or opposed.
    Mr. Fetter. Well, I am someone who felt that regulation 
served some beneficial purposes but would prefer a market 
oriented setting.
    The Chairman. All right. We will let you further explain 
your views on what FERC did yesterday.
    Mr. Fetter. On the small chance that FERC's action 
yesterday does not solve all the problems within the Western 
United States, and the members of this committee are accosted 
at July 4th barbecues on the issue of price caps, let me say 
these thoughts.
    Major investments have been made in California and other 
States based on the particular competitive frameworks mandated 
by State legislatures and commissions. Price levels for 
generation asset auctions were driven by the new market 
orientation. A retrenchment on these policies back to a form of 
cost-of-service regulation would likely curb investors' 
enthusiasm for additional investment pending clearer signs as 
to future policy direction. This is especially the case where 
the change in direction might come from the Congress, which is 
considering proposals for price controls that could apply to 
just California, or potentially all 11 States within the 
Western energy market, or in view of Senator Schumer's remarks 
a few minutes ago, conceivably would apply to the entire United 
States.
    Industry participants, including Federal and State 
regulators and elected officeholders, have called for 
substantial amounts of investment both for new generation and 
transmission upgrades if the Nation's utility restructuring 
movement is to progress.
    I believe the policies encompassed in the legislation under 
consideration today would add to the uncertainty currently in 
minds of investors in light of the serious financial 
difficulties facing California. I draw an analogy to the well-
intentioned but flawed Federal policy enacted within the Public 
Utility Regulatory Policies Act, known as PURPA. Passed in 
1978, PURPA sought to encourage both cogeneration and small 
power production in order to diversity electricity supply away 
from traditional large utility-owned powerplants.
    In that regard, the law failed miserably. It did succeed, 
however, in touching off 2 decades of regulatory and judicial 
disputes and creating billions of dollars in stranded costs, as 
I saw firsthand has a State utility regulator.
    Though PURPA issues were with me every day during my 6 
years at the Michigan Public Service Commission, its aims only 
became evident to me from a reading of PURPA because its goals 
were never achieved in its implementation within the State of 
Michigan or anywhere else in the United States.
    I offer this example because I firmly believe that utility 
regulation is not an area where the Congress can step in every 
few years and attempt to deal with the pressing issue of the 
moment. As we saw with PURPA, such a step can have long-term 
negative economic consequences. If illegal behavior is 
occurring within the California market or elsewhere in the 
West, laws already exist to remedy those wrongs. But if this 
body seeks to preempt State regulatory prerogatives, indeed 
step in in place of the FERC and act as a guardian against 
market movement in an upward direction, you will generate 
growing concern in the minds of investors and lead them to 
question whether they really do want to be part of the changing 
energy landscape.
    Already in California questions are arising about the long-
term contracts the State recently negotiated because wholesale 
electricity prices have collapsed from the highs of a few 
months ago. In view of the proposed about-face on competition 
under consideration today, what investor would not fear that 5 
to 7 years hence, when the rates flowing from California's 
long-term supply contracts far exceed market levels, just as 
happened under PURPA, that today's proponents of price caps 
would fight to relieve their constituents from having to pay 
the outrageous above-market rates being forced upon them?
    And the situation is not necessarily confined to the West. 
The Midwest electricity spike of June 1998 and its aftermath 
led my company Fitch, to state, ``The electricity market 
involves unusual risks that will affect the credit of all 
market participants.'' Some industry observers have speculated 
that the New York City region might experience price or supply 
problems this summer.
    Does this Congress intend to maintain an ongoing oversight 
role so that price controls may be extended beyond the western 
market whenever prices in other regions fluctuate upward? If 
so, the efficiency gains envisioned coming from a truly 
competitive energy environment will likely never be achieved.
    Thank you, Mr. Chairman, Senator Murkowski.
    [The prepared statement of Mr. Fetter follows:]

      Prepared Statement of Steven M. Fetter, Managing Director, 
             Global Power Group, Fitch, Inc., New York, NY

    I appreciate the opportunity to testify before the Committee on 
Energy and Natural Resources to offer the views of Fitch on S. 764, a 
bill to direct the Federal Energy Regulatory Commission to impose just 
and reasonable load-differentiated demand rates or cost-of-service 
based rates on sales by public utilities of electric energy at 
wholesale in the western energy market, and sections 508-510 of S. 597, 
the Comprehensive and Balanced Energy Policy Act of 2001, relating to 
wholesale electricity rates in the western energy market, natural gas 
rates in California, and the sale price of bundled natural gas 
transactions. I will speak from the perspective of a member of the 
financial community as well as former Chairman of the Michigan Public 
Service Commission.
    By now we are all familiar with the factors that have led to the 
energy catastrophe in the Western U.S. electricity market. California's 
restructuring plan encouraged utility divestiture of generation and 
called for a high proportion of customer demand to be met by spot 
market supply from day-ahead or hourly transactions. This exposed the 
state's three investor-owned utilities, which were operating under 
retail price caps, to extreme financial pressures due to wholesale 
market volatility. By contrast, in more rational market structures for 
electricity and other energy commodities, approximately 85-90% of 
demand is normally provided through long-term contracts, with at most 
only 15% subject to spot market fluctuations. The extreme volatility of 
price at the wholesale level has given rise to urgent calls for a 
``fix'' in the form of lower and lower price caps.
    Three months ago, before this committee, I offered Fitch's views as 
to whether price caps could provide a solution to the problems facing 
California and the West. While I continue to believe that price caps 
would negatively influence the evolution to a competitive electricity 
market, I am willing to admit that federal enactment of a uniform price 
cap at a high level--such as $1000 per mwh--might serve a useful 
purpose. It could operate as a circuit breaker to cap wholesale prices 
during the brief periods when extremely volatile circumstances result 
in a market that cannot be contained by any manner of competitive 
forces. It also probably would not interfere with any strategic 
decision making by industry participants since builders of new 
generation or transmission would not employ prices at that level (or 
higher) in their financing models.
    However, to go lower than such a safety valve type level would 
undoubtedly slow the nation's movement toward an efficient competitive 
wholesale market. We have already seen that imposition of a low price 
cap, such as $250 per mwh or even $150 per mwh, can have the negative 
effect of encouraging suppliers to seek alternative market outlets or 
even to slow production, or could create anomalous pricing patterns 
during off-peak periods. Continued tinkering with market rules, 
especially if at the macro federal level, is sure to create uncertainty 
among energy investors and delay implementation of their business 
plans--this is even more the case in light of recent ambiguous economic 
signs.
    A further concern for market participants is that major investments 
have been made in California and other states based on the particular 
competitive frameworks mandated by state legislatures. Price levels for 
generation asset auctions were driven by the new market orientation. A 
retrenchment on these policies back to a form of cost-of-service 
regulation would likely curb investors' enthusiasm for additional 
investment pending clearer signs as to future policy direction. This is 
especially true where the change in direction comes from the Congress, 
which is considering proposals for price controls that could apply to 
just California, or potentially all eleven states within the western 
energy market, or conceivably the entire U.S.
    What concerns me most about Congressional involvement in regulation 
of the wholesale electricity market is the uncertainty it engenders 
among investors. Industry participants, including federal and state 
regulators and elected officeholders, have called for substantial 
amounts of investment if the nation's utility restructuring movement is 
to progress. New generation must be added across the country and 
upgrades to the existing transmission grid are needed to transform the 
former integrated utility structure into a complement of regional 
competitive markets operating in a coordinated manner.
    I believe the policies encompassed in the legislation under 
consideration today would add to the uncertainty currently in the minds 
of investors in light of the serious financial difficulties facing 
Pacific Gas & Electric and Southern California Edison. I draw an 
analogy to the well-intentioned, but flawed, federal policy enacted 
within the Public Utility Regulatory Policies Act, known as PURPA. 
Passed in 1978, PURPA sought to encourage both cogeneration and small 
power production in order to diversify electricity supply away from 
traditional large utility-owned power plants. In that regard, the law 
failed miserably. It did succeed, however, in touching off two decades 
of regulatory and judicial disputes and creating billions of dollars in 
stranded costs--as I saw first-hand as a state utility regulator.
    In 1987, I was appointed to the Michigan Public Service Commission 
(MPSC). At the time, I had no idea what PURPA was, but I soon learned 
of the positive objectives Congress sought in enacting the legislation. 
Unfortunately, those aims only became evident to me from a reading of 
PURPA, because its goals were never achieved in its implementation 
within the State of Michigan or anywhere else in the U.S.
    Soon after the announcement of my appointment, I began to receive 
calls--both pro and con--about the largest cogeneration facility in the 
world, a 50% utility-owned facility, that was to be considered by the 
MPSC under PURPA. I was confronted with PURPA issues every day of the 
six years I served as a state regulator. Finally, in May 1993, the MPSC 
resolved the final major cogeneration matter before the Commission. I 
left soon after, never having seen the congressional intent--and good 
intentions--underlying PURPA being manifested.
    I offer this example because I firmly believe that utility 
regulation is not an area where the Congress can step in every few 
years and attempt to deal with a pressing issue of the moment. As we 
saw with PURPA, such a step can have long-term negative economic 
consequences. If illegal behavior is occurring within the California 
market, laws already exist to remedy those wrongs. But if this body 
seeks to preempt state regulatory prerogatives and act as a guardian 
against market movement in an upward direction, you will generate 
growing concern in the minds of investors and lead them to question 
whether they really do want to be part of the changing energy 
landscape.
    Already in California there is talk that the state may try to back 
out of some of the agreements it recently negotiated because wholesale 
electricity prices have collapsed from the highs of a few months ago. 
And what of the contracts that remain in place for the next ten to 
twenty years? In view of the proposed about-face on competition under 
consideration today, what investor would not fear that five to seven 
years hence--when the rates flowing from California's long-term supply 
contracts far exceed market levels (just as happened under PURPA)--that 
today's proponents of price caps would fight to relieve their 
constituents from having to pay the ``outrageous'' above-market rates 
being forced upon them.
    And the situation is not necessarily confined to the West. The 
Midwest electricity spike of June 1998 and its aftermath led Fitch to 
state that ``the electricity market involves unusual risks that will 
affect the credit of all market participants'' (See Fitch report, 
``Electricity Price Spike: Lessons Learned,'' October 29, 1998, at 
www.fitchratings.com). Indeed, there have been other instances of rate 
aberrations in both the electric and natural gas sectors in various 
regions of the country over the recent past. Some industry observers 
have speculated that the New York City region might experience price or 
supply problems this summer.
    Does this Congress intend to maintain an ongoing oversight role so 
that price controls may be extended beyond the western market whenever 
prices in other regions fluctuate upward? If so, the efficiency gains 
envisioned coming from a truly competitive energy environment will 
likely never be achieved.
    Already in the wake of California's serious difficulties, 
restructuring activities have come to a dead halt across the country. 
You may believe you are playing the role of the cavalry coming over the 
hill to save the day, but from where investors sit, it appears more 
like the waving of a white flag on electric industry competition.

    The Chairman. Thank you very much.
    Mr. Brill, why don't you go right ahead.

STATEMENT OF THOMAS R. BRILL, DIRECTOR OF REGULATORY POLICY AND 
             ANALYSIS, SEMPRA ENERGY, SAN DIEGO, CA

    Mr. Brill. Thank you, Mr. Chairman. Thank you, Senator.
    Today I am going to limit my remarks to the provisions of 
S. 764 that would reinstate the maximum rate ceiling on short-
term capacity releases for transportation of natural gas into 
California. I am going to attempt to do so in the context of 
the order that FERC issued yesterday, which will be something 
of a challenge in light of the fact that I have yet to see that 
order. But I certainly have listened to the Commissioners' 
statements.
    The Chairman. This is the only place where we have 
intensive, in-depth discussions of orders that have not yet 
been issued.
    [Laughter.]
    Mr. Brill. It makes it easier to be right.
    The Chairman. That is correct. That is why we do it.
    [Laughter.]
    Mr. Brill. What I will try to do is make reference to the 
order based upon what I have heard the Commissioners say in 
describing the order, and specifically I would like to refer to 
some of the comments of Commissioner Massey who pointed out 
that whether or not and the extent to which the order is 
effective will depend upon the natural gas prices at the border 
of California. Now, they have three pricing points, but in any 
event, those input prices that will form such a significant 
impact on the electric prices provided for under this order 
will be impacted by the price of natural gas at the wellhead as 
well as the imputed value of interstate transportation services 
for getting that natural gas to California.
    In order to save some time, I am going to cut my remarks 
short, but at the end of my testimony, there is a table. I am 
going to make reference in the comments I am about to make to 
the table at the end of the testimony that I have provided. I 
do have additional copies if that would be helpful.
    The Chairman. It would be helpful. Thank you.
    Mr. Brill. Essentially the table that is being provided to 
you tracks natural gas prices at the California border 
beginning January 1 of last year. On that table, you will see 
the imputed value of interstate transportation services since 
the beginning of last year as well as the FERC-approved cost-
of-service rate for interstate transportation. The line at the 
bottom of the table represents the weighted average FERC-
approved cost-of-service rate, including fuel use for 
transportation to California.
    As you will note, the table depicts three dates: the 
effective date of FERC order 637 which lifted FERC's cap on 
capacity release transactions last year; second, the date that 
SDG&E filed an emergency request with FERC, seeking relief 
similar to that embodied in S. 764 with regard to natural gas 
rates; and three, the date of a recent FERC order requesting 
comments in response to SDG&E's emergency filing on whether 
FERC should reimpose the maximum rate on short-term capacity 
releases into California.
    As you can see, shortly after the cap was lifted, the 
imputed value of interstate transportation began to exceed the 
FERC-approved cost-of-service rate. In fact, prices remained 
well above the as-billed rate since mid-June of last year. To 
understand the magnitude of the cost Californians and 
generators in California have had to pay since this cap was 
lifted, keep in mind that the FERC-approved cost-of-service 
rate for transportation to California ranges from 31 to 67 
cents, excluding fuel use. By contrast, since mid-June of last 
year, excluding fuel use, the imputed value of this service has 
exceeded $2 on 147 days. The imputed value of this service has 
exceeded $6 on 110 days. This is for a service whose weighted 
average rate is worth about 50-52 cents.
    This is not all. Excluding fuel use, the imputed value of 
transportation to California has exceeded $10 on 36 days. It 
has exceeded $18 on 15 days and even reached a high of $49, all 
for a transportation service with a FERC-approved cost-of-
service rate of less than 67 cents.
    In light of these values, there should be no doubt that the 
experimental lifting of the cap, at least for natural gas 
transportation services to California, has failed.
    As I have noted, the chart contains three dates, and you 
can easily see what has happened in reaction to each of these 
three dates. After FERC lifted the cap on an experimental 
basis, the values began to increase. The values hit a high last 
December, but possibly in response to a threat of reimposition 
to the caps, the values declined significantly. After a period 
of time when it appeared that there would be no action, the 
values increased again, and when FERC issued an order 
requesting comments on this issue, indicating potential action, 
values began to decline once again. However, they remained 
significantly above the as-billed rate.
    The point of this presentation is that if FERC's order of 
yesterday is to be effective and is to effectively drive 
electric prices to a just and reasonable level, it will be 
dependent upon what FERC or Congress does with regard to the 
imputed value of natural gas transportation service to 
California.
    [The prepared statement of Mr. Brill follows:]

 Prepared Statement of Thomas R. Brill, Director of Regulatory Policy 
               and Analysis, Sempra Energy, San Diego, CA

    Good morning. I am Tom Brill, Director of Regulatory Policy & 
Analysis for Sempra Energy. Sempra Energy is a Fortune 500 energy 
services holding company headquartered in San Diego. Our subsidiaries 
provide electricity and natural gas services. Sempra Energy's two 
California regulated subsidiaries are San Diego Gas & Electric Company 
(SDG&E) and Southern California Gas Company (SoCalGas). Thank you for 
the opportunity to testify here today.
    I would like to first commend Senator Feinstein for the leadership 
she has shown on this issue. As Californians are all too aware, there 
are some who would rather blame others for the energy crisis than look 
for meaningful solutions. There is more than enough blame to go around, 
but that won't build powerplants any faster or lower the high-energy 
prices that nearly all Californians are paying for both electricity and 
natural gas. Senator Feinstein has worked tirelessly to craft a 
solution, found in S. 764, that is equitable to both consumers and 
producers. Senator Bingaman, we also appreciate your willingness to 
hold today's hearing as one of your first acts as Chairman, to address 
this crisis which threatens the western United States.
    Sempra Energy has testified on previous occasions before this and 
other Congressional Committees, both regarding how the western energy 
crisis began, and stating our support for the effort that Senators 
Feinstein and Smith have undertaken in this legislation.
    The western states, consumers, utilities and other interested 
parties have sought a meaningful solution to the current crisis of high 
energy costs, which include both wholesale electric costs and natural 
gas prices. S. 764 takes a critical step toward solving the crisis by 
instituting a much needed cooling off period for California's 
dysfunctional energy market: first by imposing ``Cost of Service Plus'' 
rates and then for reinstating the Federal Energy Regulatory 
Commission's price regulations on short-term interstate pipeline 
capacity release transactions for transportation services to 
California.
    Today I will limit my remarks to the provisions of S. 764 that 
reinstate the maximum rate ceiling on short-term capacity release 
transactions into California.

                           NATURAL GAS COSTS

    Before discussing the merits of reinstating the cap on prices that 
can be charged for interstate pipeline capacity, I would like to 
briefly address the impact of natural gas spot prices on the price of 
electricity. I want to make very clear that our support for 
reinstatement of the cap is not in any way intended to lend credence to 
arguments that natural gas prices by themselves, or costs of production 
in general, explain the explosion in electricity prices in California. 
The interrelationship between the price of natural gas and the 
magnitude of change in electric commodity process is terribly out of 
alignment. For example, in the summer of 2000, the price of natural gas 
was $3.50 per mcf, yet the electric commodity price was as high as 
$2000 per MWh. These numbers provide little justification for the 
skyrocketing electric prices that have been charged in the wholesale 
market. In fact, some believe that the high natural gas prices are the 
result of the skyrocketing electricity prices we have seen in 
California, rather than the cause of those prices. Nonetheless, to the 
extent they are a factor in western electricity prices they need to be 
addressed. Indeed, FERC itself has made them a factor in its limited 
approach to market mitigation. Beyond their linkage to the electricity 
crisis, they are a cost factor for California consumers in and of 
themselves. So addressing this problem may have a dual benefit to the 
regional economy.

                               BACKGROUND

    Holders of capacity on the interstate pipelines can sub-lease the 
space to marketers or others in a transaction known as a ``capacity 
release.'' While the pipelines can only charge FERC-approved rates, 
non-pipeline sellers can charge as much as the market will bear for 
released capacity if it is sold for a term of less than one year. 
Often, marketers sell the commodity of natural gas and capacity 
together as one product as a ``bundled sale'' for delivery at the 
California border. The price of this bundled product is known as the 
California Border Price. Until the spring of 2000, the FERC had imposed 
a cap (the regulated rate) on the prices that could be charged for 
capacity that was released to others. At that time, prices at the 
California border were about 25 cents per therm. In Order 637, the FERC 
lifted the cap on an experimental basis at a time when there appeared 
to be excess capacity and before demand increased so dramatically 
during the summer of 2000. What has happened since is telling.
    The table that is attached * to this testimony depicts the imputed 
value of interstate transportation services since the beginning of last 
year based upon an analysis of California border prices and commodity 
prices at the wellhead. The line at the bottom of the table represents 
the weighted average FERC-approved cost of service rate, including fuel 
use, for transportation to California. This table depicts three dates: 
(1) the effective date of FERC Order 637, which lifted the cap last 
year; (2) the date that SDG&E filed an emergency request with FERC, 
seeking relief similar to that embodied in S. 764; and (3) the date of 
a recent FERC Order Requesting Comments on whether FERC should re-
impose the maximum rate on short-term capacity releases into California 
in response to SDG&E's filing.
---------------------------------------------------------------------------
    * The table has been retained in committee files.
---------------------------------------------------------------------------
    As you can see, shortly after the cap was lifted, the imputed value 
of interstate transportation began to exceed the FERC-approved cost-of-
service rate. In fact, prices have remained well above the as-billed 
rate since mid-June of last year. To understand the magnitude of the 
cost Californian's have had to pay since the cap was lifted, keep in 
mind the fact that the FERC-approved cost-of-service rate for 
transportation to the California border ranges from 31 to 67 cents, 
excluding fuel use. By contrast, since mid-June of last year, excluding 
fuel use, the imputed value of this service has exceeded $2.00 on 147 
days and even exceeded $6.00 on 110 days. But this is not all: 
excluding fuel use, the imputed value of transportation to California 
has exceeded $10.00 on 36 days; exceeded $18 on 15 days; and even 
reached a level as high as $49.00, all for a transportation service 
with a FERC-approved cost-of-service rate of less than 67 cents! In 
light of these values, there should be no doubt that the experimental 
lifting of the cap, at least for natural gas transportation service to 
California, has failed.
    As I have noted, this chart contains three dates. What is important 
to note is what happened to prices shortly after each of these dates.
    Shortly after FERC lifted the cap on short-term capacity release 
transactions, the imputed value of interstate transportation increased 
above the FERC-approved as-billed rate, where it has remained ever 
since.
    By contrast, shortly after SDG&E made a filing at FERC seeking 
relief similar to that proposed in S. 764 including reinstatement of 
the cap, prices declined. However, after several weeks, when it 
appeared that relief would not be forthcoming, at least any time soon, 
prices began to increase again.
    Finally, on May 22, FERC issued an Order Requesting Comments on 
whether FERC should re-impose the maximum rate on short-term capacity 
releases into California. As you can see, FERC's May 22 Order was 
followed by another decline in prices. Clearly, even the prospect of 
reinstatement of cost-of-service regulation has provided some relief to 
California gas consumers, but under current market conditions, this is 
not enough. Unfortunately, it is unclear that the FERC will take any 
meaningful action to address this issue, which is why S. 764 is so 
critical. In short, there is a clear need for congressional action.

                     WHAT CAN CONGRESS DO TO HELP?

    S. 764 would require the re-imposition of the maximum rate ceiling 
on short-term capacity release transactions into California and 
reasonable reporting requirements for bundled sales at the border, 
action that FERC has hesitated to take but that would significantly 
affect the price of gas in California. A reduction in natural gas 
prices would address one significant energy cost in the western region. 
The extreme nature of wholesale electric price swings and generation 
costs may be so out of alignment that we would hesitate to claim that 
reducing natural gas prices would by itself reduce wholesale power 
prices. However natural gas costs have been a consistent component of 
the market mitigation measures that have been proposed and adopted by 
FERC and are a significant factor in the costs of electric generation 
that form a basis for the electric rate provisions of S. 764.

                               CONCLUSION

    While it continues to be Sempra Energy's desire that FERC follow 
the law and ensure ``just and reasonable'' energy rates, we have seen 
little evidence that the Commission will take actions that are 
necessary to mitigate the extreme prices that we have seen over the 
past year in the western United States. The magnitude of the energy 
crisis has reached the point at which consumers are entitled to action.
    The energy crisis in the Western United States has already wreaked 
havoc on local and state economies. Congress must direct FERC to follow 
the law and enforce rates that are just and reasonable by temporarily 
reinstating the cap on prices that can be charged for interstate 
pipeline capacity and requiring that sellers separately disclose to 
FERC the transportation and capacity components of their rates. We urge 
Congress to pass S. 764.

    The Chairman. Thank you very much.
    Mr. Henning, why don't you go right ahead.

STATEMENT OF BRUCE B. HENNING, DIRECTOR, REGULATORY AND MARKET 
 ANALYSIS, ENERGY AND ENVIRONMENTAL ANALYSIS, INC., ARLINGTON, 
                               VA

    Mr. Henning. Thank you, Mr. Chairman. My name is Bruce 
Henning, and I am director of regulatory and market analysis at 
Energy and Environmental Analysis, Incorporated. EEA is a 
privately owned consulting firm that provides analysis to 
institutional, government, and private sector clients in the 
areas of natural gas, electricity, transportation, and related 
environmental issues.
    Along with my colleagues at EEA, I have conducted a number 
of analyses in the North American gas market. EEA provided the 
analytical support for the National Petroleum Council study of 
natural gas, published in 1999; the INGAA Foundation study of 
the infrastructure requirements to meet a 20 trillion cubic 
foot market; and provides the modeling services for the Gas 
Research Institute's baseline. We also do numerous studies for 
individual private clients looking at the infrastructure 
requirements.
    I am here today to discuss the natural gas market in 
California and to relate the California market to the recent 
behavior in the entire North American market. The views that I 
express are my own and do not reflect the views and positions 
of any of EEA's clients.
    Over the past 2 decades, the structure of the natural gas 
market has changed from a market that relied almost exclusively 
upon price regulation to a market where prices are determined 
by the balance of supply and demand, subject to the oversight 
of the FERC. Over this period, consumers have benefitted in 
terms of declining real natural gas prices. From 1983 to 1999, 
the average price delivered to all consumers fell by almost 50 
percent in real terms. And even with the run-up that occurred 
in the year 2000, the average consumer price fell by more than 
34 percent compared to 1983.
    That being said, natural gas prices in the California 
market experienced unprecedented increases beginning back in 
April 2000. The increase reflected two distinct components. The 
first component reflected the price increases that were 
occurring all across the United States because of the overall 
tightness in the balance of the market between supply and 
demand. Producers were producing all that they could and there 
virtually was no excess deliverability. Production utilization 
approached 100 percent.
    But in addition to that general tightness in the supply/
demand balance, California prices also were affected by a 
significant increase in the transportation basis. The 
transportation basis is the market value of transportation 
capacity available to move gas from one location to another. As 
gas throughput increases and approaches the capacity of the 
pipe, the value of transportation services increases. In a 
capacity constrained market, the value of transportation can 
significantly exceed the maximum regulated rate. This happened 
in California, but it has also happened for shorter periods of 
time in other markets, such as in New York and in the Northeast 
last December. But in California, however, the condition did 
persist for much of the past 12 months.
    The maximum regulated rate is a measure of the cost of 
transportation on an annual or long-term basis. Since the 
market value for transportation is often below the cost of 
transportation, it must also at times be above the regulated 
transportation rate. If not, the market value of transportation 
is lower than its overall cost. When the market value of 
transportation is below cost, no one invests in the new 
infrastructure that is required.
    The California market reached the point of constraint last 
summer. Gas consumption for power generation increased 
dramatically. The low hydro availability, which we have talked 
about here today, required that gas generators run far more 
hours than they ever were expected to do before. EEA estimates 
that the California power generation gas consumption rose by 87 
percent from 1999 to the year 2000.
    Now, the growth in consumption unmasked an intrastate 
capacity constraint. In short, there was more capacity 
available to bring gas to the State border than there was to 
take the gas and move it to the ultimate customers. The power 
generation customers bid against one another for a limited 
supply of natural gas, and those generation customers are 
generally very price sensitive, but they were willing to pay 
very dearly for their natural gas supplies and bid against one 
another.
    Now, the fact that the constraint occurred inside the State 
is a subtle but important point. The reality was that there 
just was insufficient take-away capacity to distribute the 
natural gas to all of those customers, and the value reflected 
the intrastate capacity constraints as well.
    Now, in economic terms, a rent is when its value exceeds 
its production cost. And the existence of these large basis 
differentials are not proof of market manipulation. There is a 
distinction between a market rent or a scarcity rent and a 
monopoly rent. I am not prepared to make a conclusion regarding 
that. That analysis is being done by the FERC, and I believe 
that they are perfectly capable of making that analysis.
    From my perspective, the natural gas market is far more 
mature and competitive than the electricity market in virtually 
every region of the country, including in California. As such, 
I would like to throw out a couple of distinctions between 
proposals for caps for the gas market and the electricity 
market.
    First, the electricity market in California was responsible 
for pulling up the gas prices, not the other way around. High 
electricity prices pushed up the entire gas demand curve.
    Second, the prices in the California gas market are 
actually doing what they are supposed to. They are drawing more 
infrastructure into the State. In fact, if all of the proposed 
capacity expansions get built, EEA believes that that market 
will wind up returning to a period where substantial discounts 
will be prevalent.
    Finally, if price caps are imposed in the gas market, they 
run the risk of delaying that infrastructure needed to serve 
that market.
    I would be happy to answer any questions.
    [The prepared statement of Mr. Henning follows:]

Prepared Statement of Bruce B. Henning, Director, Regulatory and Market 
    Analysis, Energy and Environmental Analysis, Inc., Arlington, VA

                              INTRODUCTION

    Good morning. My name is Bruce Henning. I am Director, Regulatory 
and Market Analysis at Energy and Environmental Analysis, Inc. EEA is a 
privately owned consulting firm that provides analysis to 
institutional, governmental, and private sector clients in the area of 
natural gas, electricity, and transportation and related environmental 
issues and policy. For the past 24 years, I have been an analyst of 
natural gas and energy markets. Along with my colleagues at EEA, I have 
conducted a number of comprehensive analyses of the North American 
natural gas markets and energy infrastructure requirements. EEA 
provided the quantitative analytic support for the 1999 National 
Petroleum Council study, Natural Gas: Meeting the Challenges of the 
Nation's Growing Natural Gas Demand. EEA also authored the INGAA 
Foundation study, Pipeline and Storage Infrastructure Requirements for 
a 30 TCF Gas Market, and performs the forecast and market analysis for 
the GTI (formerly Gas Research Institute) Baseline Projection. In 
addition, we have performed a large number of natural gas market 
analyses for private sector clients from all sectors of the energy 
industry including local natural gas distribution companies, natural 
gas producers, interstate natural gas pipeline companies, energy 
marketers, regulated electric utilities and independent power 
generation companies.
    I am here today to discuss the natural gas market in California and 
to relate the California market to the recent behavior in the entire 
North American gas market. The views that I express are my own and do 
not reflect the views and positions of any of EEA's clients.

           BACKGROUND AND STRUCTURE OF THE NATURAL GAS MARKET

    Over the past two decades, the structure of the natural gas market 
has changed from a market that relied almost exclusively upon price 
regulation to a market where prices are determined by the balance of 
supply and demand subject to the regulatory oversight of the Federal 
Energy Regulatory Commission (FERC). Over that period, U.S. consumers 
benefited greatly in terms of declining real natural gas prices. From 
1983 though 1999, the average price of gas delivered to all consumers 
fell by almost 50 percent in real terms. Even with the run-up in prices 
that occurred in 2000, the average consumer price was more than 34 
percent below the average price in 1983. (see Exhibit 1).
    That being said, natural gas prices in the California market 
experienced an unprecedented increase beginning in April of 2000. The 
increase reflected two distinct components. The first component 
reflected the price increases that were occurring across the U.S. 
because of an overall tightness in the market. Gas producers were 
producing all that they could. There was virtually no excess 
deliverability and production capacity utilization approached 100 
percent. Since the gas price was already above oil product prices, 
dual-fueled customers had already switched to their alternative fuel, 
generally oil. As cold weather arrived in November and December, the 
market required customers that did not have a readily available 
alternative fuel source to reduce their gas consumption. The market was 
brought into balance via this difficult load shedding. EEA estimates 
that more than 6 billion cubic feet a day out of a potential gas load 
of 98 billion cubic feet was shed as a result of the price increases. 
In short, although it was very painful to consumers throughout the 
country, gas market prices performed as economists expect, allocating a 
commodity during periods of scarcity to those customers that value it 
most. Moreover, the high prices also fulfilled their role by sending 
the price signals to producers, resulting in a dramatic increase in gas 
drilling activity that is increasing deliverability and contributing to 
the recent moderation in wellhead prices.

                       THE CALIFORNIA GAS MARKET

    But in addition to the general tightness in the supply/demand 
balance, California prices were also affected by a significant increase 
in the transportation basis. The transportation basis is the market 
``value'' of transportation capacity available to move natural gas from 
one market to another. When excess capacity is available, the market 
``value'' for pipeline capacity is generally far below its maximum 
regulated rate. As the gas throughput increases and approaches the 
capacity of the pipe, the ``value'' of transportation increases. In a 
capacity-constrained market, the ``value'' of transportation can 
significantly exceed the maximum regulated rate. This happened in 
California, but it has happened for shorter periods of time in other 
markets, such as New York and the Northeast last December. In 
California, however, the condition has persisted for much of the last 
year.
    The maximum regulated rate is a measure of the ``cost'' of 
transportation service on an annual or long-term basis. Since the 
market ``value'' of transportation is often below the ``cost'' of 
transportation, it must also be above the regulated rate at times. If 
it is not, the market value of the pipeline capacity is less than the 
costs. When market value is less than cost, no additional expansion of 
capacity is made. New capacity is proposed only when investors see or 
anticipate that the market ``value'' of capacity exceeds its cost.
    The California gas market reached its point of constraint last 
summer. Gas consumption for power generation increased dramatically. 
Low hydroelectric availability in the Pacific Northwest and high 
electricity demand throughout the entire western part of the United 
States required that gas-fired generators in California operate far 
more hours than normally expected. EEA estimates that power generation 
using natural gas in California in 2000 was 42 percent higher than the 
1999 level. Moreover, the units that were running were often older and 
inefficient peaking units. As a result, the amount of gas being 
consumed for generation experienced even greater amounts of growth than 
the overall growth in kilowatt hours of electricity generated from 
natural gas. EEA estimates that California power generation gas 
consumption rose by 87 percent, from 375 billion cubic feet in 1999 to 
700 billion cubic feet in 2000.
    I believe this growth in consumption unmasked an intrastate 
capacity constraint. In short, there was more capacity available to 
bring gas to the state border than there was to move gas to the 
consumers in the state. The total amount of intrastate capacity 
available was insufficient to satisfy the demand. Power generation 
customers bid against each other for the scarce supply. Moreover, 
because of the extreme conditions in the electricity market with very 
high prices, generators--who are usually extremely sensitive to fuel 
prices--were willing to pay dearly for any supply available. The result 
was the extremely high basis value.
    The fact that the capacity constraint was inside the state is a 
subtle, but important point. Trade publications, which are widely used 
for price discovery in the gas industry, were reporting very high gas 
prices at the California border delivery points. Industry analysts 
initially concluded that the constraints must have existed on the 
interstate pipeline system. However, pipeline web sites that are 
required by FERC to show operationally available capacity indicated 
that some interstate capacity to the California border had no takers. 
This raised concern that market participants were withholding capacity 
and exercising market power. The reality was that there is insufficient 
``takeaway'' capacity to increase the deliveries from the pipelines to 
their capacity limit. The prices being reported at the border reflected 
the ``value'' of the scarce intrastate capacity minus the state 
regulated cost of distribution.

                 SCARCITY RENTS VS. MARKET POWER RENTS

    In economic terms, a rent is the market value of a product in 
excess of its costs. In and of themselves, rents are not a dispositive 
indicator of an exercise of market power. The existence of very large 
basis differentials to the California market is not proof of market 
manipulation. The legal and economic analysis required to differentiate 
between scarcity rents and market power rents is complex, and at this 
time I am not prepared to reach a conclusion. It is this very analysis 
that is being conducted by the FERC and, in my opinion, that is the 
appropriate venue for the inquiry. I have confidence in the ability of 
the agency to fulfill its statutory authority. As discussed earlier, in 
a market where prices can often be below costs, scarcity rents are 
necessary to attract capital for infrastructure expansion. Any attempt 
to limit the scarcity rent runs the risk of eliminating the price 
signals needed to attract the investments required to alleviate the 
infrastructure constraints.

   RESPONSE OF THE MARKET TO PRICE SIGNALS FROM THE CALIFORNIA MARKET

    The marketplace is responding to the market signals coming from the 
California market. A number of projects have been announced that will 
increase the pipeline capacity to the state and--more importantly--
inside the state. In our recent monthly review, EEA identifies almost 
3.6 billion cubic feet per day of FERC jurisdictional projects and both 
Sempra and PG&E have announced plans to expand their systems as well. 
Ironically, EEA believes that construction of all of these projects and 
a return of ``normal'' rainfall to the Pacific Northwest would result 
in the return of California to a market with ``excess gas 
transportation capacity'' and discounted rates.

                         MARKET DATA COLLECTION

    Part of the legislation being considered would require collection 
of copious amounts of data regarding gas transactions in the California 
market. FERC is already proposing to collect data similar to that 
required by the legislation. In this effort, FERC is considering a 
comprehensive collection effort based upon the agency's extensive 
expertise in examining natural gas markets. Within this process, all 
interested parties have the opportunity to comment on the proposed data 
collection proposal. With this input FERC is capable of identifying any 
market manipulation and has the authority to promulgate and enforce any 
required remedy.

                   PRICE CAPS AND RESOURCE ALLOCATION

    From my perspective, the natural gas market is far more mature and 
competitive than the electricity market in virtually every region of 
the country including California. As such, I would like to draw several 
distinctions between price cap proposals for the gas market and the 
electricity market. First, the electricity market in California was 
responsible for pulling the California gas market prices up, not the 
other way around. High electricity prices pushed the entire gas demand 
curve up, as power generators could still operate profitably despite 
high gas prices.
    Second, prices in the California natural gas market acted to 
allocate the incremental supply of natural gas in the state. If price 
caps are placed on the gas market, regulators will be forced into the 
position of deciding which customers will get the gas that they want 
and which customers won't. There is really no getting around that 
reality. Finally, if price caps are imposed in the gas market, they run 
the risk of delaying the infrastructure needed to serve the gas 
requirements of the state.

                               CONCLUSION

    I'd like to thank the committee for the opportunity to express my 
views and I would be happy to answer any question that I can.

    The Chairman. Well, thank you very much. Let me ask just a 
few questions and then defer to Senator Murkowski.
    Very broadly speaking, I picked up that there is a 
difference of opinion between Mr. Brill and Mr. Henning on 
whether or not FERC should go ahead with this reimposition of a 
maximum rate on short-term capacity releases into California. 
Mr. Brill, you believe that reimposing that will get this 
imputed value of transportation down where it should be, where 
it traditionally has been. And Mr. Henning, I understand your 
view is that unless we continue to leave that unregulated, we 
will not have the incentive for the construction of the 
additional capacity that is needed to bring gas into California 
and disburse it around the State.
    Let me ask first Mr. Brill. Is that a fair paraphrase of 
the difference of opinion that exists there or not?
    Mr. Brill. Well, I am not sure. I will not speak for Mr. 
Henning.
    But with regard to my point of view, yes, either for FERC 
or Congress to reinstate the cap and require reasonable 
reporting requirements for bundled sales at the border, you 
have to realize that when FERC lifted the cap, it did not do so 
for pipeline sellers. So, those that actually construct 
capacity are not in a position of getting these revenues that 
exceed the as-billed rate.
    Now, I have heard arguments against caps in the past 
because people are very concerned that they might discourage 
additional construction. In this case, these values are not 
going to those that do the construction. That argument 
therefore does not apply to FERC's lifting of the cap on an 
experimental basis.
    The Chairman. Who is getting these payments?
    Mr. Brill. Anyone from marketers to I have read about 
companies that happen to have long-term contracts for 
interstate capacity that have actually shut down their plants 
and sold the gas at the border. But any seller of natural gas 
within California or at the border is in a position to obtain 
that value, and that would be anyone that has a long-term 
commitment to interstate capacity for transportation to 
California or a production contract with a California producer.
    The Chairman. Mr. Henning, what is your view on this?
    Mr. Henning. There are two points I would like to make, Mr. 
Chairman. One is that very clearly the increase in market 
value, as the transportation differentials that we are talking 
about here, do wind up spurring additional pipeline 
construction. While Mr. Brill is correct that it is not a 
direct deregulation of what the pipeline company gets, the 
change in those market values affects how shippers contract for 
their services. A little over a year ago, no one was interested 
in buying capacity into the California market. More recently, 
when it was resold, people were willing to pony up for max rate 
contracts for a term of 5 years. So, the effect of the value of 
that transportation winds up affecting how the gas shippers 
wind up contracting for the regulated natural gas pipelines.
    It has brought about in EEA's estimates--we can document 
more than 3.6 billion cubic feet a day of new pipeline 
proposals that have been going into the market--FERC 
jurisdictional proposals. In addition, Mr. Brill's company and 
the other intrastate companies are involved in proposals to 
expand their own infrastructure as well. So, the market signals 
are being sent.
    The second point I would like to make is if one winds up 
imposing price caps, beyond the subject of whether or not it 
attracts the capital, it puts government in the position where 
government and regulators will have to decide which customers 
that want the gas will get it and which customers will not 
because at this point in time, it is the market prices that are 
making that determination in the natural gas market. It is a 
much more competitive and mature commodity market than the 
electricity markets. I am very hopeful that the concerns 
regarding electricity markets do not drive mistakes for the 
natural gas markets.
    The Chairman. Let me ask I guess Mr. Roberts about your 
comments about the need for regulatory certainty. Would you not 
concede that the issuance of the order that came out yesterday 
adds to regulatory certainty, at least for the next 15 months, 
in the sense that there is not nearly as much questioning going 
on about what FERC is likely to do. We now know what they have 
done, and assuming that they stick with it and assuming that it 
has some of the results that they are anticipating, do you not 
think that they have helped to stabilize the market and thereby 
bring regulatory certainty and thereby perhaps encourage some 
investment?
    Mr. Roberts. Mr. Chairman, going directly to the question, 
I think that in the short term, yes, there is some regulatory 
certainty. However, the tonic of drinking price controls, price 
caps is one that is often difficult to wean yourself of.
    In addition to that, I think that the investment horizon 
that a company like myself works under, where from a start of a 
project conceptually, it may be anywhere from 2 to as many as 5 
or 6 years before that project is actually on line. We look far 
beyond that time horizon. Also, clearly we end up with an asset 
that has a 40- or 50-year life, and so we are looking very much 
long term on that.
    So, I would agree that in the short term it does provide 
some certainty, but the certainty, as one who is looking to be 
active in an active and healthy marketplace, is one where it 
adds a lot of regulatory uncertainty because you start at one 
point and it is very easy to start down a slippery slope 
imposing other additional controls, et cetera.
    So, I guess in answer to the question, I see two issues. 
One is the fact that we have a different type of a time frame. 
The other one is a concern in general on caps and price 
controls.
    The Chairman. Dr. McMahan, let me just ask about the chart 
that you have given us with all of the powerplant development 
that is projected in the West. Is it your opinion that the 
order that went out yesterday or that FERC is going to issue 
tonight that they started talking about yesterday is going to 
interfere with the development of these? Is that what you were 
saying? Do you think that possibility exists?
    Dr. McMahan. Yes, Senator, I definitely think that that 
possibility exists. The projects that are under construction 
are going to be built. Those are the projects essentially that 
the FERC is counting on coming on line by September of 2002 
that should hopefully get the market back in balance. If you 
put yourself in the position of a developer of a project not 
currently under construction, you are going to ask yourself if 
and when you should actually break ground on that plan.
    I would expect to see a lot of these companies sort of go 
into a wait and see mode for certainly the next 6 months, 
depending on where they are in their development process, until 
they can understand whether this is going to be in fact some 
short-term control or whether the entire development 
environment has changed. I have just dealt with these things, 
again, through boom cycles, bust cycles in the industry and I 
know that this sort of thing tends to take the steam out of 
some of this development drive that has been stimulated in the 
last few years.
    The Chairman. But let me just press you on that a little 
more. The Commission, at least the way they understand what 
they have done, they have entered an order which they believe 
does allow for a price to be charged by generators which is 
sufficient to incentivize additional investment. So, I think 
they would say--I probably should have asked them--that even if 
their order were extended for an additional period, it is 
sufficiently flexible and it is taking into account what 
potential costs will be of producing power and a reasonable 
profit in the future so that there is really no reason for 
anyone to suspend action on these plants as a result of what 
they issued yesterday. I think that would be their view, and 
you think that is just wrong.
    Dr. McMahan. Well, no. Essentially what I think is that the 
people that are developing these plants, to the extent that 
they now will get better commitments, long-term commitments on 
a contract basis for those projects, if the math works for 
that, they will do that. Those people that were building plants 
with, say, half of the capacity under contract and counting on 
sort of recent history in the spot market, will think about 
that and maybe not really move these projects forward until 
they get more long-term contracts.
    So, I think ultimately, yes, the result of the order will 
be to see more of these projects find longer-term commitments 
and come on in a more staggered manner. I do not think they 
will go away.
    The Chairman. Mr. Fetter, let me just ask you, do you think 
there is anything positive in the order that came out yesterday 
in terms of providing stability and certainty to the investor 
community or to the markets in general? It seems to me that a 
lot of what the Commission was saying is that they believe 
their action will stabilize the situation, get it back into a 
range of normalcy that it has not been in in recent months. Do 
you think there is anything to that or not?
    Mr. Fetter. Mr. Chairman, when I appeared before this 
committee in March, I was willing to admit that perhaps a 
$1,000 per megawatt hour cap might serve purposes where the 
price spikes cannot be contained by any market mechanism. I 
view the FERC's action yesterday should eliminate the potential 
for such out-of-control price spikes. At the same time, it 
maintains a connection between supply and demand within 
California and the entire Western region, and to the extent 
that the prices that flow from the FERC mechanisms are not 
satisfactory to the consumers or the elected officials in 
California, the fear of investors would be that then there 
would be growing support to lock into a price cap at a lower 
level that would impact on future investments.
    In fact, the comments of Senator Schumer--just the thought 
that once you start down that slippery slope of setting price 
caps in a region, then anywhere in the country where a problem 
crops up, it just becomes so easy to say let us just import 
that idea to New York or New England or to the Midwest. And 
that is what investors fear.
    The Chairman. Senator Murkowski.
    Senator Murkowski. I will try to be brief. I think we have 
come to the conclusion, based on the statements from Senator 
Feinstein and Senator Smith, that price caps, wholesale caps, 
as we were considering them, are probably, for all practical 
purposes, a thing of the past as a consequence of FERC's 
action.
    But FERC's action is for 15 months. Now, Mr. Fetter, you 
are in the business of an investment analyst to some extent, 
among your other areas of expertise. Are you satisfied with 15 
months? That 15 months is a small piece of time in relationship 
to an investment in a new powerplant costing several millions 
of dollars. And you are looking at an unknown factor after 
that. Does FERC come in? Do we have a free market? Do we have 
an increase in supply so we have a free market working?
    In reference to Dr. McMahan's chart here, where he paints a 
very interesting picture of what is reality and what may be 
myth, these plants that are under construction are one thing, 
but those that are planned and those that are announced suggest 
that firm commitments for financing are probably yet to be 
arranged.
    So, what I would like you to address is your evaluation of 
what this 15-month FERC order means in relationship to the plan 
and the announced capacity. If you could provide for the 
record, either one of you, a determination of what you see--I 
think Dr. McMahan, you indicated about an 8,000 megawatt 
deficit still with those under construction. What we are trying 
to get, I guess, as a bottom line is some degree of certainty 
in the sense of your collective opinions on whether there is 
still an unknown quantity associated with September of next 
year relative to financing commitments that are going to have 
to be made now to address planned and announced new facilities. 
I would refer primarily to Steven Fetter and then Dr. McMahan.
    Mr. Fetter. My view, Senator, is that once the order is 
issued and if it appears to be what was discussed today, if 
support coalesces and it appears that that is going to be the 
last word on these issues, I do not think it would affect 
investment either in California or elsewhere. To the extent 
that yesterday's FERC's action just becomes a first step and 
there are going to be other actions, either at the FERC or 
within this body, then I think there is a large likelihood that 
investment would be affected.
    Senator Murkowski. Dr. McMahan.
    Dr. McMahan. It is my opinion that the mechanisms that the 
FERC has implemented are very interesting. I think the one 
thing that they will do by the chart that the Commissioner drew 
this morning--basically it says that I am going to get some 
minimum price in the spot market. In other words, I do not have 
to wait until the market gets bid up and hope that I am above 
the curve, that all spot prices will come in at what is 
intended to be a reasonable rate. Again, I think once all of 
the developers punch this up in their computers and look at 
their models, we will see how much that impacts development. 
But I do commend the FERC for making such a good attempt at 
keeping some market stimulus in their order.
    Senator Murkowski. My last question is the cost-of-service 
issue, which I think you brought up. I think we had one of the 
FERC Commissioners also comment on it. I was surprised that it 
was brought up. It seemed it just kind of came up in his 
presentation individually as opposed to being connected to any 
of the other matters. Cost-of-service is fairly uniform in 
utility concepts, but in a situation like this, somebody has to 
set the rate of return. What is your comment relative to the 
application of cost-of-service as a standard guideline to try 
and address new developing power generating facilities?
    Dr. McMahan. Are you talking to me, Senator?
    Senator Murkowski. Yes.
    Dr. McMahan. Just as so many people characterized 
yesterday's order as a giant step forward, I think a cost-of-
service regulation would clearly be a giant step backward. 
Obviously, the genie is out of the bottle on deregulation. It 
is moving ahead in several States, and in spite of what is 
going on now and perhaps because of what is going on now, it 
will move forward. I think that it would be almost impossible 
to administer and talk about the slippery slope. I just think 
it would be a big mistake.
    Senator Murkowski. I guess we generally agree that FERC 
action added stability to the market yesterday. I am curious to 
know in your opinion whether California's action--there is a 
grand jury investigation, legislative investigations, PUC 
investigations, existing proposals that the companies that 
allegedly overcharged refund the overcharge and some question 
that the Governor is going to file suit for repayment. We heard 
from Senator Boxer.
    What does that do to the climate that we are looking at 
here, on the one hand, a positive application of FERC's work 
and, on the other, the political ramifications associated with 
the finger pointing in California? Mr. Roberts?
    Mr. Roberts. As a potential investor, clearly the overall 
environment is positive I think from the steps that FERC is 
taking, but certainly very negative from the additional 
rhetoric that is in the environment surrounding any potential 
investor. Again, that would enter into any investment decision.
    Senator Murkowski. Does anybody else want to comment on 
that very briefly? The chairman has been as patient as I have 
had to be over the years. So, I will defer any further 
questions other than to thank the panel and to thank the 
chairman for arranging this very timely hearing.
    The Chairman. Well, thank you, Senator Murkowski, Mr. 
Chairman, at least chairman for a substantial portion of this 
session of Congress.
    Let me thank all the witnesses for being here and your 
excellent testimony. We appreciate it. We will include it all 
in the record.
    The hearing will be adjourned.
    [Whereupon, at 12:15 p.m., the hearing was adjourned.]

                               APPENDIXES

                              ----------                              

                               Appendix I

                   Responses to Additional Questions

                              ----------                              

              Federal Energy Regulatory Commission,
                                    Office of the Chairman,
                                     Washington, DC, July 23, 2001.
Hon. Jeff Bingaman,
Chairman, Committee on Energy and Natural Resources, U.S. Senate, 
        Washington, DC.
    Dear Chairman Bingaman: Thank you for your letter of June 25 
enclosing questions from Senator Ben Nighthorse Campbell for the record 
of your Committee's June 19 hearing on the Federal Energy Regulatory 
Commission's price mitigation plan for California and the Western 
region of the United States.
    I have enclosed my responses to Senator Campbell's questions. If 
you need additional information, please do not hesitate to let me know.
            Sincerely,
                                       Curt L. Hebert, Jr.,
                                                          Chairman.
[Enclosures]
               Answers to Questions From Senator Campbell
    Question 1. It appears that you have taken the unprecedented step 
to put FERC jurisdiction over the municipal utilities and co-ops. Is 
this true?
    Answer. The Commission is not expanding its jurisdiction over non-
public utilities, such as municipal utilities and co-ops. In the market 
monitoring and mitigation plan established in the Commission's June 19, 
2001 order, the Commission is exercising its authority to impose 
conditions with respect to matters within its jurisdiction. Thus, to 
the extent a non-public utility voluntarily sells power in the 
California Independent System Operator (ISO) or other spot markets 
which are subject to the Commission's jurisdiction or voluntarily uses 
the ISO's or Commission-jurisdictional interstate transmission 
facilities elsewhere in the Western Systems Coordinating Council 
(WSCC), it must comply with the must-offer requirement and the price 
mitigation plan.
    Question 2. It is unclear what the legal basis is for this action. 
Can you please explain?
    Answer. The basis for this requirement is the Commission's mandate 
under Section 206 of the Federal Power Act to ensure that rates, terms 
and conditions for jurisdictional service are just and reasonable. The 
Commission determined that it cannot meet its statutory 
responsibilities in California and the WSCC if it allows non-public 
utilities to participate in relevant spot markets and use the 
interstate transmission grid unless they observe the same conditions as 
public utilities.
    The Commission has previously exercised authority to review non 
jurisdictional activities or to take actions that may impact non-public 
utilities. For example, in City of Vernon, California, 93 FERC para. 
61,103 (2000), rehearing denied, 94 FERC para. 161,148 (2001), the 
Commission explained that it has the authority to evaluate non 
jurisdictional activities to the extent they affect the Commission's 
jurisdictional activities. In City of Vernon, the Commission reviewed 
the transmission revenue requirement of a municipal utility that 
voluntarily participated in a public utility ISO subject to the 
Commission's jurisdiction to determine whether the municipal's rate 
methodology would result in a just and reasonable component of the 
ISO's rates. In another case, the Commission concluded that any 
resellers of Firm Transmission Rights, whether public or non-public 
utilities, must require that all resales are subject to the terms and 
conditions approved by the Commission. California Independent System 
Operator Corp., 89 FERC para. 61,153 (1999), rehearing denied, 94 FERC 
para. 161,343 (2001).
    Question 3. Do you think that the rates under this new order are 
just and reasonable?
    Answer. I am confident that the price mitigation established in the 
Commission's June 19 order will yield just and reasonable rates in 
California and throughout the WSCC. The Commission has expanded the 
market monitoring and mitigation plan to produce spot market prices in 
all hours that are just and reasonable and emulate those that would be 
produced in a competitive market. These rates must fall within a zone 
of reasonableness, and to achieve this mandate, the mitigation plan 
brings market-oriented price relief to the California and Western 
electricity markets, provides greater price certainty to buyers and 
sellers of electric energy, promotes conservation, and simultaneously 
encourages investment in efficient generation and transmission. The 
mitigation plan adopted in the June 19 order is designed to provide a 
structure that will minimize potential market power abuses, thus 
lowering customer rates, and encouraging adequate supply. I have every 
reason to believe it will succeed.
                              Appendix II

              Additional Material Submitted for the Record

                              ----------                              

                                  Bear, Stearns & Co. Inc.,
                                       New York, NY, June 14, 2001.
Senator Frank Murkowski,
Ranking Member, Committee on Energy and Natural Resources, U.S. Senate, 
        Washington, DC.
    Dear Senator Murkowski: Price controls are a recipe for disaster. 
Regulators in California have already proven this point. Their 
imposition of price controls at the retail level, along with 
regulations prohibiting energy suppliers from entering into long-term 
contracts, have created shortages in the form of blackouts and 
brownouts and forced one major supplier--Pacific Gas and Power--into 
bankruptcy. Now many involved in the creation of the current chaotic 
situation would like to see the federal government impose price 
controls at the wholesale level. This would be a mistake of gigantic 
proportions.
    When caps are imposed and prices pushed below the market level, 
three things happen: (1) buyers seek to purchase more overriding public 
conservation efforts, (2) sellers supply less by diverting scarce 
supplies to more rewarding markets, and (3) new energy transportation 
and production facilities would continue to decline as the 
uncertainties created by the regulations drive investors elsewhere. 
Even when controls are imposed, this scenario is played over and over 
again, with some appearing not to notice. Somehow, they believe that 
the next episode of price controls will be different.
    The ramifications of price controls imposed by President Nixon 
provide valuable lessons. Even though the general controls were imposed 
for a relatively short time, they retarded investment, reduced the 
mobility of labor and created other dislocations that hampered the U.S. 
economy throughout most of the 1970s.
    When the general controls were removed in 1973, the price caps in 
the energy sector were retained. Were it not for their tragic impact on 
the lives of people, the results would be comical. Regulators and 
suppliers ended up in court, debating on whether crude oil originated 
from new wells or old wells because the caps permitted the former to be 
sold at a higher price. Even as the shortages multiplied, wells 
containing sizable amounts of oil were removed from the market because 
the price caps made it too costly to use modern technology to remove 
the remaining crude. The controls also led to long gas lines; service 
stations with limited supplies were open only a couple hours each day. 
These outcomes were not imposed upon us by either OPEC or greedy oil 
companies. They were the result of the energy price caps. Thus, they 
did not occur in Western Europe and other parts of the world where 
price caps were absent.
    Price caps invariably make it appear that the situation is far more 
severe than is actually the case. The energy price caps illustrate this 
point. When President Reagan removed the energy price controls in early 
1981, the pundits told us that gas prices, which were approximately 
$1.25 per gallon at the time, were sure to soar to $2 or more. Against 
the chaotic situation of the 1970s, their predictions had a credible 
ring. However, as market forces replaced political allocation, the 
reality was much different. During the first two weeks following the 
removal of the controls, prices rose by about a dime a gallon, but they 
soon leveled off and began to fall. Six months after the controls were 
removed, gasoline prices were well below the prior controlled level. 
Propelled by market forces, they continued to decline for almost two 
decades.
    With regard to California's energy market, the conservationists are 
absolutely right. If blackouts and brownouts are to be avoided in the 
near term, conservation must be practiced and consumption reduced. 
Without the appropriate price signals, however, conservation will be 
weak and ineffective. Millions of people must be encouraged by high 
prices to switch to lower wattage light bulbs, use fans more and air-
conditioning less, purchase more energy-efficient appliances and so on. 
The California decision to shield consumers by picking up the energy 
tab ensured that conservation was not going to happen. Price incentives 
are absolutely essential for the practice of wise conservation.
    While supply responses provide the long-term solution, price 
controls create uncertainty and undermine the incentive to invest, 
which is essential for the expansion of future supply. It is easy for 
politicians to promise that the controls will be imposed only 
temporarily and that reasonable profits would spur investment. Not so. 
Investors know that when regulators interfere with market signals 
today, there's no assurance that they will not do so tomorrow. Rather 
than placing themselves hostage to an uncertain regulatory climate, 
many potential investors will place their energies elsewhere driving up 
the cost of transportation and production energy capital in California.
    The confidence of the investment community has already been 
severely damaged by California's regulatory policies. It will take time 
to repair the damage and regain credibility with investors. The worst 
thing regulators could do at this time would be to impose still more 
controls.
    However well intended, political manipulation is no substitute for 
market forces. The Nixon price controls and the gas lines they created 
provide ample evidence on this point. The sooner regulators make it 
clear that they are not going to intervene, the sooner market 
incentives will restore order to the California energy market and the 
current crisis, like the gas lines of the 1970s, will be behind us.
            Sincerely,
                                   Wayne D. Angell,
                                           Senior Managing Director
                                           and Chief Economist.
                                 ______
                                 
              Statement of Marcia Baker, EIR News Service

    Dear Chairman Bingaman and Senators:
    On the occasion of your hearing today, we wish to reiterate our 
support for passage of Bills intended to restore ``just and reasonable 
pricing''--the traditional, standing mandate of our energy law, and in 
line with the General Welfare concept of the Constitution itself. We 
are glad at the renewed prospects for action by Congress.
    The EIR News Service, in two previous testimonies submitted this 
year to the Senate Energy Committee, urged Congressional action to stop 
runaway electricity prices, along the lines of the Feinstein/Boxer 
Bills (S. 26, S. 80, and S. 287); and their House counterparts proposed 
by Rep. Jay Inslee, Rep. Peter DeFazio, and others, for cost-based 
pricing. We urged ``going the whole way'' to cover electricity prices 
nationwide, and also to take the same kind of action to put a stop to 
the energy hyperinflation and hyper-profiteering in all modes (natural 
gas, propane, gasoline, heating oil, coal spot-markets, etc.).

         LAROUCHE FOREWARNINGS ON DEREGULATION, HYPERINFLATION

    Since the 1970s, the EIR News Service, and its founding editor 
Lyndon LaRouche, in particular, have campaigned against implementing 
deregulation in the first place--in health care (HMOs, ``managed 
care,'' and hospital closures), agriculture (ending parity-pricing), 
transportation, banking, etc.
    A year ago, LaRouche warned of today's situation. On March 8, 2000 
at the time of truckers' protest convoys in Washington, D.C., he said:
    ``There is a global hyperinflationary spiral in the process of 
taking off. And whatever else is also true about it, the essential 
bottom line is, that there is a global hyperinflation in real asset 
prices, prices you realize, now ongoing globally. And the petroleum 
price is chiefly a reflection of that, apart from whatever temporary 
incidental features there are. This is simply, predominantly--it is not 
some `market-this, market that'--it's a hyperinflationary process, 
which has taken off, where it does take off. Hyperinflation tends to 
hit--when it hits in a real form, as opposed to inflation--tends to hit 
in primary values, such as food, and primary materials, and that's 
what's happening.''
    Since that warning, LaRouche has personally led a mass public 
education drive for reregulation of energy, including the use of all 
means available--Chapter 11 bankruptcy reorganization, where called 
for, and other measures, to keep economic activity going, and create 
the conditions in which to restore the economy.
    In this testimony, we wish to bring to your attention three 
interrelated points, which we document below. They are:
    1) The backdrop to the U.S. energy hyperinflation and blackouts 
crisis is that the entire financial and economic system worldwide, is 
in crisis.
    2) Bringing energy prices under control is best considered as the 
first step to returning national policy in all respects, to a 
regulation-based way of serving the public good. In particular, new 
energy projects are needed. They must be undertaken in the traditional, 
successful way that the FDR-era projects--TVA, Colorado and Columbia 
River Dams, and Rural Electrification programs, etc.--were advanced. 
They were launched by government, and carried out by private 
enterprise. A most appropriate point of reference for the principle 
involved is the February 1996 report known as the ``Bingaman-Daschle 
Report,'' titled ``Scrambling To Pay the Bills: Building Allies for 
America's Working Families.''
    3) If the Senate acts in the national interest on energy, this will 
occur in concert with certain nation-serving initiatives now taking 
place in key parts of the world. Combined, these kinds of initiatives 
can have far-reaching strategic effects of economic and diplomatic 
benefit, to reverse the current plunge toward economic chaos and war.

                  `HOUSTON CARTEL' NOW WELL-DOCUMENTED

    On the matter of hyper-profits of the energy cartel companies--
Enron EOG, Mobil-Exxon, Reliant, AES, Dynegy, El Paso, and the many 
others--and their interconnections with the Administration and certain 
Congressional offices, we do not provide further information in this 
document. We think that the volume of information now coming into 
public view, to the attention of the relevant investigative committees, 
and the soon-to-be-formed California criminal grand jury, is sufficient 
to document that the current looting system, now referred to as the 
``Houston Cartel,'' should be stopped. Our News Service has provided 
detailed dossiers on the scope and scandal of these operations over the 
past months. We have coined the term ``Southern Strategy, Inc.,'' to 
describe these political-business interconnections involved, which are 
now deservedly vulnerable to being thrust from power.

                   CONTEXT: FINANCIAL SYSTEM BLOWOUT

    The backdrop to the energy hyperinflation and hyper-profiteering 
crisis now racking the U.S., and other economies, is that the financial 
system itself is in breakdown. We are seeing the end phase of a period 
of ``casino economy'' bubbles--stock market valuations, debt pyramids 
of all kinds, futures, and derivatives speculation. Look at the 
spectacular blowout of info-tech stocks, the foreign debt crises of 
major nations, from Argentina to Turkey, and the sweeping collapse of 
whole sectors of the economy, for example, the telecommunications 
sector. The U.S. manufacturing sectors since last July has lost more 
than 600,000 jobs.
    The actions of Federal Reserve chairman Alan Greenspan, to lower 
interest rates and pump liquidity into the system, only create the 
conditions for worse breakdown ahead.
    LaRouche is spearheading a collaborative effort to take nation-
serving measures--such as energy re-regulation--to implement today a 
form of ``New Bretton Woods'' approach, like the steps taken in the 
aftermath of World War II, to deliberate about and set up a new 
financial system. On May 24, speaking in Warsaw, Poland, LaRouche 
described the situation:
    ``The world is gripped at the present, by the worst, biggest 
financial crisis in all history, in all human existence. . . .
    ``Let me give you a picture of how bad the situation is on the 
financial side. According to best estimates, official estimates, the 
Gross Domestic Product of all nations of the world combined is 
estimated at $42 trillion equivalent. Of this, the United States 
represents an estimated $11 trillion a year. In the past approximate 12 
months, the United States' financial values have lost nearly $11 
trillion. On the books, what is admitted publicly, is about $6 trillion 
have been wiped out of financial assets of the United States during 
this period. Actually, there is another $4 trillion or so, in hidden 
losses, which will come to the surface soon. The United States has been 
operating at a loss, as an economy, for a number of years. At my last 
actual count, late last year, the rate of the current account deficit 
of the United States was about $600 billion a year. That is, the United 
States was spending $600 billion more than it was earning on the world 
market.
    ``In addition, the United States was being supported, not only by 
what it was not paying for, but the United States was receiving 
trillions of dollars of influx of foreign exchange into the United 
States for investment in the U.S. financial markets. So that, at 
present, any collapse of this inflow of money, from Japan, from Europe, 
and so forth, into the United States, means an absolute catastrophe for 
the U.S. financial markets. . . .
    ``[So far, there is resort to liquidity-pumping in the U.S., Japan 
and elsewhere]. . . . As a result of this, there is an outbreak of 
significant hyperinflation in various parts of the world market. For 
example, inside the United States, there is a hyperinflationary rate of 
increase of prices of energy. . . .''
    LaRouche described the scope of policy response required, in a 
radio interview in Mexico May 28, broadcast in Leon, Guanajuato:
    ``What you can do, is, you can put the whole world through 
bankruptcy reorganization. That's the only solution, which means 
cancelling most of the debt, especially the financial derivatives and 
similar debt. Most of the foreign debt of the Ibero-American nations 
will have to be cancelled. And then, what this `New' Bretton Woods 
means, is, going back to 1945, to the legacy of Franklin Roosevelt, to 
create the kind of system we had between 1945 and 1958, and continuing 
into the middle of the 1960s.
    ``In other words, that means fixed exchange rates, that means 
capital controls, it means exchange controls, it means financial 
controls within and among governments. It means a protectionist policy 
on trade and tariffs. The best example is the Monnet Plan, the 
relationship between the United States and Europe during the immediate, 
first 15 years after World War II. There are a few differences today, 
but in principle, that plan, that method will work. The difference is 
that we have to apply it on a global scale, not just a transatlantic 
scale. The issue is, finding the political will to do that.''
    after price controls, start up national-interest infrastructure
    Along with ending out-of-control energy prices, restoring sound 
energy policy requires attention to actual infrastructure deficits in 
high-tech generation, up-to-date transmission systems, and related 
questions. Graph 1 (at the end of the document) shows the decline in 
U.S. generating capacity per capita. Taking appropriate action on 
energy infrastructure, will also be part of a driver for rebuilding 
economic activity, now in a spiral of shutdown.
    The approach to be stopped at all costs, is that embodied in the 
Cheney/Bush National Energy Plan, and also in Energy Secretary Spencer 
Abraham's proposal of a private electricity transmission project for 
California. These plans axiomatically demand giving sovereign 
government power over to the ``Houston Cartel'' to decide whether, 
what, and where any aspect of energy provision would be built, and how 
it would function. Thus the cartel demands the right to locate, own, 
and operate, pipelines, wells, electric transmission lines, power 
plants, etc. on their terms, which means disaster. The fact that the 
cartel wraps itself in the mantle of promises of use of high-tech 
methods (nuclear innovations, superconduction, etc.), and providing 
jobs, is merely a crass case of the Big Bad Wolf, clad as Little Red 
Riding Hood's grandmother, explaining its big teeth by smiling.
    Appended to this text, are four illustrations, to focus on the 
point of difference between public interest decisions on infrastructure 
and the cartel-demands.
    Figure 1 shows proposed corridors of new, advanced rail routes 
worldwide, interconnecting the Americas with proposed Eurasian routes, 
and overall defining certain ``corridors'' of potentially new economic 
development zones--either alongside, or as intersection nodes. The 
principle involved, is the same as that applied in the 19th century to 
the building of the U.S. transcontinental railroads: opening up whole 
new areas for towns, agriculture, industry, mining. etc. In turn, power 
provision--nuclear, advanced-coal, even hydro-generation--could be 
sited in an integrated way, benefiting the overall development 
``process'' for generations to come.
    Figure 2 shows in schematic form, how the siting of oil and gas 
lines, power plants, and also electricity transmission systems (by 
implication) are most rationally located in connection with towns, 
agriculture, industry, and transportation.
    Figures 3 shows a map, presented in September 2000 to the House 
Energy Subcommittee by Robert Evans, president of Duke Energy Gas 
Transmission Corp., on behalf of the Interstate Natural Gas Association 
of America. The association is demanding that they have rights to gas 
deposits shown. No pretense is made to explain how or why this might 
contribute to any overall resources and infrastructure development of 
the nation or continent.
    Figure 4, for reference, shows the existing natural gas 
transportation corridors in the United State. Clearly there is a lack 
of adequate capacity to serve California; in a regulated energy 
business environment, correcting this would be made a priority. But in 
the recent era of deregulation, Houston-based El Paso Natural Gas has 
acted to keep transmission infrastructure limited, and is the target of 
multiple investigations for bilking California and racking up mega-
profits. El Paso, recently merged with Coastal, accounts for well over 
25% of all natural gas moved in the United States.

             BINGAMAN-DASCHLE 1996 REPORT: `PUBLIC BENEFIT'

    A good taking-off point for understanding the concept of 
infrastructure development in the public interest, is a Feb. 28, 1996 
report issued jointly by Senators Bingaman and Daschle, ``Scrambling To 
Pay the Bills: Building Allies for America's Working Families.'' The 
study proposed to recreate a framework in law, which would once again 
give substance to the ``General Welfare'' provisions of the 
Constitution. Corporations should act in the public interest; their 
private profits could and should be made accordingly. This 
Constitutional view was a counter to the Conservative Revolution, and 
to what Sen. Ted Kennedy called at the time, the threat from the 
``most-favored corporations.''
    In the five years since then, the networks Kennedy called ``most-
favored,'' have bulled through unprecedented asset grabs in energy (and 
other vital supply lines--food, minerals, etc.), and are now conducting 
speculation, extortionist profit-rates, and destruction on an 
unprecedented scale. It is time to gain control over these processes, 
before we find ourselves returning to the worst of the bad old days of 
the 19th-century robber barons.

                         INTERNATIONAL MOMENTUM

    At the same time as the Senate is taking up emergency action on the 
domestic electricity crisis, there are several key international 
diplomatic initiatives, involving rejection of the destructive ``free-
market'' practices, in favor of what will benefit national economic 
interests. Energy, transport, and other infrastructure are at the core 
of these new policy commitments.

   On May 15, Moscow announced a new Eurasian Transport Union, 
        to provide the institutional basis for nations and companies to 
        collaborate on priority transportation and related 
        infrastructure projects. A map of the series of ``Main 
        Directions'' has been drawn up (available on www.mintrans.ru; 
        and in EIR magazine's June 1 issue).
    On June 15, an historic six-nation summit occurred in 
        Shanghai, launching the ``Shanghai Cooperation Organization.'' 
        The formal founding meeting was attended by the heads of state 
        of China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan, and 
        Uzbekistan. The new ``Shanghai Pact'' agreed to, is committed 
        to ``safeguarding regional security,'' with mutually beneficial 
        economic projects as the foundation. Russian President Vladimir 
        Putin called stronger economic ties the key aim: ``Cooperation 
        in economics, trade and culture is far more important than 
        military cooperation.'' Rebuilding the ``Silk Road'' (modern 
        rail routes) and expanding water supplies, were the particular 
        goals cited by Kazakh President Nursultan Nazarbayev.

    Other expressions of return to national-interest economics, are the 
instances of resistance to demands by the energy cartel for 
privatization and takeover. For example, in April in Central Asia, 
AES--the Virginia-based energy mega-firm, now operating in 20 nations--
was rejected in Armenia. AES had moved to acquire four electric 
distribution systems there, and all the power plants, but was stopped. 
There were protest rallies in Yerevan, and one-third of the Parliament 
came out strongly against the AES privatization as a threat to national 
security. There are many other instances of similar resistance.
    Thus, the scope of action taken now in the U.S. Senate, will be 
crucial to the immediate economic condition for millions in the United 
States, and a leadership factor internationally. This is a matter of 
strategic concern. As we endeavor to maintain and strengthen alliances 
of long standing, and at the same time reach out to nations with which 
we have not previously had friendships, the United States of America, 
Americans, and American corporations can ill afford to appear like the 
heartless, ruthless robber barons whose brutalities became legend.

[Illustrations cited are available in hard copy, from EIR News Service]
                                 ______
                                 
         Statement by William C. Dudley, Chief U.S. Economist, 
                          Goldman, Sachs & Co.
    My name is William Dudley. I am the chief U.S. economist for 
Goldman, Sachs & Co. It is my pleasure to submit this statement to the 
U.S. Senate Committee on Energy and Natural Resources as part of the 
hearings on S. 597 and S. 764. The views expressed in my statement are 
my own and do not necessarily reflect the positions or views of Goldman 
Sachs.
    The constituency that favors high electricity prices is a small 
one. Only the firms that earn extraordinary profits and their 
shareholders benefit much. As a result, the pressure grows to come up 
with a solution. In the case of the California energy crisis, the call 
is to impose price caps on wholesale electricity rates. The idea is 
that this would prevent the type of large price spikes that have 
transferred considerably resources to a few power-generating companies.
    What's wrong with that? After all, if the caps are set high enough, 
the firms involved will still make healthy returns on their investment 
and the cost of electricity to the State of California and, ultimately, 
its citizens and its businesses will be reduced.
    The answer is that the imposition of price caps would have 
significant negative consequences. First, the imposition of price caps 
would deter the type of investment in electric power generation and 
transmission capacity that the State of California seeks to encourage. 
That is because price caps would reduce the prospective rate of return 
and raise the risks associated with new investment. The expected return 
would fall because one tail of the probability distribution of possible 
outcomes with respect to electricity rates--the tail associated with 
high price spikes--would be eliminated by the imposition of the caps. 
But the other tail of the distribution--the one of very low prices--
would remain. After all, no one is proposing that, if wholesale 
electricity rates were to plummet, a corresponding transfer would be 
made back to the power generating companies. The proposals are for rate 
caps. They do not also include floors. That reduces the prospective 
rate of return.
    The risk would rise because the imposition of price caps is by its 
nature arbitrary as to level, timing, and duration. If the caps were 
imposed, this would increase investor anxiety that the caps could, in 
the future, be lowered, broadened, or extended in terms of duration. 
This would increase the level of uncertainty concerning the likely 
future rate of return on the firms' investment. This risk would be 
reflected in the cost of capital the firms would incur and in their 
equity prices.
    Lower expected returns, higher risk. This is not the desired 
outcome if the goal is to encourage greater investment. In fact, the 
imposition of caps would deter the type of investment that would, over 
time, act to ameliorate the California energy crisis. Put simply, price 
caps would work at cross-purposes to the goal of increased electric 
power generation and transmission capacity that is part of the solution 
to the California energy crisis.
    Second, the caps would deflect attention away from the underlying 
problems that have caused wholesale electricity prices to spike: The 
lack of adequate power generation and transmission capacity and a 
system of price signals that encourage demand management. The spikes in 
wholesale electric power prices are a symptom of the underlying 
problem--a deeply flawed regulatory regime in which wholesale prices 
have been decontrolled, but customers do not see a corresponding 
increase in retail prices. The price caps would do nothing to fix this 
underlying problem. Moreover, they could do harm by reducing the sense 
of urgency needed politically to generate a viable, long-term solution.
    Finally, even if one were convinced that price caps were not a 
terrible idea in general, one would still be faced with the difficulty 
concerning the specifics. When a market system is overridden, then the 
devil lies in the details. How high is too high? How long is too long? 
How would the price caps be administered? How would they be phased in? 
And out?
    History has shown quite clearly that price caps distort the 
allocation of resources by wiping out the price signals determined in 
the marketplace. Command economies such as the late Soviet Union simply 
do not work. History has shown that price caps are difficult to 
administer and tough to remove. Once implemented, price caps create 
their own entrenched political constituency.
    In my view, the solution to the California energy crisis lies not 
in price caps, but in encouraging the installation of additional 
electric power generation and transmission capacity. Imposition of 
price caps works against this.
    In my view, the solution to the California energy crisis lies in 
California businesses and consumers seeing the true economic cost of 
incremental power generating capacity. In particular, a broad system of 
peak load pricing should be implemented. This would allow businesses 
and consumers to see the true costs of incremental power capacity. It 
would also encourage demand shifting that would reduce the size of the 
wholesale power rate spikes and the need for incremental power 
generation and transmission capacity. Moreover, because the demand 
shifting would be concentrated among those firms and individuals that 
had the lowest costs to shift demand away from the power peaks, the 
costs of shifting would be minimized. The goal should be to improve the 
quality of the pricing signals sent to consumers and businesses, not to 
subvert those signals.
                                 ______
                                 
                                                     June 18, 2001.
Hon. Frank Murkowski,
U.S. Senator, Hart Senate Building, Washington, DC.
    Dear Senator Murkowski: Over the past year, we have watched with 
concern as California's failure to provide adequate electricity to meet 
its needs has threatened to harm the energy supply throughout the West. 
In response to this concern, we have advocated policies which would 
increase the supply of energy in both California and the West--the only 
effective solution to the problem in our nation's largest state.
    Accordingly, we are writing to reiterate our strongly held view 
that price controls on electricity in the West will not encourage 
conservation or the construction of the additional generation necessary 
to meet the long-term energy needs of our region. The uncertainty 
caused by such government intervention could very well discourage the 
development of the new generation we need.
    This problem did not occur overnight, in fact California's first 
stage two alert was in May 2000. Thus, it is not reasonable to expect a 
solution to appear overnight, it will take time for California to work 
out of this difficult situation. We support the work they have 
undertaken to overcome the many years during which no new generation 
was constructed in their state.
    We understand the Federal Energy Regulatory Commission (FERC) has 
acted unanimously to further address this issue through the existing 
process. This further underscores the effectiveness of the existing 
regulatory process and eliminates the need for Congressional 
legislation in this area. There is considerable evidence that the 
combination of state efforts and the extensive assistance from the Bush 
Administration is producing a positive turn in the California energy 
market. The reports of an energy savings of 11 percent in California 
indicate that they have the ability to achieve significant demand 
reduction. At the same time, numerous other initiatives by the state 
and federal governments have resulted in recent reduction in 
electricity prices in California.
    Further, in rare instances where there have been attempts to take 
advantage of the people of California, since January the Department of 
Energy and the FERC have effectively instigated investigations of 
wrongdoing and obtained refunds where they are due.
    Along with other Western Governors, we have previously expressed 
our willingness to support and participate in measures that would 
provide short-term relief for California as they move toward the 
electric generation necessary to meet their needs. However, we have 
also consistently stated our opposition to policies that would help 
California at the expense of its Western neighbors. The Clinton 
Administration order issued late last year essentially required other 
Western states to subsidize California's energy costs by requiring the 
sale of electricity from throughout the region into California.
    We fear that were region-wide price controls adopted by Congress, 
it would provide no benefit to the West but potentially impair demand 
seduction, the operation of existing generation and the construction of 
generation that is imperative to the energy future of California and 
the West.
    Thank you for your consideration of our position on this issue, 
which is of critical importance to the well-being and economic 
opportunity for the people in each of our states.
            Sincerely,
                                   Jane Dee Hull,
                                           Governor of Arizona.
                                   Michael O. Leavitt,
                                           Governor of Utah.
                                   John Hoeven,
                                           Governer of North Dakota.
                                   Jim Geringer,
                                           Governor of Wyoming.

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