S. Hrg. 107–156

RESTRUCTURING OF ENERGY INDUSTRIES

HEARINGS

BEFORE THE

COMMITTEE ON

GOVERNMENTAL AFFAIRS

UNITED STATES SENATE

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

JUNE 13, 2001

ECONOMIC ISSUES ASSOCIATED WITH THE RESTRUCTURING OF

ENERGY INDUSTRIES

JUNE 20, 2001

THE ROLE OF THE FEDERAL ENERGY REGULATORY COMMISSION

ASSOCIATED WITH THE RESTRUCTURING OF ENERGY INDUSTRIES

JUNE 28, 2001

THE IMPACT OF ELECTRIC INDUSTRY RESTRUCTURING ON SYSTEM

RELIABILITY

Printed for the use of the Committee on Governmental Affairs

(

RESTRUCTURING OF ENERGY INDUSTRIES

U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

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75–477 PDF 2002

S. Hrg. 107–156

RESTRUCTURING OF ENERGY INDUSTRIES

HEARINGS

BEFORE THE

COMMITTEE ON

GOVERNMENTAL AFFAIRS

UNITED STATES SENATE

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

JUNE 13, 2001

ECONOMIC ISSUES ASSOCIATED WITH THE RESTRUCTURING OF

ENERGY INDUSTRIES

JUNE 20, 2001

THE ROLE OF THE FEDERAL ENERGY REGULATORY COMMISSION

ASSOCIATED WITH THE RESTRUCTURING OF ENERGY INDUSTRIES

JUNE 28, 2001

THE IMPACT OF ELECTRIC INDUSTRY RESTRUCTURING ON SYSTEM

RELIABILITY

Printed for the use of the Committee on Governmental Affairs

(

(II)

COMMITTEE ON GOVERNMENTAL AFFAIRS

JOSEPH I. LIEBERMAN, Connecticut, Chairman

CARL LEVIN, Michigan

DANIEL K. AKAKA, Hawaii

RICHARD J. DURBIN, Illinois

ROBERT G. TORRICELLI, New Jersey

MAX CLELAND, Georgia

THOMAS R. CARPER, Delaware

JEAN CARNAHAN, Missouri

MARK DAYTON, Minnesota

FRED THOMPSON, Tennessee

TED STEVENS, Alaska

SUSAN M. COLLINS, Maine

GEORGE V. VOINOVICH, Ohio

PETE V. DOMENICI, New Mexico

THAD COCHRAN, Mississippi

ROBERT F. BENNETT, Utah

JIM BUNNING, Kentucky

JOYCE A. RECHTSCHAFFEN, Staff Director and Counsel

DAVID M. BERICK, Professional Staff Member

HANNAH S. SISTARE, Minority Staff Director and Counsel

PAUL R. NOE, Minority Senior Counsel

WILLIAM M. OUTHIER, Minority Investigative Counsel

DARLA D. CASSELL, Chief Clerk

(III)

C O N T E N T S

Opening statements: Page

Senator Lieberman.................................................................................. 1, 61, 163

Senator Thompson .................................................................................. 3, 63, 165

Senator Carnahan ......................................................................................... 35, 96

Senator Collins .............................................................................................. 38, 85

Senator Voinovich.......................................................................................... 42, 94

Senator Carper .............................................................................................. 46, 92

Senator Durbin ................................................................................................. 83

Senator Torricelli .............................................................................................. 87

Senator Bennett ................................................................................................ 89

Senator Domenici ............................................................................................. 99

WITNESSES

WEDNESDAY, JUNE 13, 2001

Hon. Barbara Boxer, a U.S. Senator from the State of California ...................... 5

Hon. Larry E. Craig, a U.S. Senator from the State of Idaho ............................. 7

Hon. Dianne Feinstein, a U.S. Senator from the State of California .................. 10

Alfred E. Kahn, Ph.D., Robert Julius Thorne Professor of Political Economy,

Emeritus, Cornell University .............................................................................. 13

Severin Borenstein, Ph.D., Director, University of California Energy Institute

and E.T. Grether Professor of Business Administration and Public Policy,

Berkeley’s Haas School of Business, University of California .......................... 16

William W. Hogan, Ph.D., Professor of Public Policy and Administration,

Center for Business and Government, John F. Kennedy School of Government, Harvard University ................................................................................... 18

Paul L. Joskow, Ph.D., Director, Center for Energy and Environmental Policy

Research, Massachusetts Institute of Technology ............................................. 21

Lawrence J. Makovich, Ph.D., Senior Director and Cohead, North American

Energy Group, Cambridge Energy Research Associates ................................... 23

Frank A. Wolak, Ph.D., Professor, Department of Economics, Stanford University ................................................................................................................... 25

WEDNESDAY, JUNE 20, 2001

Hon. Frank H. Murkowski, a U.S. Senator from the State of Alaska ................ 66

Hon. Patty Murray, a U.S. Senator from the State of Washington .................... 69

Hon. Maria Cantwell, a U.S. Senator from the State of Washington ................. 71

Hon. Barbara Boxer, a U.S. Senator from the State of California ...................... 74

Hon. Gray Davis, Governor, State of California ................................................... 75

Hon. Judy Martz, Governor, State of Montana ..................................................... 106

Hon. John Hoeven, Governor, State of North Dakota .......................................... 110

Hon. Christine O. Gregoire, Attorney General, State of Washington ................. 117

Roy Hemmingway, Chairman, Oregon Public Utility Commission ..................... 120

Hon. Curt L. He ́bert, Jr., Chairman, Federal Energy Regulatory Commission

(FERC) .................................................................................................................. 127

Hon. Linda K. Breathitt, Commissioner, Federal Energy Regulatory Commission (FERC) .......................................................................................................... 132

Hon. Nora Mead Brownell, Commissioner, Federal Energy Regulatory Commission (FERC) .................................................................................................... 134

Hon. William L. Massey, Commissioner, Federal Energy Regulatory Commission (FERC) .......................................................................................................... 135

Hon. Patrick H. Wood, III, Commissioner, Federal Energy Regulatory Commission (FERC) .................................................................................................... 138

Page

IV

THURSDAY, JUNE 28, 2001

David N. Cook, General Counsel, North American Electric Reliability Council 167

Phillip G. Harris, President and CEO, PJM Interconnection, L.L.C. ................. 169

Kevin A. Kelly, Director, Division of Policy Innovation and Communication,

Federal Energy Regulatory Commission ............................................................ 171

Irwin ‘‘Sonny’’ A. Popowsky, Consumer Advocate of Pennsylvania, on behalf

of the National Association of State Utility Consumer Advocates

(NASUCA) ............................................................................................................. 173

ALPHABETICAL LIST OF WITNESSES

Borenstein, Severin, Ph.D.:

Testimony .......................................................................................................... 16

Prepared statement .......................................................................................... 194

Boxer, Hon. Barbara:

Testimony .......................................................................................................... 5, 74

Breathitt, Hon. Linda K.:

Testimony .......................................................................................................... 132

Prepared statement with an attachment ....................................................... 462

Brownell, Hon. Nora Mead:

Testimony .......................................................................................................... 134

Prepared statement .......................................................................................... 484

Cantwell, Hon. Maria:

Testimony .......................................................................................................... 71

Cook, David N.:

Testimony .......................................................................................................... 167

Prepared statement with attachments ........................................................... 509

Craig, Hon. Larry E.:

Testimony .......................................................................................................... 7

Davis, Hon. Gray:

Testimony .......................................................................................................... 75

Prepared statement .......................................................................................... 391

Feinstein, Hon. Dianne:

Testimony .......................................................................................................... 10

Gregorie, Hon. Christine O.:

Testimony .......................................................................................................... 117

Prepared statement .......................................................................................... 415

Harris, Phillip G.:

Testimony .......................................................................................................... 169

Prepared statement with attachments ........................................................... 526

He ́bert, Hon. Curt L., Jr.:

Testimony .......................................................................................................... 127

Prepared statement with an attachment ....................................................... 430

Hemmingway, Roy:

Testimony .......................................................................................................... 120

Prepared statement with an attachment ....................................................... 423

Hoeven, Hon. John:

Testimony .......................................................................................................... 110

Prepared statement .......................................................................................... 825

Hogan, William W., Ph.D.:

Testimony .......................................................................................................... 18

Prepared statement with attachments ........................................................... 200

Joskow, Paul L., Ph.D.:

Testimony .......................................................................................................... 21

Prepared statement with an attachment ....................................................... 351

Kahn, Alfred E., Ph.D.:

Testimony .......................................................................................................... 13

Prepared statement .......................................................................................... 191

Kelly, Kevin A.:

Testimony .......................................................................................................... 171

Prepared statement .......................................................................................... 533

Makovich, Lawrence J., Ph.D.:

Testimony .......................................................................................................... 23

Prepared statement .......................................................................................... 365

Martz, Hon. Judy:

Testimony .......................................................................................................... 106

Prepared statement .......................................................................................... 821

Page

V

Massey, Hon. William L.:

Testimony .......................................................................................................... 135

Prepared statement with an attachment ....................................................... 494

Murkowski, Hon. Frank H.:

Testimony .......................................................................................................... 66

Murray, Hon. Patty:

Testimony .......................................................................................................... 69

Popowsky, Irwin ‘‘Sonny’’ A.:

Testimony .......................................................................................................... 173

Prepared statement .......................................................................................... 545

Wolak, Frank A., Ph.D.:

Testimony .......................................................................................................... 25

Prepared statement .......................................................................................... 371

Wood, Hon. Patrick H., III:

Testimony .......................................................................................................... 138

Prepared statement .......................................................................................... 504

APPENDIX

JUNE 13, 2001

Chart entitled ‘‘California Day-Ahead Power Prices’’ (submitted by Senator

Thompson) ............................................................................................................ 551

Chart entitled ‘‘The Big 5 Energy Generator’s Profits’’ (submitted by Senator

Boxer) .................................................................................................................... 552

Chart entitled ‘‘Closed for Maintenance?’’ (submitted by Senator Boxer) .......... 553

Article by Robert J. Samelson, Washington Post, dated June 13, 2001, entitled

‘‘Short-Circuiting Supply and Demand’’ (submitted by Senator Craig) ........... 554

Letter from Wayne D. Angell, Senior Managing Director and Chief Economist,

Bear, Stearns and Co., Inc., dated June 11, 2001 (submitted by Senator

Thompson) ............................................................................................................ 556

William C. Dudley, Chief U.S. Economist, Goldman, Sachs and Co., prepared

statement .............................................................................................................. 558

Marcia Baker and John Hoefle, EIR News Service, prepared statement ........... 561

JUNE 20, 2001

Report entitled ‘‘Meeting the Energy Challenge: How the State of California

is Taking Charge of the Energy Future’’ (submitted by Governor Davis) ....... 569

Chart entitled ‘‘Total Wholesale Cost of Electricity in California’’ (submitted

by Governor Davis) .............................................................................................. 742

Chart entitled ‘‘1999 Per Capita Electricity Consumption’’ (submitted by Governor Davis) .......................................................................................................... 743

Chart entitled ‘‘Table 1: Average Monthly Bill By Sector, Census Division

and State, 1999’’ (submitted by Senator Collins) .............................................. 744

Prepared statements for the record:

Hon. John A. Kitzhaber, M.D. Governor, State of Oregon ............................ 746

Jerry Ellig, Ph.D., Senior Research Fellow, Mercatus Center at George

Mason University, with an attachment ...................................................... 749

Vernon L. Smith, Ph.D., Economic Science Laboratory, University of Arizona ................................................................................................................ 774

John M. Quain, Chairman, Pennsylvania Public Utility Commission ......... 786

Question for the record and responses from:

Governor Davis ................................................................................................. 788

S. David Freeman, Sr. Energy Advisor to Governor Davis ........................... 800

Chairman Curt L. He ́bert, Jr. ......................................................................... 802

Commissioner Linda K. Breathitt ................................................................... 810

Commissioner William L. Massey ................................................................... 812

Commissioner Patrick H. Wood, III ................................................................ 815

JUNE 28, 2001

Chart entitled ‘‘Bundled’’ (submitted by Senator Lieberman) ............................. 819

Chart entitled ‘‘A Fully Unbundled Electric Industry Model’’ (submitted by

Senator Lieberman) ............................................................................................. 820

(1)

ECONOMIC ISSUES ASSOCIATED WITH THE

RESTRUCTURING OF ENERGY INDUSTRIES

WEDNESDAY, JUNE 13, 2001

U.S. SENATE,

COMMITTEE ON GOVERNMENTAL AFFAIRS,

Washington, DC.

The Committee met, pursuant to notice, at 9:33 a.m., in room

SD–342, Dirksen Senate Office Building, Hon. Joseph I. Lieberman, Chairman of the Committee, presiding.

Present: Senators Lieberman, Durbin, Cleland, Carper, Carnahan, Thompson, Stevens, Collins, and Voinovich.

OPENING STATEMENT OF CHAIRMAN LIEBERMAN

Chairman LIEBERMAN. Good morning and thank you all very

much for coming.

Since this is our first hearing since the transition within the Senate, I wanted to begin by just saying what a great honor it is for

me to become Chairman of the Senate Governmental Affairs Committee. This is a Committee with a proud history, and I hope and

believe on a bipartisan basis we can make its future as proud.

It is an honor for many reasons for me to become the Chairman,

but perhaps the most meaningful is that one of my childhood heroes and later one of my mentors, Senator Abe Ribicoff of Connecticut, served as Chairman of this Committee back in the 1970’s.

Under his leadership the Committee did what was right to protect

the interests of the American taxpayer, and that is a legacy that

I hope all of us will carry on.

I want to particularly thank my friend and colleague, Senator

Fred Thompson of Tennessee, for the distinguished and thoughtful

leadership he has given this Committee over the past several

years. Though we are switching seats today, I know that Fred and

I will continue our very strong working partnership in pursuit of

the fulfillment of the responsibilities of this Committee, which, as

I see them, are to make sure that the people that we represent

have the most responsive, efficient, ethical, and economical government that we can provide them. Sometimes fulfilling this responsibility will lead to producing legislation, but I think uniquely within

the Senate Governmental Affairs Committee more often it will involve oversight.

Over the course of the next 2 weeks, we will be paying particular

attention to the economic interest of the taxpayers as consumers of

electricity and natural gas. As a Committee charged with oversight,

it is our job to make sure that Federal agencies are doing their job

2

to fairly and appropriately protect the interests of the American

people.

America now faces an array of serious energy problems. Whether

it is the price of gasoline in the Midwest, shortages of heating oil

in the Northeast, consumers and businesses struggling to pay their

natural gas bills, or electricity blackouts and price spikes in California, energy price and supply problems are becoming regular

events from one end of the Nation to the other. I think that if we

ignore these problems, we put our economy at risk. California accounts for 15 percent of the U.S. economy. If you add its Western

neighbors Oregon and Washington, which are also part of this most

recent crisis, we are talking about the health of roughly one-fifth

of the American economy. And earlier this spring, the North American Electric Reliability Council issued warnings not only about

California and the Pacific Northwest but New England and New

York City as well. So none of us should say of the West’s problems

today that we will not face them in our part of the country tomorrow.

What the Federal Government does in this situation out West, I

think, will set a precedent for what it will do in the next energy

crisis elsewhere in America. So today and again next Wednesday,

when we will hear from the members of the Federal Energy Regulatory Commission, Governor Davis of California, and another witness that Senator Thompson will call, we will be looking at the role

of the Federal Government in addressing the issues of energy price

and supply. In particular, we are going to be looking at the effects

of deregulation on the energy market and how FERC has carried

out its responsibility to oversee these changes.

FERC was created in 1977 under the Department of Energy Organization Act and charged with the same responsibility as its

predecessor, the Federal Power Commission, to set just and reasonable wholesale energy rates. But I doubt that there is any among

us today that would say that California’s energy costs are now just

and reasonable.

In 1999, the State spent $7 billion—that is all of the consumption of electricity energy, $7 billion on energy. Last year the number multiplied to $27 billion, and estimates for this year go as high

as $70 billion, even though Californians are conserving and using

11 percent less energy today than last year.

In fact, last fall FERC itself said that electricity prices in California were not just and reasonable. Like most of our expert witnesses today, in fact, I think maybe all of them, I am a fan of free

markets. I do not believe in price controls or price caps or other

economic contrivances that inhibit the free marketplace, but the

energy market in California and the West is not free today. It may

not even be functional. So we need to examine, I think, the appropriate role for regulators when the market does not work.

This is a matter about which we may differ, but the differences

should not be, and I do not believe are, partisan or personal. In

fact, the primary legislative response to the crisis in the West that

has been proposed is bipartisan, the legislation authored by Senators Feinstein and Gordon Smith, and I hope that our deliberations in this Committee will focus on finding a solution rather than

on finding a scapegoat.

3

We are fortunate to have a distinguished panel of nationally renowned economists to help us understand the changing nature of

the energy markets and how consumers have been affected by the

transition from the regulation of electricity and natural gas at the

State and Federal levels to an unregulated, more market-oriented

system. The fact is that 25 States and the District of Columbia

have moved to deregulate their electric utility systems, but the recent experience of California in both electricity and natural gas

markets and the price hikes in the Midwest in 1999 and the Northeast last spring have very serious doubts about this new world of

spot markets, electricity futures, and open access to natural gas

and electricity transmission systems.

Several States on the verge of regulation, including two of California’s Western neighbors, New Mexico and Nevada, have blinked

and put the brakes on deregulation, and that is understandable

considering what has been happening in California. So I think that

if the Federal Government doesn’t find a way to provide temporary

price relief out West now, the natural and, I think, desirable trend

toward deregulation across the country will come to a halt.

So I look forward to the testimony of our witnesses. I hope they

will help us learn the lessons we need to learn from what is happening in California and in the Western grid and outline for us the

role they think the Federal Government needs to play in these new

markets. I hope they will tell us what we can do when, as in the

case of California, good intentions go painfully off course.

I am now going to call on Senator Thompson. I do want to say

in this first hearing that I have the privilege to Chair that I am

going to borrow some of the procedures that I have learned on the

Armed Services Committee, with the indulgence of my colleagues,

and just have Senator Thompson and myself give opening statements but extend the time for questioning in each round by the

Members of the Committee to 10 minutes, so that if they wish to

make an opening statement they can do so during that 10-minute

time. And we will call on Senators in order of arrival, switching

parties as we go along.

Senator Thompson.

OPENING STATEMENT OF SENATOR THOMPSON

Senator THOMPSON. Thank you very much, Mr. Chairman, and

you know, as the old saying goes, if it had to happen, it couldn’t

have happened to a nicer guy. I look forward to working with you

as we have in the past. We went through some interesting and trying times a couple of years ago, and throughout all of that and up

until now, we have had a good working relationship. You have been

very cooperative with me in every respect, and I intend to be the

same with you. So I am looking forward to it.

The energy troubles that have plagued the State of California

and the West over the past year are well known to all Americans.

Most are probably as aware of the problem from stories about

blackouts as they are from stories about fingerpointing and placing

blame.

I think it is important to know that California’s problems did not

begin on January 21, 2001. Efforts to place blame on the current

administration, to hire consultants at $30,000 a month to spin the

4

issue, or to pit one State against another are not only misplaced,

but do not help arrive at a solution.

In truth, there appear to be many causes of the problems now

faced in the West. The restructured energy system in California

had flaws. There was evidence of mounting problems a couple of

years ago, but the State was reluctant to address them. The State

was slow to react when prices rose sharply last summer. It has

shied away from passing rate increases along to consumers sufficiently to affect demand, and it resisted the kind of long-term contracts that could have mitigated the current crisis.

In addition, natural gas prices have risen sharply, increasing the

cost of producing energy. A lack of rainfall in the Northwest has

decreased the available hydro power in the region, and the best

way to head off this problem, building new generations, has been

difficult given the State’s burdensome requirement for building

new plants. In sum, California has not provided an energy supply

that could meet the demand of its growing economy.

The question we face now is what should be done to address the

short-term problem of power shortages and certain blackouts this

summer and the long-term problem of ensuring sufficient supply to

the West in the future. The long-term answer appears more clear:

More supply. New generation is being built, and some estimate a

sufficient amount will be online within 18 months.

In addition, signing long-term contracts could help provide stability to the region. The short-term solution is more difficult, particularly because it is so late in the game. Prices exploded last

summer and stayed high all winter. Now Governor Davis has asked

the Federal Government to step in and fix the problem now that

it is too late for anyone to prevent rolling blackouts.

Some suggest temporary price controls through early 2003. While

that may get us through the next election, temporary price controls

have rarely stayed temporary, nor have they worked. President

Nixon’s wage and price controls, oil price controls in the 1970’s,

and rent control in New York City are just a few examples of temporary fixes that lasted far longer than intended and actually did

more harm than good. And governments do not have very much

credibility with investors when it comes to talk about temporary

price controls.

Many economists, including two that we will hear from here

today, believe that introducing price controls into the current situation would do more harm than good. Setting price controls could

provide a disincentive to new generation and drive suppliers to

other markets, creating more shortages and blackouts over the

summer.

In addition, it is difficult to know how workable these solutions

are. One option which will be discussed today is a cost-based price

control. Under this scheme, government officials would set plantby-plant price rates which are unrelated to the marketplace. This

raises a host of practical implementation problems given that there

are hundreds if not thousands of operators providing power in the

Western energy market.

In addition, if you only impose price controls on investor-owned

power, then half the electricity in the Western market escapes.

That creates market distortions and loopholes for evasion. And

5

1 Chart entitled ‘‘California Day-Ahead Power Prices,’’ appears in the Appendix on page 551.

with regard to the possibility that by delaying FERC action we are

in some way delaying reform in other States, my concern is we may

set back the case for real reform if we lead other States to believe

they can take the same measures that California did and FERC

will come in and bail them out.

What FERC has done is to institute a market-based price mechanism on price levels during level one, two, and three emergencies

within the State. Since that order, prices have dropped below $100

per megawatt hour for the first time since the crisis began 1 year

ago.1 FERC has taken action, and that may be working. However,

the State of California has a responsibility, too. If the governor

truly believes that price controls are the answer, he has the authority to set the price that the State will pay. He can also take

steps to fix the broken system in his State to prevent these types

of problem in the long run.

I look forward to hearing from our witnesses today as to what

possible solutions there are for the problems in the West and what

the Federal Government could and should do.

Thank you Mr. Chairman.

Chairman LIEBERMAN. Thank you, Senator Thompson.

When we put out a notice that we were going to convene this

hearing, we had a request from three of our Senate colleagues to

testify, Senators Boxer, Craig, and Feinstein, and two of them are

here and I would like to call on them and ask them to begin their

testimony. And I believe Senator Feinstein may be on the way.

Why don’t you come to the table?

Let me also note the presence here in the room of Congresswomen Jane Harman and Anna Eshoo. These members of the

House serve on the House Energy and Commerce Committee and

have been very involved in fashioning a response to the crisis in

their State. Obviously, this is a topic of enormous importance to

the people of California, and the presence of these two distinguished colleagues from the House testifies to their very deep and

active interest, and I thank them for being here.

Senator Boxer.

TESTIMONY OF HON. BARBARA BOXER, A U.S. SENATOR FROM

THE STATE OF CALIFORNIA

Senator BOXER. Thank you Mr. Chairman. I want to give the

largest thank you to all of you, Republicans and Democrats alike,

from my constituents, 34 million of them in California. This is really the first hearing we have had on our emergency situation. We

have had emergencies before. We have had earthquakes, floods,

fire, and everything else, and you have always been there for us.

This one took a little longer because it is not as obvious an emergency. But trust me, it is an emergency. So thank you very, very

much.

Today you are going to hear from economists about the costbased pricing. I give it another name, Senators. I call it antigouging pricing, and I hope you will think of it in that light. And

I called for such pricing by FERC last August, and last September

6

1 Chart entitled ‘‘The Big 5 Energy Generator’s Profits,’’ appears in the Appendix on page 552. 2 Chart entitled ‘‘Closed for Maintenance?’’ appears in the Appendix on page 553.

I introduced a bill with Representative Filner of San Diego. Those

are the people that felt this first. We called for such pricing.

California is facing price gouging by the electric generators. The

generators’ profits increased on average by 508 percent.1 I have a

chart here. We go through the various large generating companies.

We average them out at 508-percent increase, and at that time

that they were making the 508-percent average increase, demand

was going up by 5 percent. So, Senators, I have to tell you, when

you see this, it makes your stomach turn.

I have to also tell you one of these companies, who was just advertising in Roll Call and all the other—the New York Times—I

have a copy of the advertisement here. I want to just hold it up.

It is bragging about keeping the lights on in California, reliant energy. Their profits went up, Mr. Chairman, 1,685 percent during

that period.

This is the ad. It says, ‘‘Helping California keep the lights on, reliant energy.’’ What they did not say is ‘‘and gouging California

consumers at the same time.’’ They left out that part. It is very,

very disheartening and discouraging.

One of the primary causes of price gouging in my opinion—and

I leave this to you to ponder—is the generators’ holding back supply. So when you talk about a free market, I say to my friends, you

cannot hold back supply if it is really a market that is working.

We will show you this amazing chart.2 The blue shows you how

much power was taken off-line for maintenance last year. And this

is how much power was taken off for maintenance this last year,

current year, in the yellow. It is hard to imagine that suddenly you

would have this great disparity in how much power has to be

pulled off-line.

I am going to be quick—because I know you have so many

folks—and make a couple more points. If the average price of milk

went up the way the average price of electricity went up, we would

be paying $190 a gallon for milk from $3. I want you to think about

that. It is just stunning. And I want to leave with you this point,

Mr. Chairman, and your Ranking Member and all of you good

Members who care a lot about people.

We are getting letters from businesses. I have a letter from John

Odaman of San Marcos, California. He wrote to President Bush

and sent me a copy. He said, ‘‘I am 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 benefit of having a full-time parent at home. We are currently spending money

on electricity bills that should be going into family investments for

college and retirement planning.’’

Mr. Odaman and other Californians have less disposable income.

I have other letters.

I have another letter from a California farmer, Ann Zack. Ms.

Zack wrote to me asking for help.

She writes, ‘‘Our family has owned and operated an alfalfa ranch

since 1965. Our crop is irrigated in the summer with water

pumped from wells by electric pumps. We have been informed by

7

Edison that our power rate will double this summer, will possibly

be raised beyond that in the future. Since we have narrow profit

margin’’—their profit margin is not 508 percent, Mr. Chairman— ‘‘this will effectively put us out of business.’’ So my question to you is: How can these electric generator executives go to sleep at night? I honestly to God do not know. They are

hurting real people. This is not right. We all want our businesses

to operate at fair profits. God knows that is the essence of our system. But gouging is something that must be stopped.

I met with the Vice President yesterday. It was a cordial meeting, Mr. Chairman. We did not make too much headway on this

issue of caps, but I hope he will rethink it, and I hope that you will

help us by getting FERC to understand that their job is to protect

us from unfair and unjust and unreasonable prices and to stop the

gouging now.

Thank you, Mr. Chairman, for your concern about California.

Chairman LIEBERMAN. Thank you, Senator Boxer, for your concern and for your testimony this morning.

Chairman LIEBERMAN. Senator Craig, we just had the second run

of bells goes off, but we have got a good 8 to 10 minutes left.

Thanks for being here this morning.

TESTIMONY OF HON. LARRY E. CRAIG, A U.S. SENATOR FROM

THE STATE OF IDAHO

Senator CRAIG. Mr. Chairman and Members of the full Committee, thank you very much for an opportunity to come and visit.

This is the fifth hearing on the California energy crisis I have

participated in since it began well over 6 months ago. I also asked

for and convened a hearing of FERC in Boise of the 11 Western

States to examine what is truly a broken energy system in the

West. So it is not the first time that the Congress has focused on— and I am guessing it will not be the last time that we will focus

on this issue.

But my message today, Mr. Chairman, is that with the energy

crisis in the West, we pay closer attention to the facts and move

away from a great deal of the political myths involved. There has

been much too much distortion and rhetoric in this debate. In part,

I guess it is understandable.

Like other serious and complicated problems we face, the Western energy crisis is laced with both emotion and I believe now some

partisanship. This is clearly evident in the statements on the crisis

of high prices that have been charged for the wholesale electricity

in California.

In this debate, Mr. Chairman, there have been many for their

own purposes engaged in what I believe is an intentional distortion

and misstatement of the facts. They say that there is no lack of

supply in the West. They say that there are plenty of power plants

and transmission lines to meet all of the demands for electricity.

And they say that small groups of companies, based primarily in

Texas, have conspired to withhold electricity from the market in

order to drive prices up to an unreasonable, indeed unconscionable

level.

It is they who are, I think, the unconscionable crowd in this rhetoric. They are either unconscionably ignorant because they have

8

not looked at the reality of what is going on out there, or they are

unconscionably and deliberately distorting facts.

Now, Mr. Chairman, in all of these kinds of situations, I think

we have some who are always in search of a conspiracy. And as you

know, Mr. Chairman, conspiracy theorists are always around at the

right time, despoiling and oftentimes using public discourse in a

variety of critical ways. Conspiracy theorists reject what most of

the rest of us view as plain and real. Instead, they search and usually find villains and conspirators. Some of these conspiracy theorists engage in the craft full-time. I must tell you that, as I have

listened to the rhetoric of the Governor from California, I am frustrated in trying to understand where he is.

Since 1990, there has been a 26-percent increase in the demand

for electricity in the State of California. During that time, not one

major new power plant was constructed. I repeat, not one. Even

Governor Davis, who has led in what I believe is misdirected and

politically inspired assaults on independent generators in his own

State, has repeatedly alluded to the fact that California has been

derelict in new generation. In other words, it appears that he is

working full-time to be on both sides of this issue.

Governor Davis in a prime-time speech delivered last spring said

that the major problem facing the State in this crisis was a lack

of available generating capacity. Despite a chronic shortfall in electrical capacity to meet peak demands, Californians have until recently been able to get bailed out of their blackouts and their price

spikes, and here is why. They have relied on the hydro power of

the Pacific Northwest, but now, as you mentioned, and as I think

Senator Thompson mentioned, the Pacific Northwest is suffering

from what is probably the worst drought since 1930. Our reservoir

levels are the lowest since the 1930’s.

In addition, the economic growth in the Pacific Northwest, in Arizona, and in Nevada have caused power plants in these areas to

dedicate more of their output to their own localities and less to

California.

To be specific, peak summer demand in the West has increased

at an annual rate of 8 percent in Arizona, New Mexico, and Nevada, 3.2 percent in California, 2.8 percent in the Rockies, 2.4 percent in the Pacific Northwest. Yet, from 1991 to 1998, the growth

rate of new generation capacity additions in that whole region was

less than 1 percent.

All of these factors have resulted in a stark exposure of the electrical supply deficiency within California. California has been subsisting off the surplus of its neighbors, and now those neighbors

have no surplus, and they have to take care of their own.

Another important part of the reality in California has been the

high prices of natural gas and of securing necessary emissions

credits. The cost of both have soared through the roof. The reality

of the charts that have just been shown in many instances are real.

This has created enormous upward pressure on the price of electricity and generating capacity of old gas-fired plants. A shortage

of electrical generating capacity, a regionwide drought causing reduction in imported power and high natural gas and emission credits, these are all fundamental causes of the electricity crisis. Any

9

1The article referred to by Senator Craig appears in the Appendix on page 554.

of these factors could cause or would have caused the problem. All

of them combined have probably crippled the market.

Now, I believe that is the big picture, Mr. Chairman, and frankly

I believe that is the true picture. How do we deal with it? And that

is, of course, part of what you are looking at today. And how do

we deal fundamentally with our electric and gas utilities?

I know now that the spot market in California is lower than the

long-term contract prices that Governor Davis negotiated. Why?

Because California recently began to expose the consumer in California to the real market price and the consumer in California

began to make real choices.

It is also happening across the West as our power rates go up.

Is conservation the only solution to our problem? Absolutely not.

But there are no blackouts in California at this moment, and one

of the reasons why is that there is an 11 percent conservation that

has now taken hold in the State of California. The major utilities

of California have stated that during deregulation, conservation almost stopped altogether because the consumer knew the price was

fixed. Those were the realities of the situation.

Chairman LIEBERMAN. Senator Craig, forgive me. We are down

to about 2 minutes left on the vote.

Senator CRAIG. Then I will conclude. I must tell you that Governor Davis has moved swiftly. While I criticize him, I must also

recognize the fact that 5,000 new megawatts of power are going to

come online next spring in California and 5,000 within a year, and

that is an effort at reducing and changing regulation and process,

and the governor ought to be applauded for that.

Let me quickly refer to FERC and what I think FERC is doing

now in a very responsible fashion. Out of the Boise hearing came

the new order, and that new order largely says all of those in the

market have to supply capacity to that market on a full-time basis.

That has helped bring those prices down.

Satisfying political preserve by choosing price caps, is not a way

to fix the market. Investment is rushing to California at this moment to supply a need. They are rushing there because they believe

the market is becoming more free and will be allowed to operate

in a more unfettered fashion.

Let me ask that you allow to be part of the record an op-ed by

Robert Samuelson this morning in The Washington Post. I would

recommend it for your reading. It is called ‘‘Short-Circuiting Supply

and Demand.’’ 1

Chairman LIEBERMAN. Without objection.

I have noticed that the Ranking Member has been reading that

op-ed here at my side this morning. I thank you Senator Craig and

Senator Boxer. I think the two of you in some ways have framed

the discussion that will go on here in the coming weeks.

We are going to recess now. We will come back and hear Senator

Feinstein and then proceed with the witnesses. Thank you.

[Recess.]

Chairman LIEBERMAN. The hearing will reconvene. I apologize to

our witnesses and others here for the interruption which was necessitated by two votes on the floor of the Senate.

10

We are privileged now to have the third of our colleagues who

asked to testify before this hearing and lead co-sponsor of the legislative proposal responding to the price crisis in California and the

West, Senator Dianne Feinstein. Thank you for being here.

TESTIMONY OF HON. DIANNE FEINSTEIN, A U.S. SENATOR

FROM THE STATE OF CALIFORNIA

Senator FEINSTEIN. Thank you very much, Senator Lieberman,

and Senator Collins, and I saw Senator Carper. He is over here.

I want to thank you for this opportunity.

I have been carefully watching as a member of the Energy Committee now what has been happening with the deregulation in California, and I have watched the problems spread to seven other

Western States. So California is no longer alone.

I must tell you, Mr. Chairman and Members, that I have really

come to question whether deregulation of electricity and natural

gas can work. You know, when we deregulated airlines, individuals

had a choice of airlines. If they did not like one, they could go to

another. When we deregulated telephones, individuals had a

choice. If they did not like one service, there was another.

In the area of natural gas and electricity, the consumer has no

choice. You get your bill. You cannot change companies if you do

not like it.

What I have also seen is that it is a broken market, caused in

part by California’s not having adequate generation. However, having said that, I have got to make a point. Californians have been

conserving. In January, the State consummed 5 percent less energy

than the previous year.

In February, the savings was 7 percent. In March it was 9 percent. And in April, Californians saved 7 percent. The energy savings last month was 11 percent, and the cost of all electricity for

California in 1999 was $7 billion. The cost in 2000 was $28 to $30

billion, and the costs this year are predicted to be $50 to $65 billion.

In that milieu, you have had two big investor-owned utilities, the

middlemen, buying the power on the wholesale market, selling it

to the consumer, go into bankruptcy. One is in bankruptcy. Southern California Edison, if it does not work out an arrangement with

the State, will be in bankruptcy. And you have the State so far this

year having spent $8 billion buying electricity to try to keep the

price low. As recently as 2 weeks ago, electricity prices in California were almost 10 times higher than they were a little more

than a year ago.

Now, the Federal Power Act clearly states that if FERC, the Federal Energy Regulatory Commission, finds prices to be unjust and

unreasonable, FERC must regulate and set those rates. They did

find the rates unjust and unreasonable last November. They have

really refused to move aggressively to set those rates, and I and

many other Californians have tried to sound a consistent drumbeat

to move to do that.

In late April, FERC issued a limited—what is called price mitigation order, which would cap wholesale costs during stage one, two,

and three emergencies. And it now appears that on Monday, FERC

may extend this order to the entire Western energy market and

11

may ensure that the order stays in place at all times—in other

words, going to 24 hours a day, 7 days a week, and requiring power

generators in the entire Western region to sell electricity back into

the grid. That is another step forward.

The question I have about it is manipulation. Because this is tied

to the least efficient megawatt, so it is tied to the dirtiest, most polluting plant.

Now, I ask this question: Is that then an incentive to keep dirty

plants in order to drive up price and produce profitability for clean

plants? And we are going to have to see.

I called the head of the independent systems operator—known as

the ISO—yesterday, Terry Winters, and he agreed that this could

be manipulated. He agreed that we do not have enough information

yet to know whether, in fact, the acute drop in prices over the past

week or so is a result of the April FERC order, whether it is a result that the generators now feel that the heat is on, whether it

is a result of the Senate having changed power, whether it is a result that Senator Smith’s and my bill now has a markup date in

June which would set Western regional caps, we do not really know

yet what the case is. But we do know a couple of things, that just

a few days ago one generator admitted to selling electricity into

California at $3,000 a megawatt hour, 5,000 megawatts at that

price, and that another generator fessed up to $1,900 a megawatt.

So what we still have out there is a ribald, unregulated marketplace.

The natural gas issue has been an interesting one because natural gas is three times higher in California than anywhere else in

the United States. FERC is looking into this. There is no transparency when it comes to natural gas. It is very hard to tell what

is going on. But when you have three times the price, when the

transportation cost of natural gas should be between 50 and 70

cents a decatherm and the gas is selling, instead at $3 or $4, $12

to $15, you really come to question what is going on.

Let me give you a couple of examples of what has happened. We

have one sugar refinery in my backyard. It is in Crockett, California, C&H Sugar. They employ about 1,200 people. Their normal

cost of natural gas to produce steam is $450,000 a month. It has

risen to $2 million a month. They have had to lay off people. They

have had to close down the plant. They have had to try to get

bridge financing. I can tell you about California steel industries

with the costs escalating literately millions of dollars. Now, that is

not restaurants. That is not others that use electricity as well.

You should know that yesterday the Attorney General of California announced that he will convene a criminal grand jury to investigate whether power generators illegally manipulated energy

prices. The investigation will begin shortly after July 1 when a new

19-member Sacramento County grand jury is seated. As Mr.

Lockyer said, this does not indicate we have reached a conclusion.

It is a process to get at the truth. This is the beginning of the

criminal focus.

So the belief is among many of us—and I am one—that the generating community has made use of the problems in California,

quite simply stated, to manipulate the market and gouge prices.

12

John Bryson, CEO of Southern California Edison, testified before

the Energy Committee, in answering a question of mine, that when

they divested of generating facilities and sold those facilities to outof-State generators, I asked this question: What were you selling

a megawatt hour power from the facility when you owned it? The

answer was $30. Then the next question was: When it was divested, what did the company that took over ownership charge?

The answer was $300 a megawatt hour. So, in other words, power that had been selling at $30, when the

facility was sold, they had to buy that same power back at 10 times

the price. One of the reasons they are close to bankruptcy today.

I am sure Senator Craig mentioned the concerns in Idaho. I am

sure Senator Burns and others can mention the concerns in Montana where you have got a mine closing where people are losing

their jobs, and in these seven Western States where it is anticipated that there will be rate increases from a low of 14 percent to

a high of over 100 percent.

So the situation is changing dramatically and I thank you, Mr.

Chairman. I wrote you a letter urging that you take a look at some

of the relationships between the big generating companies and the

regulatory agency that is supposed to be regulating these very companies. We see no semblance of really meaningful regulation yet,

and particularly in the area of natural gas, there is very deep concern.

My bill will be marked up, I believe, on June 27. Whether we can

get it to pass the Senate or not, let alone get it to pass the House,

I do not know. I should tell you, when Senator Smith and I went

to see Congressmen Tauzin and Barton, they were not very sympathetic. I now think that is changing in the House, and instead of

the word ‘‘control,’’ the word ‘‘mitigation’’ is being substituted.

Whatever you call it is fine with me, as long is it works.

Thank you very much Mr. Chairman.

Chairman LIEBERMAN. Thank you, Senator Feinstein, for very

thoughtful testimony. I want you to know that we are in receipt of

the letter you referred to, and we are looking into the questions

that you have raised.

I am going to call now on the panel of economists who I think

will begin to answer some of the questions that Senator Feinstein

and others have posed. We have a very distinguished panel of

economists who were asked both by myself and Senator Thompson,

and I appreciate the trouble that they took to come and be with

us. I have read the papers they submitted. In my opinion, though

they are more accustomed to grading than I am, they all deserve

high grades. They are very thoughtful and very thought-provoking.

It had been my intention to call people in alphabetical order, but

since this is the Senate where we follow the seniority rule, I wonder if his colleagues would mind if I call Dr. Kahn first.

Mr. KAHN. No one is more senior than I, sir.

Chairman LIEBERMAN. Well, we do have Senator Thurmond here.

But among the witnesses you are definitely the most senior.

Dr. Kahn has certainly been, I guess I would say, if you will

allow me the liberty, the father of the modern deregulation movement in our country, perhaps best known for his work as Chair of

the Civil Aeronautics Board during the 1970’s. He is currently a

13

1The prepared statement of Mr. Kahn appears in the Appendix on page 191.

professor emeritus of political economy at Cornell University, and

I am delighted that he was able to be with us today.

We are going to run this clock and ask you to try to stay within

5 minutes for your opening statements, although your full statements will be entered into the record. And then it will give each

of my colleagues here an opportunity to engage in discussion for a

greater period of time.

Dr. Kahn, thank you for being here.

TESTIMONY OF ALFRED E. KAHN, PH.D.,1 ROBERT JULIUS

THORNE PROFESSOR OF POLITICAL ECONOMY, EMERITUS,

CORNELL UNIVERSITY

Mr. KAHN. Thank you, sir. It is an honor to be here. I should

begin by recognizing that the only reason I am here is that I did

play an important role in deregulating the airlines, trucking, railroads, and telecommunications, and I do not offer myself as an expert on the electric power industry. In point of fact, I have tried

to stay away from the electric one because it frightened me.

I agreed partly because there are around me people who know

much more about the electric industry generally, and, after all, one

of them is a former student of mine, so he has been very well

trained, and I urge you to listen to him carefully.

Just one other introductory remark. The discussion of the California situation has become so deplorably simplistic, if not ideological, and again I am hoping that by my having decided that I wanted to subscribe to the letter that Professor Wolak started, that we

can de-ideologicize it, if you will, and I have all sorts of examples

that I would be happy to cite, but I am not going to waste your

time because you have encountered them as well.

I think perhaps I will merely quote that eminent economist William Safire, who referred to ‘‘the demagogic call for energy price

caps, always politically satisfying, populist interference with the

market’s self-correction that would lead to worse shortages and rationing, to inflation and wage control.’’

I suppose Mr. Safire deserves a good grade for the first 2 weeks

of elementary economics, but from there on he flunks.

I hope he, however, and others like him will be satisfied that all

the sybarites in California with their hot tubs and the politicians

and militant consumer advocates who promised them the benefits

of free markets but without the risks of being exposed to the free

market—I hope the opponents of putting caps on will be satisfied

that those parties have been sufficiently rewarded for their opportunism.

I have in a paper I have written—and, in fact, Paul did the

same—about the opportunistic nature of the move for deregulation.

Nobody was in favor of deregulation of electric power in the 1950’s

and 1960’s when real rates went down. No one was in favor of deregulation in the 1970’s and 1980’s when it looked clearly as tough

regulation was holding rates below competitive levels. It only became a bonfire movement when in the middle 1990’s, because of

mistakes that had been made in the past, it looked as though

prices would go all the way down.

14

Of course, we should have realized that since the big errors were

made in the past, we should have realized that this one, too, was

based on an unrealistic assessment of the future. But, in any case,

here we are in the situation that has been described so well by

other people, and moving beyond the first 2 weeks of Economics

101, let me just mentioned the factors that have induced me to sign

on to this letter, apart from the fact that I have great confidence

in the other people who signed.

First, when you have extreme inelasticity of supply and demand,

when prices can go up 5-fold, 10-fold, 15-fold and not induce a substantial response in demand, very largely because these prices operate in spikes by particular times of day and particular days of

the year, and consumers do not have meters that tell them those

prices. So demand is highly inelastic.

But, similarly, when you have a highly inelastic supply, you

reach a certain point, if you look at Severin Borenstein’s figures at

the end, where supply just suddenly turns vertical, and you do not

get any more supply as the prices double, treble, and quadruple.

Markets do not work very well, to put it mildly.

And that leads me to the second point that everybody who talks

about wage and price controls in the past or caps in the past have

interfered with supply, and there is a letter by some very eminent

economists who apparently know even less about the electric power

industry than I, who say there are all sorts of plants, higher-cost

plants that will come online as prices go up. I ask you to pose that

question particularly to the people who know what is going on in

California. It is simply not true. The supply—no matter how inefficient the plants, there is ample reason for them to be operating if

the price gets above the incremental cost of operating, and yet we

have a virtually totally vertical supply curve. In those circumstances, this equilibrating character of free markets just doesn’t

work very well.

Third, it is true that the elasticity response was prevented by the

ridiculous freezing of retail prices. That was one of these cases of

‘‘we will give you all the benefits but you will not have to bear any

of the risks.’’ And the increases that have come since have been

grudgingly inadequate. But since the extreme shortages, producing

10-, 20-fold increases in wholesale prices, have been the spikes and

consumers do not have meters that tell them when those spikes

occur, you are not going to get the demand response. And, therefore, you can say, well, you would not have blackouts if you let the

price go up to whatever extent necessary, but that extent necessary

is reckoned in terms of not doubling but increasing 10-, 20-, or 50-

fold. Then you have to say as against the possible benefit of a 10-

fold increase in prices in getting a better balance of supply and demand, you have to realize, first of all, the income distributional

consequences of that and, second, the macroeconomic consequences.

I had the misfortune to be adviser to President Carter on inflation just when we had the increase in OPEC prices from $10 a barrel to $40 a barrel on the East Coast, and we know that that extraction of those dollars from the pockets of consumers had a major

role in promoting the stagflation from which we were all suffering.

Well, look at what is happening to the California economy and the

widespread distress that it is causing to a lot of innocent people,

15

without eliciting increased supply, without bringing about re-equilibration.

Fourth, the spectacular cases in history where price controls

have done more harm than good cited by all the opponents, and

correctly so, particularly in the 1970’s when we held the price of

crude oil below marginal costs—marginal cost was the cost of imports, and so we held the domestic prices below that. Of course,

that interfered with supply, and the same thing was true with the

case of caps on the price of natural gas. That clearly did interrupt

supply. But the notion that caps automatically interfere with the

increase of supply in the electric industry is absurd. It ignores the

whole history of regulation. Look at my ‘‘Economics of Regulation.’’

There must be 50 pages on the fact that regulation of the electric

industry through this entire history has not interfered with expansion of capacity. The major criticism has been that it has led to

overexpansions of capacity because it guaranteed the investors a

return on their capital and they made money by investing more. So

it is simply historically incorrect that regulation, recognizing the

full costs of additional capacity, necessarily interferes with supply.

Moreover, one can make certain of that. The problem is that we

are not going to get any new plants for 2 or 3 years. Make the caps

temporary. Make them automatically sunset in the 2 to 3 years.

Make them not apply to new power.

There is no shortage of people interested and willing to build new

power plants, and for that they do not have to have $1,000 a megawatt or $1,500 or $2,000 a megawatt. That is Economics 101.1, and

I wish Mr. Safire would come back and learn it.

So we must not interfere with the fundamentally required

correctives. We must press ahead with time-of-day metering or

something like that. We must be willing to let retail prices go up

more than the grudging amount by which they have. But where the

demand and supply response takes years, it is simply sadistic to insist that elementary economics tells you that price controls do not

make any sense.

Thank you.

Chairman LIEBERMAN. Thanks, Dr. Kahn. You got us off to a

very good beginning, a provocative beginning.

Dr. Severin Borenstein is a professor of public policy and business administration at the University of California’s Haas School

of Business. He has focused on electricity deregulation, market formation, and competition. In addition, he is the director of the University of California Energy Institute and a member of the Governing Board of the California Power Exchange Corporation. So he

is right in the middle of the California crisis. Thanks for being

here, Doctor.

16

1The prepared statement of Mr. Borenstein appears in the Appendix on page 194.

TESTIMONY OF SEVERIN BORENSTEIN, PH.D.,1 DIRECTOR,

UNIVERSITY OF CALIFORNIA ENERGY INSTITUTE AND E.T.

GRETHER PROFESSOR OF BUSINESS ADMINISTRATION AND

PUBLIC POLICY, BERKELEY’S HAAS SCHOOL OF BUSINESS,

UNIVERSITY OF CALIFORNIA

Mr. BORENSTEIN. Thank you, Senator Lieberman. I just want to

start out by talking for a few seconds about how we got here, into

the crisis that California now faces, and understanding what the

problems are and, more importantly, what the problems are not.

There is no question that demand has grown rapidly in the Western United States and that we are now in a situation where there

is a real tight market in the entire Western grid. There is also no

question that that creates a real supply-demand mismatch. That

has two effects.

One is the effect that you learn in the first 2 weeks of Economics

101, which is when demand shifts out and supply does not keep up,

the price goes up.

The second effect, which is just as easy to understand if you sat

through the first 6 weeks of Economics 101, is that when you are

a seller and you are in a market where there are few substitutes

for your product on the demand side and the other sellers are unable to expand their supply because they are already at capacity,

you can raise your price without losing much in sales. Economists

do not call this market manipulation. They call this exercising market power. This is not illegal under U.S. antitrust laws, and it is,

in fact, what businesses do.

When Microsoft decides how much to sell its software for, it is

not basing it on its cost. It is trying to figure out how much money

it can make, how many sales it will lose as it raises its prices.

That’s what the sellers in the California electricity market are

doing.

The problem is that we have set up a market where they can

raise prices quite a bit without much demand response at all and,

because of the technology of electricity, without other sellers able

to expand their output.

Let me address two myths about how we got into this. The first

myth is that the California crisis is the result of rabid environmentalism in California that blocked the building of new power

plants. There is a lot of environmental consciousness in California,

and there is no question that the permitting process in California

takes a bit longer than it takes in most other States, on the order

of months. But this is not a case that California just closed its eyes

and refused to build new power plants when they were necessary.

The reason no new power plants were built or started between

1995 and 1998 is because nobody applied to build new power plants

during that time. And they did not just apply in California. They

did not apply in Arizona. They did not apply in Nevada. They did

not apply in Montana or Wyoming or the other parts of the Western grid.

The fact was that the sellers in the Western grid in 1996, 1997,

and 1998 believed that the prices in Western United States were

going to be low, that there was not going to be a shortage, and that

17

there was not going to be a need for this capacity. They did the economic calculation and they found out that it did not make sense

to build power plants at that time.

By late 1998, they figured out they were wrong. Demand was

growing and we were facing a tighter market. By the way, most of

the demand growth was not in California. It was outside California, but it was all part of the Western grid. And so the market

tightened up, and at that point there were plenty of applications.

Firms started building power plants. They started trying to get

power plants sited. Unfortunately, the process of getting from

starting to build a power plant to having the power online is a 4-

or 5-year process, and that is why we are still 1 or 2 years away

from solving that problem.

The second myth is that wholesale price caps caused these problems in California. California has had wholesale price caps. They

were at $250 throughout most of the market. They were $750 for

a period from October 1999 to June 2000. They were not frequently

hit, and during that time, if you look at the rate of return on owning these power plants, it was astronomical. These firms have

made plenty of money. There was no period essentially until November 2000 where you could possibly argue that the price caps actually deterred production. In November 2000, we actually did see

this happening. In November 2000, the price of natural gas skyrocketed in California, and there was a period of time where it cost

$400 to buy the gas for which you could then sell the power for

$250.

That is the bad old problem with price caps. That is exactly what

we had in natural gas. That is exactly what we had in gasoline in

the 1970’s. That is the danger of price caps. It can happen.

But prior to that, it did not happen and suggesting that firms

were not building plants or firms were not producing from those

plants is just not supported in the data.

So California now faces two issues, and I think it is important

to keep the two issues clear and separate from one another. California and the entire Western grid faces a longer-run problem of

building power plants, of getting investment in the West. The market is solving this problem. I think this really is not a major issue.

This is the problem of power in summer 2004, and I think the

problem of power in summer 2004 is going to solve itself.

The question we are facing now is the problem for power in summer 2001, and telling California at this point to build more power

plants is not a solution to that problem. Power plants are not going

to get built for this summer. There are only two areas where California can help itself or be helped to get through this summer. One

is conservation, and the State has been way too slow to get its conservation plans going. They are now moving on them. We have

been way too slow to get real-time pricing in place so that particularly large commercial and industrial consumers would actually see

those high prices on hot summer afternoons and would have an incentive to scale back their consumption.

We have not sent price signals and we have not done enough to

encourage voluntary conservation. We are moving. We are getting

some results. We need a whole lot more results to get through this

summer without a major economic crisis.

18

1The prepared statement of Mr. Hogan appears in the Appendix on page 200.

The other area is the area of price controls. As Professor Kahn

said, price controls can be used in a way that would prevent a massive transfer of wealth from consumers to producers without having

the adverse effects. The idea of dismissing price controls because

they were used, frankly, extremely badly and without much analysis in the 1970’s is as silly as the idea of dismissing electricity deregulation because California electricity deregulation has gone

awry. Price controls can be used well and carefully. It has to be

done extremely carefully. And electricity restructuring can work

successfully. We cannot dismiss it based on California’s bad experience.

However, I have to say, listening to some of the testimony this

morning reminds me of the dangers of price controls. That is, once

we go down this road, we are going to have to be careful to recognize what price controls do effectively is control market power.

What price controls do in a damaging way is attempt to just control

the transfer of wealth in a regular competitive market.

In the 1970’s, we tried to control that transfer of wealth in a very

competitive market, and we ended up completely screwing up the

market and causing shortages. What we need is the analytic capability to tell the difference. Unfortunately, the Federal Energy Regulatory Commission, which came into this deregulation as a legaloriented process, has not shown the policy skills to do that sort of

analysis and as a result has been blindsided by a lot of the economic operation of this market. I think if they had the policy skills

to do it, they could implement price caps in a way that would be

very carefully done, that would not solve all of the problems—a lot

of the problem is a real shortage and real scarcity—but that would

solve a significant amount of the problem without causing the sort

of damage that price caps did cause in the 1970’s.

Thank you.

Chairman LIEBERMAN. Very interesting. Thanks, Dr. Borenstein.

Dr. William Hogan is a professor of public policy and administration at Harvard’s Kennedy School of Government, also a research

director for the Harvard Electricity Policy Group, which is exploring the issues involved in the transition to a more competitive electricity market. Professor Hogan has also held positions dealing

with energy policy analysis in the Federal Energy Administration.

We are delighted to have you here, and I look forward to your testimony now.

TESTIMONY OF WILLIAM W. HOGAN, PH.D.,1 PROFESSOR OF

PUBLIC POLICY AND ADMINISTRATION, JOHN F. KENNEDY

SCHOOL OF GOVERNMENT, HARVARD UNIVERSITY

Mr. HOGAN. Thank you very much, Mr. Chairman. I have a prepared statement which I would like to submit for the record, but

in the few minutes that are available I will summarize the highlights of the initial points I would like to make.

I would emphasize three ideas. First, echoing the comments of

my colleague, the diagnosis of what the problems are in California

should be the first thing we do in order to understand the recVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 75477.TXT SAFFAIRS PsN: SAFFAIRS
19

ommended policies, because different diagnoses lead to different

policies.

Second, I would say a few words about the price caps debate,

which I think has motivated much of this hearing and the discussion, and to re-emphasize the theme that the details matter. People

are talking past each other on this subject.

The third point would be to return to the question of what should

be done about market design, which is the long-term and continuing problem in California. I have some suggestions that I will

summarize.

The problems in California are quite serious, and they had been

serious well before last summer. It is not apparently widely known,

but the Federal Energy Regulatory Commission found that the

many design features of this market were fundamentally flawed, in

their words, in late 1999. So this is not a new problem, but it became much more serious when the prices increased.

Essentially, because of the problems that developed after the

summer and the collapse of the market earlier this year, things

fundamentally changed as people stopped paying their bills. Market participants were not paying for the power they were taking.

Some of the utilities got in financial trouble. One of the utilities

went bankrupt. I think the diagnosis of that problem is widely accepted.

This situation was unsustainable and it also tells us what needs

to be done to deal with it. First, California should pay its bills in

order to re-establish the credibility of transactions. No system can

work without creditworthy buyers; and then, further, to provide incentives for conservation, retail prices for incremental energy electricity should be raised to market levels, at least for commercial

and industrial customers. Changing the rules and metering to support demand responses would help on many fronts, and I agree

with my colleagues on that matter.

Other topics are more controversial, about in particular whether

or not the principal cause of the high prices is scarcity or the principal cause is strategic withholding by generators in the exercise of

market power. There is a debate about this issue, and unfortunately, this is one of the areas where the debate tends to lead to

different policies. It is not so obvious what to do.

Broadly speaking, I think we are talking past each other when

we talk about price caps. I would identify three broad ideas that

have been suggested. One is a uniform price cap, just setting a cap

on the price that will be paid. Second is traditional cost of service

regulation where you have a different cost for every plant and you

pay them according to those traditional costs. And third comes

what are known as bid caps, where you set limits on what each individual plant can bid. It may be different for different plants in

different hours, but then everybody gets paid the market-clearing

price. There also is a requirement for people to bid.

I will not go into the details now, but I believe uniform price caps

would be counterproductive for all the usual reasons. As far as traditional cost of service regulation, trying to reimpose that on the

system, it is far from clear how this kind of administrative process

could facilitate the market or be implemented in a way that would

not exacerbate the immediate problems in the West.

20

However, to the extent that the problem of high prices results

from withholding of supply in order to raise prices, the better solution would be to go to the bid cap approach, which is already in

use in other parts of the country as authorized by the Federal Energy Regulatory Commission in PJM, New York, and so on. Under

a bid cap generators are required to bid and they cannot bid more

than a certain level, which is related to their cost. But unlike with

the price cap, the generators would still be paid the market-clearing price. The requirement to supply works in support of a competitive market and would counteract the effect of market power. On

the other hand, to the extent that the problem is scarcity, bid caps

will not do much to reduce prices. But if scarcity is the problem,

then administrative action to reduce prices would probably make

conditions worse, not better.

If we are going to intervene, the best of this bad bargain would

be to do so with bid caps. This is basically the direction that the

Federal Energy Regulatory Commission went to at the end of April

with the order that they presented at that time. And I think that

is the right direction. There are some fixes that you could put that

to make it work better but, nonetheless, I think basically what they

are doing is in the right direction.

The problem that I emphasize in my prepared remarks is not

dealing with the symptoms of prices and rolling blackouts. The

problem that I would emphasize is that the Federal Energy Regulatory Commission has not gone far enough or fast enough in dealing with the market design problems, how to change the basic rules

of how the market operates in the West. The details I summarized

in my prepared remarks reduce to a simple prescription. Namely,

the market for the West should be set up to emulate that which

is working so well in the East, in the PJM system, in New York,

and is soon to be adopted in New England. These systems are not

perfect, but they are the best systems that we know about, and

they are much different than what California adopted.

Market design is not necessarily the cause of the high prices, but

it constitutes another set of problems which are fundamental and

have been ignored or delayed, as everybody is worried about the

symptoms of high prices and blackouts. It is time to move on, because we are running out of time if we want to see electricity restructuring work.

Thank you.

Chairman LIEBERMAN. Thanks, Dr. Hogan. I feel like I am going

back to Economics 101. It has been very helpful, and this brings

me logically to Dr. Joskow, who is engaged in teaching and research at the Massachusetts Institute of Technology in the areas

of industrial organization energy and environmental economics and

government regulation of industry. Dr. Joskow has been focused on

the competitive electricity markets for over 20 years and in that

time has published five books and over 100 articles and papers.

Senator Thompson, in the interest of full disclosure, I do want

to reveal that while a graduate student at Yale in 1970, Dr. Joskow

was a very important volunteer in my very first campaign for the

state Senate. [Laughter.]

Is that where you learned your economics?

Chairman LIEBERMAN. That is why I mentioned Economics 101.

21

1The prepared statement of Mr. Joskow with an attachment appears in the Appendix on page

351.

Dr. Joskow, nice to see you.

TESTIMONY OF PAUL L. JOSKOW, PH.D.,1 DIRECTOR, CENTER

FOR ENERGY AND ENVIRONMENTAL POLICY RESEARCH,

MASSACHUSETTS INSTITUTE OF TECHNOLOGY

Mr. JOSKOW. Thank you, Senator Lieberman, Senator Thompson.

It is a pleasure to be here. Actually, my job on that campaign was

to be a poll watcher and make sure that people who died in the

past 2 years did not vote.

Senator THOMPSON. We should have had him for our prior hearing.

Chairman LIEBERMAN. You are a very valuable witness in most

matters this Committee is interested in.

Mr. JOSKOW. I have a prepared statement that covers a number

of issues related to FERC’s responsibilities and performance across

the country. In my oral remarks, however, I would like to focus on

California.

The causes of California’s electricity crisis are complex, reflecting

a combination of bad market design, bad regulatory decisions, unanticipated changes in gas prices and other supply and demand

conditions, credit problems, and, I believe, supplier behavior which

rationally took advantage of opportunities created by these conditions to further increase market prices above competitive levels.

I would like to agree with Senator Thompson. These problems

did not start on January 21, 2001. Indeed, they did not start in

2000. The first problems in California’s markets began to emerge

as early as July 1998, and in my view, the events of the past year

were an accident waiting to happen.

Some progress has certainly been made in the last year. However, I continue to believe that both Federal and State officials can

and should do more to deal with the immediate problems and to

make longer-run reforms in California’s wholesale and retail market institutions. While wholesale electricity market problems have

been most severe in California, they are not unique to California.

I think it is important for the Committee to understand that. There

have been market performance problems requiring a variety of reforms and mitigation measures in the new wholesale markets in

New York, New England, and the Pennsylvania-New Jersey-Maryland pool as well.

And this should not be surprising. Electricity has unusual physical attributes that make the design of well-functioning competitive

wholesale markets a significant technical challenge. Spot markets

perform especially poorly when supplies are tight, demand is completely inelastic, and a large fraction of demand is served out of the

spot market.

Midcourse corrections have frequently been necessary after competitive electricity markets first go into operation. Price caps, bidding rules, cost-based contracts, and a variety of other mitigation

mechanisms have been used and are being used in most new

wholesale electricity markets in the United States and other countries. I must say some of the recent discussion about ‘‘price caps’’

22

is a bit of a mystery to me because we have been using them for

several years.

In this regard, the term ‘‘price caps’’ has become so ideologically

loaded and means so many different things to different people, I

think we should just use a different term. My concern is not that

wholesale prices are high per se. My concern is that prices are significantly above competitive levels because of a variety of market

failures. What I would like to see is a comprehensive, short-run

market failure mitigation program, not rigid uniform price caps,

combined with a longer-term program to fix market design and regulatory flaws. You can call it anything you want—price mitigation,

since Fred Kahn is here, let’s call it a banana. The issue is to move

forward.

Of course, we need to be sensitive to the possibility that mitigation measures can make things worse rather than better if they are

poorly designed. Of course, we want to use mitigation mechanisms

that do not discourage new investment in generating facilities. Of

course, the proper long-run strategy is to fix the market and regulatory institutions that are broken. But we also must be concerned

about the interim cost to consumers and the economy of unmitigated market failures.

Despite the recent break in wholesale prices in the West—and I

would be happy to answer questions about that if you have questions—I remain concerned that hot weather plant breakdowns, reduced hydroelectric supplies, and remaining market design flaws

are likely again to present conditions that create the incentive and

opportunity for suppliers to engage in behavior that increases

prices significantly above competitive levels this coming summer. It

is this potential problem that should be the focus of immediate

mitigation efforts while we continue to focus on longer-term fixes.

As Senator Thompson observed, the summer is now upon us. The

practical mitigation options for this summer are, therefore, quite

limited. FERC did put in place a supply and price mitigation protocol in California on May 29, and I will not call it price caps, price

mitigation. Let’s see if we can build on it.

I would like to see FERC extend the number of hours to which

these mitigation rules apply to all summer hours, 7 by 24. I would

like to see it identify and close remaining loopholes available to resellers, and I think very importantly to find ways to integrate suppliers in other Western States into this mitigation program.

I do not think this is going to be easy. I do not think it will be

successful if FERC follows its usual course in applying these mechanisms. But I think it can be done if FERC staff and the control

area operators in the West work together to make it happen.

I also would continue to urge California officials to continue their

efforts to remove unnecessary barriers to the construction of new

generating plants, if any still exist, to raise retail prices to reflect

wholesale market prices, to implement real-time pricing, to restore

credit to the system, and to continue energy efficiency and conservation efforts.

Thank you. I would be happy to answer any questions you have.

Chairman LIEBERMAN. Thank you, Dr. Joskow. Thank you very

much. Right on time, too.

23

1The prepared statement of Mr. Makovich appears in the Appendix on page 365.

Dr. Lawrence Makovich is senior director of Cambridge Energy

Resource Associates, an energy consulting firm started by Daniel

Yergen, who many of us have been pleased to know and worked

with over the years. Dr. Makovich is an expert on electricity markets regulation, economics, and strategies, the author of several reports and articles on the future of the electric power business, and

a lecturer on managerial economics at Northeastern University’s

Graduate School of Business.

A pleasure to have you here.

Senator STEVENS. Mr. Chairman, do we have a copy of his statement?

Dr. MAKOVICH. I did submit a copy of the statement, yes.

Chairman LIEBERMAN. He did. We can get you one.

Go right ahead, Dr. Makovich.

TESTIMONY OF LAWRENCE J. MAKOVICH, PH.D.,1 SENIOR DIRECTOR AND COHEAD, NORTH AMERICAN ENERGY GROUP,

CAMBRIDGE ENERGY RESEARCH ASSOCIATES

Mr. MAKOVICH. Power prices in California are too high because

the power market has a real shortage caused by serious structural

flaws in the market design and in its implementation. California

did not follow the example of other power markets that use rules

to create a market for capacity. In addition, California’s complex

siting and permitting processes have created formidable barriers to

the development of new generating capacity that the State so badly

needs. Quite simply, California ran out of capacity because it did

not set up a market to pay for it or a process to enable it.

A third flaw in the California market design was the use of price

caps in retail power rates. As scarcity drove up wholesale power

prices in 2000, the majority of customers in California continued to

consume power at price levels frozen at 1996 levels. The retail

price caps distorted the market by increasing demand and driving

price spikes higher. Yet utilities remained obligated to provide all

the power people wanted at capped prices. As a result, price caps

had the unintended consequence of driving Pacific Gas and Electric, California’s largest utility with $22 billion of assets, from an

A credit rating to bankruptcy court in less than 4 months.

Of course, the bankruptcy also distorted the market by making

suppliers reluctant to buy fuel and produce power to deliver to

someone who was not likely to pay for it. Price caps, although well

intentioned, usually distort the market and create unintended consequences. We have already seen this in California, and the history

of price controls is a record of distortion and unintended consequences.

Price caps may sound simple in theory, but, in fact, they are anything but simple. The bureaucracy to administer them always becomes many more times complicated than originally expected.

Now, many people want price caps because they believe that

power suppliers are withholding capacity to drive up prices. If this

were true, then price caps would limit their gains. Further, this argument goes, if we could just get them to knock it off, then this

24

artificial shortage would end and power prices would drop back

down to reasonable levels.

Why do so many people want to believe in market power? Putting the blame on suppliers diverts blame from the basic design

flaws and weaknesses in the current California power market. An

examination of the California power market does not support the

market power hypothesis. Power generators have market power if

they can act to set prices; however, high prices alone can occur for

many other reasons as well.

The California power exchange began operation in 1998. In anticipation of this, we developed a computer model in CERA to analyze the interaction of supply and demand in the determination of

prices. When we simulate the Western power markets in 1998 and

1999 and compare the results to the actual market-clearing prices,

the evidence is quite compelling. During this period the California

power market was in a demand and supply balance, and we observe that wholesale power prices cleared at the level of short-run

operating costs—fuel, environmental costs—— Chairman LIEBERMAN. What time periods was that, Doctor?

Mr. MAKOVICH. This is 1998 and 1999.

Chairman LIEBERMAN. Thanks.

Mr. MAKOVICH. Fuel, environmental costs, and other operation

and maintenance costs.

Over this time frame, the California energy market was doing

just what it ought to do: Efficiently determining the utilization of

power plants to meet demand at each hour with price signals reflecting the operating costs of rival producers.

We must confront the fact that the industry structure that delivered a competitive outcome in 1998 and 1999 did not change in

2000. What did change was the demand and supply balance. Since

no significant generation additions were made, demand finally outstripped supply. Any market with a severe shortage of a commodity

that customers value highly and have few substitutes for will end

up with buyers’ bidding up scarce supply—in other words, a shortage or scarcity premium.

We must recognize that when supply and demand were in balance, the competitive energy market in California produced prices

with a level and volatility that was half of what was necessary to

support new power plant development. During 1998 and 1999, the

annual wholesale power price of power was between $14 and $30

a megawatt hour. The evidence is clear. The energy market alone

in California did not provide a timely price signal for new investment. As a result, the shortage was both predictable and preventable, and as early as April 1997, CERA published a report predicting just that.

Other markets have capacity markets along with energy markets—like Texas and New England—and they have been able to attract more than enough power investment in just a few years to

avoid similar shortages. We must face the fact that California competes with other power systems around the world to attract power

plant investment and price caps discourage investment. Remember,

the power business is one of the most capital-intensive businesses

in U.S. economy. California remains a highly flawed power market

in which the only way to recover costs above short-run operating

25

1The prepared statement of Mr. Wolak appears in the Appendix on page 371.

costs is through a periodic shortage premium. By adding price caps

to the current flawed California market design, investors will see

no way to recover the full cost of power investment through the

market. California cannot afford to continue to bring forth power

development by guaranteeing payment through long-term power

purchase contracts from the Department of Water Resources. The

State’s record in long-term power contracting is abysmal. Remember, half the stranded costs in California that drove the State to

deregulate were due to long-term power contracts the State mandated under the Public Utility Regulatory Policy Act. California has

not fixed its market to create a positive investment climate for

power development. To assist California, the FERC should insist on

a minimum set of structural elements in its wholesale market design. It will be a mistake to make price caps the centerpiece of a

Federal response to the California power shortage. They would

make a bad situation worse, and they do nothing to fix the flaws

that so desperately cry out for solution.

Thank you.

Chairman LIEBERMAN. Thanks, Dr. Makovich. Thanks for your

testimony.

And, finally, Dr. Frank Wolak, whose impressive credentials I

will describe now. Dr. Wolak specializes in industrial organization

and economic theory at Stanford University where he is professor

in the economics department. His recent work studies methods of

introducing competition into infrastructure industries and assessing impacts of this competition policies on consumer and producer

welfare.

Dr. Wolak is also notably the chairman of the Market Surveillance Committee of the California Independent System Operator

and, therefore, again, right in the middle of the California crisis.

Thanks for being here.

TESTIMONY OF FRANK A. WOLAK, PH.D.,1 PROFESSOR,

DEPARTMENT OF ECONOMICS, STANFORD UNIVERSITY

Mr. WOLAK. Thank you very much. I would like to focus my remarks on a specific issue, and that is really the design of what I

will call—Paul Joskow called it bananas. I will call it regulatory

interventions required under the Federal Power Act to protect consumers from unjust and unreasonable wholesale electricity rates.

First, I would like to state the two goals of regulatory intervention, and then I will briefly explain why I believe that the plan recently implemented by the Federal Energy Regulatory Commission

will fail to achieve these goals. And, finally, I will just summarize

the plan that has been proposed by the Market Surveillance Committee in its December 2000 report to FERC, which I do believe

satisfies the goals.

The first goal of market power mitigation is to reduce the average wholesale price that California pays to a level that would occur

in a competitive electricity market, given California’s current supply and demand conditions and the cost of input fuels. And any

successful market power mitigation plan has to guarantee that it

can at least satisfy this goal.

26

The second goal of a market power mitigation plan is also, I

think, very important, to alter the incentives faced by the market

participants so that it will no longer be profit maximizing for generators to essentially withhold capacity from the spot market by

bidding substantially in excess of the variable cost of producing

electricity from their facilities. The idea is essentially to alter the

rules in such a way that, post-intervention, spot market functions

in a manner that is consistent with the competitive market in the

vast majority of the hours.

I believe the market power mitigation plan that has been recently implemented by FERC is very unlikely to achieve these

goals. In the first place, the plan provides for no mitigation during

hours without system emergencies, and unfortunately, as has been

noted by a study prepared by the Department of Market Analysis

at the ISO as well as my own work with Severin Borenstein and

Jane Bushnell at the University of California Energy Institute, the

majority of overpayment due to the exercise of market power occurred during the hours when there were no system emergencies.

Consequently, this market power mitigation plan currently fails to

address the greatest source of the unjust and unreasonable prices

in the California electricity market noted by the Federal Energy

Regulatory Commission is its November and December 2001 orders.

So even if this mitigation plan was extended to all hours, it still

has the potential to be virtually ineffective at mitigating market

power. For example, the plan only requires generators give all their

uncommitted capacity into the ISO’s real-time energy market at

what is called a proxy bid price, which is computed by ISO to essentially account for the heat rate of the unit, the price of natural

gas, and the price of other inputs that the firm might use.

However, a very straightforward way for generators to avoid this

requirement, is simply to sell its energy in advance to a power

marketer, and then even if this firm sells its energy to an affiliated

power marketer, that will satisfy the condition that FERC now has

to saying the capacity is committed, and therefore not subject to

the mitigation measure.

So this aspect of the FERC plan creates a very simple strategy

for a generation owner to essentially obtain higher prices. The firm

simply sells its energy to an entity located outside the State on a

day-ahead basis. This effectively commits the capacity, so it is no

longer subject to the real-time bid rule. Then in real-time market

approaches, the ISO discovers it is short of electricity in California,

and must find some out-of-state producer to sell into the market.

Under these circumstances, the out-of-state suppliers can effectively bid whatever they wish into the ISO’s real-time energy market, because they certainly have the option of not supplying energy

into California if they do not receive the price they want. And

through this process, a generator located in California can effectively achieve significantly higher prices than what are certainly

seen to be envisioned by the mitigation plan by selling outside of

the State at a high price, knowing that in all likelihood, this power

will be sold back into the State in real time when the ISO calls the

out-of-state supplier to produce more energy, because as all market

27

participants know, California is a net importer of energy, and this

is particularly the case in the summer months.

And to give some idea of the potential profitability of this activity, it is not unusual for a megawatt delivered to California to

trade between 5 to 10 times in the forward market before it is actually consumed. So a second aspect of the order that I think will

render it ineffective, even if it is applied to all hours, is that generators still have the ability to receive their justifiable costs, rather

than the market-clearing price computed by the ISO using the generator’s proxy big prices. So, for example, if a generator’s proxy bid price is computed by the ISO to be $50, and if this unit is necessary to serve demand and it bids its cost-justified bid of $150, if

the bid is necessary to serve demand, the generator will be paid its

bid for $150 for the energy supplied, not the $50 per megawatt

proxy bid market clearing price.

So, consequently, even though the market-clearing prices posted on the ISO website would say $50, generators can receive substantially in excess of this market clearing price if they are willing to

cost justify their bids in the ISO’s real-time energy market. And

given FERC’s unwillingness to order significant refunds from generators and their use of a methodology that is exceedingly generous

to generators in determining the recoverable production cost, it is

no surprise that right now many generators are currently submitting bids that are accepted and paid as bid at prices significantly

higher than the market-clearing price set by FERC under its recently implemented market power mitigation plan.

So this provision for paying as bid for energy is very similar to the $150 soft-cap policy, which was implemented in 2001. This policy said that all bids in excess of $150 had to be cost justified, and

if necessary to serve demand, they would be paid as bid. And during the period July 1, 2001 to May 1, 2001, even though there was

$150 soft price cap in place, average prices in the ISO’s real-time

market were in excess of $250 per megawatt hour. So this guarantee by FERC in its former soft-cap regime, and in this recently

implemented mitigation plan to pay as bid any cost-justified bids,

as I think the best illustration of the point that cost of service regulation, which is essentially what the soft-cap policy is, without a

prudency requirement, is the equivalent to no regulation at all. Unless FERC seriously investigates the prudency of these claims cost,

something it did not do during the former soft-cap regime, the current mitigation plan will once again return California to a world

without effective market power mitigation.

And the final aspect of the FERC mitigation plan is that if it

were applied to all hours, and even if these two problems described

above were solved, it is extremely unlikely to achieve the second

goal of market power mitigation, because it just does nothing to

alter the incentives of generators to bid aggressively in the spot

market and to maintain their units in top working order. This is

effectively the point made by Senator Feinstein. In fact, on the contrary, the plan creates strong incentives for generators to declare

forced outages and planned outages of their low-cost units so these

units will not set the market-clearing price, but instead, their higher cost units will more frequently set the market-clearing price that

is earned by all the units.

28

And, so, moreover, this mitigation plan creates incentives for

generators both in and out of California to sell outside the State

for the reasons discussed above, so consequently, the FERC plan

has the potential of creating the worst of both worlds for California,

a less reliable grid, because generators do not want to sell into

California and have little incentive to maintain their plants, and

high prices because it is very easy to cost justify virtually anything

with no serious prudency review on the cost incurred.

And just to finish up, the December 1 Market Surveillance Committee Report presents a plan which I think can achieve both of

these goals, and this remedy does not impose a soft cap on the spot

market, but it does require FERC to make a one-time regulatory

intervention that results in just and reasonable rates in California

for the next 2 years. The essence of this plan is that all sellers in

California would be ineligible to continue to receive market-based

rates only if they offer 75 to 80 percent of their expected annual

sales in the form of a 2-year forward contract at a price set equal

to the perfectly competitive benchmark over this time period. This

after all is market-clearing price that the FERC no-market-power

standard explicitly stated in its competitive market requirement for

a participant to receive market-based rates. So consequently, with

this mitigation measure in place, the firm still has a significant upside potential, but California consumers are protected from the significant volatility in the spot market for at least 75 percent of their

sales, and moreover, this plan will create the incentives for generators to be aggressive competitors in the spot market, to maintain

their plants in top working order, and the other advantage of it is,

it is simply a one-time intervention, and has no danger of essentially, once implemented, remaining in place. Thank you very

much.

Chairman LIEBERMAN. Thank you Dr. Wolak. Thanks to all of

you for very interesting and thoughtful and helpful testimony. You

have come from different places. In fact, four of you were asked by

the majority, two by the minority.

Generally speaking, it sounds to me that though there may be

some disagreement on what action FERC should take, just about

all of you agree there should be some price mitigation action, although I do want to give you a chance to clarify, Dr. Makovich, because at the end of your statement, you spoke out strongly against

price caps. Do you think there is any role here for FERC to play

in what Dr. Joskow and others have called price mitigation in the

Western markets now?

Mr. MAKOVICH. The price mitigation idea, as Dr. Wolak has said,

there is this opportunity to get around it with the power traders.

There is also a problem here that half of the power produced in the

west is not under FERC jurisdiction. So on a practical basis, it is

hard to imagine that this kind of bid capping or price mitigation

is really going to work, given the reality of the jurisdiction limits

out there and the ways to end run this set of regulations.

Chairman LIEBERMAN. So what would your answer be to folks in

California who say that prices are too high; in a year and a half,

supply is going to equal demand because of the power plants that

are coming online; we have done all we can in California; the power

plants are moving again; conservation is working, we are 11 perVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 75477.TXT SAFFAIRS PsN: SAFFAIRS
29

cent down; but we need the Federal Government, through FERC,

to come in and do something for us in the short-term, temporary

price leash. What would you say in response to somebody from

California who asked you that?

Mr. MAKOVICH. Well, there is a number of things that needed to

be done in the short run, some of which were not done. So the price

increases that we have seen were important, but they are very uneven. We have yet to—— Chairman LIEBERMAN. Things not done by FERC, you mean?

Mr. MAKOVICH. The retail pricing pieces. What has not been done

in the short run is there should have been more done to bring additional supply in for this summer. And people say, well, it takes 4

years to build a power plant. But the truth is, I know people that

can build barge-based emergency power systems in the Houston

ship channel, and within several months could have that power

plant—they could have hundreds of megawatts of additional supply

in various locations through California. There were proposals to do

that last year. Those proposals were denied. There are, according

to the California Energy Commission, 5,000 megawatts of emergency backup generation that we have never taken the legal and

environmental restrictions off temporarily to coordinate that supply

to have it available for this summer to help meet these demands.

So there are a lot of things that can still be done in the short run,

short of price caps, to help mitigate the blackouts that are coming.

Chairman LIEBERMAN. Dr. Borenstein, would you like to respond

to that?

Mr. BORENSTEIN. Yes, I would like to respond to a number of

things. First of all, I think Dr. Makovich did not hear the news,

that in the last couple of days, there has been a lifting of a lot of

the environmental restrictions, and so a lot of those backup generators are going to be allowed to run.

Chairman LIEBERMAN. By the State.

Mr. BORENSTEIN. By the State. They are heavy polluters and

that is certainly not the way I would go. If I ever asked beyond

price caps what the State should be doing, is pushing much, much

harder on conservation than we are pushing. We still have buildings air conditioned to the point that people need sweaters, and

that is just crazy, given the situation.

I think it is really not accurate or at least not relevant to say

that half of the power produced in the west is not FERC jurisdiction. Most of that is public power. In the case of municipals, who

produce their own power, those are not—they generally are not

ones exercising market power. It depends on their net import or

net export position. Most of that power is produced by public utilities who are just consuming their own power. So I think the argument that there is a lot of power you could not control, is not a reason to implement price mitigation. It is true that demand has outstripped supply, but I really have to say, if Dr. Makovich’s company

is advising companies and telling them that you cannot exercise

market power in this market, they need a refund, because if you

are in this market, and you own 4,000 megawatts of capacity in

California, and you cannot exercise market power, you are not paying attention. It is really pretty straightforward. It is something

that many of us pointed out before the market even opened. It is

30

something that we have interacted with people at these companies,

who are certainly aware of their ability to do it. They have argued

that they are not doing it, but I think that if that is the case, it

is out of benevolence, which is not how capitalist systems actually

work well.

Chairman LIEBERMAN. Let me ask one or more of the five of you,

who have advocated some sort of price relief by FERC on a temporary basis, to respond—there was some mention of it, but I

would like to hear a little bit more about it—to respond to the argument that price relief or price caps—although that is a bad term;

price relief or mitigation is better—if they are imposed, they are

going to cut off supply by reducing the incentive for new power and

new power plants by intervening in the market in that way.

Dr. Kahn, what is wrong with that argument?

Mr. KAHN. The whole history of regulation of the electric power

industry has been one in which the effective regulation on capacity

has always been deemed to be one of encouraging excessive expansion of capacity. There is no reason why, if you set rates that insure an operator return on investment that is sufficiently high to

do so, that it will discourage construction of new capacity. And it

seems to be it is very useful to look in history. People just say it

and say it and say it, but I was never aware of any contention—

I was chairman of the New York Public Service Commission and

studied this for 50 years—that anyone has ever argued that had

the effect of retarding investment. On the contrary, it is a very

well-known phenomenon, which Paul Joskow has studied, and it is

not always empirically demonstrable, but I have never seen anybody argue it had the opposite effect. The only thing that had the

opposite effect was, of course, the uncertainty in the 1990’s about

what was going to happen.

Mr. JOSKOW. Senator Lieberman, let me take a crack at this. I

think the greatest danger right now to new investment in California and the rest of the west is the continuing chaos in the markets out there and the uncertainties about public policy. The price

mitigation programs that have been proposed by a variety of different people, yield prices that make it very profitable for new efficient generating plants to enter the market. Those plants lined up

for permits back in 1998 when prices were very low. The new

plants are 30 percent more efficient thermally than the existing

plants. They emit a tenth of the nitrous oxide of the existing

plants. There are just enormous incentives, once those plants can

get licensed, to come in to the market, and many of them are being

built in California, and in Arizona, and in Nevada. So if this is

done effectively I think it will in fact, make it easier for investors

to commit resources to the west because they will have a stable

market and regulatory environment against which to shoot at.

Chairman LIEBERMAN. Let me just say it is an important point,

because we hear this in a host of different economic areas here in

Congress. The business community is always asking for stability,

predictability to base their judgments on. But as both of you are

saying, obviously, a price mitigation will, under anybody’s vision of

it, preserve a healthy profit margin for the producer. So, presumably the market will still be there, sufficient to encourage them,

31

1Letter from Wayne D. Angell, Bear, Stearns and Co., Inc., dated June 11, 2001 appears in

the Appendix on page 556.

particular with the stability and predictability we are talking

about, to get into the business, which they are.

Mr. JOSKOW. Yes, indeed, and there is a very good study that has

been done by an economist at the California ISO, Eric Hildebrand,

which looks at exactly this question, if we kept prices at the competitive levels that a number of us have simulated, there is still a

very healthy margin for new investors. I would like to get us out

of the game of placing blame, of demonizing the suppliers, to recognize we have to do something in the short run to keep the system

from going out of control, make long-run fixes, but to provide a stable regulatory and economic environment for new investors to invest in. I think that is substantially more important than continuing what I think will be continuing chaos and the blame game

over the next 18 months if we do not take effective action now.

Chairman LIEBERMAN. Dr. Wolak, did you want to say something?

Mr. WOLAK. I just wanted to add something following up on what

Paul Joskow said. I think it is very important to bear in mind the

time lag that it effectively takes in a decision maker deciding

whether or not to build new capacity. What he is interested in is

not the prices right now, not the prices a year from now, not the

prices even 18 months to 2 years from now, but the prices after the

period when the plant is in the ground and producing.

So following on what Paul Joskow said, if what we—the fear I

think of many firms is, what will happen in California if we go

through this summer and it is a complete implosion, then it will

be public power or whatever strange solution comes out of the California initiative process and that will be the sort of thing that I

think will chase all investment away, because of the fact that it

takes 2 years to build a power plant. So high prices now do nothing

to signal new investment to come into the market. It is the expectation of high prices 2 years from now to 3 years from now, when

that plant is in the ground and operating, that cause me, as a rational firm, to invest in the market. All you are doing by mitigating

prices within the interim 2-year period, is simply just not distorting

any investment decisions, but just reducing essentially the punishment, as Professor Kahn said, that consumers have to bear during

that period.

Chairman LIEBERMAN. Thanks. My time is up. Senator Thompson.

Senator THOMPSON. Thank you very much Mr. Chairman. This

is a great panel, because we have so many people who are so much

more knowledgeable than we are, and it is always good when we

are struggling to try to keep up. I think maybe we are making

progress.

But on that point of investment, and listening to you talk about

that, it sounds like a rosy scenario compared with some of the

things we have heard from some people involved in the activity. In

a June 11 letter,1 Bear, Stearns’ senior managing director and chief

economist Wayne Angell writes that price controls are a recipe for

disaster. He goes ahead and makes the usual points, I guess, conVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 75477.TXT SAFFAIRS PsN: SAFFAIRS
32

2Prepared statement from William C. Dudley, Goldman, Sachs and Co., appears in the Appendix on page 558.

cerning price control, but he says the confidence in the investment

community has already been severely damaged by California’s regulatory policies, and 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. A prepared

statement of June 13 from William C. Dudley,2 chief U.S. economist, Goldman, Sachs; he says that price caps would deter the type

of investment in electric power generation and transmission capacity that the State of California seeks to encourage. The risk would

rise because the imposition of price caps is by nature arbitrary as

to level, timing and duration. If caps were imposed, this would increase investor anxiety that the caps could in the future be lowered, broadened, extended, in terms of duration. He says, ‘‘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, and imposition of

price caps work against this.’’ We may be comparing apples and oranges here, but I would ask that these two statements to be made

a part of the record here.

Chairman LIEBERMAN. Without objection.

Senator THOMPSON. People in the community are concerned

about the attractiveness of California in the current environment

as far as future investment is concerned. It seems to me that it is

important to understand the nature of the problem, complex in

some respects, not so complex in others, perhaps. It seems from all

of you have said, and other experts have said, that we do in fact

have a system, that is not working and from the very beginning,

had inherent flaws: Retail caps, which went against our need for

conservation; utilities with no ability to enter into long-term contracts, had to operate on the spot market, which looked good at the

time, and, well, looks good today, as I understand. Now that California has gone to long-term contracts, the spot market is down. So

they are buying high and selling low in both respects. Insufficient

capacity, perhaps insufficient infrastructure, weather, all these

problems come together. But in looking at all of that, and listening

to these comments, would anyone disagree with the proposition,

that as a part of this mix, California needs to allow retail prices

to rise more and be more consistent with the actual cost?

Mr. Kahn, if I understood you correctly, you referred to ridiculous freezing of retail prices. Mr. Borenstein, you talked about the

need for conservation. I do not see how we can get there without

that. Does anyone disagree with California’s need to do that?

Mr. WOLAK. I think it is important to make the distinction between the cost, prices that reflect cost versus prices that reflect

what people offer the power at. So I do not think anyone would disagree that prices that reflect cost should be passed on to consumers. The big debate is over exactly the extent to which the

prices that are currently being charged in the market, are reflective of cost, because of the fact that there is the standard under

the Federal Power Act that says that rates must be just and reasonable, and one way to obtain just and reasonable rates is rates

33

that recover costs, and as I said with the various studies that have

been done by the various members of the panel here—— Senator THOMPSON. Even if the retail prices were what you feel

like they ought to be, without the influence of market power, would

you still not agree that the idea of retail caps was a bad one?

Mr. WOLAK. I think the other thing to remember with the retail

caps is this is not something that is unique to California. This exists in every market that has been restructured in the United

States. The other thing that I think is important to remember from

the retail caps—— Senator THOMPSON. Retail caps, letting alone the wholesale

prices—— Mr. WOLAK. Fluctuating wholesale prices and——

Senator THOMPSON [continuing]. And caps along these lines?

Mr. WOLAK. Yes, it exists in PJM, New England, New York. It

is just the only difference is, is the extent to which there is an outstanding position on the part of the retailer to sell the power to

purchase from the spot market. And the other markets, the extent

to which they have to—if you like their net short for energy—is

much less. They own significant amounts of generation capacity to

meet their own loan obligations, whereas California, because of the

divestiture, had large amounts of net short, and that really is a

major source of the problem.

Senator THOMPSON. These other States that have deregulated,

for example, have allowed long-term purchases, have they not?

Mr. WOLAK. Yes. California did as well. It is just that—the unfortunate thing is that California allowed the investor-owned utilities

to do that. It is just that the incentives that the investor-owned

utilities faced at the time were such that it was a good deal not

to engage in long-term contracts, so it is not an explicit prohibition.

Senator THOMPSON. Mr. Kahn, would you comment about the efficacy of these price caps?

Mr. KAHN. Yes. Two things. One, looking at it now, of course, it

is clear that the imposition of rigid retail caps was a mistake. At

the time, it may have seemed a reasonable bargain, because you

will remember that 4 or 5 years ago, the main concern was that

the distribution companies, the big electric utilities, would be left

with stranded costs. That is, the cost of over investment in capacity, the cost of those huge contracts that they were forced to buy

at artificially-set prices, and so at the time, it looked like a bargain.

You give us the assurance that we will be able to recover our

stranded costs. In exchange, we will freeze retail prices. So we have

to be a little bit gentle. The fact is, after the fact it has proved to

be a catastrophe from the point of view of the companies who in

effect—— Senator THOMPSON. There comes a point in time in which public

officials, theoretically, should be able to perceive that it was a bad

idea.

Mr. KAHN. I think that is right.

Senator THOMPSON. Mr. Makovich, do you have a comment?

Mr. MAKOVICH. Well, I think the idea that this problem can be

solved simply by long-term contracting is one that is also a fairly

dangerous idea. There is a couple of problems there. One is, suppose we got 80 percent of people to voluntarily contract long run

34

of their demand in California. If then we rely on the spot market

to supply the rest of it, and people will not build on the basis of

the spot market, which we have already seen, and we come up

short again. We do not have the capability to cut off the customers

that are covered under long-term contracts versus those that are

not. So there is an enforcement problem here, because when we

shed electric customers in a blackout situation, we shed circuits.

We do not differentiate one customer to the next.

Second, if long-term contracts are the solution, and they keep the

market in balance because the price is high enough to cover all the

cost of a new power plant, power marketers are going to attack

them because they are going to be able to buy on the spot market

that clears on short-run costs, and they are going to be able to have

a short position, sell long term—— Senator THOMPSON. You are getting a little down into the weeds

for me. [Laughter.]

Mr. MAKOVICH. Right.

Senator THOMPSON. I am not making a case for long-term or

spot. I assume you need both. What I am trying to get at is a decent analysis of the structural situation that underlies this and

presents the problem.

Mr. MAKOVICH. Suffice it to say, long-term contracts alone will

not solve the problem we have in California.

Mr. BORENSTEIN. If I can answer on retail rates, I very much

agree with you, and we were very slow in California to raise retail

rates, and I am fearful that as the bills arrive in the next few

weeks, particularly residential customers are going to find out their

bills did not go up very much because they did not on average. But

I think it is important to recognize that electricity is not a storable

good. The cost of providing electricity is something that varies hour

to hour tremendously, even in a completely competitive market.

Senator THOMPSON. So these great spikes we see, I understand,

are just momentary.

Mr. BORENSTEIN. Right. We have deregulated the supply side of

the market and have not deregulated the demand side of the market in the way we really need to to make that work, and that is

with real-time pricing. That is, prices that are sent through reflecting the rate, the real rates. If all we do is just raise the flat retail

price you are going to be facing an incredibly high price in the middle of the night which is way too high, and the same price on a

hot summer afternoon when it is way too low. What the real mistake California did on the retail rate is not the freeze, I would say,

although I think that is a big part of the problem, it is that we did

not get to pricing on the retail side that really reflects the scarcity.

Senator THOMPSON. Can I impose on the Chairman, and ask Mr.

Joskow to respond to that also?

Chairman LIEBERMAN. Sure.

Mr. JOSKOW. I agree completely with Mr. Borenstein, who by the

way, was my student. I think California was too slow in increasing

retail rates, but I also think it is important to make these markets

work, that at least some significant fraction of demand be on realtime prices.

Just to give you an example from June 2000. On June 8, the demand was low and the price was $50. On June 13, 2000, demand

35

spiked and the price went up to $750. You cannot respond to that

if you are not seeing those prices, and if you get your bill a month

later that tells you that you paid that. One of the things that

makes markets work is that consumers can say no when they see

a high price. If you go into a restaurant and you see on the menu

that a hamburger is $85, you say I am not going to have a hamburger. I will have a tuna sandwich, or I will have a salad. You

cannot do that now in these electricity markets, and they are just

not going to work until we implement these kinds of strategies.

We have made a lot of mistakes. There is a lot of blame to go

around, not just in the west. In New England, in New York and

PJM, this was much harder to do than a lot of people thought. We

need State and Federal regulators to work together to fix these

problems, not just in California, but elsewhere in the country, and

I think that really is the big issue, not finding blame. There is

plenty of blame to go around. But to get FERC, to get the State

commissions, to get the reliability councils together to make the

system work in the short run and the long run. I think we can

mitigate prices in California this summer if we take that approach.

I agree with Frank Wolak. It would have been better if they had

followed advice that was given to them by the Market Surveillance

Committee last summer. But FERC essentially ignored the Market

Surveillance Committee. But here we are. It is June 13. The summer is upon us. We have got to work quickly together to get us

through this summer and probably next summer, while we do not

forget that we need to fix the longer run problems as well.

Mr. KAHN. This is not a new idea, 25 years ago the price of electric power on Long Island was 5 cents a kilowatt hour, morning,

afternoon, evening, summer, fall, winter, and spring. By the time

I left, we had all big commercial and industrial consumers on timeof-day meters, and the prices ranged from 2.5 cents at night to 30

cents when the thermometer got above 84 degrees. That was 1976.

Mr. JOSKOW. Fred was being modest when he said he knew nothing about electricity. He was the chairman of the Public Service

Commission in New York, and in fact, implemented these ideas in

New York State.

Chairman LIEBERMAN. Thank you both. Senator Carnahan.

OPENING STATEMENT OF SENATOR CARNAHAN

Senator CARNAHAN. Yes, thank you, Mr. Chairman.

I realize that our topic today is about energy in California, but

I want you to know that the people of Missouri are very concerned

about the energy picture as well. They have watched as the crisis

has unfolded in California, and they have worried also as their own

fuel prices have spiraled. I have heard from a number of people

whose natural gas bills have doubled, and in some cases tripled,

just since last winter. Many of them are seniors on fixed incomes

and working families who are barely making ends meet.

So as we talk about the economics of the electricity industry

today, we should be mindful that this discussion is about far more

than just competing theories. And it is about more than beliefs in

free markets. It is about the everyday lives of real people and the

impact that our decisions have on them.

36

The price spikes in many States, combined with the crisis in

California, and the current debate about a national energy policy,

have caused confusion and anger all across America. In the past,

most of us purchased our electricity from a single regulated utility.

State agencies determined the utility’s cost in producing the electricity, added a reasonable profit, and set the price charged to consumers. Changes in the electricity industry, including technology,

have allowed us to consider new deregulated systems. Under such

a system, consumers would choose from whom they wished to buy

electricity. Many have argued that competition should lead to lower

prices, but California’s experiment with deregulation has caused

serious doubts among many Americans.

Whatever the original cause, California’s problems have been

compounded by the hands-off approach of FERC. Instead of vibrant

competition, California has suffered from shortages and skyrocketing prices.

Does this mean that deregulation is bad policy? No. We may very

well conclude that the best interest of the American people are

served by deregulated electricity industry, but I think we must ask

a very fundamental question. Is a deregulated market the same

thing as a competitive market? I think California’s experience

shows us that the answer is clearly no.

Obviously, the deregulation must be approached with caution.

The transition from a regulated industry to a competitive model is

a process that will require a willingness to make adjustments.

When the initial approach proves unworkable, corrections must be

made. During that transition, we must ensure that someone has

both the legal authority and the will to look out for the purchasers

of electricity. Thus far, the sellers have proved adept at protecting

their own interest.

Undoubtedly, as academics, each of you will continue to study

the wisdom of California’s approach to deregulation for some years

to come. However, one thing is clear today: The responsibility for

insuring just and reasonable prices in the wholesale electricity

marketing in California and around the Nation lies with the Federal Government and particularly FERC.

As you may know, Senator Lieberman and I recently wrote to the

General Accounting Office to express our concern about recent reports that market power has been abused in California. It is alleged that this, in turn, has contributed to the spiraling cost of

electricity in the State. We have asked the GAO to use its oversight

authority to review whether FERC is up to the task of ensuring

just and reasonable rates.

The recent debate has centered on whether FERC should take

measures to help ease the pain during the transition to a competitive market, and I hope that today’s discussion will continue to

shed light on that question.

I believe that part of the long-term solution to California’s problems lies in additional infrastructure—more generation and additional transmission capacity. Some have argued that any transitional efforts by FERC would disrupt much needed investment. I

must tell you that I am not entirely convinced by that argument.

Pennsylvania is often held up as an example of how to manage the

transition to a competitive market correctly. I find it interesting

37

that there are price caps on both the wholesale and retail markets

in Pennsylvania during the transition.

I understand the need to protect incentives for investment. However, I must question how much incentive is required. It seems to

me that the profits of the energy companies are more than adequate incentives to be a part of this industry. For example, last

year the operating income of Enron, a Houston-based energy company, rose 140 percent from the previous year, from $802 million

in 1999 to $1.953 billion in 2000. By comparison, Anheuser-Busch

is a Missouri-based Corporation with a reputation for being a very

well managed company. Last year, they experienced outstanding

sales and growth. Their operating income grew by 8.4 percent, compared to Enron’s growth of 140 percent. Last year, the S&P 500 declined by 9.1 percent. Anheuser-Busch outperformed the index with

a return of 30.5 percent, but Enron surpassed the S&P 500 with

a whopping 89 percent return. This level of return indicates that

the incentives to invest in the energy sector are firmly in place.

I believe we can reasonably conclude that this will result in additional supply. Once this additional supply is in place, I would hope

the market would level out. So my concern is how we protect the

interest of the consumers during the intervening period. As we

make the transition to a truly competitive market, who will ensure

that prices are just and reasonable? Thus far, FERC’s response has

been timid. In my view, this will not do. I hope that today’s questions and answers will provide insight into how the Federal Government can play a constructive role in relieving this temporary

but extraordinary crisis.

Mr. Chairman, I am having to leave in just a moment, but I

would like to ask Mr. Borenstein one question before I do.

As you know, many States are examining the deregulation proposals now. These States may continue to believe that competitive

electricity markets can provide long-term benefits to consumers.

However, they are concerned about what is happening in California. You have researched the situation in California extensively,

and based on your research of what is happening there, what lessons can States like Missouri—that have not yet moved to deregulation—what can we learn? What guideposts should States use as

they design a deregulation process?

Mr. BORENSTEIN. Well, there are a number of things that I think

we can learn from the California experience. And they almost all

fall under the general notion of making sure that there is the infrastructure support for having a competitive market. If you are going

to move to a competitive market, you have to make sure that the

supply side of the market will be competitive. To do that you have

to have analytical tools that will let you look into the structure of

the market and what sort of prices it will yield. In fact, these tools

were around in 1995, and many of us were suggesting FERC use

them, and FERC ignored them, and went ahead using a completely

antiquated approach of simply looking at the market share of each

player. But if you use the right tools, you can see how much divestiture into separate companies would be necessary to get a competitive market. At the same time, you have to have price responsiveness. You have to be willing to let people see the prices, and as I

said to Senator Thompson, you have to be willing to let the people

38

see the prices in a way that reflects in real time what is going on

so they have an opportunity to respond to those prices.

Then of course you have to have the infrastructure to actually

carry the power around. One of the mistakes that California made,

which has not really come to the fore yet, but will in the next few

years, is that we deregulated without having a real vision of how

to invest in transmission capacity in a deregulated market, and

transmission investment, as a result, has virtually come to a halt.

So we really do need to have a system that will beef up transmission and will then price power appropriately at each location in

the system. If you do that, if you make sure you have a competitive

supply in the market, if you make sure you have a demand that

can respond to prices, I think you can go forward with electricity

restructuring that can really work. At the same time, you do want

some fall-back position, and the way you get that is as you enter

restructuring, you have long-term contracts in place or ownership

by the regulated utilities, that are effectively a hedge. One of

things I pointed out in Pennsylvania is Pennsylvania has had huge

price spikes. It is just that Pennsylvania buys very little power on

the spot market because they have effectively hedged, because the

utilities continue to own almost all of their capacity.

But I think if you follow that recipe, it is still a recipe for success

and eventually for benefits to consumers in electricity markets.

Senator CARNAHAN. Thank you very much.

Chairman LIEBERMAN. Thanks so much, Senator Carnahan. I

just want to indicate that I appreciate that you were one of the

first to draw this subject to my attention anyway. I know our staffs

have met with GAO, and we hope for some kind of interim report

in the next three or 4 weeks to our request. Thank you. Senator

Collins.

OPENING STATEMENT OF SENATOR COLLINS

Senator COLLINS. Thank you very much Mr. Chairman. I have

really enjoyed this hearing today and the chance to hear such a

distinguished panel of economists present their divergent views on

this issue. I think that the competition that we have seen among

ideas here is as important as the competition that we hope to see

among electricity generators.

I do want to take advantage of this opportunity, as the Chairman

has suggested, to share with the Committee some of my thoughts

on this issue. Many of our States, including my home State of

Maine, are striving to promote more competition in electricity markets. Maine was one of those States that pioneered this and

plunged very early into the brave new world of deregulation. Competition in properly functioning markets, should, over the long

term, result in cheaper prices, better service, and more innovative

products for our consumers. Since price caps limit competition, they

should be avoided in properly functioning markets. Unfortunately,

however, electricity markets do not always function properly, and,

as we have seen, California is a clear example. California’s electricity markets are not functioning correctly because they were not

set up correctly. When you do not allow retail prices to rise in the

face of electricity shortages, you are setting up a flawed system. It

is clear to me, based on the testimony we have heard today, that

39

California needs to restructure its market to remove artificial barriers that inhibit the marketplace. Even in an electricity market

without the kinds of major design flaws that we have seen in California, however, there are still some factors inherent in the nature

of electricity that can cause the market to function improperly. Because electricity is generated and consumed simultaneously, and

cannot be meaningfully stored or inventoried, there are essentially

8,760 hourly electricity markets each year. Even if the markets

work most of the time, there may be hours when, because of an imbalance between supply and demand, they are not workably competitive. This can lead to incredibly high prices. Since it is impossible for most consumers to respond to high hourly prices, the sellers of electricity can raise their prices an unlimited amount for

short periods.

I want to give you an example that affected my State last year.

During a few hours last May in Maine and the rest of New England, the price of electricity in the spot market went to $6,000 per

megawatt hour. That is more than 100 times its usual level, and,

as Dr. Kahn and others have pointed out today, very few customers

saw this price spike in a timely way. They could not adjust their

demand. They could not respond by turning off their air conditioners for a few hours, or waiting until later to do their laundry.

So in this instance, in my judgment, the market simply did not

work. Subsequent to this price spike, FERC imposed a price cap of

$1,000 per megawatt hour in New England during periods of significant supply shortages. Given its limited applicability and the

extremely high level, this cap seems to me to be a reasonable response. Furthermore, there is no evidence at all that it is deterring

new plant construction in our region.

I want to emphasize that ultimately our goal by speaking is to

alert the consumers, not just in California, but in the Nation as a

whole. In Maine, homeowners and businesses alike are burdened

by some of the highest electricity rates in the country. In fact, one

of the reasons that Maine jumped into deregulation early was the

hope and the elusive promise that it would lead to a lowering of

electricity rates since we have always been at a competitive disadvantage compared to other regions in that area. Households are

seeing their electricity and other energy costs eat up more and

more of their incomes, and many businesses, particularly manufacturers, are seeing smaller and smaller profit margins as more

money goes to purchase energy. Some businesses in Maine are even

threatening to move to other regions where electricity prices are

lower. I hope that we can succeed today in helping to identify solutions for California, but I also hope that our goal is to identify ways

to lower electricity prices in the rest of the Nation. We need to look

closely, and we have looked closely, at the lessons that we can

learn from California, and we also need to be careful that we do

not blindly apply California-size solutions to New England, which

has been by and large very successful in avoiding California-size

problems. In fact, we have had a number of new generating plants

come online, and yet we are still experiencing these distortions in

the market.

In the final analysis if we are firmly committed to competition,

as I believe that we should be, we cannot seek government interVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00047 Fmt 6633 Sfmt 6633 75477.TXT SAFFAIRS PsN: SAFFAIRS
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vention whenever the prices are high. But on the other hand, we

must recognize that electricity markets have unique characteristics

which may cause them to not work competitively at times. Thus,

in dealing with electricity issues, I think we need to combine competition with common sense. Finding the right mix, that which will

lower electricity prices for all Americans, is no easy task, but this

hearing provides a basis for us to try to strike the right balance.

I do want to ask Dr. Kahn a question, since I agreed with so

much of what you said in your statement.

Mr. KAHN. That is funny, Senator. I was going to say I wish I

had written what you just said.

Senator COLLINS. The approach you have suggested makes much

sense to me, as does the idea for short term carefully constructed

price caps. My one concern is that we have seen price caps that

were intended to be temporary, become permanent. We have seen

these results. And I like what you have suggested about having

them designed to be temporary, to automatically sunset them and

to make them inapplicable to new capacity coming online. But, can

you give us some more guidance on what you think should trigger

the expiration of the price caps in the kind of scheme that you have

described?

Mr. KAHN. There are only two ways that occur to me, both of

which I have mentioned. I like the idea of automatic sun setting;

that is to say, one makes a reasonable estimate of what it takes

for new capacity to come online and then requires a reenactment,

rather than requires an explicit repeal. So that was the one that

I suggested. We have been through a period 30 or 40 years ago

where we tried to differentiate caps on old and new sources of supply in the case of natural gas. And I think we would have to say

that was not a success, to put it mildly. Whether that is feasible

in these circumstances, I truly do not know. Certainly, it is not a

good long-term expedient. Power is power is power, and it is absurd

to have discrimination in charges to different people. But some way

of making absolute the guarantee that new investment will not be

subject to any kind of—even if it is an arbitrary cap.

The only other observation follows partly from what I have said.

In electric power we have not had a problem of shortage under regulation. On the contrary, regulation, by assuring an adequate return on investment, has tended if anything, to encourage gold plating of service, and having excess capacity.

Senator COLLINS. Which is why everyone thought it was going to

be this boon to consumers.

Mr. KAHN. That is why we thought we had such enormous excess

capacity, including by the way, the inflated prices that the electric

distribution companies were forced to pay to independent generators. I think Dr. Makovich mentioned the ridiculous prices under

the Public Utility Regulatory Practices Act. It has all been in the

direction of encouraging excess capacity. That is why I kind of bristle when people say yes, but price controls always restrict supply.

You have to look at the particular situation. That is not true historically. But other than that, I am really repeating what I said,

different ways of ensuring automatically that new capacity coming

online will not be subject to these.

41

Senator COLLINS. Thank you. Dr. Joskow, do you have anything

to add to that?

Mr. JOSKOW. Yes, Senator Collins, very briefly. By the way, I

would love to subscribe to your statement as well.

Let me talk about New England just to move across the country.

I remember those $6,000 megawatt hours very well, and I think I

paid for them in August. In New England I think we can establish

a relatively small set of criteria for when the market is sufficiently

reformed to remove price controls, except perhaps for these kinds

of damage control price caps at very high levels, so that the price

does not go to $1 million a megawatt hour. So in New England

right now we are in the process of a major market redesign. There

are specific items that have to be completed. When they are completed, we should be in much better shape in terms of operating

the spot market and dealing with congestion management. We

have a number of power plants in Maine, New Hampshire, Massachusetts and Rhode Island that are in the process of being

completed. The New England ISO has a target minimum reserve

margin. We are going to reach that I hope next summer. That is

another criterion. Third, I think contract cover is important, that

retail customers and the entities that serve them, have substantial

contract cover. We are pretty good at that in New England right

now, and I think we need to stay at around 70 percent. Finally, I

would like to see us get about 10 percent of the load in New England on real-time prices, really, some of their demand, so they in

fact, can see and respond to the $6,000 a megawatt hour prices if

they emerge again. I see those structural fixes being in place over

the next 18 months, and I am hopeful that the markets in New

England will really be working well then, and that we can take off

any of the heavy-handed regulation and rely on continuing very,

very light-handed regulation to ensure that the markets work competitively.

Let me note that since last summer I have had more calls from

State officials in New England than I think I have the rest of my

life. Five of the six States in New England have restructured radically. They did many of the same things California did, and the

people there are scared. We cannot do what they can do in Missouri, which has not moved forward, and I have been very, very

pleased to see the kinds of cooperation that the market participants, the ISO, the kind of cooperation they have gotten from the

public utility commissions in the region, from the Governors of the

States, from the attorney generals. I really see people working together in New England in a very, very constructive way, and I

must contrast that with the atmosphere in California. Maybe we

are just more civilized in New England. I do not know, but——

Senator COLLINS. I have always thought so.

Chairman LIEBERMAN. We show a bipartisan agreement on that.

Senator COLLINS. That is right.

Mr. KAHN. I think it shows we can do a lot better if we work together, rather than just screaming at each other. Thank you.

Senator COLLINS. Thank you. Thank you very much. I really enjoyed your testimony. It was very interesting.

Thank you, Mr. Chairman.

42

Chairman LIEBERMAN. Thank you, Senator Collins, and thanks

for asking some questions about New England. Senator Voinovich.

OPENING STATEMENT OF SENATOR VOINOVICH

Senator VOINOVICH. I, too, have enjoyed the testimony this morning. It may come as a surprise to you that Ohio is the third-largest

energy dependent State in the Nation behind California and New

York, and back in March 1999, in my first State of the State address as Governor of our State, I called for a comprehensive energy

strategy to keep the lid on energy and utility costs for our citizens,

and to try and stay competitive with other States that I was concerned would be taking some of our businesses away because of the

lower cost of energy, particularly the State of Pennsylvania, which

was one of the first States to restructure. As a result of that effort,

we proposed and published the energy strategy report. That was

back in 1994, and we started to discuss the whole issue of restructuring and did not pass the legislation until 1999, but a lot of the

heavy lifting in anticipation of it was done during the 3 years prior

to my leaving the governorship.

One of the major provisions in the restructuring effort was that

rates were capped during the first 5 years of energy restructuring

to protect our consumers, but we were careful in terms of the rate

because we had to recover stranded costs, and we tried to get a reasonable return for our utilities, and it has worked out, and we have

had new energy producers come online, several thousand megawatts, and have another 13,000 or 14,000 in the pipeline. The thing

that bothers me about the new facilities coming on is that they are

all powered by natural gas, and because of some environmental

concerns, a new source review and lawsuits that were filed by some

folks in the northeast, they have turned away from the use of clean

coal technology for our coal, and of course we are all aware of the

fact that we could be doing a much better job in terms of taking

advantage of nuclear energy in this country.

But the fact is that we have a crisis in California, and everybody’s wringing their hands, and I think California did it the

wrong way. They separated the major functions of the generation

transmission and distribution system. Three of California’s major

utilities were required to divest large portions of their generating

capacity. They precluded major utilities from entering into longterm contracts for electricity supply and required that they sell

their remaining capacity on the spot market. I do not think they

did it right, and now the chickens have come home to roost, and

they have a problem.

The question I have for this panel is this: Does Congress need

to get into this and start passing legislation to deal with this problem, or should we let this problem be worked out through the traditional ways? Now FERC is involved. They got in a little bit late,

but they are involved in the process. Do we need Federal legislation to deal with this, or should we leave it to the system that we

have in place? You were talking, Dr. Joskow, about the governors

and the utility commissions getting together and working together.

FERC is now involved. What is your opinion about that? Should

the U.S. Congress get involved?

43

Mr. JOSKOW. Senator, I think that is a very good question. Ideally, I think no. I think FERC should enforce the law, and if I could

recommend anything, it would be perhaps a letter from the U.S.

Congress to remind FERC the Federal Power Act has not been repealed, Congress has not just deregulated wholesale power markets, that their job is to ensure that they work well and to continue

to oversight, of FERC, to get them to do their jobs. I think in the

longer run there are some questions in my mind as to whether

FERC is currently structured, both in terms of personnel and its

conception of its missions and its procedures, to oversee the development of well-functioning competitive electricity markets. I would

like to see FERC evolve more into an agency that is involved in

monitoring, identification of market failures, and mitigation. It is

structured as an agency that for almost 50 years basically did rate

cases when investor-owned utilities sold power to municipal utilities. I think the agency needs to change. It has got to be more like

the SEC in monitoring these markets, and I think that would be

a very productive thing for Congress to look at and to explore

whether amendments to the Federal Power Act are necessary to

make that happen. FERC’s responsibilities are now very different

from what they were only 5 years ago in terms of the quantities

of electricity, the amounts of money and the nature of the industry.

I think it does make sense to revisit whether that agency is properly structured and whether its objectives are properly focused on

the new world rather than the old world.

Senator VOINOVICH. Thanks. Dr. Hogan.

Mr. HOGAN. Senator, I think this is a very good question. Legislation by the U.S. Congress at this point would be premature, and

I think it is because the problems that you are dealing with here

are so complex, that trying to prescribe the solutions that are going

to be applicable for California and the rest of the country, cannot

be done through legislation. We have an example of that going on

in the discussion here today. When Fred Kahn introduced into

economist lexicon the term ‘‘banana’’, because of the difficulty of

getting the ideas across, he was talking about, as I recall, a situation where he wanted the same idea but a different name, because

he wanted to be able to talk about it politically. I think what is

going on here is we are talking about different ideas and putting

them all under the same name, and people are very confused as I

have heard it in the discussion today. For example, Senator

Lieberman said that five of us were in favor of price mitigation.

But I think, at least for part of the discussion, when I heard Paul

Joskow talking, he was talking about market failure mitigation,

and that is a helpful contribution to this discussion. I am in favor

of market failure mitigation, and I described a mechanism, the bid

cap scheme, that FERC has been pursuing that is directed at that

problem. It may lower prices. It may not lower prices. It is not targeted at price mitigation. That is not the objective, and I do not

think it should be the objective. I think correcting the market failures as quickly as possible should be the objective and that is

something that is not a good thing for the Congress to try to do.

That is something you need FERC to do. And then when you look

at FERC—I agree with Paul Joskow’s observation. I do not have

any question in my mind about it. I do not think that the commisVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 75477.TXT SAFFAIRS PsN: SAFFAIRS
44

sion is able to deal with these problems at the moment, and I think

they have been going in the wrong direction.

FERC’s responsibilities have changed in reality, if not in their

perception, and their responsibility has to be to design, and make

sure that people adopt the rules for effective markets, the kinds of

market infrastructure that Severin Borenstein has been talking

about. They have been very slow to do that, partly because they

feel confused by these very complicated problems. And if they are

confused by these complicated problems, imagine what it would be

like trying to write legislation. So the real challenge is to beef up

the FERC staff and change their mindset.

Senator VOINOVICH. One of the issues that this Committee has

been dealing with, and I have been addressing in the Subcommittee on Oversight of Government Management and Restructuring, is the human capital crisis that we have in the Federal

Government. I would be interested in your observations. If it is like

some of the other agencies, such as the Nuclear Regulatory Commission, for example, the number and quality of people really needs

to be punched up if we expect it to do the job that it is supposed

to be doing.

Mr. HOGAN. They have some very good people at FERC, but they

do not have enough, and they need more, particularly people

trained in markets and able to deal with market design issues.

They increased the size of that staff to reorient the agency and to

make the Commission take it on that it has a new job—market design.

Mr. JOSKOW. And let me give you a couple of good examples. The

Federal Trade Commission has a large economic staff that is fully

integrated with the lawyers and others in enforcement and investigations. It is considered to be a prestigious place to spend a couple of years if you are an economist. The Antitrust Division of the

Justice Department is a similar type of arrangement. FERC has

lost some very good people in economics and markets, and they

never really had enough. I really think that we should look at other

agencies that have been successful, like the Federal Trade Commission and the Antitrust Division, to see if we can bring the best

skilled people to bear with the appropriate focus. I do think there

are compensation issues that have to be addressed. It is one thing

for me to come and spend a couple of years, take a leave from MIT

and spend a couple of years. It is another thing for a civil servant

to spend his or her whole life in the agency. We need to recognize

and compensate these people, as well as to make it a rewarding

professional experience for them.

Senator VOINOVICH. Dr. Wolak.

Mr. WOLAK. I guess on your first question, what I would say is,

I think that the same fundamental problem is going to arise again

and again in competitive electricity markets until the following

issue is addressed, is that competitive markets do not, by their

very nature—or markets, rather, by their very nature, do not yield

just and reasonable prices. And having in the Federal Power Act,

a standard that rates wholesale electricity prices must be just and

reasonable, is really in some sense incompatible with a market, because it creates, I think as Senator Thompson said, ‘‘this sort of incentive of OK we will do what we do, but if things go really bad

45

because of the just and reasonable rate standard, we will get bailed

by the Federal Government.’’ So if I was going to say the one thing

that would be necessary is to essentially either get rid of it, of that

standard in the Federal Power Act, and say, look, in a market,

prices will be what prices will be, so you need to take the precautions necessary in advance to make sure that those sorts of

eventualities do not occur, and then I think the market will work.

But if you create the sort of circumstance where there is this just

and reasonable rate standard, then you always have this problem

that I always have the recourse, and in some sense, that is to me

the fundamental incompatibility between a competitive market and

this just and reasonable rate standard.

Senator VOINOVICH. Any other comments?

Mr. BORENSTEIN. I had one comment. I know personally of a couple of economists who have gone to the FERC, and compensation

is an issue, but I think the much bigger issue is the mindset. The

economists and the policy analysts at the FERC have not really

had enough influence on decisionmaking. I was a staff economist

at the Civil Aeronautics Board during airline deregulation. I was

lucky enough to work under Professor Kahn, and I was lucky

enough to work at a time when we were going through deregulation and we were spending many days sitting around, saying,

‘‘Well, if I were an airline and these were the rules, what would

I do trying to make as much money as I can?’’ And just walk

through that analysis. Had the FERC had people who were doing

that and were being listened to in 1996, we would not be here

today because there were many people telling the FERC, ‘‘If I were

a generator and you set up these rules, here is what I am going

to do.’’ Unfortunately, FERC did not have that mindset. FERC had

the mindset of, ‘‘We have a legal process we go through. People file

documents. We read them, etc.’’ FERC really needs to get the staff,

and to listen to the staff, who are going to do that sort of policy

analysis. And if they do that, I think they can be quite successful.

Senator VOINOVICH. Thank you.

Chairman LIEBERMAN. Dr. Makovich.

Mr. MAKOVICH. My final comment on that. I think what you see

here is a general consensus that the California market was set up

flawed. Because it was so complicated and difficult to do, it was not

done well. What we have also, I think, agreed on here, is it has not

been fixed, and price caps are a Band-Aid, not a solution to the

problems there. So the role of the Federal Government, either

through FERC or legislation, is to provide leadership here on how

power markets have to be set up right, and there are a minimum

set of structural requirements that we have to have in all power

markets to avoid the market failures that we have been talking

about.

Chairman LIEBERMAN. Thanks, Senator Voinovich. That was a

very interesting series of questions, and they really go right to the

heart of the Committee’s oversight role, because what we are really

overseeing here is not the California or Western energy crisis that

happens to engage us, but it is what is FERC doing about it? And

I appreciate the comments you made about the role of staff within

the agency, and there is no question—may be one of the unexVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00053 Fmt 6633 Sfmt 6633 75477.TXT SAFFAIRS PsN: SAFFAIRS
46

pected results of this crisis is that bright, young economists will

think about going to work at FERC.

Mr. BORENSTEIN. Well, bright, young economists did in the last

few years, and they were there for a year, and they left.

Chairman LIEBERMAN. That has to change then.

Senator THOMPSON. Speaking of the jurisdiction of the Committee, I am reminded of the fact that it is very relevant to another

subject we spend a lot of time on, and that is federalism. Here you

have the classic question of what should government do and at

what level should it do it? We have got a State responsibility and

a Federal responsibility, and they overlap somewhat. Each is trying

to cast responsibility on the other side, and each wants perhaps the

best of all worlds. It is a fascinating federalism issue.

Chairman LIEBERMAN. True.

Mr. KAHN. A very brief answer, if I may, to Senator Voinovich

is, that this is an oversight committee, and I have had 6 years of

experience in two places with oversight committees, and legislation,

I do not think you could get any agreement right now what the legislation would be. But inducing the kind of discussion and thinking

that is going on, or should be going on here, I think that is where

you all play a very essential role. Everybody seems to agree with

that.

Chairman LIEBERMAN. That is certainly my hope here. I would

rather that we not have to go forward with the legislation, that

FERC provides a response that is adequate to the occasion, whatever that might be. So thank you. Senator Carper.

OPENING STATEMENT OF SENATOR CARPER

Senator CARPER. Mr. Chairman, I apologize to our panel and to

my colleagues. I have been presiding over in the Senate during the

debate on education, and I have missed, with the exception of Dr.

Kahn’s comments, I have missed all of your comments, and I will

not ask you to repeat yourself, but I will ask you to do one favor

for me, and sort of provide us with a benediction. I like to say

sometimes when I am speaking to a group, I try to tell them what

I am going to tell them, I tell them, and then when I finish, I tell

them what I told them. And we are at that point where I am going

to ask you to tell us what you told us.

What I want to do is this. I am going to ask each of you to take

maybe a minute, tell me where you agree. Tell me, throughout this

panel, where you agree and what is the appropriate role for us in

the Federal Government, in the Senate, where is the consensus?

And I will just start with you, Dr. Borenstein.

Mr. BORENSTEIN. You want to specifically focus on what the appropriate role of this Committee is?

Senator CARPER. The Federal Government, where is your consensus? No, where is your consensus of the role of the Federal Government?

Mr. BORENSTEIN. I think the consensus is that California is in

the midst of a crisis this summer, that a lot of it needs to be done

at the Federal level. I think there is near consensus that the FERC

can do something to help mitigate prices for this summer, and I

think there is widespread consensus that that should not be a longrun tool that the FERC should be using.

47

Senator CARPER. Is part of that consensus that the FERC has

every authorization that they need to proceed without our legislating?

Mr. BORENSTEIN. I am not an expert in that area, but it is certainly my impression that the FERC, if they wanted to step up to

the plate, would have all the powers they needed to.

Senator CARPER. Thank you very much. Dr. Hogan.

Mr. HOGAN. I think there is also a consensus that there are a

number of things that have to be done in California that have not

been done or done fast enough to raise prices to retail customers,

put in metering, get the demand side included in this marketplace,

and that is an urgent matter. It has been for a long time, and it

continues to be. This is something FERC has relatively little control over, but it is something that California has a lot of control

over. And then fixing the market design, which has been a problem

since day one of operation of this market, not just this last year,

should be completed, and that is a problem not just in California.

It is a problem in the west. It is a problem in the midwest, the

southwest, the southeast. About the only place that has, I think,

a workable market design is the northeast.

Senator CARPER. Good. Thank you, sir.

Chairman LIEBERMAN. Here here.

Senator CARPER. When I was leaving, Dr. Kahn was saying that

there was somebody on the panel who was his former student. Is

that you?

Mr. JOSKOW. It was me.

Senator CARPER. I noticed when he spoke, your lips moved.

[Laughter.]

Chairman LIEBERMAN. In the interim, Tom, Dr. Joskow indicated

that Dr. Borenstein in turn was his student.

Senator CARPER. And Dr. Borenstein then told us that he worked

for Dr. Kahn at the CAB, so it is a little bit—pretty incestuous, is

it not?

Mr. JOSKOW. Senator, I think there is actually a lot of agreement

on this panel. We all agree that the markets in California and the

west are broken. There is a lot of blame to go around. We agree

that there are both long-term problems and short-term problems.

We agree that FERC has the authority and needs to do a better

job in fixing both short-run and long-run problems. I think a majority of us agree that mitigation options exist for this summer that

are important both to protect California consumers as well as to

convince other States that are on the path to restructuring competition, that Federal officials will not abandon them if they have

problems. We agree that these mitigation methods have to be designed sensibly, that they can be designed in a way that does not

deter investment in new generating capacity, and I think on all of

those things, I think most of us agree. We have some differences

as to exactly what is wrong, exactly how much of the price increase

is due to market failures, market power, and how much is due to

higher gas prices and higher demand, and higher NOX credit

prices and so on.

But I think what you are hearing from this panel is that FERC

needs to step up to the plate, they need to become informed, they

need to do something. And I would add my personal view, just lookVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00055 Fmt 6633 Sfmt 6633 75477.TXT SAFFAIRS PsN: SAFFAIRS
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ing at this over the—I do not know if there is agreement—over the

past year, there has been too much screaming and too much paper

flying back by Federal Express written by lawyers, back and forth

between Washington and Sacramento. And I really would like to

see the technical people at FERC be able to get together with the

technical people at the ISO, with some of the economists in California, have a series of technical conferences and work out some

fixes for this summer. I think this is not as hard as everybody has

made it. We need to have a more cooperative spirit here, and as

I said when you were out, there is plenty of blame to go around,

and let us all accept the blame and let us move forward. I just

think we can do much better.

Senator CARPER. Well, as one who was trained as an economist,

not as a lawyer, I do not take any umbrage to which you just said

here. Dr. Kahn.

Mr. KAHN. I really do not have much to add to what the people

on my right have said. I do not think that legislation is necessary.

You have got the provisions of the Federal Power Act now. It seems

to me that the oversight function of getting FERC here and saying,

‘‘OK, there are your responsibilities, what are you doing about it?’’,

is terribly important. You are never going to get complete agreement about in what respect these designs were perfect or imperfect, so there is a very wide range of agreement. I am curious that

no one has raised the question about whether it was wise totally

to require the generating companies to divest their—I mean the

distribution companies to divest their generation.

Mr. BORENSTEIN. I think there is agreement it was not wise.

Mr. KAHN. Obviously, it was not undertaken lightly. No one has

raised it. Obviously, if you still owned all the generation and you

were still regulated at the distribution level, the situation would be

very different.

The one area in which we may not have come sufficiently close

to agreement, but we have never really encountered, is that there

have been studies by people like Dr. Borenstein and Professor

Joskow, which purport to find definitively that there has clearly

been evidence of withholding, of exercising market power, and I

have not seen anybody directly challenge that except The Wall

Street Journal, which published an editorial saying he left out five

other causes—the price of natural gas, the cost of NOX emissions—

well, read his letter in The Wall Street Journal today. As Paul

says, I looked at every one of those things. I mean, The Wall Street

Journal is still trying to get President Clinton impeached. It paid

no attention to the fact that he had done all these things, and so

I have been acting in part on the belief, and I think Frank Wolak

has done the same thing, that there have been people who have

found that there has been a market power problem here. Well,

mitigation of that is surely something you have the right to demand of an agency that operates under your jurisdiction.

Senator CARPER. Mr. Chairman, thank you. I really want to

thank you for being here today and for your good work over the

last several decades, as well as training a whole new generation of

economists. Please.

Chairman LIEBERMAN. Senator Voinovich, did you have something you wanted to say?

49

Senator VOINOVICH. I was just going to comment that I think

that Dr. Kahn, as one who has observed this whole area for many

many years, has two students, or one student and one indirect student here, has made a great suggestion, and probably the most

positive thing that you could do as Chairman of this Committee is

to bring FERC in here and have a hearing and have them respond

about what they are going to do about it.

Chairman LIEBERMAN. And in fact, they are coming in next

Wednesday on the 20th.

Senator VOINOVICH. Good.

Chairman LIEBERMAN. That is exactly what we would want to

do. And I do want to repeat, I hope that FERC will act in a way

that the move to have legislation adopted here ends, because it is

not the best way to do it, particularly in the short-term case here

where everybody is saying what is needed is temporary relief.

Those who are saying that any relief is needed, say it is temporary

relief, so I look forward to having them in—all five commissioners

will be here next Wednesday.

Senator CARPER. Two more witness, please, if you would just conclude. Go ahead. Thank you.

Mr. MAKOVICH. I think there is a consensus here that power

markets are very complicated, and as a result, we have got multiple flaws as we look to the California example in particular,

which means that there is no simple solution including price caps,

that it is difficult to fix in the short run, and that there are however, examples of people that have done things far better than California, like New England, and Pennsylvania, New Jersey, Maryland, the way they set up their markets.

Senator CARPER. PJM?

Mr. MAKOVICH. Yes, PJM.

Senator CARPER. Glad you mentioned that. Thank you.

Mr. MAKOVICH. This can be done right. Just to differ on—there

is not a consensus here that market power is the problem. It harkens back to, for example, when we had the blackout in 1965, 9

months later The New York Times ran an article about the record

births at Mt. Sinai Hospital, and there were experts that had testified or had reported to The New York Times that there was reasons

to expect that the blackouts had lead to people become amorous.

And it was 5 years later—— Senator CARPER. I am anxious to see where you are going to take

this.

Chairman LIEBERMAN. I may have to exercise the gavel on my

first day as Chairman.

Mr. MAKOVICH. It was 5 years later in August 1970, that there

was a study done by the School of Public Health at the University

of North Carolina that went through all the data and debunked the

notion that there was a boomlet of births after the blackout.

Mr. KAHN. How disappointing.

Mr. MAKOVICH. Some of this outage data, we have to be careful,

that we may be misinterpreting it right now. It is complicated.

Senator CARPER. Thank you, sir.

Chairman LIEBERMAN. This might have led to an appeal for more

blackouts, and we would not want to have that adverse market effect.

50

Mr. WOLAK. The advantages of being last is you do not have

much to say, but the only thing I would say is, to follow-up on what

Paul Joskow said, as the chairman of the Market Surveillance

Committee, which was, believe it or not, established by FERC to

be, if you like, the eyes and ears in the California market, it was

shocking to me that in sort of—when the crisis sort of first started,

there was absolutely no communication with the Committee, despite the fact that we had prepared over the intervening 2 years,

numerous reports, had analyzed the bid data, the production data,

etc., so I really think that, exactly, rather than the lawyers talking

it out, a very good thing would be a discussion among the staff at

FERC, as well as the market monitoring committee, as well as the

department of market analysis at the ISO, to essentially work to

formulate a solution that will help to make things work, and I

think there are a lot of very good and capable people at the ISO

that I think could very much help FERC do its job very well.

Senator CARPER. My thanks to each of you. I again apologize for

missing much of your testimony.

Mr. Chairman, thank you for indulging me and I am delighted

to hear, in response to what Senator Voinovich said, that we have

got all five commissioners coming in next week, and we will look

forward to that. Sounds like a great idea.

Chairman LIEBERMAN. Thanks, Senator Carper. That was very

helpful to do that.

I think Senator Thompson and I at least, and maybe Senator

Voinovich, want to ask a few more questions. So that was a great

summary of what has happened.

I appreciate the focus on FERC, and it is interesting that as this

discussion was going on today. It was noticeably different, and one

of the reasons I think is that we have been thinking at least here

in very legalistic terms, because after all, FERC operates under a

law and we have been talking about just and reasonable rates and

what powers they have and should have to exercise them. I think

there has been a lot of common sense here at the table.

I am curious about whether so much experience and good thinking around the table—are any of you ever consulted by FERC in

what they do?

Dr. BORENSTEIN. When FERC did their investigation last summer, I am on the governing board of the California Power Exchange and director of the UC Energy Institute, and I called Scott

Miller, who was the person—I guess one of the people running

that, and never was called back.

Chairman LIEBERMAN. Dr. Joskow.

Mr. JOSKOW. When the California markets were being set up,

FERC, at that time in 1996 and early 1997, had a series of technical conferences, and they invited me to speak. Indeed, one of

them involved setting up a market surveillance committee at the

ISO, and what data they should collect. And so one of the great

mysteries to me in all of this, is why they set up these entities

which were supposed to be independent, and then for 2 years, ignored them. I thought that was a brilliant idea, to sort of decentralize the monitoring, that Frank Wolak, Carl Shapiro, who has

been the chief economist in the antitrust division is now at Berkeley. Al Klevorick was on the PX, and I think it is a worthwhile

51

question to ask FERC. You set up these market monitoring entities. They have got great people on them, they do good studies.

Why do you not build on that and work with them? And I have

asked them that, and I do not understand the answer.

Chairman LIEBERMAN. We will ask. Let me ask another question.

I think I will ask Dr. Wolak this one, and invite anyone else who

wants to respond. There has been some concern, as you know, that

even though FERC determined last November that the prices in

the California market were not just and reasonable, that they have

done not enough regarding examining past overcharges and providing refunds to wholesale customers, which might make up for

some of the high costs. Do you have a reaction to that?

Mr. WOLAK. I very much agree with that.

Chairman LIEBERMAN. Excuse me. Dr. Kahn, you have to depart,

am I right?

Mr. KAHN. In a few minutes.

Chairman LIEBERMAN. Thanks very much for being here. You

contributed——

Mr. KAHN. I apologize.

Chairman LIEBERMAN. No, not at all.

Mr. KAHN. The people who deregulated those dammed airlines.

[Laughter.]

Chairman LIEBERMAN. Thanks very much for coming.

Mr. KAHN. I am awfully sorry.

Chairman LIEBERMAN. Not at all. We are going to wind up soon.

You were a great help.

Mr. KAHN. Thank you so much.

Chairman LIEBERMAN. Dr. Wolak.

Mr. WOLAK. I guess as I said, I definitely agree with the viewpoint. In fact, I would go even further to say that effectively FERC

said that if there is market power, then we will essentially order

refunds of any rates that reflect the exercise of market power. Unfortunately, effectively in my entire 2 years, almost 3 years on the

Market Surveillance Committee, FERC has never determined what

constitutes the exercise of market power, in other words, what

prices would reflect the exercise of market power? What behavior

on the part of the generator would result in prices that reflect the

exercise of market power? So in many ways it is sort of looking for

something that you do not know what it is. So what we have had

to do, as well as Professor Joskow has had to do, is essentially say,

well, we will use the standard definitions from economics to determine what are the payments in excess of competitive prices and

what reflects the exercise of market power. But as far as FERC is

concerned, even despite numerous meetings with FERC staff and

conferences with FERC commissioners, a definition for what constituted market power and what constituted prices that reflect the

exercise of market power, that definition was never given. So in

some sense, it makes it very simple never to have to confront that

issue.

Chairman LIEBERMAN. Anyone else want to speak to the question

of refunds? Dr. Makovich.

Mr. MAKOVICH. The question of just and reasonable prices is a

difficult one for many reasons, but right now, the prices in California with the shortage are too high, and that is why the finding

52

of just and reasonableness by FERC was that these are too high.

But we have to remember, when the California Power Exchange

opened, on its first day, there were hours when the price of power

cleared at zero. And it continued. That is something that we have

seen through time, that the price will clear at zero. Is zero an unreasonable or unfair price to a producer? And the point that has

been made here, is if there is a 4-year lead time on building power

plants, the prices are too high right now but this is not the right

time to give somebody a signal to build. It was 4 years ago that

we had to give people the expectation that if they build a power

plant, they could make money. And if the explanation was, sure,

prices clear at zero. They are averaging $14, but in the year 2000

and 2001, there will be an extreme shortage, and you will be able

to make all your capital costs back within just 2 years, although

you will be vilified as the cause of the problem, I do not think you

would have got a lot of investment. So there is fundamentally still

a problem here on investment incentives and just and reasonable

prices. Capping them now neglects the fact that they are too high

now because they were too low previously.

Mr. WOLAK. May I just respond to that? I think it is very important to bear in mind that the zero prices he is referring to were

not really paid to anyone.

They may have been paid to small, small, small amount of capacity sold, but primarily most of the times when those prices of zero

occurred, these were in a capacity that is called ‘‘must take’’ and

is being paid under a different contractual arrangement as primarily setting the price.

So the other, I think, I want to also correct a few more misunderstandings here is the statement that these prices were too low. The

average price for 1998 was not $18, it was above $30. And, moreover, generators in California also have the opportunity to earn ancillary service payments, which are payments to provide reserve capacity that roughly average on the order of about 7 to 10 percent

more revenues to their facilities. Moreover, generators in California

also have the opportunity to sign up for reliability must-run contracts, which pay them large amounts of money in payments to

provide local reliability service, in addition to the prices that they

receive for energy.

So, I think we want to be very clear on all of the sources of revenue for generators in California.

Chairman LIEBERMAN. We seem to be replicating the ‘‘Cross

Fire’’ show on television.

Mr. MAKOVICH. Just a quick one——

Chairman LIEBERMAN. Just a quick one because I want to ask

one final question, though it is a good exchange.

Thank you.

Mr. MAKOVICH. The $30 level is an average on-peak price.

Mr. WOLAK. No, it is not.

Mr. MAKOVICH. Well, even if it is across all hours—— Mr. WOLAK. Yes, it is across all hours.

Mr. MAKOVICH. You need something closer to $50 to justify building a power plant, and not everybody gets ancillary services. It depends on location.

Mr. WOLAK. That is not true, either.

53

Mr. MAKOVICH. The fact that nobody built power plants in California has to make one wonder, if they built them in Texas, and

they built them in New England and did not build them in California, maybe there was a problem with the investment incentive.

Chairman LIEBERMAN. Yes. Let me move on because I was really

asking about refunds, and we got off a bit.

The final question is the effect of what is happening. We are all

focused on California, but they are part of a regional grid, and I

know seasonally power generating facilities in other States have

fed into California. I was in Washington State, where, I am sure

you all know, they tell me some of the aluminum plants have

stopped because they are selling their electricity and making more

than they could making aluminum, and people are out of work. So

it is serious.

I wonder whether you think that FERC should be including the

other Western States in its response to the problems in California

and its regulatory response to the problems in California.

Dr. Joskow.

Mr. JOSKOW. Senator Lieberman, if I might, I think to make the

mitigation program that I mentioned before, which is extending the

protocol FERC put into effect on May 29 to all hours, it is essential

that it apply to the rest of the region, as well. This is the only way

to deal with some of the problems that Frank Wolak mentioned, involving essentially daisy-chaining the power from one reseller to

another.

So I would strongly recommend that if that is the approach that

FERC takes that, in addition to extending the number of hours,

that it include at least the other major control areas: Arizona Public Service, Tucson; Nevada, Bonneville; Public Service in New

Mexico, in this program, and that is going to be the only way to

tag the power plants that are supplying the power and applying

their marginal cost base mitigation plan.

Chairman LIEBERMAN. Dr. Borenstein.

Mr. BORENSTEIN. Yes, I agree with Dr. Joskow that we really do

need to do this on a regional basis because there are a lot of loopholes that can easily be exploited. I think it is also important to

recognize, when we get onto this investment subject, I should also

say, as director of the Energy Institute, I do not do consulting for

any private companies in the business. So I have no financial interest here.

It really concerns me when we start talking about the need to

give firms capacity payments in order to get them into the market.

Economics tells us pretty clearly that if you have competitive prices

all of the time, you will get the right investment. Now it is going

to be pretty disruptive in the electricity industry if you do not have

a demand that can participate, and that is why you want to have

long-term contracts and that is why you want to have demand responsiveness.

But we need a regionwide approach to this, and we need to recognize that the goal here is not the lowest prices in history. The

goal here is competitive prices that will ultimately serve consumers, and sometimes those competitive prices will be very low,

and sometimes they will be high. The goal is to make sure they are

the competitive ones.

54

Senator JOSKOW. Could I add a note of history to this? When I

was at Yale, I taught economic history. The Federal Government

induced California to build long transmission lines to link them

with the Northwest in the 1960’s: Two AC lines, one DC line, and

then in the 1980’s a third AC line for the municipal utilities, and

they were encouraged to rely on the Northwest for power and for

the whole region to operate as an integrated system.

One of the things that has happened as a result of this crisis is

that every State is trying to grab onto its power supplies, which is

just the opposite of what we hope to emerge in competitive wholesale markets, and abandoning would have been one of the best examples of regional cooperation anywhere in the United States, and

I really think that we do not want to go back to a system where

every State think it has to be energy self-sufficient. It would be a

terribly, terribly costly mistake.

Chairman LIEBERMAN. My time is up, but, Dr. Hogan, I want to

give you a chance to respond.

Mr. HOGAN. On this question of extending the FERC order to

around the clock and to around the region, there are a number of

things you have to be very careful about in doing this. It is not so

simple.

The FERC order includes a requirement that people bid in,

under these bid caps that they have put in place, and it is one

thing during these emergency hours. But it would be another thing

during all hours. For example, there is the credit worthiness problem. They also are going to require that they be paid, and right

now a lot of the problem is that people are not being paid, and that

is why they do not want to produce. And if the Federal Government

is going to mandate that you produce, they have to address that

problem.

Second, there is the problem of dealing with facilities that have

cumulative limits because of environmental restrictions or any

other kind of constraints, hydro facilities and the like, where the

amount that you can produce over the year is limited, even though

in any particular hour it might not be. And right now the order

punts on that because they did not know how to deal with that

problem, but they were only dealing with it during shortage hours

so it did not matter so much. But if they go around the clock, this

is going to become a big problem that they are going to have to address.

Right now they have a system where they have discriminatory

pricing rules for inside California and imports and power that is

coming from outside California. That creates the opportunity for

the marketers to get around the rules, as they perceive them,

which I think is a good thing. The way to solve that problem is to

simply go to a single-market clearing price. As Fred Kahn said earlier, when the imports are the marginal supply, then you should

use those to set the marginal cost, not trying to set multiple prices

for different markets.

If they extend to the rest of the rest, they are going to have to

deal with the problem of reserves. Do you want to draw down the

reserves in Idaho in order to satisfy California and create reliability problems? These are not trivial issues and they are going

to have to be worked out. There are solutions to these problems.

55

They are going to have to get demand-side participation into the

system somehow, which so far they have not been able to get in

California, and that should be done across the whole West, if they

can get to it.

Chairman LIEBERMAN. Thanks very much. I will think about

your answer. Senator Thompson.

Senator THOMPSON. Thank you very much, Mr. Chairman.

I think it is good that we have FERC in, but least we spend all

of our time concentrating on what they might could do with what

I read is about 50-percent of the power that we will be dealing

with, I think we need to understand that we are in the midst of

a political issue. I mean, this is something public officials are going

to have to decide, and I think until then, we need to take a close

look at what FERC’s proper role in this should be.

But until we have some acknowledgment that California will

allow its consumers to pay a little closer to what their energy costs

really are, instead of relying on other forces and outside forces to

do that for them, I think politically you are going to have great difficulty on shifting responsibility all on FERC.

I just do not think that when you look at all of the factors that

everyone acknowledged played a part: The structural situation that

they set up, the insufficient capacity to meet the demand, the infrastructure problems, the weather problems—you are just not going

to get most people to believe, I do not think, that all of this is because of wicked suppliers in Texas. So we need to look at a whole

part of the picture. The governor will be here, and hopefully we

will be able to see whether we could get the State and the Federal

entities to agree that everybody needs to do a little something here

and have a more likely solution.

I want to ask one question, but I want to lead into it a little bit.

I want to ask about the risk of not getting this cap situation right.

In the first place, Dr. Hogan, do you agree that there is near unanimity with regard to the role of market power in this problem or

do you think that is questionable?

Mr. HOGAN. I do not agree with that. I have looked at the analyses of this study, and I have done some independent analysis of

some of the data that we can get in the public domain. My position

on it at the moment is that it, with the information that we have

in the public domain, which is insufficient, it is not possible yet to

make a determination; in other words, that the margin of error is

larger than the size of the effect we are trying to estimate.

Senator THOMPSON. But we have, I presume, somewhat of a disagreement on the panel. At least two of you have questions with

regard to the significance of market power playing into this price.

Assuming that it does play a part or a large part, I want to address

the difficulty in getting the caps right—the unintended consequences, the deciding of who, what, where, when, and how. I also

want to address the complexity, if it is going to be a cost-based situation, of having hundreds or I guess thousands of suppliers and

trying to determine what their individual costs are so you can determine what they are going to be allowed to charge. Also there is

the issue of FERC only covering half the system and having two

tiers, new entrants who are not covered, and old entrants who are.

56

You know, we are reminded of Marc Rich back in the oil cap

days. That is the way he made his money, apparently, with those

two tiers and playing them against each other. Obviously, it is different with electricity, but it comes to mind. The point being the

investors. You say in a perfect world here is the way it could work.

You put it on at the right price, not too high, not too low. Have

it administered correctly. Then you take it off at the right place,

knowing that there is nothing that the government does that cannot be undone, causing credibility with regard to potential investors.

My point being that it seems to me, and I think maybe several

of you have acknowledged on both sides of this issue, that this is

a complex proposition. It is a complex proposition, perhaps not impossible, perhaps something that cannot be done.

But I want to ask what if, in fact, it turns out that this is not

primarily a problem of market power? What if, in fact, and let us

say there is maybe even a 30- to 40-percent possibility that it is

not primarily a market power problem, that it is a supply and demand problem, and we impose these price caps or controls? From

what I can understand of this, there is a tremendous risk that we

would have substantially greater problems than we would otherwise have, and the blackouts would be more pervasive than they

otherwise would be.

First of all, Dr. Hogan, I will start with you. Is my premise correct? That is, that if we are incorrect about our assumption, basing

all of this on the significance of market power and it turns out to

be other things, are the risks of imposing caps into those circumstances great?

Mr. HOGAN. I think the answer is yes. That is why I made the

point earlier that I think the diagnosis of what the problem is, is

critical in deciding what to do.

Senator THOMPSON. Excuse me, but as I understand it, if, in fact,

it is market power, then they are right. If you impose caps, then

the inducement to hold back is not there any more, so you will

come across with the electricity. Again, my concern is are we that

certain that this is the cause, that we can go in this direction? And

if we are wrong, what are the consequences?

Mr. HOGAN. Well, I think there are many causes, and I am not

certain about which is the dominant effect here. That is why the

proposal that the FERC is pursuing, this bid cap proposal, is attractive if we are going to do anything at all. That is because a bid

cap is the most robust policy with respect to the problems that you

are talking about. To the extent that it is scarcity and you have

a competitive market out there, and it is not market power, the bid

caps effectively become redundant. It is a complicated process to

get it put in place, but they effectively become redundant.

And if you have market power out there and people are withholding, the bid caps target that problem exactly, and that is what

they are trying to do to eliminate it.

This is a very delicate business because when you are trying to

do this, there are many ways to get it wrong, but this is, I think,

the most robust mechanism. That is why it is so important to be

careful about trying to target the market failures, rather than just

57

worrying about making prices lower, because our objectives should

not be just to make prices lower.

Senator THOMPSON. If I understand what you are saying, you

sound to me like you are somewhere in the middle between market

caps, on the one hand, and what FERC is doing today.

Mr. HOGAN. I would not characterize what FERC is doing today

as a price cap, in the traditional sense. I think it is different, and

the term of art is a bid cap mechanism. It does not determine what

the market price will be. The market price can go up and down and

varies with conditions at every hour and depending what plants

are running and what is happening to the water in the Northwest.

You do not have to decide those things before the fact. It adapts

it the same way, trying to emulate what the competitive market

would do, and so it targets the market failure. But it does not guarantee—you have to be candid about it—it does not guarantee that

prices will be low because if there is a scarcity problem, prices will

be high.

Senator THOMPSON. Dr. Joskow.

Mr. JOSKOW. Thank you, Senator Thompson.

There is one thing I would like to make crystal clear. Nobody

who has done the studies of market prices, market behavior and

market power in California in year 2000 has concluded that the

dominant source of the price increases was market power. We have

all recognized gas prices went up, demand went up, imports went

down, NOX credit prices went up and have tried to take that into

account in our analysis.

Merely $5 to $6 billion out of $27 billion, I think that is the average of the various studies, are due to market power. I think that

is a lot of money. It would be a lot of money to me. I have done

a study with public data, the ISO has done a study with confidential data. Frank Wolak, Severin Borenstein, and Jim Bushnell have

done a study with public and some confidential data, and they basically all come to the same conclusion. There is evidence of market

power driving prices up above what would have already been high

prices.

And Mr. Hogan wrote a very thoughtful paper criticizing some of

these studies, and I am about to finish a response that recalculates

our numbers. I would be happy to provide it to the Committee. I

hope it will be done in a week. So that is my first point.

Senator THOMPSON. Is it fair to say, and do not let me keep you

from your second point——

Mr. JOSKOW. Sure.

Senator THOMPSON. Is it fair to say that the confluence perhaps

of all of these circumstances in this history put California in a situation where market power could come into play?

Mr. JOSKOW. Absolutely. This is not a conspiracy issue. This is

a result of the conditions in California that provide suppliers with

opportunities to maximize profits that lead to prices that are above

competitive levels.

The second point I would make is that FERC is already applying

a price mitigation program. We can call it whatever we want. I will

not use the term ‘‘price caps,’’ but it does effectively cap prices at

a certain level when it is implemented. I agree with Mr. Hogan

58

that is the appropriate framework because it is targeted on trying

to simulate competitive prices.

I would like to see us at least explore whether we can expand

the number of hours, and more importantly close some of the loopholes in the current program by bringing other States into the program as well.

And the final point I would make is that we have a lot of experience with applying mitigation mechanisms around the country. You

would think from the public discussion of this that this is some

new thing that has never been done before. It has been done. We

have had bid caps and PJM for 6 months. We have had price caps

in New York and in New England. It has not discouraged investment, it has not led to shortages. It has given folks the confidence

that they can fix what were pieces of broken markets without unreasonable economic consequences.

So I think we have a lot of experience. If they bring knowledgeable people to the table to fix this problem, we can do it in a way

that minimizes the concerns, the legitimate concerns that you have,

and we need to recognize that none of these schemes are going to

be perfect. We need to do the best we can in an imperfect world.

Senator THOMPSON. Thank you. Before I call on Dr. Makovich,

we always or oftentimes go back and get the statements of experts

or academics and cross-examine them with them. I want to turn

the tables a little bit here and point out that Dr. Makovich wrote,

in April 1997, an analysis of the California market, and said,

‘‘There is no reliable mechanism in California to pay for the fix and

operating costs of new generating facilities, since the means for

doing so, that is, long-term contracts and high ancillary service

payments are unlikely to be widely available for several years,

given the rate for these and above-noted trend toward low PX

prices. This is likely to lead to extended periods of low prices, followed by periods of very high prices, as supply shortages and surpluses develop. Price volatility will not be conducive to a smooth

transition to competition.’’

Congratulations, Mr. Makovich. Not only apparently was this

foreseeable by some, it was foreseen. I understand the folks at Bonneville, in early 1999, pointed out that it looked like there was

going to be some hydro shortages in the Northwest. So that is a

parenthetical. I do not want you to move too far away from the

question I ask, and that is the consequences of getting it wrong.

Mr. MAKOVICH. Right. Well, I think the consequences of getting

it wrong are very serious. For example, it has been mentioned

today it would be a good idea to exempt new supply from any kind

of price cap proposal, but it is important to realize, as we look back

over the decade of the 1990’s, a major source of new supply in this

country, if not the majority of new supply over the first half of that

decade, came from the refurbishment and investment in existing

power plants.

And so we are either going to create a disincentive to investing

in power plants and improving efficiency, and availability and capability, or we are going to create a very complicated review process, where people are going to have to try to argue what percentage

of my plant is now new capacity versus old capacity.

59

We have already seen, within the past week, an announcement

that 500 megawatts are not going to be developed in California by

a major supplier who had a site that was permitted, and they were

ready to go on construction.

And, finally, with this idea, there is a bit of a circular argument

here with withholding capacity. The conditions of the very inelastic

supply and demand curves only exist in a shortage so that the only

way it is rational to withhold is if you have got a shortage. So to

argue the shortage is caused by withholding is a bit of a circular

argument, and there are problems with the basic data. People are

running these power plants far harder this year and last than they

ever did before.

So the basic data here is something that has to be looked at far

more carefully to come to the conclusion because it is a very dramatic accusation to somebody that they are withholding capacity

and supply from this market—— Senator THOMPSON. You could ask why they did not withhold in

1998 and 1999, I suppose.

Mr. MAKOVICH. It would have been worth a lot more to them to

do so.

Senator THOMPSON. My time is up, but obviously—— Chairman LIEBERMAN. Do you want to have the last word?

Mr. BORENSTEIN. Well, actually, it would not have been worth a

lot more to them to do so. In 1998 and 1999, there was a lot more

supply, and the economics of withholding were much less attractive

in 1998 and 1999.

Put simply, the right question to ask is, when you put yourself

in a position when the ISO is near a blackout, they have 2-percent

reserves left, and you own 6 percent of the capacity in the State,

what do you bid? And the answer is whatever you can get away

with, and that is not to demonize the generators. They are out

there trying to make money. That is what they are supposed to do.

Our job is to create markets where when they try to make as much

money as they can, they end up helping consumers.

But it is a fantasy to say that this is a market in which generators cannot exercise market power. It is a serious issue. I do want

to respond to Senator Thompson’s question that it would be a

major disaster to set the price caps too low. We saw that last November when we had this 250 price cap, and the price of natural

gas went too high, and generators did the rational thing and shut

it off. That is exactly the 1970’s all over again, only worse.

However, it would also be a major disaster to simply walk away

and pretend there is not a problem here. Because at those times

of peak demand, if we have no price mitigation, we will have billion-dollar prices. There is just nothing to stop it.

Chairman LIEBERMAN. Thanks, Dr. Borenstein.

Thanks, Senator Thompson, and thanks to all of you. It has been

a long hearing, but it has been a very productive hearing. I think

we have all learned a lot about the situation in California, and

frankly about FERC, and you have helped us to get ready to ask

some constructive questions of FERC. I do think that there is

agreement that the rates in California now are not just and reasonable, that FERC has some role to play here, although there is a

disagreement as to what the role is.

60

The other thing I have heard is that no one thinks, in spite of

the drop in prices out there in the last few days, that the crisis is

over or that everything is going to be OK this summer. So this calls

on us all to continue to work together. And I hope that some of the

kinds of discussions among technical people can occur that many

of you described, and that may get us some way forward.

Anyway, thanks for taking the time to come here. Thanks for

sharing your expertise with us. It has been a very productive morning.

The hearing is adjourned. Thank you.

[Whereupon, at 1:19 p.m., the Committee was adjourned.]

(61)

THE ROLE OF THE FEDERAL ENERGY REGULATORY COMMISSION ASSOCIATED WITH

THE RESTRUCTURING OF ENERGY INDUSTRIES

WEDNESDAY, JUNE 20, 2001

U.S. SENATE, COMMITTEE ON GOVERNMENTAL AFFAIRS, Washington, DC.

The Committee met, pursuant to notice, at 9:35 a.m., in room

SD–106, Dirksen Senate Office Building, Hon. Joseph I. Lieberman, Chairman of the Committee, presiding.

Present: Senators Lieberman, Durbin, Torricelli, Carper, Carnahan, Thompson, Collins, Voinovich, Domenici, and Bennett.

OPENING STATEMENT OF CHAIRMAN LIEBERMAN

Chairman LIEBERMAN. Let me ask everyone to take their seats

and we will begin the hearing. I appreciate very much the presence

of all of our witnesses and guests. I wish you good morning and I

thank you for joining us today as the Senate Governmental Affairs

Committee continues its hearings into how the Federal Government has conducted itself in response to the deregulation of the

U.S. energy industries, with a particular emphasis, of course, on

the cost and supply of electricity in California and the Western

United States.

Last week, we heard from five economists, including Alfred

Kahn, the father of deregulation himself. They agreed that the

California market was so dysfunctional that the Federal Government needed to intervene and temporarily regulate. On Monday,

the agency that oversees electricity rates, the Federal Energy Regulatory Commission, which is known here in Washington by the acronym FERC, agreed to take action.

Today, we are going to hear about FERC’s latest order and

whether or not it adequately carries out the Commission’s statutory responsibility to provide just and reasonable rates for electricity consumers in California and the West.

I must say that I am relieved that the Commission has asserted

itself more aggressively to address the severe problems in Western

power markets, although I remain concerned that even at this late

date it has not done all that it could. The price limits established

by FERC may still be too high, and ratepayers in California and

in other Western States may still deserve substantially greater refunds for overcharges that have previously been imposed for them.

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We are very fortunate today to have most of the key participants

in this complex matter as witnesses before the Committee, including Governor Gray Davis, the Governors of North Dakota and Montana, Representatives from the State Governments of Oregon and

Washington, the five members of FERC, as well as three distinguished colleagues here in the Senate.

To put this hearing briefly in historical context, let me say that

Federal oversight of wholesale electricity sales began in 1935 when

Congress passed the Federal Power Act mandating that prices for

electricity be just and reasonable.

Originally, those oversight duties were assigned to the Federal

Power Commission, which in the 1977 reorganization of the Department of Energy became FERC. The Federal Power Act remains, however, the primary statute governing FERC oversight of

wholesale electricity sales. And the law requires that all rates in

connection with the transmission or sale of electric power under

the Commission’s jurisdiction shall be, ‘‘just and reasonable and

not unduly discriminatory or preferential.’’

FERC is authorized upon outside complaint, or its own initiative,

to investigate prices that appear suspect. And if the rates are found

to be unjust or unreasonable, the Commission is obligated to take

remedial action, including the ordering of refunds to customers.

Traditionally, FERC has met its obligation to ensure just and

reasonable rates by ordering rates that provided for cost recovery

plus a margin of profit, in the same manner that most State public

utilities authorities or commissions have done for generations.

More recently, FERC has allowed market-based pricing or proxy

pricing, such as it ordered Monday, to be the standard for just and

reasonable.

No matter what the methodology, FERC remains responsible for

ensuring that the wholesale markets operate competitively and

that the rates they produce are just and reasonable.

As the Committee heard last week, in 1996, California enacted

legislation to deregulate its electricity markets beginning in 1998.

To put it mildly, it has not been an easy transition, either for California or other Western States, because of record prices for electricity, supply shortages, rolling blackouts, and price spikes for natural gas.

The transition to deregulation prompted the bankruptcy and

near bankruptcy of major investor-owned utilities, and in an extraordinary development, the State of California has now assumed

responsibility for wholesale power purchases.

So as I see it, the question today is: Has FERC responded adequately to this crisis? What is the record? Last July, almost a year

ago, FERC began a staff investigation into electricity problems in

the West and a formal investigation into California prices. In a December 15 order, FERC concluded that the California market was

deeply flawed, which, when combined with other factors, caused

electricity prices to be neither just nor reasonable. So the Commission ordered changes in the California market and established a

procedure for refunding excessive charges.

Yet in March and April of this year, as the Commission began

implementing that procedure, it also significantly limited the numVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00070 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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ber of transactions subject to refund and the circumstances under

which prices would be mitigated.

In April, the Commission also initiated a formal Federal Power

Act investigation of the Western electricity market. Two days ago,

FERC expanded those actions by setting a soft cap on energy

prices, around the clock, and regionwide.

In my opinion, the Commission’s record in this matter raises serious questions about whether it will, and has, adequately overseen

newly deregulated energy markets. It has been very slow in responding to this real and painful crisis. While the Commission by

its own admission has had the authority to intervene to ensure just

and reasonable rates, it has been surprisingly reluctant to do so.

It did not initiate a formal investigation of the Western market

outside of California until April of this year. In the past, when it

has intervened in response to California’s problem, the result has

fallen short of what the public interest required.

I, of course, hope that Monday’s order will be more successful,

but I continue to have substantial concerns. I believe the order addressed the matter of refunds for electricity in California in an unsatisfactory manner, and it did nothing for refunds for consumers

elsewhere in the West.

Monday’s order will constrain some price spikes and close some

loopholes in the previous FERC order, and that, of course, is all to

the good and appreciated. But will it ensure that electricity prices

in California and throughout the West are just and reasonable?

That is not only the bottom-line question, it is the law. And it is

that question that I hope our witnesses will address this morning.

Senator Thompson.

OPENING STATEMENT OF SENATOR THOMPSON

Senator THOMPSON. Thank you very much, Mr. Chairman. I

think it is obvious to all of us that California is in a state of crisis.

Two of its largest utilities have gone under or one has taken bankruptcy. California bonds have been downgraded on two occasions.

Producers, suppliers, who the State is going to have to depend

upon for additional supply in the future, are expressing concerns.

Some projects now have been delayed. We have seen blackouts, and

we are told that, apparently regardless what happens from here on

out, we are locked into future blackouts this summer. It is of concern to all of us, not only from a humanitarian standpoint but from

an economic standpoint. California, of course, is extremely important to the rest of the Nation from that standpoint. So we are addressing the question of what to do about it at this stage of the

game and who is responsible.

I am reminded, as I look at this, of the wisdom of the Founding

Fathers and the system of federalism that they created, and that

was that we should have responsibility at two different levels of

government, and one of the reasons for that was to assess accountability. And if there was ever a place where we do not have federalism, it is here. We have a split system where the State is responsible for the retail market, as it were, and a Federal system

where the Federal Government has some responsibility in terms of

wholesale prices with regard to private suppliers. And it ensures

that no one will really have to accept accountability when things

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go wrong, and that is one of the reasons, of course, we are seeing

all of the finger-pointing and the blame-gaming that we are seeing

now.

But it is true that this hearing today has been focused on FERC.

I think it is unfortunate. I see we have five panels here, and a certain thing in some businesses they refer to as ‘‘prime time,’’ and

FERC’s appearance is not in it. And I certainly hope that we have

at least a semblance of the interest in hearing the FERC testimony, which is supposed to be the primary subject of this hearing

when they come on sometime probably mid-afternoon.

But they do have a responsibility in certain areas, and part of

that has to do with just and reasonable prices, whatever that may

be. The idea of a Federal agency deciding what is just for something as important as this would be laughable in any other context,

but that is the law, and that is what we operate under.

That has led many to call for hard caps. Constituents and elected

leaders, after thoughtfully mulling over this for long periods of time

come down on the side of lower rates instead of higher rates. But

we know that in any long-term sense, anyway, that generally

speaking caps do not work when supply is the problem. And neither the FERC while President Bush is President or the FERC

while President Clinton was President has thought that hard caps

were a good idea. In fact, the prevailing opinion is that when supply is the problem, they make a bad situation worse.

Now we are told that this is different, this situation is different,

that we can apply a Goldilocks test to this one and we can get the

rates not too high, otherwise, they would be ineffective; not too low,

otherwise, we would drive supply out of the market; and we would

lift it just at the right time and all of that would work out, although I see no model for that in history anywhere. There are a

lot of very credible people who think that that is the way to go.

So there has been tremendous pressure on FERC because of that.

They have taken several actions. I was reading a summary of the

written testimony of FERC Commissioner Linda Breathitt. She

says that since last August, FERC has issued 50 orders implementing important remedial measures and price mitigation, instituted investigations into rates and market design flaws, established programs to maximize electricity supply and delivery and demand reduction, and directed sellers to provide refunds.

And, of course, those refunds, rebates, are an important part of

this process. It does not shock me to find out that in a matter involving this much money and this many people and this many suppliers that there probably have been some out there who have not

behaved as they should, even though I see no allegations of criminal activity—at this point, anyway. Those investigations are ongoing, and they should be ongoing. But for most people, the idea that

this problem was caused solely or even primarily by that is farfetched, to say the least. So let that play out as it may. Let’s acknowledge that that might be a part of the mix.

FERC, on April 25, of course, entered into a price mitigation system. Prices have dropped since that time. Now we are switching

somewhat from a blame game to a credit game, and everybody is

scrambling to claim credit for the recent drop in prices in California, and we will watch that play out with some interest. But

65

now they have expanded the price mitigation system. It is not a

hard price cap, and it is not price controls in the normal sense of

the word, I would think. But it has been expanded to all of the

Western grid and to an around-the-clock operation.

However, some people believe that this problem has to do with

more than just a Federal agency fine-tuning wholesale prices, and

I am one of those. And some people believe that to determine

where to go, it is good to consider how we got here in the first

place.

Now, for Governor Davis, the answer is simple. A bunch of Texas

cowboys got down at the corral and decided they were going to take

advantage of helpless California, and we are seeing the results of

it. In fact, we have seen no shortage of villains. The governor at

one time or another has blamed Federal regulators, State regulators, the President, suppliers, the former governor, and a bankrupt public utility.

However, I think we need to cast our net a little wider. Clearly,

there are other factors at play. We know, for example, that we had

a drier Northwest during crucial periods of time that cut back on

the hydropower that the West normally sent down during the summer months and that California depends on. We had an inordinately hot summer. We had an inordinately cold winter. During all

of this, we were experiencing increased demand throughout the

West, and especially in California because of the growth of that

part of the country. It was clear that California was becoming more

and more dependent upon imports.

Surely, none of us can blame anyone for those factors, but the

other interesting point about that is none of those factors were secret developments. One would have thought that State officials

might have noticed those things as they were occurring, especially

since they were getting warnings as early as early 1999 with regard to the problems in the hydropower situation, at least.

Other factors, of course, enter into play, and that has to do with

the policies of California, the policies of the Public Utility Commission, and the governor. No power plants in 10 years. The governor

is not responsible for most of that. But capped retail rates at a time

when the utilities were locked into spot markets, which everybody

acknowledges was a mistake. When deregulation came about, we

had a supply surplus of about 30 percent in California. That situation, as we saw, rapidly changed, but the policies did not change

with it.

So PG&E was paying 30 cents and selling for 3 cents and, of

course, ultimately went bankrupt as they were saying last year

that they needed relief and others were saying they needed relief.

No relief was coming.

So no additional power, capped retail rates, locked into spot markets, a siting process that was longer than apparently anybody

else’s made it very difficult to put new power online. And then even

more warnings from experts who were talking about the storm

clouds that were looming, and then, of course, we saw shortages in

May 2000.

So all of the policies that were clearly a part of the problem were

locked into place and kept there until the problem became a disaster. I think that it is instructive to look at other States around

66

the country that have deregulated, that have not had similar problems. They did not have some of the natural problems either that

California had, in all fairness, but they did not have some of the

policies or adhere to them the way that California did either.

Now, after blackouts are inevitable, apparently, according to the

experts, some changes have been made. California now enters into

long-term contracts, but apparently they are paying very high rates

for the contracts, higher than spot markets. So when spot market

prices were higher than long-term contracts, they were paying spot

market prices. Now that long-term contracts are higher than spot

market prices, they are paying long-term prices. A policy of buy

high, sell low. And we do not know exactly what prices they are

paying because California has not been willing to release the prices

that California citizens are paying for the long-term contracts for

municipalities, which, of course, continue to be large suppliers of

power.

So I do not want to rain on anybody’s parade here today as we

bring FERC to task, but I guess, as Paul Harvey would say, perhaps we ought to look at the rest of the story and, before the day

is over, perhaps a more balanced view we will have not only as to

what should be done at the Federal level but as to how we got here

in the first place.

Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thank you, Senator Thompson.

It is a long hearing. We do have serious questions to ask. I assure you I will be here when FERC comes on, regardless of what

hour it comes on. And in some sense, the morning testimony will

pose questions which I think will be fair and reasonable both to

those who are in the morning and to those who will follow in the

afternoon.

As is our custom, we will now go to Members of the Senate who

asked to testify this morning, though I do note the presence of a

growing number of members of the California delegation. I do want

to welcome them here. I see Congresswoman Jane Harman, Ellen

Tauscher, Hilda Solis, Anna Eshoo, Joe Baca, Lois Capps, and

Lynn Woolsey. And I thank you. Obviously your presence here is

an expression of your concern about the ongoing problems regarding electricity rates in your State and your hope that we and FERC

together can bring some relief to citizens and businesses in your

State and to the economy of the State generally.

I am pleased to have three colleagues with us. I can go in alphabetical or seniority order. Do you have a——

Senator MURRAY. Seniority order.

Chairman LIEBERMAN. This is most encouraging. Your two colleagues from Washington State, acknowledging that you are obviously much older than either one of them, Frank, have yielded to

you. So, Senator Murkowski, ranking member of the Senate Energy

Committee, we thank you for being here and look forward to your

testimony.

TESTIMONY OF HON. FRANK H. MURKOWSKI, A U.S. SENATOR

FROM THE STATE OF ALASKA

Senator MURKOWSKI. Thank you, Mr. Chairman, and let me

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preciative that you included Energy and Natural Resources Committee representation here at your hearing.

Everybody seems to want to get in on the energy crisis at this

time. There are many chairmen holding hearings, and that certainly is the prerogative. Some are even involved in spinning away

their responsibility associated with the crisis in California. We

have heard criticism of our President, of our Vice President, for

being chummy and cozy with big oil, criticism that indeed the higher costs associated with the shortage are the responsibility of the

administration.

It strikes me, Mr. Chairman, that if you have a sickness—and

we have a sickness right here with the gentleman that just turned

the chart over. It is upside down. [Laughter.]

He is relatively highly paid—or I mean he was.

Chairman LIEBERMAN. Of course, there was some chance that we

were upside down and the chart was right side up.

Senator MURKOWSKI. Well, we have been accused of that, too.

Senator THOMPSON. I am glad we noticed.

Senator MURKOWSKI. But the point I wanted to make relative to

the criticism of the President and the Vice President for being too

chummy and out of the oil patch and part of the bad guys from

Texas, I think somebody did a calculation that suggested that

Texas-owned companies contribute about 12 percent of the energy

that California consumes. But, ordinarily, if you have a sickness or

a crisis of some kind, you address it with some degree of expertise

as opposed to holding a public hearing. And I think the energy situation in this country is a sickness. You need people who know

something about it, how to correct it, and how to bring about

change. And I think both our President and our Vice President fit

that category.

Now, we know something about energy as well, Mr. Chairman.

We have held 24 hearings, Senator Bingaman and I. We have had

164 witnesses. And what we found is very simple: We must increase production, we must develop alternatives and renewables,

and we must improve conservation. It is just that simple. And

those that suggest it is more complex are leading you down either

goat or rabbit trails, as the case may be.

We had a hearing in this room yesterday. We had FERC here.

We had all five commissioners. And it was rather interesting because they did reach a conclusion. All five concluded that Congress

should not legislate price control legislation or wholesale price caps,

as the case may be.

I would also remind you that FERC is just recently up and running. They just obtained the last two members, and now they have

a five-member commission. Further, both sponsors of the price cap

legislation, Senator Smith and Senator Feinstein, have indicated

they will not push for legislation to a markup on their proposed

wholesale cap bill, which I think is relative to the action that

FERC has taken and their belief that FERC is doing the job that

they were set up to do.

Now, I commend the President and the Vice President for staying the course, staying the course against wholesale caps. This is

the only way the energy supply will increase. If you put caps on,

you will not get investment. We heard testimony given yesterday

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1The chart entitled ‘‘California Day-Ahead Power Prices,’’ appears in the Appendix on page

551.

by the investment community relative to the fact that if you have

tight caps, there is not the incentive for investment. And the investment can go a number of places.

I think it is also important to point out that under the Bush Administration, FERC has taken their responsibilities seriously,

somewhere between 30 and 50 orders, as Senator Thompson indicated, since they took over. Now, where was FERC before that?

Well, they were running pretty lean. But, nevertheless, the crisis

did not occur beginning in January. The crisis in California was in

effect beyond that. And why FERC did not act, why, perhaps you

could pursue that. Their just-issued West-wide order will further

help both California and the entire Western United States.

Now, we do have the chart now right side up, and the point I

want to make with that chart is that it is working.1 What you are

looking at is California’s price structure relative to the peak power

costs. And you will see it is down now to somewhere in the area

of $48, and when you compare it to what it was, nearly $550 or

$600, I think you can see that it is moving in the right direction.

Now, basically, that FERC has done its part, the question is

what must California do, and I think that is an important reflection on the responsibility of the Congress.

California, of course, has driven one investor-owned utility into

bankruptcy and has put the other two on the brink of bankruptcy.

The governor once said that he could solve California’s problems in

15 minutes if he just let the true cost of electricity be passed on

to the consumer. Well, you can ask him about that. But it appears

that California has continued to try and hide the true cost of power

by having the State now pay for it instead of the utilities. This puts

the taxpayer of California on the hook for somewhere in the area

of $47 billion.

My question is: What is the difference between the ratepayer and

the taxpayer? I find little difference. Although California officials

accuse investor-owned power as being ‘‘pirates,’’ they have done little to protect California consumers from power sold by municipally

owned utilities that are within California’s own authority.

A recent Los Angeles Times article reported that the city-owned

Los Angeles Department of Water and Power was one of the largest moneymakers in the California spot market and made $17.8

million. And I would remind you that is owned by the city of Los

Angeles.

Further, California’s problem is not lack of regulation. It is really

a lack of generation. California bet it could stop building new

power plants and instead import power from outside the State.

California ordered its investor-owned utilities to divest their fossil

fuel generation but exempted the municipal utilities. Why would

they exempt one and not the other? Well, you can ask the governor.

California prohibited its investor-owned utilities from using longterm contracts for power and forced them to rely on the spot market. This strategy can work for a time when there is excess in that

spot market. But it did not work when that excess was removed.

69

California has taken steps to expedite power plant construction.

It has let a lot of permits. But the question is: How many of those

permits have firm take-outs from financial bodies that are prepared

to back them without a degree of certainty on the rates that those

investments are going to amortize?

So I think the jury is still out whether the California investor

will want to build in California given the investment climate the

State has created.

As we look at the issue, Mr. Chairman, of those that are alleged

of profiteering, I am going to ask that this be included in the

record, the ‘‘Top 10 in Profits.’’ According to the California independent systems operator say that they total $505 million. Two-thirds of that are associated with

British Columbia Power Exchange, $176 million, Mr. Chairman;

Bonneville Power, $30 million; Los Angeles Department of Water

and Power, $17.8 million. There you have a significant portion of

those overcharges, and they are municipally owned. In the case of

BC Power, they are outside.

Finally, in conclusion, the solution to California’s problems is

more power plants of all types, natural gas, nuclear, renewables,

and incentives for conservation. And you provide that incentive for

conservation when you pass on the true cost of power to the consumer. Then the consumer will conserve, go down and buy a new

refrigerator or whatever. FERC’s order clears the way for Congress

to focus on the national energy crisis that is affecting millions of

families from coast to coast, not just California. Before the recent

change in the Senate, we were on a course to bring President

Bush’s task force legislation to the floor, Senator Bingaman and I

in a bipartisan package. As I have indicated, we have had the hearings. Senator Lott said at that time the energy legislation would

be the next order of business after the Senate finished education.

But under the new Senate schedule, energy has slipped on the Senate schedule. That is unfortunate in view of the fact that polling

indicates that energy is the number one issue in the country at this

time.

So now is really the time for action on a comprehensive energy

legislation to bring about a long-term and meaningful solution to

the Nation’s real energy problems, and I am convinced that the

time for talk is behind us. The time for action is now.

Thank you for the courtesies extended to me. I would ask to be

excused. I have another hearing on the Energy Committee at this

time.

Chairman LIEBERMAN. Thanks, Senator Murkowski. Thank you

for being here.

Senator Murray.

TESTIMONY OF HON. PATTY MURRAY, A U.S. SENATOR FROM

THE STATE OF WASHINGTON

Senator MURRAY. Thank you very much, Mr. Chairman and

Members of this Committee, for calling this hearing. In my home

State of Washington, there is no more important issue than the energy crisis today. Two days ago, after months of delay, the Federal

Energy Regulatory Commission finally woke up and took action

against alarming energy rates. FERC, as all of you know, put in

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place price controls that are similar to what Senator Lieberman

and I and Senator Cantwell and others have been urging for

months. I am glad that FERC finally came around, helping us

bring some order to this volatile energy market, but this one step

is not going to solve the energy crisis.

The energy crisis is very real, Mr. Chairman. It is not going

away, and the Federal Government needs to do its part to help our

communities. Today, I want to share with this Committee how the

energy crisis is hurting Washington State, and then I want to offer

six things that the Federal Government must do to protect our people and our economy.

Let me begin with the impact in Washington State. We have already lost thousands of jobs because of rising energy rates. Entire

industries could be idle just to prevent massive rate increases. According to one estimate, Washington State could lose another

42,000 jobs over the next 10 years unless we take action. Not only

are there economic costs, but there are environmental impacts as

well, including our ability to recover endangered salmon.

I want to share with you a typical letter I received from a constituent in Washington State. Mrs. Valeria Mesler of Okanogan,

Washington, wrote to me: ‘‘I am a 91-year-old widow living on my

Social Security check each month, which is small. I cannot afford

any increase in the cost of my electricity. I am sure there are many

like me and also younger families on low incomes.’’ Mr. Chairman, she is right. There are thousands like her.

Today, the energy crisis is hitting our pocketbooks, and unless

we act, tomorrow it will threaten our prosperity. Even Washington

State schools are feeling the impact. Nancy Olson, who is the superintendent at the Ocean Beach School District wrote me that energy costs will add another $200,000 to their budget. As a result,

they are going to have to lay off the equivalent of 3.5 teachers. According to Superintendent Olson, ‘‘We have no extras anywhere in

our budget. We will now have to resort to cutting teachers, which

means increased class sizes.’’ They are even, Mr. Chairman, considering going to a 4-day week in that school because of the costs.

Energy is impacting everything from our kids’ education to jobs

in our economy, to every family’s personal quality of life and finances. We in Washington State are doing our part. We are conserving and we are cutting our energy use. Several of Washington’s

public utility districts have worked with consumers and have

agreed to cut back on the amount of power they receive from Bonneville Power Administration. Last week, the Benton County PUD

agreed to reduce its energy load by 10 percent. Recently, Clark

Public Utilities, Franklin, and Ponderay and Grace Harbor PUDs

have signed load reduction agreements as well.

People are changing their habits and buying more energy-saving

products. In fact, in many parts of my State, you cannot even find

a compact fluorescent light bulb on store shelves because they are

all sold out.

We are also bringing new energy sources into service, especially

renewable sources like wind. We have a 300-megawatt wind field

being developed near Walla Walla and another 150- to 500-megawatt wind field planned for Prosser. We have a company in Kelso,

Washington, that takes plastic from landfills and turns it into highVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00078 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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octane, low-sulfur diesel fuel. We are doing our part. But we need

the support and the leadership from this administration.

I, of course, am not saying that this administration caused this

crisis. It did not. But I have believed that it has stood in the way

instead of providing us the help that is critically needed. First, they

identified it as just a California problem. Then, instead of urging

conservation, they decried it as simply a personal virtue. And later,

when we introduced bipartisan price cap legislation, the administration said no. Instead, they sent us an energy plan that focuses

too much on drilling for oil and gas with very little support for alternative and renewable sources of energy.

Throughout, FERC has not done anything to help Washington

State consumers get relief from predatory pricing. This week the

administration’s FERC appointees finally came around and accepted what we have been telling them all along, that we need price

caps, temporary price caps, to protect consumers from outrageous

rates. Frankly, I think the bipartisan legislation we have pushed

has helped them make that decision.

Mr. Chairman, this administration has minimized this crisis for

months, and people across my home State of Washington are paying the price. We are doing our part to conserve and to generate

new, clean energy in Washington State. Now it is time for the Federal Government to do its part, and I want to quickly outline six

steps I think we need to do at the Federal level.

First, we need a disaster declaration so that hard-hit small businesses can get low-interest loans from the Small Business Administration.

Second, we need real Federal support for conservation.

Third, we need to diversify our energy sources.

Fourth, we need to site new plants.

Fifth, we need FERC to keep its word and investigate price

gouging in Washington State and other Western markets. If prices

have been unjust, there have to be swift refunds.

And, finally, we need to make sure that as we expand our energy

infrastructure, our oil and gas pipelines are safe.

Mr. Chairman, those are the steps we need to take at the Federal level to keep this crisis from getting worse. I hope that this

administration will see the wisdom of acting now to protect our

economy, our communities, and our citizens before it is too late.

Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thank you, Senator Murray, for that testimony.

Senator Cantwell, good morning and thanks for being here.

TESTIMONY OF HON. MARIA CANTWELL, A U.S. SENATOR

FROM THE STATE OF WASHINGTON

Senator CANTWELL. Thank you, Mr. Chairman and Senator

Thompson. I thank you for this opportunity to testify before the

Committee today and for your leadership on this important issue.

The Senate Energy Committee, of which I am a member, has had

numerous hearings on this issue, and I want to applaud Chairman

Bingaman for the leadership and commitment that he has brought

to this issue, and to Senator Murkowski for the number of hearings

that we have, in fact, held for his attention to this issue.

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Today’s hearing focuses on a subject that I believe Congress must

explore fully and, more importantly, be prepared to act on: The role

of FERC. Our Nation’s top energy regulator probably has never

been more important than today.

As the energy crisis has evolved, I have had an opportunity to

get to know all the FERC Commissioners and am pleased that we

now have a full contingent of commissioners with two new members, Commissioner Pat Wood and Commissioner Nora Brownell.

Today, the FERC is in the unenviable position of being on the

Congress’ radar screen. I think it is important to keep in mind that

this agency is in transition, responding to a brave new energy

world. But as our recent experience in the Northwest has shown,

the FERC has a long ways to go in its transition.

I am concerned about two things. I am concerned that the agency

has been slow to respond, and even when it has responded, it has

not always acted with equal vigilance from State to State. One cannot, as Senator Murray pointed out, open up newspapers in Washington State without finding stories about the energy impacts on

our State, families, businesses, and community. As perhaps too few

people realize in the midst of these bright lights shining on California, this really has been a crisis from which the Pacific Northwest has suffered. Yes, it has been exacerbated by a drought that

has been the worst drought in 30 years. But, nonetheless, our need

to go out and buy power on the spot market left us subject to rates

11 times what they were a year ago today.

The results have been devastating and have touched every part

of our economy, from traditional energy-intensive industries such

as aluminum and paper, to small businesses, farmers, and even

technology companies. Thousands of people have already lost their

jobs and plants have been shut down. A hospital in Washington

State has experienced probably $1 million in additional energy

costs that will come off of their bottom line. Small businesses as

diverse as grocery stores and hotels have already started adding

energy surcharges. And this is despite an effort by most of these

businesses to curtail their energy consumption by over 30 percent.

Governor Locke has issued a challenge for people and business

in Washington to conserve 10 percent. Many businesses are reaching far beyond that and still seeing rate increases that are the

same amount as what they paid for their entire energy bill last

year. Our State’s LIHEAP caseload is expected to rise by over 50

percent this year due to skyrocketing energy prices.

These facts point to an inescapable, common-sense conclusion—

that the Western power markets have been dysfunctional for quite

some time and that the electricity prices in the Northwest have

been neither just nor reasonable. Like many of my colleagues, I

want to say I appreciate the steps that the FERC Commissioners

took on Monday, June 18, to help mitigate the impacts of the Nation’s energy crisis and rein in the runaway electricity prices in 11

Western States. I am hopeful that these actions will help address

the crisis in the Northwest.

However, during the hearing before the Senate Energy and Natural Resources Committee yesterday morning, I had an opportunity

to ask the FERC Commissioner and the FERC’s general counsel

about my concerns given that we had not had a chance to read the

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order. In response to my questions, I found one piece of information

very troubling. That is, Mr. Chairman, despite a year of skyrocketing prices throughout the Northwest and other Western

States, the FERC admits that it will not provide a mechanism for

those in the Western States outside of California to seek refunds—

this is a very important issue—other than refunds that would occur

after July 2, 2001.

On the one hand, FERC has offered long overdue relief to Washington State consumers who are staggering from these high energy

prices. But, on the other hand, it has taken away an opportunity

for us to get these refunds. With the support of Senator Murray

and other Senators from the Northwest, I am sending a letter to

FERC Chairman Curtis He ́bert today asking for a rehearing on the

Commission’s December 15 order in which FERC denied Puget

Sound Energy’s complaint regarding the West, outside California.

We are asking FERC to set a refund effective date consistent with

Puget Sound Energy’s October 2000 filing.

Mr. Chairman, whether this refusal to consider consumer refunds outside of California is an oversight or an accident, it is certainly the latest in a series of FERC actions that have elicited

questions and concerns from many people in my State.

Over the last year, people in Washington State have endured

many impacts from this energy crisis, and I think it is very important that FERC go further in addressing this issue of repayment.

Mr. Chairman, obviously this Committee and the Congress in

general, as policymakers, need to ferret out the many causes of

FERC’s slow-to-act performance in the face of this crisis, whether

it is lack of a clear mandate arising from dramatic changes in the

energy industry, a lack of necessary information or resources to do

its job, or simply just a lack of will. But as we work to prevent such

crises in the future, we also need to focus on how to correct the

mistakes that have been made.

We know that there are Pacific Northwest communities that

have been devastated by plant closures and job loss due to an unprecedented run-up in electricity prices and FERC’s inactions and

omissions. It is simply unacceptable that the Federal agency

charged with ensuring that consumers are protected does not meet

that responsibility.

With this in mind, Mr. Chairman, I hope that FERC heeds our

calls to reverse its decisions on issues of retroactive refunds for

Northwest consumers and applies the same standards of fairness

to the constituents of my State as they have to ratepayers in California.

I thank the Committee for this opportunity to speak on this

issue, which is important to so many people in Western States, and

I thank the Chairman for holding this hearing and look forward to

your continued oversight of this commission.

Thank you.

Chairman LIEBERMAN. Thanks very much, Senator Cantwell, and

we will be sure to ask the members of FERC this afternoon some

of the very relevant questions you have raised here this morning.

I note the presence of another member of the California House

delegation. I am delighted to welcome not only to this hearing but

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to the Congress Congresswoman Diane Watson. Thank you for

being here.

Before the Committee calls the Hon. Gray Davis, Governor of the

State of California, Senator Boxer, our colleague, has asked to very

briefly introduce Governor Davis.

TESTIMONY OF HON. BARBARA BOXER, A U.S. SENATOR FROM

THE STATE OF CALIFORNIA

Senator BOXER. Mr. Chairman, Senator Thompson, thank you so

much for inviting my governor here. I promised you that I would

make a minute, a minute-and-a-half introduction, and I will because I know how many people you have yet to come.

But I want to say that in California we need the help of everyone

on this Committee. The reason we have such a beautiful delegation

sitting behind me here is because of their deep concern. They have

got many other issues on their plate. I think it shows and demonstrates that we are all speaking with one voice, that we need relief for our consumers, and our governor has been fighting this

fight in the middle of a crisis that he did not make. And he has

been doing everything he can to heed what Members of this Committee have said, which is to bring sources of power online to push

the State toward energy efficiency and conservation, which we are

succeeding at—we really are—and also to call attention to the

gouging. And if I might say, that is the only word I can use, and

I think when you hear the governor, you will understand why we

use the term ‘‘gouging.’’

Mr. Chairman, I think this Committee is key for us. You are an

investigative committee. You are a Committee that is an oversight

committee. It is very appropriate that you oversee the FERC. I believe with your leadership, Mr. Chairman, and others on both sides

of the aisle, we have seen FERC finally look at their charter, which

says they must protect against unjust and unreasonable prices. We

have seen them take action. We in California welcome that action,

and at this time, it is really my honor to introduce a man who has

been working on this crisis day and night. It is a lonely and difficult thing, many times, and he has really done everything within

his power to keep the power on in our State.

Thank you very much for welcoming him here, and thank you for

your deep concern, Mr. Chairman, and also Senator Thompson.

Chairman LIEBERMAN. Thanks, Senator Boxer.

Governor Davis, I am honored to welcome you here. I appreciate

very much that you took the time to come out and share your

thoughts and your experiences with us. This is a hearing room that

is often used by another committee. I am privileged to be a member

of the Senate Armed Services Committee, and it does strike me

that there are some parallels here. I feel like I do when we had

leaders of our military come in from areas of battle to report on

how the battle was going. It is not quite that serious, but you face

a serious crisis that was not of your making. You have been tested.

I think some of the improvement that is reflected in the charts that

we have seen from Senator Murkowski you deserve some credit for.

I am delighted to hear from you now, and I suppose the question

is: How goes the battle?

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1The prepared statement of Mr. Davis appears in the Appendix on page 391.

TESTIMONY OF HON. GRAY DAVIS,1 GOVERNOR, STATE OF

CALIFORNIA

Mr. DAVIS. Well, we are making progress, and thank you very

much, Senator Lieberman, and Ranking Member Senator Thompson. Thank you for inviting me as well. I want to thank our junior

Senator, Barbara Boxer, for her friendship and for her introduction, and our senior Senator, Dianne Feinstein. They both worked

very hard on price relief for California and the West, and I want

to thank all of our Congress people that have been staunch allies

in this. You have mentioned their names, but I would like to repeat: Congresspersons Tauscher, Harman, Solis, Eshoo, Baca, Watson—have I missed any?—Lois Capps and Lynn Woolsey. Did I

miss anybody else? And there are many others who are not here.

They are very busy, and I appreciate their taking their time to be

here today. Obviously this is an important issue. That is why so

many people have come today. I applaud the Committee for having

this hearing.

I want you to know that California is doing its part to meet the

energy challenge. As you know, there are two constructive things

the State can do: Build more plants, conserve more power. We have

approved 16 plants since I have been governor starting the fourth

month I was in office. Ten are under construction, more than at

any time in our State’s history. We are also the most electricityefficient State in the Union, as that chart, based on U.S. Department of Energy figures shows, and we are not resting on our laurels. It is in our self-interest to become even more electricity efficient as the summer proceeds.

Those two goals—building plants and conserving—are the major

prongs of a long-term energy plan that we have put together for

every Member of this Committee. Long-term contracts are also a

big part of that, and I want to thank David Freeman, who is with

me today, formerly of the Department of Water and Power—he

helped negotiate those—and Michael Kahn who is president of our

ISO, who is also with me in attendance today.

Let me just elaborate for a second on the building of power

plants and conservation. As was noted earlier, for the 12 years before I was a governor, not a single major power plant was built in

our State. Not one. But we began earnestly to right the ship, and

as I said, we have licensed 16. Ten are under construction. Four

will be online this summer. The first one a week from today will

come online in Bakersfield. Two more will come online by July 7.

Those three plants will provide roughly 1,200 megawatts of power.

In addition, we have sited 10 peakers. Through my emergency powers, I have cut the permitting process to 21 days to site peakers.

They represent more than 800 megawatts of power.

Part of our effort to get more plants online involve reducing the

time to site permits. That was mentioned earlier. We have cut that

in half from a year to 6 months, and I have reduced that even further through my emergency powers to 4 months.

So the combination of the plants online plus additional renewables, distributed generation, and re-rating of existing power plants

we believe will provide 4,000 megawatts of power by the end of

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September. Then we have 5,000 megawatts coming online in each

of the next 3 years for roughly 20,000 megawatts by the end of a

4-year period. Suffice it to say, at no time in the history of the

State have so many plants been under construction in California.

On conservation, we are not resting on that laurel. I signed the

bill for $850 million, which encourages more efficiencies in people’s

homes and places of work. Plus we signed an executive order which

gives people and businesses a 20-percent rebate if they reduce their

electricity by 20 percent any of the 4 months—June through September—of this summer. Plus we have signed agreements with 137

companies, including the Bank of America and Wells Fargo, Hilton

Hotels, for them to reduce their consumption by 20 percent from

June to September of this year. We have signed agreements with

225 municipalities, special districts, for them to achieve between 10

and 20 percent conservation. So all across the State, Californians

are pulling together to build plants and to reduce electricity usage.

I think the proof is in the pudding. In May, it was reported that

Californians had reduced electricity usage over last year by 11 percent and by 10.4 percent during peak periods. I think that is a remarkable contribution, but we are going to do even more.

So I think it is fair to say on long-term contracts, which have reduced our dependency on the spot market by roughly 40 to 45 percent, on building plants, more than any governor has done before,

and on conservation, California is doing its part. The one mission

element, at least until Monday, was any efforts to regulate the

wholesale price of electricity. As the Chairman correctly pointed

out, that is exclusively the function of the Federal Government.

The State has no control over that, even if it wanted. Our only

power is the power to advocate, testify, occasionally to shame, to

make sure that action is taken.

As the Chairman also said, the Commission is responsible to see

that rates are just and reasonable. That comes as a great shock to

some people who think that market forces should take hold no matter what. I am going to speak to that a little later. But that is not

the law. As Ranking Member Thompson pointed out, the law does

require just and reasonable rates be enforced, and FERC by its

own admission has allowed those rates to remain in effect, even

though they made a finding November 2000, reiterated in December 2000, reiterated again in April 2001, that our rates were not

just and reasonable and our market was dysfunctional.

Under law, the Commission must order refunds once they make

a finding that a marketplace is dysfunctional and rates are not just

and reasonable. Under law, if rates are not just and reasonable,

they are by definition unlawful, and the ordering of refunds is not

a matter of discretion. It is a matter of law.

Yet at every point where the Federal Energy Regulatory Commission could have restored some sanity to wholesale prices, it

failed to do so. I have done my best for approximately a year to advocate, to urge, and to encourage appropriate Federal action. I have

testified before the Federal Energy Regulatory Commission. I have

written countless letters. I have spoken personally to Presidents

Clinton and Bush. Our electricity oversight board, the independent

service operator, and the PUC have made at least 100 filings for

77

1The chart referred to by Governor Davis appears in the Appendix on page 742.

relief. But in every case, even in the face of mounting evidence in

support of our position, our requests have been denied or ignored.

Two days ago, the Federal Energy Regulatory Commission did

bow to public pressure and took a step in the right direction. But

here is what the Commission’s inaction over the last year has

yielded, and I refer you to the chart on the right where it says

‘‘Total Wholesale Cost of Electricity in California.’’1 In 1999, Californians paid roughly $7.4 billion for electricity. In the year 2000,

with demand up only 4 percent, we paid $27 billion, roughly a 400-

percent increase in electricity costs. This year, we are on track to

spend between $50 and $60 billion, even though we are reducing

our electricity usage by roughly 9.5 percent each month. And as I

explained to President Bush when we had a nice visit in Los Angeles, a functioning market in which the consumer is reducing use by

9 to 10 percent a month should produce a reduction in prices, not

a doubling. So we are looking at ratepayers’ paying 700 to 800

times more for electricity than they did just 2 years ago.

You will not be shocked to hear that Duke Energy Company acknowledged not too long ago that they charged the State about

$3,800 a megawatt in January. Reliant, I pointed out, charged us

$1,900 a megawatt on 2 successive days a month ago. So it is clear

that the energy companies have exerted extreme power over our

market and are driving up prices dramatically. That is why Governors Locke, Kitzhaber, and I, some time ago proposed cost-based

pricing which would allow for a reasonable profit on a temporary

basis until more plants could come online.

A number of noted economists, including Alfred Kahn, the proponent of airline deregulation, came before this Committee last

week and spoke to the wisdom of temporary price relief for California and the West.

On Monday, the Federal Energy Regulatory Commission again

refused to impose cost-based pricing. I want to thank Commissioner Massey for his long effort in that regard. I believe to this

moment that that is still the most effective way to restrain prices

and provide a reasonable profit.

Again, my thanks to our two Senators for their long efforts and

our congressional allies, not just in California but throughout the

West, who have worked night and day for price relief for the West.

On Monday, with two new commissioners, the Federal Energy

Regulatory Commission did grant some price relief. I thank them

for that. The commission did correct the most obvious errors in its

April order, but it was months too late and there is much more for

FERC to do.

The California ISO estimated that from May 2000 to February

2001, power generators charged Californians $6.7 billion more than

a competitive marketplace would otherwise warrant. They have recently updated those figures through May, and the overcharges are

now $8.9 billion.

To date, however, Mr. Chairman, not a single penny in refunds

has been returned to California. I believe it is unconscionable if

generators are allowed to keep these egregious overcharges. Mr.

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Chairman, FERC must move quickly to enforce the law. FERC

must order these energy companies to give us back our money.

Then, finally, Mr. Chairman, FERC must turn its attention to

natural gas. Until very recently, California natural gas prices were

2 to 3 times higher than the national average, and for a while they

were 8 times higher. That was due in part to the fact that El Paso

Natural Gas controlled a significant portion of the major pipeline

into Southern California. It was not until that contract expired and

was divided essentially to 30 other energy companies that the price

started to come down and get close to what the rest of the country

is enjoying.

So, clearly, FERC must be—I would suggest this commission

could do a useful service in urging FERC to exercise its responsibility to enforce laws against manipulation on interstate pipelines

to California.

Mr. Chairman, in conclusion, California will continue to do its

part, building all of the plants California needs and setting an example for the rest of the country on conservation. With the greatest

of respect, I would ask this distinguished body to do its part by

joining us in holding the Federal Energy Regulatory Commission’s

feet to the fire. It is unconscionable that the commission look the

other way while energy companies bilk Californians out of $9 billion. Californians are due billions of dollars in refunds. Together we

have made progress on price relief. Now it is time to move forward

on refunds, not just refunds for California but refunds for the entire West.

Again, I thank you for the privilege of being here. I know there

were a couple of questions earlier that were raised about California’s activities, and if it is appropriate to respond to those questions, I will.

Chairman LIEBERMAN. Thanks very much, Governor Davis, for

that excellent testimony. I think the record does make clear, as you

have documented, that the State of California and the people of

California have taken very significant steps forward in a most difficult situation which no Member of this Committee would want to

have their State go through, to try to make things better. That

says the obvious. I would say no governor of one of our States

would like to have that State go through that either. Both in terms

of bringing more power online through the State, but also in the

very impressive conservation figures that are coming out now from

California, which means that individuals, families, businesses understand the crisis and using less electricity, progress is being

made.

We are focused, because we are Federal an oversight committee,

on the Federal Energy Regulatory Commission. And as you said,

and I said before, that is the group that we have been asking to

do what you cannot do and no one else can do—that is, the State

cannot do, and that is to deal with the wholesale price of electricity.

I wanted to ask you a few questions about the order that came

out on Monday. The first is this—I am going to get to the nature

of the price relief in a moment, but in its order, FERC provided

price relief until the end of next summer, September. And my question to you: Is that enough time? In other words, can we expect

79

that by that time enough of the power plants that are now in the

process of being constructed will be online, and conservation will be

sufficient so that supply and demand will be equivalent or that

supply will surpass demand and we can have a genuinely competitive market? So is September of next year sufficient time for the

State at this point?

Mr. DAVIS. Well, as I said, I think the Commission’s action is a

step in the right direction. They will have to be vigilant to make

sure that there are not too many loopholes and that the order is

enforced.

We will not have, however, about enough power to meet our demand until sometime late in 2003. Alan Greenspan has said on a

number of occasions that electricity deregulation really does not

work unless you have 15 percent more power than demand. We

will not get to that point until sometime late in 2004.

So, optimally, the order should extend at least until we get

enough power online to bring demand and supply into equilibrium,

and that will not be until late 2003.

Chairman LIEBERMAN. I will ask that question of the FERC

Commissioners this afternoon, why they limited the order to the

end of next summer and whether they are open to extending it if

conditions suggest that they should.

My second question goes to this matter of refunds. In my own review of the law, it does seem to me that the statute is clear that

if FERC decides that rates are unjust and unreasonable, not only

that they have to take action prospectively but they have the power

to act in a just manner, which is to order refunds.

In the order that came out on Monday, as has been testified to

earlier, nothing was said about refunds for the overcharges outside

of California along the Western grid. And I was struck, as Senator

Cantwell or Senator Murray said this morning, that their electricity prices in Washington State have gone up 11 times, by a multiple of 11 in the last year.

FERC’s new plan issued Monday, as I get it, is for a 15-day settlement conference presided over by an administrative law judge.

So I wonder if you have had enough time to give a response to that

as an adequate forum in which to try to obtain the refunds necessary for the State. And if you do not, what other avenues do you

have available to you?

Mr. DAVIS. Well, as you suggest, there does not appear to be

much guidance to the administrative law judge as to what to consider and how to proceed. Obviously, I believe California should

have a seat at the table. So should the other States who believe

they have been overcharged. And we would present information

from the California ISO that is advised by many of the economists

that you had testify before you last week and have come to the conclusion that Californians are owed at least $9 billion in overcharges.

Again, the FERC itself came to that conclusion on three separate

occasions, but it has taken no action to put money back in the

pockets of Californians. So they have suggested that about $120

million might be subject to refund, but there is an ongoing process

that allows the companies to rebut that and put in evidence to the

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contrary. The bottom line is no money has yet come back to California.

I do not know if 15 days is enough time to resolve this issue, but

I do believe the FERC should get a clear signal from this Committee that refunds are part of its function. Yes, they have provided some relief going forward. It is not exactly what we wanted,

but there is no question that it will have a downward impact on

prices, on the real-time market. But that is only half the job. The

other half of the job is to give us back the money that was wrongly

taken from us. The Commission made the determination it was

wrongly taken from us. They just did not follow through and order

refunds.

What I would suggest is that at the end of the 15-day period, you

call the FERC back to this hearing and ask what has happened,

how much progress has been made, have States had a chance to

make their case, and what is, in fact, going to happen on refunds.

Refunds—I mean, as you know, there is really no justice if you have a right but no remedy. We have a right to $9 billion, but

there has been no remedy.

Chairman LIEBERMAN. Thank you. I agree with you. And let me

just say that it is my intention, though the Committee has a lot

on its agenda, that this is an important enough crisis, and it is a

crisis, obviously, that affects the West, but it sets a precedent for

how energy price and supply crises will be responded to by the Federal Government. So I intend to continue to exercise, on an ongoing

basis, the oversight authority of this Committee with regard to

FERC. And I hope that will be helpful to them and to people

throughout the country.

Mr. DAVIS. If I may, Mr. Chairman, I might suggest that you put

those questions to Commissioner Wood. I have had three conversations with him. I find him to be a very reasonable person. He suggested to me that he thought a more aggressive approach to refunds might be in order. So I think he might be sympathetic to—— Chairman LIEBERMAN. I will do that this afternoon. Thank you.

Senator Thompson.

Senator THOMPSON. Thank you very much. Governor, welcome

very much.

Mr. DAVIS. Thank you, sir.

Senator THOMPSON. Governor, you heard my opening comments,

and they will lay the basis for some questions I have. I started off

by saying that I admire you in many respects. I wouldn’t wish your

problem on my worst enemy. You certainly were not responsible for

many of the things that occurred, certainly as they developed before you became governor a couple years ago. I was especially impressed by the fact that you said you had seen all my movies.

[Laughter.]

Chairman LIEBERMAN. Late at night.

Senator THOMPSON. Which makes two of us, now that I have calculated. Perhaps you can talk to the Chairman about salutary effects of that. But you have made some pretty pointed comments

concerning other people. You have made some here today. I have

made some. And I am sure that you understand from one elected

official to another that it is appropriate that we get into some of

the history of this and some more pointed comments and questions.

81

And I appreciate the fact that you do not shy away from that and

you come here today and present yourself for some of those questions.

So having said all that, I want to ask you how it was that you

seemed to let things get totally out of hand. My information is that

back as far as 1998, the California Energy Commission warned of

possible energy shortages as early as 2000. In February 1999, Bonneville put out a warning concerning the problems as far as hydropower in the Northwest. In July 1999, the CEC once again warned

of short supplies. All this time, of course, you are becoming more

and more aware, and, of course, last summer, a hotter summer

than normal, the lack of moisture in the Northwest, all of the other

factors that we have mentioned concerning increased demand—I

think your electric power demand from 1996 to 2000 increased by

about 24 percent. You were obviously becoming more and more dependent on imports for your power. May 2000 spikes, shortages,

California’s first two-stage alert. January of this year, a letter from

20 prominent economists saying it would be a fateful mistake to

proceed with current policies such as the price caps and the spot

contracting.

All of those things obviously developed over a period of time, it

looks like a couple of years. But they were there for anyone to see.

Did you see these developments as they were occurring? Did they

cause you concern? If not, why not? And if you did, why didn’t you

act sooner?

Mr. DAVIS. In my testimony, I made clear, Senator, that we

started licensing plants my fourth month in office. I became governor in January 1999. We talked about electricity usage increasing from 1996 to 2000. I came in in 1999. We started approving

plants in April. That first year of 1999, before this matter was really—had not really been chronicled, it certainly was not in the

newspapers with the regularity it is now, we approved six new

plants.

When the matter worsened in 2000, particularly in San Diego,

which experienced the full frontal effect of deregulation, we passed

appropriate legislation to relieve the problem there, and I began

testifying in front of the FERC in the fall of 2000 after a San Diego

meeting.

So I have spent an inordinate amount of time on this issue. It

is obviously important to the growth of the economy in the West

and in California.

But just to put a couple things in perspective, according to the

U.S. Department of Energy, 85 percent of the growth of electricity

in the West in the last 5 years has been outside of California. We

have, as you can tell, a very enviable record on conservation, and

that is not just the product of the work that I have been engaged

in with our legislature. But for 20 years, we have been requiring

energy-efficient buildings, appliances, all kinds of things which

have reaped benefits for our State.

So we have been working on this for a very long time, and to

suggest otherwise is simply not accurate.

Senator THOMPSON. Well, I see my time is up. I would ask you,

though, to—I want to ask one more question. You can answer it

now or later, if I might.

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Mr. DAVIS. It depends how hard it is.

Senator THOMPSON. I will just take a few seconds.

I take note of what you said, but in the eyes of many people,

many more fundamental problems were not addressed, for example, the lifting of the retail caps. Mr. Kahn, who, as you correctly

pointed out, testified here last week in favor of caps, said that the

idea of keeping these retail caps on was ridiculous. You acknowledge yourself that you could probably solve the problem if you

wanted to raise rates. So you have the combination of keeping the

retail caps on, forcing the utilities to buy on the spot market, which

was great when the spot market was not, not good when it became

high. The approval process, the siting process, you addressed after

the blackouts occurred, I believe.

These are fundamental structural things, I think, which all investment advisers—we have had Bear, Stearns, Goldman, Sachs

and others testify—say that these were structural things that

clearly, regardless of who was responsible for how you got to that

point, that clearly had to be addressed. And now they are being addressed at a price that is much greater than you would have had

to have paid had you addressed them last year, last summer, when

the crisis was obvious to everyone.

So do you not claim—or do you not accept any responsibility for

not having addressed these structural problems that were inherent

in your system that obviously had to be changed when so many of

the circumstances were changing, especially in light of your emergency powers, if you needed to exercise them?

Mr. DAVIS. First of all, it is nice for us to sit back here and talk

about passing on the true price of electricity. But let me assure

you, if I passed on a 700-percent increase to the citizens of California, there would be an outrage the likes of which you have never

seen, and electricity deregulation in this country would not benefit

from the——

Senator THOMPSON. I do not think anybody is suggesting a particular price here today.

Mr. DAVIS. Well, but I do not know that—I do not think you

have, Senator, but I believe I have heard many people say why

didn’t we pass on the true price of electricity. The legislature and

I believe it is important not to shock our economy into recession,

and so we have phased this out over about a 10-year period. The

highest residential user this year will get about a 45- to 50-percent

rate increase. We did increase rates in January of this year. They

went up again 2 or 3 months ago. There are also a number of incentives for conservation no matter what your rates are, and the

people who are the most efficient, who just use 130 percent of baseline usage, do not see their rates go up.

But we are trying to manage a system which, as your question

suggests, was basically flawed. The bill that passed in 1996 unanimously, with every Democrat and Republican voting for it, and the

previous governor signing it, deregulated the wholesale market but

not the retail market. The flaws of that did not become crystal

clear until sometime in 2000, and we began earnestly taking steps

above and beyond the steps we had done in 1999 to improve the

siting process and to put new plants online.

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So, everybody benefits from hindsight, but I make no apologies

for the aggressive efforts we have taken to correct situations that

we inherited. I did not, as you suggest, cause the electricity problem. President Bush did not cause it. Obviously it is on our respective watches. We have to try and manage it as best we can for the

people of our State. And I think we are doing that.

Senator THOMPSON. Thank you.

Chairman LIEBERMAN. Thank you, Senator Thompson.

Let me just say for the record that it is my understanding that

in almost all States that have deregulated electricity prices, retail

caps, caps on retail prices for a temporary time period are the rule,

the custom. That is the norm, usually. And so what was adopted

here I know had an adverse effect because of all the other things

that went wrong. But I would just make the point that if, in fact,

California electricity customers were forced to pay the true price of

electricity as it was being fed into the State, I think unfairly, very

unfairly, it would have not only been a jolt to your economy and

the American economy, because you are almost 15 percent of the

national economy, but I honestly think it would have terminated

the movement toward energy deregulation. I mean terminated the

deregulation of energy which is occurring across the country, and

is, generally speaking, I think the way to go.

So I think what is on the line here in your response to this crisis

and FERC’s response is not only how this Federal agency is doing,

but whether we are going to continue to enjoy the benefits of deregulation.

Senator THOMPSON. Mr. Chairman, if I may just point out, I

think that the issue is not a very good solution versus a very bad

one. I think the issue is a choice between two bad solutions and

whether or not by allowing more of the true price to be passed on

we are creating a larger problem down the road.

Chairman LIEBERMAN. This dialogue could go on a while, but I

think we will hear more of it as the other Senators question. I am

going to call on Members as they arrive, going from Democrat to

Republican. Next is Senator Durbin.

OPENING STATEMENT OF SENATOR DURBIN

Senator DURBIN. Thank you, Mr. Chairman. Governor Davis,

thank you for joining us.

Mr. DAVIS. Thank you, sir.

Senator DURBIN. I have listened to your plight with great interest. You would think that if you are from Chicago or Illinois, far

away from California, it would just be an academic endeavor. It is

not. We have faced natural gas price increases, home heating cost

increases over the last winter that are at record levels in Illinois.

We have just seen a run-up in gasoline prices, which mercifully are

starting to come down again. And it has sensitized people across

my State and I think across the Nation to the fact that this is not

just California’s problem. This is a national energy debate.

Sadly, your State and the people living there have been the first

victims of some of the worst things that have occurred here. But

what I find interesting is that the debate usually centers on whether or not there is an understanding of market forces. And those

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who want to explain away what has occurred in my State and

yours say you just do not understand supply and demand.

I think behind that statement is the suggestion that we can trust

supply and demand, that we can trust the market forces when it

comes to energy. And yet for a long time here in Washington, we

have come to the opposite conclusion.

In 1935, when we created the Federal Power Administration, we

basically decided that energy was so important to our Nation’s future and that the energy corporations so unpredictable that they

could not go unguarded or unsupervised. So from 1935 forward, we

said we as a government, as a people, will regulate this market,

this industry. It is just too important to ignore. And I think that

brings us to where we were a few years ago and where we are

today.

In 1996, as States like your own embarked on deregulation, before you were elected governor, I can tell you that repeatedly the

folks from the industry came to us and said, Washington, get out

of the way, we do not want you involved in this. Every State is

going to come up with its own solution. One size does not fit all.

This is not a national thing to do. Let the States do it.

And as you have noted, and Senators Thompson and Lieberman,

in 1996, when Governor Wilson came forward with his plan, it

passed unanimously in the California General Assembly, which is

probably a rare occurrence on an issue of this complexity. And so

those who were second-guessing whether that California deregulation was smart or not so smart have to understand that in the context of 1996, virtually all the parties to the debate said this is the

way to go, setting the stage for what happened to California and

to your administration just a few years later.

I think that is a background which we should not lose sight of.

As we look at this today, we should be reminded that 66 years ago,

this Congress created the precursor to the Federal Energy Regulatory Commission and said: Watch this market, watch energy in

America. There are things here that can happen that are devastating. California sadly today is on center stage as we look at the

results.

Let me ask you about a couple things in particular. First, you

have suggested that California should have a seat at the table in

this discussion. I wholeheartedly agree. I think the residents of all

the States should have a seat at the table. Sadly, this debate comes

down to a face-off between the energy giants and the giant bureaucracies, and there seem to be some groups that are absent

here, including families and businesses and others that are going

to get nailed if we let the market run amok.

I have proposed a consumer energy commission that will involve

all three, not only the producers and the regulators but also the

consumers, so that they could have a voice at the table about the

need not only for generation and conservation but also, as in your

remarks—and I thought this is critical from where I live—stabilization so that there is predictability, so a business knows from month

to month or week to week the parameters of potential energy increases.

I would like to have your comment on that, and particularly I

would like you to address your repeated suggestion, which I can

85

surely understand, about this need for a refund. FERC has the authority to give refunds. They have not addressed this issue. As I

sit here I do not know if historically they have ever considered

doing that. But I would like you to comment on that refund question, what it would mean to your State and whether there is any

precedent that you are aware of at FERC for such a refund.

Mr. DAVIS. Well, first of all, I appreciate your description of the

background to the situation we currently face in California. It was

accurate and well done.

Obviously, refunds are a primary way of policing the market, and

if the Federal Energy Regulatory Commission is supposed to be a

watchdog for the consumers—and that was the original notion back

in 1935—then their primary vehicle is to provide relief, not just

prospectively but retroactively. It is one thing if—well, I was going

to give an analogy, but I will not.

So it is helpful to know that maybe we will not reach $60 billion

this year, although we are halfway through it, in expenditures for

electricity—a little shocking when you realize it was just $7 billion

2 years ago—but that does not fully balance the equities since we

have shelled out far more money for electricity than would be the

case.

All I can say is that whether or not there is a precedent for refunds of this magnitude, they are owed, they should be paid, and

this oversight committee I believe, and with respect, should hold

FERC’s feet to the fire and ensure they issue the orders to give us

back our money. That is the only message the energy companies

will understand. If they have to reach in their pocket and write a

check back to Californians, they will think long and hard before

they take advantage of the market again.

And in response to your question, Senator Lieberman, I consider

myself a marketplace Democrat. My parents were actually Republicans. But this is a special market. You cannot store electricity,

unlike any other commodity. The user has to have it on the day

they need it, whether you are on a fixed income, whether you are

a police station or a hospital, and the seller has to sell it on that

day. And so you do need some kind of buffering situation, and the

umpires in this contest, if you will, are the Federal Energy Regulatory Commission. They need to see themselves as the—again, another analogy—circuit breaker to make sure they step in when

there are problems. And the best remedy, I think, is refunds. That

sends a very clear message.

Senator DURBIN. Thank you, governor, and I just in closing

would say to the Committee here, your tragic experience in California has taught some national lessons, and I think particularly

in the area of conservation. You have given us some real guidance

as to what we can do as a Nation to deal with energy and view

conservation as more than just a personal virtue.

Thank you.

Mr. DAVIS. Thank you, sir.

Chairman LIEBERMAN. Thanks, Senator Durbin. Senator Collins.

OPENING STATEMENT OF SENATOR COLLINS

Senator COLLINS. Thank you, Mr. Chairman.

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Governor Davis, I would like to join my colleagues in welcoming

you this morning. Although Maine and California are far apart geographically, we actually have quite a few things in common. We

each have beautiful coastlines. We were each early movers in electricity restructuring. And both of our States have citizens that recognize that women make great Senators, although California has

not gotten the party affiliation right yet.

There are also, however, some major differences, particularly

with how our States have handled electricity restructuring. Maine

has been steadily building new power plants. California went a decade without building any. Perhaps most important, Maine did not

make California’s fundamental error of artificially capping retail

rates.

Fixing retail rates, even in the face of power shortages and escalating wholesale rates, has clearly been a disaster for your State.

You cannot expect the benefits of a free market if you have a market which is not free.

Nevertheless, as I said at last week’s initial hearing, electricity

markets are not like other markets. By its very nature, electricity

is a unique commodity. It cannot be stored or inventoried. It is sold

continuously on the spot market at prices that may vary widely.

We had a case last summer in Maine where the spot price for a megawatt of electricity went to $6,000, which is more than 100

times its usual rate. And, obviously, it is very difficult, if not impossible, for most consumers to respond to price spikes by turning

off air conditioners or doing the laundry at a different time.

So it seems to me that while it is fundamental that electricity

markets must first and foremost be structured properly, they can

also create instances where they do not operate in what FERC calls

a workably competitive manner because consumers are not aware

of price spikes. Therefore, I believe that FERC’s actions to mitigate

prices appear to be reasonable.

But while it is important that FERC take action in the clearly

dysfunctional California market, I would caution the Governor of

California to be careful about what you ask for. While it may be

tempting to ask FERC to exercise even more control of the California market, I know from our experience in New England that

there may well come a day when you will wish that FERC would

exercise less control.

In New England, FERC decided that we needed to give generators more incentives to build capacity, so FERC increased what is

known as the installed capacity fee. This is a fee that is paid by

consumers to generators to encourage additional generation. What

was really striking was that FERC ordered a 50-fold increase in

the I-cap fee over the level agreed to by a supermajority of the

members of the New England Power Pool and recommended by the

New England independent system operator.

It is ironic that FERC ordered this increase despite the fact that

FERC’s own report shows that New England already had plenty of

capacity, and it is even more ironic that FERC ordered this fee in

New England when the region with the biggest capacity problems,

California, has no I-cap fee at all.

Governor, with better planning, your State will eventually be

where Maine is today. You will have adequate generating capacity

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to meet the needs of your State. Generators will eventually charge

lower rates, although, as in Maine, they still are unlikely to be

cheap. But if you ask FERC to exercise more authority over your

market today, how will you ensure that FERC does not exercise unwanted authority over your markets tomorrow. If you call for

FERC to set prices today, how do you know that at some point in

the future FERC will not set prices, or at least some components

of that price, at a level that Californians will almost universally

agree is too high? And, finally, if your answer is going to be that

only FERC has jurisdiction to act on these issues and questions,

are you recommending that we change the allocation of authority

between State and Federal regulators?

Mr. DAVIS. Well, I appreciate your comments, Senator, about the

flip side of asking for assistance. FERC has been such an omnipresent factor in our market, ever since I became governor, that I

never contemplated a day without FERC, even though it is probably worth a few minutes’ contemplation.

I do want to make one comment. You touched on it, Senator

Lieberman touched on it. Electricity deregulation might work efficiently if there is more power than demand. That is the key. And

to States considering electricity deregulation, I would discourage

them from doing so unless they first acquire more power than demand, because otherwise you are at the mercy of market forces

that will extract every dime FERC allows them to from your citizens.

I think it is fair to say, Senator, if you were in my shoes and facing the extraordinary price increases that our citizens have, you

would feel, as I do, that our first obligation is to fight back and try

and get some relief from those price increases and assure people

that the markets will stabilize and that henceforward they will not

be subject to these rapid price spikes.

So, yes, I am asking for assistance. What we got on Monday was

not perfect but is a step in the right direction. And I am hoping

that this Committee will ensure that refunds are forthcoming. I

think that will have a very sobering influence on the behavior of

energy generators in the future. I want them to make money, I

want them to be profitable, but not at the expense of driving our

economy into a recession, which will have an adverse consequence

on the American economy.

Chairman LIEBERMAN. Thank you, Senator Collins. Senator

Torricelli.

OPENING STATEMENT OF SENATOR TORRICELLI

Senator TORRICELLI. Thank you, Mr. Chairman.

Governor, welcome to the Committee. Governor, I do not know

that it is productive to engage in partisan blame in this matter.

People in California simply want this problem solved. But I do

have a sense of what is fair. Some things have been said about you

and your administration that simply do not bear scrutiny. But the

fact is your predecessor did not build power plants. You are building or planning 28. You claim that that is more than your predecessors or more than at any time in California history. You suffer

from unnecessary modesty. That is not simply more than at any

time in California history. That is more power plants ever built by

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any State at any time in any comparable period. And the record

should reflect it.

It has been said, indeed, that conservation should be part of this

equation. Indeed, at no time in American history has demand fallen by comparable levels. California is not simply now exercising

conservation. You have the most efficient use of electricity of any

State in the Nation. Indeed, if the State of Maine were to become

the model, every citizen of California would have to double their

consumption next month to follow the Maine model.

On the question of whether or not there is responsibility for the

current flawed deregulation plan, it should be noted that you did

not write it, you did not design it, you did not vote for it, and you

did not sign it. You just inherited it. And now you are fixing it, and

that is to your credit.

Now, I do not think that matters to people of California. They

just want this solved. But fair, nevertheless, is fair. And I think

you have handled this very well.

Now, second, let me say something to the people on the FERC

board. This Senate in confirming Presidential nominations looks to

integrity and it looks to competence. Speaking only for myself, I

want to make clear for FERC members who come before this Senate again, I am going to look for something else: Whether in this

moment of crisis for the people of California they were responsive.

FERC has been late. Its response has been inadequate. I am glad

they have acted. But unless or until this response carries the State

of California through this building program until you have adequate supply, their response is not adequate. And I hope every

member of the board who intends to return to this U.S. Senate listens very carefully to those words. This is now a Democratic majority Senate. It will remain so for some years, and we are watching

how the people of California are treated, and we are watching very

closely.

Third, let me say there are those who, I think, are genuine in

wanting to help your administration. But there is a partisan overlay that perhaps separates the fate of California from what is happening with the rest of the country. That might be true with some

States. It is not true with your State. If the economy of the State

of California suffers, this country will follow. There is no separating your economic performance from that of the Nation as a

whole. Everybody has a stake in how this evolves and whether or

not this is solved properly.

Then, finally, let me add to you it is my observation that if this

Committee were meeting on the price of corn or cotton or housing

prices and we were witnessing falling demand, increased supply,

and a 700-percent increase in prices, we would not be citing the

laws of economics.

We would be citing the criminal laws, because it is against the

law. There is a prima facie case that there must be some collusion.

Prices are being set. The free market is not working. And this is

one of the greatest examples I have ever seen in the history of our

country, watching what is happening with these projections.

I, simply for my part, because you have answered so many of

these questions, wanted to offer my compliments and to say that

there is a public perception because of the national debate, that

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some people are talking only about increasing supply, other people

are talking only about the controls of pricing and what we are

doing about consumption. Indeed, you have set records in both directions: The greatest reductions in consumption with the greatest

conservation and the largest building program in American history

for supply. Everybody else may have run to their extremes. It appears to me, you, if you alone, have struck a balanced program.

I hope the people of California in this difficult moment have the

patience to see this through. There clearly is an answer on the

horizon. And I hope, also, Members of this Committee and the administration will realize that those numbers of $60 billion for consumption, what is behind those numbers. Every rise in that cost

represents a family that cannot meet a mortgage, cannot educate

a child, is taking from their retirement income to pay electricity

bills. These are not some abstract numbers. It is people’s quality

of life and the future of their children that are being impacted.

And so when we talk about rebates from these energy producers,

when we talk about the need to control their prices, this is not

vengeance against some unnamed corporate entity. It is preserving

the quality of life of individual families in California who are paying with their futures and their children’s futures by this unconscionable taking advantage of this situation.

So, governor, I am glad you are here. You may have noted there

is not a question in there, but, nevertheless, I thought there were

some things that you might have been unwilling to say on your

own behalf that needed to be said. I suspect I have no time, but

if I do, it is yours. Thank you.

Chairman LIEBERMAN. I was going to advise you, governor, that

after Senator Torricelli’s statement, you could rest your case.

[Laughter.]

Mr. DAVIS. Thank you, Senator.

Chairman LIEBERMAN. Thanks, Senator Torricelli.

And now, Senator Bennett.

OPENING STATEMENT OF SENATOR BENNETT

Senator BENNETT. Thank you. Don’t get too comfortable. [Laughter.]

I lived in California for 12 years. I was there while you were

Chief of Staff to Governor Brown and I welcome you to the Committee now.

I am delighted to have you say that President Bush did not cause

this. I would hope you advise your political consultant of that fact.

I will just leave it at that, but you saw the piece in the Wall Street

Journal, as did I, as to how your political consultant tries to write

economic policy by focus groups. I hope you will tell him, and then

through him the people of California, that President Bush did not

cause this.

Now, having said that, let me note that by virtue of what you

have done, you have effectively nationalized the power industry in

California. If California were a separate country, you have taken

action similar to action taken by the parliament in Great Britain

when the Socialist Party, the Labor Party, took it over, and have

started doing things yourself as the chief executive of California

which previously were done by private entities. You are entering

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into long-term contracts on behalf of the State, taking out of the

hands of the private entities the right to make those kinds of price

decisions.

Let me review, therefore, the record from California with respect

to your administration’s ability to do this. I do this as a cautionary

note. I have a quotation here from the Wall Street Journal. That

is seen as a right-wing newspaper, so I will stay with newspapers

in California and the comments that they have made about your

stewardship in this area as you now step up with a nationalized

program.

This is from the San Francisco Chronicle, not known as a rightwing newspaper. This is last February. ‘‘Governor Gray Davis was

slow to respond to the economic realities of California’s power crisis

despite warning signals from legislators, regulators, and utility executives stretching back to last summer. Indeed, documents and

interviews with industry insiders, regulators, and lawmakers show

Davis may have contributed to the meltdown of the State’s two

largest electric utilities by neglecting a repeatedly suggested strategy for stabilizing wholesale prices.’’

‘‘In addition, a top former Federal regulator said he told the governor’s advisors and State Public Utility Commission officials as

early as July that a key Davis proposal, to lower wholesale price

caps, wasn’t likely to solve the State’s power problems. ‘The Governor resorted to a log-rolling strategy to get us to do things that

we understood at the outset were not going to be real solutions,’

said James Hocker, an appointee of President Clinton’s, who

stepped down in January as the Chairman of the Federal Energy

Regulatory Commission.’’

Now, moving to March and to the Sacramento Bee, Dan Walters,

‘‘Crisis Also One of Leadership.’’ I will not quote all of it, but he

says, ‘‘It is evident that it would have been a relatively minor

bump in the road had Davis not frozen last summer when the first

indications of price spikes arose. Had Davis done what private utilities, power suppliers, and others urged him to do then, adjust

power rates slightly and allow utilities to sign long-term contracts

with energy brokers and generators, the major crisis could have

been averted.’’

Now, going to a source outside of California but one of the leading left-wing newspapers in this country, The Washington Post yesterday says, and I quote——

Chairman LIEBERMAN. We will note that the laughter was coming from the media table. [Laughter.]

Senator BENNETT. Well, if I am going to refer to the Wall Street

Journal as a right-wing newspaper, I have to be even-handed and

refer to The Washington Post as a left-wing newspaper.

Quoting from The Washington Post, ‘‘The Senate will hold hearings on California tomorrow.’’ This appeared yesterday. ‘‘Governor

Gray Davis, having won the argument on price caps, plans to use

that occasion to demand billions of dollars in refunds from generators for the period when price caps were not in place. This is not

a smart way to persuade generating companies to invest in new

power plants in California, and without investment, blackouts will

return to California sooner or later.’’

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Now, as I said, governor, you have nationalized the industry in

California. You have just entered into a contract for 8 years with

Constellation Energy Group that would put a peak of $154 per

megawatt and off-peak of $58 per megawatt. That is the decision

you have made. The State has entered into that contract.

I would point out that Enron, who has come in for a good degree

of criticism in California politically, last summer with the utilities

offered them 5 years at $50 per megawatt. You have just entered

into a contract that is worse than the one that could have been obtained a year ago on the free market, and that raises questions in

my mind about your ability to handle the nationalization of energy

in the State of California.

I am assuming we will have a second round, Mr. Chairman, so

I have laid the predicate for where I am on this first round, and

either now or during the second round, we can get the governor to

respond, because I do not want to unfairly put him in a position

where he cannot respond. But I think the actions California has

taken here are unprecedented, and in the second round, I will

quote the assumption about those actions that are in both the Los

Angeles Times and the Wall Street Journal and I think we ought

to explore that very carefully.

Chairman LIEBERMAN. Senator Bennett, it had been my desire

that there not be a second round, but if the Members want it, we

will have a brief one, only because we have two other governors

and the Attorney General and the Public Utilities Commission and

the five members of FERC. But I wonder, Governor Davis, if you

want to take a moment to respond to the statements that Senator

Bennett has made.

Mr. DAVIS. Yes, Senator. I mean, I readily acknowledge I have

a number of critics and you have quoted some of them. I do want

to pick up on a couple other things you have mentioned. I have

given President Bush credit for expediting Federal approvals that

have allowed us to license 16 plants. I thank him for the extension

of a couple emergency orders at the beginning of his term, and I

believe in giving people credit when they do what I believe to be

the right thing.

As to why the State stepped in in January of this year to buy

power, it was very simple. These prices have brought PG&E to its

knees. Edison was deemed uncreditworthy, and in a meeting here

in Washington, the generators told me, we are not going to sell any

more power to your utilities. So you either find us a creditworthy

buyer or your lights are going out. The State decided to become a

creditworthy buyer and has done our best to keep the lights on, the

power flowing, and to spread out the Herculean rise in prices over

a lengthy period of time, which ensures all the power costs are

fully paid, but we don’t shock our economy into recession, which I

suggest would not do well for your economy or for the economy of

this Nation.

If you want to get into the details, if there is a second round, I

brought David Freeman with me. He oversaw the contracting process and is more familiar with it than I. But I have total confidence

in his work. He ran the New York Power Authority. He ran the

Tennessee Valley Authority. He ran SMUD. He ran the Department of Water and Power. Some people think he can’t keep a job,

92

but he has actually done a good job in all those places and he had

to negotiate with these energy companies starting in late January

when we had no leverage, prices were running $1,500, $1,600, and

$1,700 for a megawatt of power, and I think he did a good job, not

just in getting a good price for the State over 5- and 10-year period,

but in shrinking the spot market, without which we would have

seen higher prices than we are currently seeing this summer in our

purchase on the spot market, because we have shrunk it to the

point, through long-term contracts, where the price has started to

come down.

Chairman LIEBERMAN. Thank you. Senator Carper, you are next.

OPENING STATEMENT OF SENATOR CARPER

Senator CARPER. Thanks, Mr. Chairman.

I want to say to my old colleague, Governor Davis, it is great to

see you and I warmly welcome you to this place.

When I was running for the U.S. Senate a year or so ago, I asked

a sitting Senator who had been a governor, what is the difference

between being a governor and U.S. Senator, he used a football

analogy. He said, when you are the governor, you are the quarterback on the field calling every play. When you are the U.S. Senator, you are the athletic director sitting in a box watching the

game.

It is easy for us to sit here in the box watching the game to be

critical of you and the other quarterbacks calling the plays and trying to move the team down the field. Senator Torricelli has already

spoken, and I think eloquently, about your efforts, and I would just

say to my colleagues, we could find pundits in our own States and

throughout the country who would question our votes and our steps

and missteps just as questions have been raised about some of the

actions of Governor Davis. I applaud the efforts that you have undertaken and hope for you and for the people of California that the

end will be a good one and a satisfactory one.

I want to ask you, if I may, to take the lessons that you have

learned in California with respect to electricity deregulation and

with energy conservation and to share with us what applicability

there is for the rest of the country for our national policy, particularly with energy conservation. What are the lessons for us as a

Nation derived from your experiences in California for electricity

deregulation and for energy conservation?

Mr. DAVIS. In terms—I shared earlier one of my thoughts about

electricity deregulation. States who have not yet decided to go

down that road, in my judgment, should not do so until they acquire more power than their project demand. That will then give

them leverage and allow them to say no to prices that are unduly

high. We look forward to being there someday, so when someone

offers us power at $400 or $500 or $600 a megawatt hour, we can

say, well, we will just turn on one of our peakers, or thank you

very much, if you want to offer it to us for less than $100, we will

talk to you, and you have the leverage, they know you have the leverage, and you come to a reasonable resolution of that issue.

On conservation, this has been very exciting because it is something we had to do. It is not a question of whether we wanted to

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servation gains that had been built into the system before I got

there, and it is just exciting to see what people are willing to do.

When the President was in town, before my meeting, we met

with technology companies. One company is making a flat-screen

computer which reduces electricity usage by 75 percent. Intel is

making a new chip that makes your computer much more efficient

on ‘‘sleep mode,’’ so it can receive information and still conserve

about 60 percent of electricity.

We just tell people in their daily lives, if you are not in a room

and no one else is in the room, turn out the lights. Turn up the

thermostat two or three degrees. I believe in personal example. My

wife has taken this cause of conservation to new heights. When you

come into my house at night, it is like entering a tomb. There is

no light, none, except a little crack of light under whatever door in

the room she is in, and she has replaced all the lights with fluorescent lights. In the winter, the temperature was down to 55 degrees,

so it was—I went to bed with a sweatshirt on. But her bill the first

month was down 36 percent, last month, 63 percent.

So it is amazing what you can do if you are determined to reduce

electricity, plus it is exciting to see some of the technology gains

that will be on-line, not just for us but for the rest of the country,

because no matter how much excess power you have today, you will

get to a point when you don’t have it and you will want the benefit

of these technology improvements, which our crisis is forcing us to

develop, and obviously, we will share them with everyone.

Senator CARPER. You mentioned, in fact, you described here and

earlier the actions that the FERC announced on Monday as a step

in the right direction. What might be some appropriate further

steps in the right direction, one, for the FERC, and two, for us in

the Congress?

Mr. DAVIS. Well, I think they have to look closely at there is still

some potential for manipulation. Everything is geared to the leastefficient unit in the State. Everything keys off that.

Chairman LIEBERMAN. Governor, can I interrupt you? Congresswoman Susan Davis was here from San Diego and I know she has

to leave now. Before she leaves, I want to note her presence for the

record. Thank you for being here.

Mr. DAVIS. Thank you very much for being here. Thank you so

much for staying. I lost my thought—— Senator CARPER. We were talking about steps in the right direction, appropriate next steps, one, by the FERC, two, by us in the

Congress.

Mr. DAVIS. We believe what FERC has done will offer us some

price relief. I notice that Mr. He ́bert was suggesting that the order

that he implemented on May 29 was responsible for some falling

prices in California, and it may well have been for 2 days, the 30th

and 31st. But we haven’t had a stage one alert since then, so that

order only affected us 2 of the 22 days it has been in effect. So now,

by making it applicable across the board during any purchases,

real-time purchases of power, it should have a downward impact on

prices.

I don’t know all the potential for manipulation, but the people in

the energy business are smart folks. They have got trading floors

that compare favorably with the New York Stock Exchange. They

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have teams of meteorologists. They have media operations that

would shame a network, and so I am sure they will do their best

to find whatever loopholes are there and we need to be vigilant.

This Committee needs to be vigilant, and so does FERC, to make

sure that the thrust of its order is, in fact, carried out and the relief that is intended is made available to us and, hopefully, to the

rest of—in terms of refunds, to the rest of the West.

Senator CARPER. The last half of my question. What appropriate

steps are in line for the Congress? What should we be doing?

Should we simply be monitoring the actions of the FERC, holding

hearings like this, conducting oversight operations?

Mr. DAVIS. There are many things that obviously compete for

your attention. I tried not to give you too long a laundry list. I

mentioned two. The President, when we met with him, and again,

I thank him for the meeting. Even though we didn’t agree on price

caps, we agreed on this. There was no reason that the price of natural gas should be significantly higher in California than in the

rest of the country, particularly natural gas coming from Texas,

and he was open to the possibility, because I ran this by him twice

and he said, ‘‘Yes, you can say this,’’ he is open to the possibility

that the tariff should be reimposed on the transportation quotient

of natural gas. Natural gas is deregulated, but there used to be a

fixed price you could charge for transporting it. That is one possibility to reexamine.

So the two things that I would suggest this Committee focus on

in terms of its dealings with FERC are the potential for manipulation on the natural gas issue, because natural gas is not only a cost

in and of itself but a huge part of electricity costs, and what I think

is the necessity is providing refunds to Californians and other citizens in this State who have been unduly victimized by extraordinary electricity prices.

Senator CARPER. Again, welcome. Thanks.

Mr. DAVIS. Thank you. It is a pleasure to see you in your new

capacity.

Senator CARPER. Thank you.

Chairman LIEBERMAN. Thanks, Senator Carper.

Next, we will go to Senator Voinovich.

OPENING STATEMENT OF SENATOR VOINOVICH

Senator VOINOVICH. Welcome. I was just thinking that nobody

knows the trouble a governor has unless they have worn the shoes

of that governor. I went through the minefields of deregulation

while I was governor of the State of Ohio. The deregulation legislation finally went into effect a year after I left.

I have looked at your deregulation and I think that it ought to

be revisited, and I think that some of us that came in afterwards

learned some lessons from California.

Last week, we had five outstanding economists come here to

speak before us and the question to them was, do we need a legislative solution to the problems that you are dealing with in California. Their answer was, no, FERC already has authority to handle the situation, although they did admit that FERC has been

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tion, and that they probably needed some more people and expertise.

As you know, FERC has recently adopted a system of price controls that allow for all generating units that provide energy to California to recover their costs plus a reasonable profit. That is what

we did in Ohio. We created a restructured electric utility system

that recovered stranded costs while also allowing for a reasonable

profit for generators. That, in turn, encouraged greater investment

in new generation. In fact, by 2007, governor, we are going to have

18,000 new megawatts of on-line power because we had a 5-year

cap, but it took into consideration that companies have to make a

profit and recover their costs. I think that FERC’s decision this last

week is going to provide some short-term relief for you. But I do

not think there is any quick fix.

The point I am making is that price caps will not solve supply

shortages in California. In fact, price caps that are set too low discourage investment, as you know. I think Robert Samuelson noted

in the Washington Post last Wednesday that the root cause of your

problem is demand outran supply, and for California to avoid the

constant worry over the ability to provide power, investment in

new power generation has to be encouraged, including the implementation of a streamlined siting process that protects public

health and the environment, and I think that you perhaps ought

to look at your deregulation law again.

Other States, and this is something that is really significant,

have worked through deregulation issues on a cooperative regional

basis. By contrast, the California situation seems to be extremely

polarized, with California insisting that Western States take definitive positions for or against price caps.

The question is, at what point will California be willing to become part of a regional solution, as called for by FERC, rather than

insisting on its own independent governance structures to run the

electric grid? Instead of a single State operator of the transmission

grid, I think the opportunity exists for a regional transmission organization to be established, just as we did in the Midwest when

I was governor. We had a multi-State ISO. What do you think of

going to a more regional approach instead of your current handling?

Mr. DAVIS. As you know, the next largest State in America,

Texas, is not under FERC jurisdiction because they have not yet

separated generation from distribution. The next two States, Florida and Texas, have submitted to the FERC permission to be their

own ISOs because of the size of their economies. Because we are

the fifth—at least last year, we are the fifth largest economy on the

planet, I think at least for the foreseeable future, we should be our

own ISO, as well. Now, I certainly believe that until we get to a

situation where we have more power than demand.

This has been, as I am sure you can tell, being a former governor, one of my least favorite things to do, occupying a great deal

of my time, and I think it is just imperative that we stay the course

on building new power plants, on conservation. I am pleased that

there is some response from FERC on price relief prospectively. I

am hoping that with your assistance, there will be response on

price relief retroactively.

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So I would not be open to the State joining a regional ISO—I

would not be open at all until we reach the point where we got to

15 percent more supply than demand. Then I would be willing to

revisit it.

That is not to say I don’t have great respect for our neighbors

in the West. We have a particularly friendly relationship with the

neighbors that border us, be it Arizona or Nevada or Oregon and

also with Washington, and a sharing relationship with our neighbors to the Northwest.

Senator VOINOVICH. Being next to California is like being in bed

with an elephant, and you have had a dramatic impact on your regional area. Ohio is the third-largest user of electricity in the

United States of America. We had a regional ISO and we have

found it to be beneficial. I would suggest, governor, that you look

at that. I know FERC has recommended that. I would appreciate,

as a member of this Committee, that you seriously review that

issue again and I would like to talk to you more about it.

Mr. DAVIS. As a courtesy to you, Senator, I will do that, and I

would be pleased to have a discussion with you.

If I could just make this final point, until Monday, despite a year

of effort on my part and all the agencies that I work with in California, we did not have a satisfactory response from FERC on any

matter. As a matter of fact, we think their lifting our price cap in

December 2000 was responsible for blackouts because there were

no blackouts when we had a price cap in effect, none, and it was

only when the price cap was lifted there became an incentive to

withhold until the last minute. Gaming became a great prospect.

And while I quickly acknowledge that price caps on a long-term

basis don’t make economic sense, I also want to acknowledge that

12 of the 16 plants that we have licensed submitted their application when the hard price cap was in effect of $250. So they must

have thought that was sufficient, offered sufficient return on their

investment. And in terms of conservation, there is nothing that will

discourage us from improving upon our conservation because we

have to do that to minimize the potential for blackouts and disruption.

So while theoretically I acknowledge that price caps do not—they

may well discourage conservation and discourage investment, our

experience in California, given the situation I have described, is to

the contrary.

Senator VOINOVICH. I have learned in my life that when things

go wrong, so often what we do is point to other people as being responsible for our problems. I have found that it is good to look to

one’s self and see if there are things that one can do to improve

the situation, and I believe that is the attitude that you and your

State should have and work with FERC and everyone else. But I

think that the finger-pointing ought to end and we ought to figure

out how to get this job done, because it is not only affecting your

State, but the entire country, including my State.

Chairman LIEBERMAN. Thank you, Senator Voinovich. Senator

Carnahan.

OPENING STATEMENT OF SENATOR CARNAHAN

Senator CARNAHAN. Thank you, Mr. Chairman.

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Welcome, Governor Davis.

Mr. DAVIS. Thank you, Senator.

Senator CARNAHAN. I have appreciated the forthright manner in

which you have responded today.

I realize that our topic is primarily the situation in California,

but Missourians are very concerned about the energy picture, as

well. They have watched the crisis unfold in California and they

have been worried about their own energy bills and how they, too,

have increased steadily.

It is important to focus on the proper role of Federal regulators

as we restructure the electricity industry. As we consider future

policies at the national and State level, we should learn from the

problems of the past.

We are told that a fully-functioning deregulated market should

lead to lower prices, and, of course, this is a very appealing argument. But for all of the initial optimism about lower prices, California’s experiment with deregulation has caused me to question how

future transitions should be managed. If the deregulation is to continue, we must have the structure in place for a successful transition. Public confidence is an important component of any successful

market, but competitors must also feel that there is a level playing

field and that markets are not designed in ways that unfairly benefit some players while creating barriers for others.

This brings us to FERC’s role in the process. There is certainly

no shortage of opinions on the merits of the order FERC announced

last week. But the question in my mind is even more fundamental.

What is the appropriate role for the Federal Government to play

as more and more markets move from regulation to competition?

Regardless of our views on the merits of FERC’s order, the fact remains that FERC’s action came long after the market was found

to be dysfunctional, months after the rates were found to be unjust

and unreasonable.

Like many other States, my home State of Missouri is considering deregulation. If Missouri deregulates, assuring just and reasonable rates for Missouri consumers will be entirely in the hands

of FERC. FERC’s performance in California does not inspire confidence.

This week, FERC finally began closing the door on rate gouging

in California, but only after letting a $50 billion horse out of the

barn. Missourians deserve assurances that if our State deregulates,

we won’t be stampeded by runaway prices.

I am sure that leaders in California have spent countless hours

considering what mistakes they have made in the past and what

they can do in the future to improve the situation. Now, I would

hope the Federal Government would conduct the same sort of analysis.

In April, Senator Lieberman and I wrote to the General Accounting Office asking that it conduct an independent review of a number of matters relating to FERC. Specifically, we requested that the

GAO study whether FERC has fulfilled its mandate to ensure just

and reasonable prices. FERC played a very different role when

they were Federal caretakers over an often stodgy regulated industry. But I am coming to believe that a new approach will be required to oversee what has become a very dynamic industry.

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FERC must seriously reexamine its role in light of recent experiences. This Committee must aid that effort. If we find that FERC

is not living up to its mission, or if it simply cannot live up to this

mission because of limited resources or other factors, we must determine the most effective and efficient remedy. Otherwise, I believe that a truly competitive market for electricity may well be a

long time coming.

To instill public confidence in our energy markets, FERC must

prove capable and willing to assert its authority by closely monitoring markets and better anticipating potential problems, and perhaps most importantly, it must be prepared to take swift corrective

action when there is evidence of flawed markets or abuse of market

power. This is a duty we owe to the American people.

I want to thank you for being here today. I admire your courage

and your willingness to take on this very tough problem. I have

just a couple of questions I would ask you at this time.

From your experience, do you believe that FERC is equipped to

fulfill its responsibility to ensure just and reasonable prices as we

transition from a regulated to a deregulated energy market?

Mr. DAVIS. I think the jury is still out on that. Clearly, we feel

we have been denied relief, at least from November 2000 until

Monday, and then the relief we have received is prospective in nature. The true test of their leadership on this issue and whether

or not they are going to fulfill the mandate of the Federal Power

Act will be seen on how they deal with the refund question. So I

can’t answer that question any more clearly.

I know it is customary for witnesses to sort of break down on

partisan issues, but the commission did not take a positive step

until the two Bush appointees joined it. I don’t know if that means

they will take a positive step on refunds or not. It remains to be

seen. I hope they do.

Senator CARNAHAN. And one other question. Recently, we have

seen some individual transactions where prices were abnormally

high and some have argued that this has resulted from manipulation in the market and abuse of market power. Should FERC be

more aggressive in its investigation of abnormal transactions to determine if market power, in fact, has been abused?

Mr. DAVIS. I think the answer to that is unequivocally yes, Senator. In our State, we have logs that indicate plants were shut

down per marketing division. Now, in and of itself, that may not

be conclusive, but you have to ask yourself why the marketing division would have an interest in telling a plant to shut down.

The maintenance of our plants, admittedly old ones, some 30 and

40 years old, averaged 3,000 megawatts in each of the years of

1999 and 2000, averaged about 11,000 to 15,000 megawatts the

first 5 months of this year, and the figures I gave you before were

a comparison, April through May of 2000. In 1999, it was about

3,000. This year, it started at 11,000 and went up to 15,000. I

mean, we can’t prove that they withheld power in order to drive

up the price, but it does seem kind of odd that so many megawatts

were out of service.

So I think that is at least one area that the FERC could be more

aggressive in ensuring that the market is not manipulated and

that consumers are not unduly charged with excessive prices.

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Senator CARNAHAN. Thank you very much.

Mr. DAVIS. Thank you.

Chairman LIEBERMAN. Thanks, Senator Carnahan.

Senator Domenici

OPENING STATEMENT OF SENATOR DOMENICI

Senator DOMENICI. Thank you very much, Mr. Chairman.

Governor, it is good to be with you.

Mr. DAVIS. I, as well.

Senator DOMENICI. I want to just talk about one area that concerns me, and I have difficulty understanding what happened and

why it happened, and that has to do with the absence of long-term

contracts during most of this crisis. I have tried my best to go

through a chronology of events with dates and I have been able to

come up with 11 opportunities at different times. Starting in midJune 2000, there are 11 times when a U.S. governor was either offered the opportunity to enter into long-term contracts or you were

urged by some committee or group that was advising you about the

problem, where long-term contracts were recommended but that

recommendation went unheeded. So let me go through a few and

you tell us what happened.

In mid-June 2000, Southern Cal met with you, according to what

we have here, and the top advisors, and they warned that electric

prices in San Diego could soon go sky high and that his company

would have to take on significant debt. I understand at that opportunity, at that event, the suggestion was that long-term contracts

be entered into. If that is the case, why was that ignored at that

time?

Mr. DAVIS. I would like to ask if I might bring David Freeman

with me, who helped negotiate some of these long-term contracts.

Could I ask him to come forward?

Chairman LIEBERMAN. Sure. Mr. Freeman, why don’t you come

up, take the seat next to Governor Davis, and just identify yourself

for the record. Don’t tell us all you have done in your life because

we do not have enough time.

Mr. FREEMAN. I am Dave Freeman and I am the senior energy

advisor to the governor, I think I am the oldest guy around.

Chairman LIEBERMAN. That is a good sign.

Senator DOMENICI. The oldest guy around, where, in California

or up here?

Mr. FREEMAN. Both. [Laughter.]

Senator DOMENICI. Let me say to you, as the advisor, I prefer to

ask these questions of the governor, but if he needs help from you,

that is fine with me. I understand that.

Mr. DAVIS. I understand that.

Senator DOMENICI. Let me take two or three of them and then

you can answer together. I just gave you one, mid-June, Southern

Cal meets with the governor—I assume you are aware of this meeting—and the recommendation was that prices were going to go sky

high in the San Diego area and that that company was going to

have to take on significant debt. On that occasion, the idea of longterm contracts was broached, entered into, and nothing was done

about it.

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Mr. DAVIS. I can answer that question. That was before the State

got into the business of buying power in early January 2001. The

PUC did give approval to the three utilities to enter into long-term

contracting. The PUC insisted that it keep its prudency review,

which only makes sense because a utility could enter into a contract for 3,000 or 4,000 megawatts an hour and then the consumer

would be obligated to pay that.

Some of the utilities took advantage of those long-term contracting opportunities, others didn’t, but the PUC did act, I believe,

in August to allow all three utilities to enter into long-term contracts.

Senator DOMENICI. OK. Well, let me move——

Mr. FREEMAN. Senator, that is correct, and they just didn’t.

Senator DOMENICI. Please?

Mr. FREEMAN. I think the utilities who were then purchasing

their own power just failed to enter into long-term contracts. If

they were here, they would say that they weren’t sure that the

PUC would approve them, but they did not try.

Senator DOMENICI. Well, let me go on to a couple of other dates

and tie two dates together. July 21, 2000, PG&E files an emergency motion seeking authority and guidelines to sign long-term

contracts with electricity suppliers.

On July 27, the governor calls on FERC to extend wholesale electric price caps. Now, it seems to me he must not have been supporting long-term contracts at that point and I want to know——

Mr. FREEMAN. No, sir. The two actions——

Senator DOMENICI [continuing]. Were they not good?

Mr. FREEMAN [continuing]. Are not inconsistent at all.

Senator DOMENICI. Is there something wrong with long-term contracts?

Mr. FREEMAN. No, sir. The two actions are not inconsistent at all.

The price caps were to control a runaway spot market that was literally taking the money out of the pockets of the people of California. The long-term contracts were designed for the future, to establish a just and reasonable market rate. But the caps were needed not to control long-term contracts——

Senator DOMENICI. No, I know that.

Mr. FREEMAN [continuing]. But to control the spot market. So the

two actions were completely consistent.

Senator DOMENICI. I understand they are different, but it seems

to me that I have ten instances when the governor had a chance

to support long-term contracts and didn’t. On a number of occasions, instead of doing that, shortly around that time, he suggested

caps. It seems to me that is what he wanted all along, was just

caps. That was his proposal.

Mr. DAVIS. Senator, the Public Utilities Commission met in August and granted all three utilities the right to enter into long-term

contracts. Some utilities took advantage of that, some didn’t. As

David Freeman correctly points out, they will complain that they

had to be subjected to a prudency review, but every PUC commission in the history of our State that has granted long-term contracts has always insisted on an opportunity to review the

prudency of that contract for the reasons I suggested earlier.

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So we did—I can’t just say, you have long-term contracts. That

is not within my power. The Public Utilities Commission, then consisting of three members appointed by Governor Wilson and two by

me, did agree to grant that permission in August, the month after

the question arose.

Mr. FREEMAN. Senator, if I could just add, the minute that this

governor had the authority to enter into long-term contracts, that

is when we started doing it, almost the very day, in fact, a few

days before the statute was actually enacted by the legislature. It

wasn’t until January 2001 that the State began buying power. Before that, it was the utility’s responsibility and the dates that you

are mentioning are all before Governor Davis and the State got

into that business. But the minute we did, we negotiated $42 billion worth of long-term contracts in several weeks, the largest exercise of that kind in the history of this country.

Senator DOMENICI. Well, let me just generalize and then ask two

more questions. Are you suggesting here before our Committee that

you, governor, and if you are his advisor, you can answer that, you

promoted and encouraged and wherever you had authority, you actually pursued long-term contracts during all of this crisis? Were

you not at some point against entering into long-term contracts?

Mr. DAVIS. No. There are two separate periods in question. First

is a period when the utilities were buying power, and was a period

when we were buying power. We started buying power January 18,

2001. I asked David to start buying power, was it before the month

was out?

Mr. FREEMAN. Yes, sir. It was—— Mr. DAVIS. We asked within a matter of days after the State

started buying, and net short, for the State to secure long-term

contracts because we wanted to wean ourselves from total dependency on the spot market.

Now, the earlier phase, when the utilities were buying power, at

various points, they did raise to me the issue of long-term contracts, something, I might add, that FERC discouraged in 1995,

1996, and 1997. I advised the Public Utilities Commission, in my

judgment, it made sense—they had to schedule the meeting, they

have 30 days’ notice, they gave permission in August 2000. I think

two of the three utilities took advantage of that opportunity to obtain some long-term contracts, but all three were given permission

to do it.

Senator DOMENICI. If you have another chance, I will ask another question.

Chairman LIEBERMAN. Yes. Thanks, Senator Domenici.

Governor, some of my colleagues on the Committee have asked

for a second round, and because of the importance of the issue, notwithstanding that we have a couple of governors, attorney general,

etc., waiting, I am going to go ahead and do that. I am going to

ask my colleagues to stick to 5 minutes.

I do want to ask you, would you like to take a brief break?

Mr. DAVIS. If I could take a 5-minute break, I would appreciate

it.

Chairman LIEBERMAN. This reminds me. Once before, a few

years ago, I was going to meet with President Assad of Syria and

probably the most significant advice I got, excuse my explicitness,

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was to go to the restroom before the meeting because I could expect

it to go on for a long time. This apparently is also true of testifying

before a Senate Committee. So we will take a 5-minute break.

[Recess.]

Chairman LIEBERMAN. Let us reconvene. I am sure not just Governor Davis, but all of us benefitted from the break and an opportunity to stretch our legs a bit. I thank you very much. It has been

a very productive and interesting morning.

I want to say to my colleagues, though we are going to go to a

second round, I hope everyone knows they do not have a constitutional or legal obligation to ask questions on this round.

Senator BENNETT. Yes, we do. [Laughter.]

Chairman LIEBERMAN. I will now call on Senator Thompson.

Chairman THOMPSON. Thank you very much. Governor Davis, I

think that one of the increasing concerns that we all have is whether or not these plants that may be in the process of being licensed

are actually going to get built. There are several who have expressed reservations about investing in new generation in California.

Merit, for example, a spokesman said that—well, this is from the

San Francisco Chronicle, June 2, 2001. An Atlanta company that

just got approval to build a power plant in Antioch is holding off

construction, citing California’s push for Federal price controls and

rhetoric about possible seizures of power plants. The Charlotte Observer, April 27 of this year, says even though Duke Energy Corporation is building one, the Power Star, of California’s biggest

power plants, top executive Rick Prowery said the company would

hesitate to build more California plants because the State’s energy

economy resembles that of a third world. Reliance expressed some

similar concerns. ‘‘Ridgewood Power said generators find it more

predictable and less risky to operate in third world companies than

they do in the State of California,’’ griped Marty Quinn, Executive

Vice President and Chief Operating Officer.

Of course, obviously, some of these folks have their own axes to

grind. There is no question about that. But we have also heard

from investment bankers, as I indicated earlier, about this. You

can’t get away from comparing that with the rhetoric that has

come out of California. These power suppliers have been subjected

to all manner of description. You have an Attorney General there

who apparently wants to introduce the head of Enron to your

President so that he can be introduced to a fellow named Spike.

Assuming that these energy executives don’t want to meet Spike,

I wonder what that is doing to the atmosphere when you are going

to threaten to seize plants. What is that doing to the atmosphere

when you are going to have to be, I think, in the future—we are

talking about short-term solutions here right now primarily. You

are going to have to be dependent upon substantial new investment

at a time when the regulatory environment is very uncertain for

these people to start with, and now they are finding a very hostile

political environment. Is that a wise strategy at this time? Are you

concerned about the completion of plants and suppliers who are expressing these serious reservations?

Mr. DAVIS. Well, Senator, with all due respect, the people I represent are mad. They don’t like paying 700 percent more for elecVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00110 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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tricity. Small businesses in San Diego don’t exist anymore because

they had to face this problem in the year 2000 and they want us

to fight back, and that is what we are doing.

This is a rough business. You know these energy companies.

Many of them have a wildcatter mentality. My grandfather had

something to do with the oil business and I know what that attitude is like. California has been a cash cow to a lot of energy companies around this country who have done extraordinarily well,

and occasionally some harsh words get exchanged. But my job is

to fight back and say we are not going to take it, and I suggest to

you, if it were not for a good deal of what you might consider political hyperbole, we might not have the attention of the Federal Energy Regulatory Commission that stiffed us for almost a year.

Chairman THOMPSON. Do you think that FERC responded to

your Attorney General suggesting that the head of Enron be

thrown in jail with Spike, or do you think FERC responded because

you called the suppliers pirates and words of that nature? It may

make you feel better, and it may be understandable in responding

to your constituency. We all have the temptation to do that from

time to time. You are not alone in that respect. The only difference

here is, you are going to be very dependent on these same people.

Regardless of the past, it looks to me like you have to look to the

future. Is it the responsible thing to do to create an environment

for the very people who are in the process of looking at California

for future investment, and sometimes have requested license applications, who are now doubtful because of the regulatory and the political environment in your State when you are the head of that

State?

Mr. DAVIS. Well, first of all, as Senator Torricelli pointed out, we

are building more power plants than anyone has ever built.

Chairman THOMPSON. How much has come on-line in the last 2

years?

Mr. DAVIS. It takes about 2 years to build a plant, but as I said

in my initial comments, there will be three plants on-line between

now and July 7, representing about 1,200 megawatts. There will be

ten peakers representing about 800 megawatts. And there will be

a total, when you count distributive generation, additional renewables, re-rating power plants, approximately 4,000 megawatts by

the end of September. We anticipate 5,000 megawatts for each of

the 3 years following that for a total of 20,000 megawatts.

Now, obviously, we want the State to be an attractive place for

investment, but we don’t want companies walking all over our citizens. We want—responsibility is a two-way street. We understand

the obligation to be responsible and we expect corporations that operate in our State to be responsible, and by and large, they are.

Chairman THOMPSON. Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thanks, Senator Thompson. Senator Bennett.

Senator BENNETT. Thank you. I want to go in the same direction,

Governor, as Senator Thompson. Last time, you said I quoted your

critics. This time, I will quote you, and it is interesting that Mr.

Freeman is sitting next to you, because here is a circumstance

where the two of you may have said different things.

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Here is a quotation, a release from the Office of the Governor on

May 31, 2001: ‘‘I met with the municipal utilities about 3 weeks

and I was very disappointed to learn that they were charging us

more for power than the generators. Here we have been maligning

the generators, properly, because they have been selling us power

at 600 to 700 percent what we paid for it just 2 years ago. I find

out the munis are charging us even more. So I said, listen, you are

going to sell us your excess power this summer at a cost-plus basis,

roughly 10 to 15 percent over cost, or I am going to seize it from

you and I am going to make sure that we get that power at an attractive rate.’’

‘‘I gave them a couple of weeks to negotiate with the Department

of Water and Resources. The first day they had to negotiate was

this Tuesday. We will see what happens in 2 weeks, but if they

don’t come through with contracts, I am going to seize the power

because they are creatures of the State legislature. They are supposed to provide power on a cost-of-service basis, not make a zillion

dollars by charging more than these out-of-State generators who

set the Guiness Book of Records for greed themselves. The munis

are doing even more.’’

And then, Mr. Freeman, you are quoted in the Los Angeles

Times, not specifically in response to the Governor’s statement, but

generally. ‘‘ ‘These charges go under the heading, there is no good

deed that goes unpunished in this State,’ Freeman said, noting that

DWP Power helped avert more blackouts across the State. He did

acknowledge, however, that the agency has charged high prices for

surplus power at the 11th hour, but said that was only because it

cost more to produce. ‘We have consistently charged Cal ISO our

cost-plus 15 percent,’ he said. ‘It is not as though we are up there

peddling a bunch of power to jam it down their throats.’ ’’

Now, my question—first, if you want to challenge the statements,

that is fine, but my question is, you are here asking for refunds

and rebates from those whom you say gouged and bilked Californians. Are you planning to ask of that from California munis?

Mr. DAVIS. I believe everybody that unduly took advantage of

this situation should be required to make rebates. Californians expect people to treat us fairly. We expect to treat them fairly in return.

The statement you quoted from me was accurate. I was appalled

to find out that these municipal power authorities, which were

creatures of the legislature, we gave them permission to exist, because they were not supposed to be competing with the free market, they were supposed to provide cost-of-service power, had, in

fact, charged us roughly $360 a megawatt hour while the generators had charged us about $310 a megawatt hour, and I found that

out about 30 minutes before the meeting we had with the munis.

So my job is to protect all the citizens of this State from getting

a raw deal and it doesn’t matter to me if the raw deal comes from

a generator from Houston or a municipal power authority in Los

Angeles.

Senator BENNETT. Mr. Freeman, the governor has asked you to

the table. Do you feel that you gouged the State while you were

running the muni and charging cost-plus 15 percent?

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1 Chart entitled ‘‘California Day-Ahead Power Prices,’’ appears in the Appendix on page 551.

Mr. FREEMAN. No, sir, and your researcher overlooked one relevant fact, which is that the day after I left the Department of

Water and Power, that board of commissioners changed their policy

to start charging market prices for power, and it was that market

price policy that Governor Davis correctly was criticizing. They

have since then backed off and they have now agreed to sell at cost.

So the governor is entirely correct, but I think that I was accurate

when I said that our policy when I was there was to sell at costplus 15 percent.

Senator BENNETT. Do you feel that—— Mr. FREEMAN. But if there is any investigation that shows that

we charged more than that, the muni should refund the money just

like anyone else and the governor is being consistent. Indeed, he

should be congratulated for being just as hard on the municipalities in California as he is on the other generators. It seems to me

that this is just more evidence that he is standing up for the consumers across the board.

Senator BENNETT. I appreciate that clarification. Just one last

comment, Mr. Chairman, if I might. Your $50 to $60 billion projected figure does not coincide with

the earlier chart that Senator Murkowski put up that shows that

prices are, in fact, coming down. I would appreciate it if you would

supply information for the record as to whether or not you are prepared, after examining where prices are, to lower that projection or

if you stand by it. We don’t have the time to go through it here,

but we have had two separate charts that show different projections for the future and I would appreciate whatever further clarification you could give to that.1

Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thanks, Senator Bennett.

Just real briefly, I do want to quote with regard to the impact

of price relief or price mitigation questions. Fair questions have

been raised about the impact of that on the willingness of power

producers to come into the California market. The Los Angeles

Times, which I will not describe according to any particular ideological inclination, says today, headline, ‘‘Curbs Won’t Halt Plants.’’ First paragraph, reports reporters Nancy Vogel and Thomas Mulligan, ‘‘The expanded electricity price limits approved by Federal

regulators could squeeze big energy traders but will probably not

discourage power plant construction in California, electricity producers said Tuesday.’’ ‘‘But the companies,’’ I go on, skipping a

paragraph, ‘‘the companies generally asserted Tuesday that the

order would not deter them from investment in the vast powerstarved Western region, though they have often raised such a prospect in arguing against price controls.’’ So that is certainly an encouraging dispatch or independent report.

I think I am going to control myself and not ask any more questions because you have been on a long time.

Governor Davis, you have been tested generally in this crisis.

You have been tested this morning. But by my judgment, you have

passed the test very, very well. I appreciate your testimony and I

appreciate not only the fact that you have become an expert in

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1The prepared statement of Ms. Martz appears in the Appendix on page 821.

something you probably weren’t an expert in a couple of years ago,

but the tone in which you have spoken.

I think you were quite right. You said that neither you nor President Bush was there at the origin of this problem. The question is,

what do we all do about it now, and that is the question that we

are asking FERC. This is not a partisan matter, by any means.

This is just a question of a genuine crisis, not of your making, not

of the President’s making, but so genuine that it threatens the

economy. And I have noted now, California’s economy is now the

fifth largest, if it were a country, in the world, and it is critically

important that we all do our share to overcome the crisis.

I think, as you have testified very directly and eloquently today,

the State of California, the legislature of California, the people of

California have done their part and FERC has finally come into the

arena and done some things to be helpful. I have concerns, as I

stated at the outset, about how fully effective it will be. I share

your concern about the inequity of not ordering refunds to go to

electricity customers in California and the West because they suffered damage here. When you have a right, as you said, without

a remedy being offered, that undercuts our system of justice. And,

it does not deter future behavior of that kind by energy wholesalers

or anybody else who would take advantage of a consumer.

So we are going to ask that question of FERC this afternoon and

we are going to stay on the case until we feel that we have done

as much as we can by way of our oversight to make sure that the

Federal Government plays an appropriate role here, or at least that

we have adequate public discussion of the role that it is playing.

I thank you for the time you took in coming out here. You have

contributed substantially to our understanding of the problem and

I wish you well.

Mr. DAVIS. Thank you very much. Thank you, Senator Thompson.

Chairman LIEBERMAN. Thank you. We will now call the Hon.

John Hoeven, Governor of the State of North Dakota, and the Hon.

Judy Martz, Governor of the State of Montana.

According not just to the tradition but the rules of the Committee, we try to conduct these hearings and our deliberations generally in a bipartisan fashion. Senator Thompson requested that

these two governors be called and I am delighted that you two have

taken the time and made the effort to be here. Your presence obviously punctuates the fact that we have all been testifying to, that

though California may have been most extremely impacted by this

energy price and supply crisis, that certainly other States in the

West, let alone States throughout the country, have an interest in

this. So we look forward to your testimony.

Governor Martz, do you want to proceed first?

TESTIMONY OF HON. JUDY MARTZ,1 GOVERNOR, STATE OF

MONTANA

Ms. MARTZ. Sure. Thank you very much. Thank you, Mr. Chairman, and thank you, Senator Thompson and Members of this Committee. My name is Judy Martz and I am the Governor of the Big

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Sky State of Montana. I appreciate the interest this Committee has

shown in the struggles of Western States to deal with an electricity

crisis. I may, as Vice Chairman Thompson said, rain on a parade.

We are here to discuss the role of the Federal Energy Regulatory

Commission associated with the restructuring of energy industries.

However, the real issue seems to be what went wrong in California

and could it happen elsewhere? Let me try to answer this question.

The facts show that the primary responsibility for the electricity

crisis in the West lies within the State of California. A series of

mistakes made by the State and the failure by the State to take

corrective action once problems first arose more than a year ago led

directly to the crisis we are in now. This crisis, I believe, could

have been avoided if California had taken timely action.

Instead of acting, I believe the State, unfortunately, engaged in

a prolonged exercise of blame shifting. I don’t say this to be disagreeable. I really don’t. I say this from the perspective of a State

that has been hurt by the California electricity crisis. I also say

this to make sure that other States do not make the same series

of mistakes California made in the recent years.

We all want to do our share, but it is killing us. Montana has

been hit hard by the very same issues that Washington State has.

As a result of the California electricity crisis, Montana industrials

have gambled on declining future power prices that have been

hurting us as a result of the power prices rising. We have seen several closures in Montana, a State whose economic base cannot afford to lose even one single job.

But because we are tied to the Western grid, any excess energy

is pooled to other States and we face higher rates ourselves. Industries that chose to shop for energy found their traditionally low

rates of about $30 per megawatt rise to as high as $300. Much of

the pain that my State and others have felt could have been avoided if California had not shied away from making tough decisions

when they were called upon last year.

Let us review how we got here today. California was the first

State to open its retail electricity markets to competitive markets

in 1996, with Pennsylvania following quickly on its heels. The California electricity law is often described as deregulation, but it was

nothing of the kind. California did not deregulate electricity markets but merely exchanged one set of State regulatory rules for another, which led to disaster. We did better than that in Montana.

The 1996 law had a number of unusual elements. It forced California utilities to divest much of their electricity generation. It required utilities to rely completely on volatile spot markets to buy

all of their power, something no other State did. It also imposed

regulatory rules governing spot market sales that increased wholesale market prices. It froze retail rates.

One provision missing from the 1996 law was reform of the State

siting law. It can take up to 7 years to build a power plant in California, and on the average period, it is 4.5 years, nearly twice the

average as in Texas. This was a crucial mistake. Since California

retained a siting process suitable for long-term planning by regulated utilities with 10- or 20-year planning horizons, but completely

unsuitable for a competitive market where independent power proVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00115 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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ducers build virtually all power plants using much shorter planning horizons.

The failure to address siting reform was, I believe, a major mistake. Independent power producers moved quickly to meet California’s growing electricity demands, filing applications to build

14,000 megawatts of new generation beginning in 1997. Because of

the failed State siting process, none of these power plants are operating yet. Montana did not make that same mistake. We revised

our siting laws to exempt generation facilities.

It is important to note that the supply shortage in California did

not occur overnight. It developed over a 5-year period when electricity demand rose by 6,300 megawatts. Incredibly, over this same

period, electric generating capacity in California actually declined.

As I indicated earlier, California took a big gamble by forcing its

utilities to buy all their power through a volatile spot market. It

took an even bigger gamble by not ensuring that electricity supplies were adequate to meet the needs of consumers and businesses. It doesn’t take a panel of economists to know that supply

shortages and spot markets are not a good combination. They

produce the sky-high prices that California and the West have been

paying now for the past year.

California has had price caps for the wholesale power sale since

1998. Last year, California experimented with four different price

caps, starting with a hard cap of $750 per megawatt hour. This

year, FERC changed tactics, approving price mitigation that reflects gas costs and other costs. That approach seems to be working, and FERC earlier this week expanded the scope of its price

mitigation plan.

Price caps exacerbated California’s supply problems last year.

Since the caps did not apply to the Western markets and State

power producers often chose to sell electricity outside of California

at prices higher than the hard cap, as a result, power exports from

California rose 85 percent and California’s electricity supply fell by

3,000 megawatts. By the end of the year, when the hard cap had

been lowered to $250, the price cap was seriously exacerbating

California’s electricity supply problem, since prices in an uncapped

market had risen to more than $400. Ultimately, California had to

ask to lift the price caps on the grounds that it was causing serious

supply problems.

On December 8, 2000, the California ISO filed an emergency petition to waive the $250 hard cap, which FERC approved. At their

request, FERC set a soft cap. Price caps last year did not control

high prices. Each time prices were lowered, average monthly prices

rose. The experience last year showed that price caps failed to control high prices and exacerbated supply problems.

The lessons California apparently drew from the failure of price

caps last year was to expand the scope of price caps to encompass

the entire West, notwithstanding the opposition expressed by eight

of the 11 governors in the region, and I repeat that. Eight of the

11 governors in the region opposed price caps.

The main cause of the California electricity crisis is a supply and

transmission shortage. It is each State’s responsibility, not the Federal Government, each State’s responsibility to license power plants

and to get us moving. It has been clear for a long time that CaliforVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00116 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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nia’s siting process is broken. Although it has made cosmetic

changes, the State has shied away from making meaningful reforms to the siting process.

The secondary cause of high prices is the disastrous regulatory

rules imposed on the electricity market by the State. Unfortunately, the State has simply refused to act in a timely and effective

manner. The California electricity crisis, in large part, is a result

of inaction over a crucial 9-month period after the price spikes and

supply shortages began in May 2000. This inaction forfeited the

last chance to prevent a crisis. State rules barred California utilities from recovering wholesale power costs from retail rates, forcing

utilities to buy power at 30 cents per kilowatt and resell it for 3

cents.

It was those rules imposed by the State of California that destroyed the financial health of the utilities and drove Pacific Gas

and Electric into bankruptcy. If the State had allowed cost recovery, the utility’s credit would not have been destroyed. PG&E

would not have gone bankrupt, and the State would not be spending its surplus buying electricity and bailing out the very utilities

whose credit is destroyed. The bankruptcy of PG&E could have

been avoided if the State had allowed cost recovery.

Perhaps the most serious mistake made by the State was forcing

the California utilities to rely entirely on the volatile spot markets

for all of their power, even after wholesale prices had risen tenfold.

If the governor had allowed the utilities to enter into bilateral contracts last year, electricity prices would be a fraction of what they

are now. The State only recognized the need for bilateral contracts

after the financial health of utilities were destroyed and the State

assumed the burden of buying power for Californians. Once the

State was paying the bills, it realized reliance on volatile spot markets was foolish and began to enter the bilateral contracts. Ironically, the contract prices California has announced, and much of

this remains secret, indicated that they agreed to pay up to three

times higher than what Duke Energy offered them last year.

The State’s indecision on raising retail rates was another major

mistake, one that led to higher rate increases than were necessary.

Last fall, the utilities requested a modest rate increase. The State

refused to consider this proposal, which directly led to the PG&E

bankruptcy. In the end, the State ended up approving a much larger rate increase than was necessary if it had acted in a timely and

effective manner. We governors have a lot of power. It is called executive power, and I truly believe that could have been used in this

case.

Nine months after the beginning of this crisis, Governor Davis

began to take action. In February, he announced an emergency

plan to build 5,000 megawatts of new generation by July 1. According to recent reports, only 1,300 megawatts of plants that were

under construction before his announcement will be available on

that date.

Governor Davis announced a conservation plan to lower demand

by 3,000 megawatts. I understand that plan also is falling short

and may produce less than 1,000 megawatts in demand savings,

which is a good savings, but nowhere near what the demand was.

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1The prepared statement of Mr. Hoeven appears in the Appendix on page 825.

The governor’s plan to restore the financial health of Southern

California Edison appears to be languishing in the State legislature, and I am glad the State is taking this action, but regret they

only acted in response to a crisis, instead of trying to prevent one.

Threats by the governor and others to seize power plants and impose punitive taxes, which we did not do in Montana ultimately,

will discourage what is needed most, investment in new generation.

California has seen at least two power plants on hold now because

of uncertainty about regulatory stability in California. As Senator

Thompson said and one other power company said, ‘‘I have more

confidence in regulatory stability in Brazil than I do in California.’’ If the governor takes a rash step, investment in new generation

in California will come to a complete halt. The State will find itself

in the business of generating and transmitting electricity on a permanent basis. The State will continue to spend billions of dollars

on electricity instead of on schools. The power plants and transmission infrastructure will slowly degrade. And California’s neighbors, Montana included, will find that they must continue to supply

the power that California needs, since California refuses to provide

it for itself.

The time has come to quit shifting the blame, quit shifting it to

the Federal Government. We as governors have, as I said before,

tremendous power to take advantage of our own destiny. FERC has

taken strong actions to mitigate high prices in California. The time

has come for the State to buckle down and do its job, ensure adequate electricity supplies for California consumers and businesses.

So please, I am asking you, do not put caps on the utilities of

the Western States like Montana. It will be the same as inflicting

foot-and-mouth disease on our agriculture industry. It will discourage construction of generators, it will discourage transmission, and

it will surely discourage people from conserving, and it does not encourage us anymore.

I liked what Senator Carper said, that we are like the quarterback on a team and that you are maybe the athletic directors, but

I tell you what. If the athletic director doesn’t work right, the team

is out of business, and I really see if you put price caps on us right

now, if Governor Davis wants that for California, then I would advise him to do that for California. He has the power to. But do not

inflict it by FERC on the rest of the States because it will kill us.

Thank you.

Chairman LIEBERMAN. Thanks, governor. I have the feeling this

morning that we are down on the field now. [Laughter.]

Ms. MARTZ. That is right.

Chairman LIEBERMAN. We are no longer athletic directors.

Governor Hoeven, thank you for being here. I look forward to

your testimony.

TESTIMONY OF HON. JOHN HOEVEN,1 GOVERNOR, STATE OF

NORTH DAKOTA

Mr. HOEVEN. Chairman Lieberman, thank you for the opportunity to testify. I must say that I admire the diligence of both you

as Chairman and the Ranking Member, Senator Thompson, for

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conducting these hearings and sitting throughout. I appreciate it

very much.

I have to say this. I do not know if I should, or not, but Senator

Thompson, I really did enjoy your movies.

Chairman THOMPSON. I knew I would find somebody.

Chairman LIEBERMAN. Do not let this go to your head. [Laughter.]

Mr. HOEVEN. My comments today, and I will be brief, which I am

sure you will be pleased to hear, my comments today will focus on

the President’s leadership in setting the right direction for energy

policy. His plan calls for a market-based approach that will stimulate supply, promote conservation, and enable North Dakota and

other States to meet this country’s energy needs.

North Dakota exports 75 percent of the electricity generated in

our State. We are encouraging the construction of new and efficient

generation and the development of environmentally friendly renewable energy. We have also developed one of only two coal

gassification plants in the world, converting coal into natural gas,

and as you know, there is a tremendous need for natural gas right

now, which will be a big benefit to California as they continue to

site new power plants that utilize natural gas.

This diverse and growing energy portfolio will serve North Dakota’s needs for a long time in the future while allowing the excess

energy to be exported and help serve other parts of the country,

like California. We are also one of the low-cost energy producing

States in the Nation, using clean coal technology, natural gas, and

hydro, a fact that we are very proud of.

We have worked hard to ensure that we have enough electricity

to meet the demands of our consumers and businesses, and our

citizens recognize that you cannot maintain economic growth if you

lack the electricity infrastructure needed to encourage economic development and continued growth. We also see energy generation as

an important job creator for our State’s economy, while helping to

meet a national need.

In order to assure economic growth, our State has a partnership

called Vision 21, investing $10 million with any company that undertake feasibility studies for new clean coal technology generation

plants. This program will seek to access the clean coal program in

the President’s energy policy, if it is authorized by Congress, creating a Federal, State, private sector partnership for new energy

generation.

For America to move forward and ensure our energy independence, our Federal Government must utilize market-based policies

that will encourage new and efficient infrastructure. We must stimulate private investment in new generation and transmission in

order to develop a vibrant, regional wholesale market. To do this,

I believe the Federal Government has two roles. One is leadership,

and the other is to provide market and regulatory certainty.

President Bush and Vice President Cheney have shown our Nation the leadership necessary to ensure our future energy independence. President Bush has developed a long-term national energy policy while also directing his administration to take steps

that can help address short-term problems like that of the California energy crisis. The President’s initiatives to help solve the

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California energy crisis include: Two days after taking office, the

Bush Administration extended emergency orders giving the State

time to enact legislation authorizing it to buy power on behalf of

Californians. A month after taking office, the President issued an

executive order directing Federal agencies to expedite permits

needed to increase electricity supply in California. In order to reduce demand, the President issued an executive order directing

Federal facilities in California to maximize conservation this summer. And at the governor’s request, Secretary Abraham asked

FERC to extend a waiver for qualifying facilities from PURPA fuel

requirements, a request that FERC granted. Finally, 4 months

after taking office, the administration took the first steps towards

removing a transmission constraint, the Path 15, that has caused

repeated blackouts.

For a long-term energy independence, the President developed

and released the administration’s National Energy Policy. Not all

of the recommendations are popular, but they all should be considered as part of a comprehensive national energy policy. America

cannot depend on other countries to meet our energy needs.

In order for new investment to begin in some parts of the country

and continue in others, we must ensure that there is regulatory

certainty at both the State and the Federal level. State legislative

and executive agencies must show they can assure the investment

community that rules will be set and followed in an expeditious

manner. We must ensure that agencies will make tough decisions,

however unpopular, that benefit the good of the entire State and

the region. The Federal Government, both Congress and the Executive Branch, must move expeditiously to change the laws and promulgate the rules necessary to move our energy and electric industries forward. The Congress must quickly decide what laws need to

be repealed and modified to ensure a vibrant and efficient market.

The FERC, EPA, Interior, and other agencies must implement

sound, market-based rules and enforce them to ensure that market

participants are playing fair while not gaming the system.

The FERC took a step in that direction on Monday. It remains

to be seen if that order will work as designed, but we do know that

all of their orders and rules must encourage new investment in

electricity generation and transmission. Development of new transmission will require a reasonable return on investment and reasonable access to the infrastructure.

In closing, given the right type of Federal and State regulatory

environment, private industry will make the large investments and

long-term commitments necessary to build our energy generation

and transmission infrastructure. President Bush has provided a

road map for the Federal Government’s role, a market-based approach that will help States provide industry with the regulatory

certainty needed to move forward. Though there will continue to be

bumps in the road, we are making progress. The challenges are

great, but by working together, I am confident we can develop dependable, affordable, and environmentally sound energy for our future. Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thank you, governor.

Governor Martz, in your statement, you put a lot of the blame

for the crisis on inaction or mistakes by the State of California, by

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the Government of California, but let me ask you this. I do think

that Governor Gray Davis was asked most of the questions that

you asked, so I think he has given his answers for the record. Part

of his response, apart from his response to the specifics, was that

the State of California, the people are doing what they can now,

as much as they can do now, but because they are so adversely affected by the price they are being charged by the producers outside

the State who are wholesaling electricity into the State, that they

need help from FERC because only FERC can do anything to mitigate those prices.

It is probably hard to imagine. We were joking before about what

if this had been Montana that had been affected by this crisis. But

if it had been and you felt you were at a point, leaving aside what

the causes were, at a point where you had done everything you

could, wouldn’t you also be appealing to us for the Federal Energy

Regulatory Commission to help protect you from being unfairly

treated by out-of-State wholesalers?

I am coming to your point that governors have great power. That

is absolutely right. But they don’t have the power, in this case, to

regulate or at all affect, really, certainly the price charged by outof-State producers of power.

Ms. MARTZ. That is a very fair question, Senator, and I don’t believe I would be coming to the Federal Government for help. I really believe that I would, if I had the emergency powers that Governor Gray Davis does, I would be ordering facilities being built so

that we could start to speak to our own energy needs.

You talk about them having to pay high prices. Because they are

buying our markets, they are causing us to have to pay those high

prices. They are not doing anything that we are not having to do

because of them.

So I don’t believe I would. You don’t know until you are in those

shoes, but I really believe this is something States should solve on

their own and I really do think that he has some powers that he

hasn’t used yet.

Chairman LIEBERMAN. I know you criticized the State and the

governor for not building enough power plants. I am sure you know

that he was elected in 1998 and took office in 1999. It was pretty

hard, I think, but let me ask you to respond, to have built enough

power plants to have been on-line in that short of a time to deal

with the price spikes that began to occur about a year ago.

Ms. MARTZ. Well, I think he could be having power plants on-line

right now. He has got 6,300, I think, ordered. He has got 1,300

coming up, and they are not there yet. Each of us in our own

States has to do what we have to do. We are looking at wind, we

are looking at solar, we are looking at biodiversity, we are looking

at coalbed methane, we are looking at coal, and we are going to be

building as quickly as we can, also.

We have enough power in our own State—people say, well, you

haven’t built in your State, either. We haven’t because we never

needed to. We export almost as much as we use in our own State

out of State. So we didn’t need to build until California’s crisis

came upon us.

Chairman LIEBERMAN. Let me ask you this. I have a copy of a

letter dated April 6 of this year that a number of governors in the

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West, I believe all Republicans, sent to the Chair of the Federal

Energy Regulatory Commission, and the two of you signed it. In it,

it says, ‘‘Your resistance’’—this is to Mr. He ́bert—‘‘your resistance

to the considerable pressure to impose ‘penny wise and pound foolish rate controls’ has served a long-term interest of our region.’’ I wonder, now that FERC, most recently, 2 days ago, has acted

to impose what some call price mitigation, some call price relief,

some call price control, some call soft price caps, how you feel about

FERC’s action in light of your earlier request to the Chairman that

they not impose, as I read it, any form of price controls.

Ms. MARTZ. In our State, already, meetings with the utility companies, we have a transition advisory committee working on these

energy issues. Already, some of the utilities have concern over that.

So we are going to have to see how that plays out. We did not have

the full document. We had the press release from FERC that tells

basically what that does, but we don’t have the full document to

be able to read that yet, so we will have to see how that plays out

in our State. It may not be a healthy thing for us. We do not want

price caps. We want the market to play itself out.

Chairman LIEBERMAN. Your 5 minutes is up, but I do want to

give you a chance, Governor Hoeven, to give me your reaction to

what FERC did on Monday.

Mr. HOEVEN. On the ruling? Well, I view it as price mitigation,

designed to make sure there is no price gouging or overcharging.

If it works that way and still allows the market to operate so that,

again, we stimulate the increase in supply that we need, particularly in the Western area power pool, and at the same time encourage conservation, then it may work, and I think that is what remains to be seen.

And I think that is the point that I am trying to make. FERC

has to set rules of the game that are certain so that industry can

come in and make long-term commitments and make investments

and know that not only are they going to be able to recoup that

investment, but they are also going to have access to transmission

lines they build and so forth so that they can do business and truly

solve this problem for the consumers of California and other States.

Chairman LIEBERMAN. Governor Hoeven, am I right, North Dakota is not on the Western grid, is that correct?

Mr. HOEVEN. Right. We are in the mid-America power pool. Now,

we are members of the Western Governors’ Association and we sell

power, of course, to a variety of other States.

Chairman LIEBERMAN. Right. So it is both as a seller of power,

but also generally interested in electricity and energy issues, that

you are here today.

Mr. HOEVEN. Ironically, this is an incredible opportunity for our

State. We need development in rural North Dakota, in Western

North Dakota. We have oil, we have gas, we have hydro, we have

clean coal technology, we are converting coal to natural gas, we

have bio-diesel, we have ethanol. We are busting at the seams trying to export energy to the markets that need it, but we need help

from the Federal Government in terms of the rules of the game so

that our companies can invest in transmission and get that power

to market, not only in terms of recouping their investment, but also

in terms of access to the line they have built. They might build a

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transmission line and not even know what access their company is

going to have on that line under the rules that FERC has because

it is so much in transition and there is so much uncertainty.

Chairman LIEBERMAN. Thanks. Senator Thompson.

Chairman THOMPSON. Thank you, Mr. Chairman.

Governor Hoeven, I think you have hit right directly upon the

nature of the problem when we try to look at FERC’s actions, and

I think you have the right solution, and that is certainty. I mean,

that is what we look for across the board in our country. It is called

the rule of law. You may have good laws, bad laws, indifferent

laws, some kind of good, some kind of bad, but the main thing for

business and for individuals is to know what the deal is, know the

game that you are playing.

So now we are launching off under this great pressure. We are

launching off into something that has something to do with the

business’ costs, figuring out all these suppliers, utilities, I suppose,

what their real costs are and what is just. And we put FERC in

the position of deciding, somebody withholds power and they say,

well, we need repairs and what not. Well, what is really on your

mind? Why are you really doing this? We put them in a position

of deciding what is just.

So if I were thinking about building new power sources, I would

have to wonder how certain is this. I mean, is somebody going to

wake up some day and look at this thing totally differently? I think

that is the problem. It is not that we can sit here and say that it

is a good idea or a bad idea. I think hard caps are obviously a bad

idea, but that is the problem.

Carrying it further, part of the problem with hard caps is that

it is, as I said, a Goldilocks formulation, not too hot, not too cold,

just right, and if we do this and if we do that and that works out,

and we lift the caps when we say we are going to. What supplier

believes government when they tell them that? There is no reason

for them to believe. So it is uncertainty, again, and that is why you

are seeing, I think, a lot of the comments you are seeing from potential suppliers in California.

I think, also, you are right when you say the prices are high,

therefore, what are we going to do? We have got to look at that,

and that is what we are looking at, but we also have to look at the

front end. Why did prices get so high? How did it come about that

we developed this supply problem?

Governor Martz, how is Montana affected by being a part of the

Western grid when California is in the shape that it is in and urging the things that it is urging? All the talk is about California, as

I am sure you know. All the concentration is about California. The

lead-off witness, in effect, was the Governor of California. We spent

all morning, just about, with the Governor of California. You other

States are out there, too. And I might point out, as you said, eight

of the 11 governors are Republicans and the three who are for price

caps are Democrats. All three of those States will be represented

here today, by the way, but eight of the 11 governors oppose price

caps. Why is that and how is your State as a part of the grid affected by all the attention and the pressure that is being brought

to bear on behalf of California?

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Ms. MARTZ. Well, thank you, Senator, for the question. In the

morning, when California wakes up, say if they are down 3,000

megawatts in the morning and they have to go out on the spot

market and buy, we can’t even buy power in Montana. Right now,

we have tried—we are a regulated market until 2002 for our homeowners. Twelve major companies went off of that regulated market

when we deregulated, had the opportunity to go off of the market.

They are having a terrible struggle now buying power, even finding

power to fill their need because most of the power is bought up at

a higher price. We can’t buy power. It is contracted out. We are

looking at power, when the 2002 market comes up, we can’t even

satisfy the full load that we need for our homeowners because of

what is happening in California. They are paying such high prices

for it, so it is driving our prices up.

Chairman THOMPSON. And, of course, we only know part of the

story. I can’t figure out yet what has been released and what has

not been released because the State of California has resisted, and

relented, I think, partially now on releasing to the taxpayers of

California and the ratepayers of California how much they are actually paying. And I think they still haven’t released what the municipals are paying. And you have suppliers out here who don’t

want to reveal the high prices they are charging. You have purchasers in California who don’t want to reveal the fact that they

are paying several times more than they would have paid last year

if they had done what everybody was urging them to do. So we

know they are paying higher prices. We don’t know how much because of that.

I have a note here that you need to leave right away, and I think

that is probably—well, my time is up. How convenient. [Laughter.]

Chairman LIEBERMAN. Thanks. I am going to let you go, but I

cannot help but say you taught us something. You created part of

a record here that we haven’t had before, which is obviously that

anybody on the grid is affected by what is happening in California,

so that if the price goes up there, it makes it harder to purchase

in Montana. But it also brings me back to the fact that, though I

know you are opposed to any form of price mitigation or relief control, that if FERC imposed some sort of order here and lowered the

price of electricity in California, wouldn’t that help the folks in

Montana?

Ms. MARTZ. No, because we then cannot even build more generation to keep in the State at all.

Chairman LIEBERMAN. Oh, well that is the tipping point.

Ms. MARTZ. See, what FERC did, it is important to remember,

the only thing that they did, the only thing you can do to prevent

blackouts is increase supply and reduce demand. Those two things,

you can do. Yesterday’s ruling doesn’t address either of those. Price

caps won’t address getting more power.

Chairman LIEBERMAN. That is correct. Of course, these are

only—I am going to let you go, but these are only temporary. I

mean, there is no question that, conceptually, you could certainly

reach a point where price caps were so severe that you would discourage supply. Nobody wants to get there. But what I am suggesting as I hear you is that some temporary price relief until supply can overcome demand in California actually would help folks in

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1The prepared statement of Ms. Gregoire appears in the Appendix on page 415.

Montana, too, because once the price is lowered there, you are not

going to have to pay so much more to buy it off the grid.

Ms. MARTZ. But Senator, FERC admits this themselves. Anytime

they have ever put a price cap, it has never been removed. So we

are not looking at consistency for the producers at all, and, boy, if

I owned it and I am a small business person, I would not invest.

That is all I can say. And maybe some people can wait a year.

Montana can’t. We cannot lose any more jobs.

Chairman LIEBERMAN. I look forward to that oversight hearing,

hopefully, in the not-too-distance future, when we press FERC as

to why it has not removed the price cap.

Ms. MARTZ. Thank you.

Chairman LIEBERMAN. Because supply has——

Chairman THOMPSON. I thought you already guaranteed it would

be temporary.

Chairman LIEBERMAN. Just listening to the governor, I said, if

they do not remove a price cap, we will be back here when supply

exceeds demand to ask that they do that.

Thanks so much for making the effort and taking the time to

come out here and I wish you both well.

Ms. MARTZ. Thank you very much.

Mr. HOEVEN. Thank you very much.

Chairman LIEBERMAN. The next panel is the Hon. Attorney General of the State of Washington, Christine Gregoire, and Roy

Hemmingway, Chairman of the Oregon Public Utilities Commission.

I thank you both for your patience. I thank you for coming out.

I was honored to become Chairman of this Committee recently and

I said I was feeling like I was Attorney General again, which was

definitely six great years of my public service career. Of course, one

thing I missed when I came here was that nobody called me ‘‘General’’ anymore.

Anyway, General, it is nice to have you here. We welcome your

testimony.

TESTIMONY OF HON. CHRISTINE O. GREGOIRE,1 ATTORNEY

GENERAL, STATE OF WASHINGTON

Ms. GREGOIRE. Thank you, Mr. Chair, Senator Lieberman, Senator Thompson. Thank you for the opportunity to come before you

today and testify.

Let me also publicly thank both of our Senators from the State

of Washington, who came before you this morning, for their support

and their hard work with regard to the energy crisis facing the

State of Washington.

I am here this afternoon primarily in my role as chief enforcer

of the State and Federal antitrust and unfair business practice

laws for the State of Washington. But I also come to speak on behalf of my colleagues from the State of Oregon and California regarding the multi-State law enforcement investigation that we

began recently.

First, let me say that I am pleased that FERC recognized that

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sumers in my State have been paying extraordinarily high prices

for the last year. These issues are not just about legalities and economic theory, but about, fundamentally, the day-to-day lives of people, our businesses, our schools, and our environment. Let me

share some of the impact this crisis has had on the people of the

State of Washington.

Our utilities, especially our publicly-owned utilities, have paid

hundreds of millions of dollars for power over the last year. For example, Seattle City Light paid $312 million to buy power on the

open market this past year compared to a normal year in which it

spends about $50 million. Seattle consumers’ rates were raised 42

percent since January of this year, and there is another expected

rate increase of 22 percent in October. These increased costs reverberate throughout our economy and our society. Our schools have

diverted funds from needed educational programs to purchase

power, and we have idled or shut down major industries. Georgia

Pacific shut down its Bellingham plant and idled 420 workers, citing power costs as the reason.

Let me turn now into the multi-State investigation into unlawful

business practices. The multi-State investigation launched by the

attorneys general of Washington, Oregon, and California focuses on

the causes of the exorbitant prices charged to utilities serving the

West Coast consumers. We are concerned that the energy prices

and supply in the past year do not appear to be the result of natural market forces. In the past year, let me tell you what we have

observed that has led us to this investigation.

First, the wholesale market rates for a megawatt hour of elec- tricity skyrocketed from about $30 to $300, sometimes even as

much as $3,000. Were these massive price hikes caused by some

form of unfair business practice or collusive activity among the

generators and the marketers?

Second, sudden, unplanned maintenance outages at generating

plants in California, to the point where 40 percent or more of the

generation capacity has been consistently off-line, compared to historical averages of about 10 percent. What caused so many competing generating plants to suddenly go off-line at the exact same

time?

Third, prices remaining high 24 hours a day, even though power

is being purchased for off-peak hours. Why can prices stay so high

when demand has been reduced?

Fourth, transmission capacity restraints during crucial times,

further exacerbating the high prices and the availability of power.

Were the companies exchanging confidential data in a joint effort

to create transmission problems?

And fifth, suspicious activity in the California natural gas market, including claims that companies may have collusively agreed

to suppress competition or otherwise engage in illegal activity.

If we ultimately find evidence to support a violation of Federal

or State antitrust or unfair business practice laws, we will seek

restitution, injunctive relief, civil penalties, and our costs for investigating the matter. In California, a criminal grand jury is being

convened in early July to determine if criminal activity has taken

place. That grand jury will be exploring State, RICO, or other

criminal violations, including false claims under California law.

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Let me note something else about our investigation. We are having difficulty getting access to power generators’ records. California

issued civil investigative demands on these generators in February.

It is now June and these three States still do not have the documents that we requested. Some of the power generators are simply

not cooperating, and this has delayed our antitrust investigation.

They do this despite their public claims of full cooperation. Where

is the cooperation with the chief law enforcement officers of these

States? My question for the companies is, what do they have to

hide? If you have not done anything wrong, let us see. Let us see

the records on an unconditional basis in a way that is timely and

responsive to our questions. Let the truth be the judge.

Now let me return to my role as public counsel for the ratepayers

of the State of Washington. I understand how very complex this

issue is both for FERC and for Congress. However, among all the

complexities is a very simple, straightforward principle. FERC has

a statutory duty to ensure that rates in the wholesale market are

‘‘just and reasonable.’’ Though I am very disappointed that FERC

did not act earlier to address the problem on a West-wide basis, I

am pleased that it has now expanded its most recent order to provide relief West-wide. It is a step in the right direction.

I remain concerned that the order does not provide remedies for

all of the harm that has been suffered by Washington State citizens, and I want to see if, in fact, at the end of the day, it does

address the problems prospectively. For those reasons, I would like

to encourage this Committee in its oversight role to do the following.

First, monitor carefully the implementation of FERC’s order.

Judge its effectiveness by FERC’s statutory duty to ensure just and

reasonable rates.

Second, ensure FERC has the resources and the guidance to continually monitor the market and investigate rates that may be unreasonable, to enforce its order and any subsequent orders designed

to make the markets work, and to provide appropriate refunds to

all consumers, including those in California.

Third, if this order does not appear to be working, FERC must

take immediate, decisive, corrective steps to ensure that the rates

are just and reasonable. In addition to protecting ratepayers, FERC

must be vigilant to make sure that energy efficiency and protection

of the environment is an essential part of any solution, both shortand long-term.

Again, these competition and FERC issues, are not just about legalities. They are not just about money. They implicate the day-today lives of our citizens, our businesses, our schools, and our environment. As we move forward, we must keep these interests, truly

the public interests, in the broadest sense, in mind.

In conclusion, this energy crisis has had a tremendous impact on

my State’s citizens, its business, its economy, and its environment.

It is a West-wide problem and has been going on now for a year.

Although we will continue with our law enforcement investigation,

FERC really is uniquely situated to monitor this energy market

and to provide the appropriate remedies to all who have been

harmed by unjust and unreasonable rates. We ask this Committee

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1The prepared statement of Mr. Hemmingway appears in the Appendix on page 423.

ergy rates be just and reasonable at all times for consumers. Thank

you again for allowing me to testify.

Chairman LIEBERMAN. Thank you, General, for that testimony.

Mr. Hemmingway, welcome.

TESTIMONY OF ROY HEMMINGWAY,1 CHAIRMAN, OREGON

PUBLIC UTILITIES COMMISSION

Mr. HEMMINGWAY. Thank you, Mr. Chairman and Senator

Thompson. I am speaking today as the Chairman of the Oregon

Public Utility Commission. At the beginning, I want to make three

points clear about Oregon’s position.

First, Oregon believes in competition in markets. We have begun

a gradual and flexible opening of our retail electricity markets to

larger customers, but due to the Western power crisis, even this goslow approach is in political trouble and I cannot predict its future

in the Oregon Legislature at this time.

Second, Oregon believes in sending appropriate price signals to

retail consumers. We have passed on prices to consumers, as have

some publicly-owned utilities in Oregon, and this crisis has not

been brought about by the failure to pass on higher prices. Passing

on to consumers unjust and unreasonable prices at 1,000 percent

above cost will not alleviate this crisis.

Third, Oregon does believe that there is a shortage of electricity

in the West. Some of this, a good deal of it, is caused by the fact

that we have had a drought year in the Pacific Northwest. If we

had had the rainfall we had in 1998 and 1999, we would not be

here today. There would be plenty of electricity and our plans to

build new generation would come on-line just in time.

I say all this to emphasize that we who advocate serious Federal

intervention in the Western power markets have been doing our

part to augment supplies. We are not against market competition

in the electricity business. We are not advocating repeal of the laws

of supply and demand. We are simply asking that the Federal Government undertake its historical role in regulating electricity marketplaces when they are characterized by high prices and inadequate numbers of competitive suppliers.

The principal argument that FERC has given for not imposing

serious wholesale price controls is that they will work against

bringing increased supply to the market. FERC seems to confuse

here long-term supply issues with the immediate need in the Western market for power supply. There is no way, as I think other witnesses have indicated, that the amount of supply that would create

a truly competitive market that could be built in time to significantly temper the prices that utilities have been paying in the

wholesale market in the last year. The lead time is simply too long.

Oregon, for instance, has under construction 1,500 megawatts of

new generation, and we have in a plant in the permitting stage

3,000 megawatts of new generation, and in the planning stage even

more. This is in a State with 5,500 average megawatts of consumption, 10,000 megawatts of peak, so this is an extraordinary amount

of generation that is under construction. But only one of these

plants of about 400 megawatts will be on-line by July to meet the

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summer problem. Not enough generation is likely to be able to be

brought on-line this summer to alleviate the real and contrived

shortages in the Western market.

In summary, the high prices supported by FERC are simply not

needed to stimulate investment in long-term generation because—

long-term investment in generation, because that is occurring, and

they cannot magically bring in new supplies in time to deal with

the crisis this year.

Theoretically, high wholesale prices should stimulate suppliers to

bring on generation in the short term that would otherwise not

come to market. But in truth, the unfettered wholesale market favored by FERC has done little to increase supply. Over the last

year, the California market, in particular, has been characterized

by record levels of plant outages, despite these stratospheric prices.

The high prices have had a perverse effect. Owners of generation

do not need to bring new supplies to the market in order to make

record profits, which almost all the energy suppliers in California

have done, if you look at their balance sheets. Without colluding,

energy suppliers can figure out that not bringing every kilowatt to

the market will boost prices and create profits. Only as power

prices have declined in recent months have we actually seen lower

plant outage rates. The shortage has given incentive to suppliers

not to bring all their supplies ready to the market because it has

meant that they get higher prices.

I would like to turn now to the June 18 order that FERC issued

this week. I believe this order is a step in the right direction, but

I want to make clear that it is a small step and it will not end the

worst abuses that have characterized the Western power market

this year. The order remains flawed in fundamental ways.

It allows all sellers, no matter what the cost of their generation,

to get the price of the highest cost resources operating at the time.

While marginal cost pricing of this kind is appropriate for commodities in a competitive market—I think any economist will tell you

that—in a market where consumers have choices, electricity in the

Western power market has not yet reached that point. Electricity

is a commodity for which there are no immediate substitutes and

there are no technically feasible ways yet to send immediate retail

price signals when wholesale prices are high. High wholesale prices

on a hot July day do not mean that consumers will get that signal

at the right time to reduce consumption and reduce the costs to the

utility system.

Worst of all, the new FERC order still provides incentive for

gaming of the system by suppliers. All power sold in the market

gets priced, as I said, at the cost of the highest and most expensive

resource running at the time. As a result, there is still incentive

for suppliers to ensure that there are not enough efficient resources

running and that the inefficient price-setting resource does operate.

With supplies tight in a small number of suppliers, a non-competitive market results where individual suppliers can anticipate

the actions of others. FERC has not yet shown that high wholesale

prices in a non-competitive market will deliver equal or more shortterm supply than in a fully-regulated market. In fact, recent history suggests the opposite.

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FERC is still acting as if electricity in the West were like wheat

or pork bellies, where buyers can find substitutes and respond to

high prices and no one supplier can affect the market or anticipate

how other sellers into the market will respond. None of these conditions is true. In the current Western power market, we do not

have a competitive market.

For over 60 years, FERC and its predecessor, the Federal Power

Commission, oversaw conditions that created a stable power market that brought electricity to utilities and consumers at affordable

prices and rewarded investors with reasonable rates of return.

FERC’s recent ideological devotion to free-market principles in a

market that is anything but free and competitive has shattered the

public’s faith in the Federal Government’s willingness and ability

to ensure an adequate and affordable supply of power. FERC’s actions threaten to bring a political end to appropriate deregulation

initiatives around the country, such as Oregon. This is a sad legacy, indeed, which I hope will be remedied as swiftly as possible

by the Congress. Thank you.

Chairman LIEBERMAN. Thanks, Mr. Hemmingway.

You touched on something fundamental to the FERC order that

I want to ask the commissioners this afternoon, because although

it is a step forward, there remains the question from our perspective, how much of a step forward? And it does seem to me, as you

said, and I appreciate it, because you are a regulator, a utility regulator, that they have created a system here, the so-called proxy

pricing, which stated in complete layman’s terms does peg the price

to the highest price obtained in a given period on the market and

it allows everybody to come up to that price. As I understood it, in

the off-peak hours, they can charge up to 85 percent of that high

price. So it is a ceiling, and I suppose it will, therefore, protect consumers from the most extreme price hikes, but it is a pretty tall

ceiling.

What would you have done if you were a one-man FERC in this

case?

Mr. HEMMINGWAY. Mr. Chairman, I would have looked for the

possibility of reimposing cost-plus price controls. You can provide

plenty of incentive and reward for investment with a cost-plus arrangement without allowing a supplier to get 1,000 percent greater

than its costs when selling into the market.

Chairman LIEBERMAN. And that is what we traditionally have

thought of as utility regulation. Again, we are all for—not all, but

I am certainly for deregulation with competition. It does strike me

that the cost-plus system—the idea that you get your money back

that you spent plus some reasonable profit—is also easier to apply

than this system. It is certainly easier to understand, for me, than

this system that FERC has adopted. Am I right from a regulator’s

perspective or not?

Mr. HEMMINGWAY. Well, there is the problem that there are hundreds of transactions that are going on and these have to be

tracked.

Chairman LIEBERMAN. Right.

Mr. HEMMINGWAY. But FERC is experienced at this. After all, it

did it for over 60 years, so I think they could go back to that.

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And I am for competitive markets and believe it is a better way

to price a product than is regulation, but you need to have a fully

competitive market with multiple suppliers in it in order to get to

that point where you can say that that kind of pricing is appropriate and I do not think we have that in the Western power market today.

Chairman LIEBERMAN. Right. General Gregoire, obviously, the

FERC order is good news for Washington State and the rest of the

West in that it both extends the previous FERC order to 24 hours

a day, 7 days a week, but more importantly for you, it extends the

order throughout the Western grid, including your State. The bad

news for your State, obviously, is that there is nothing said regarding refunds that you think you are entitled to. So let me ask you,

what, if anything, the State can do to right that wrong, and if you

have any counsel for this Committee or for FERC, I suppose, as to

how to deal with the question of refunds that electricity customers

in Washington State may be entitled to.

Ms. GREGOIRE. Well, thank you, Mr. Chair. I am one who believes that there have been unjust and unreasonable rates beginning about June 2000 and that needs to be corrected and refunds

are in order, and you heard from both of my Senators this morning

speaking to that issue, as well. FERC has suggested that it does

not think it has the legal authority in that the Federal Power Act

would call for it to be able to give refunds only 60 days after it had

opened its investigation, and that would, for purposes of this particular instance, for the West-wide investigation, didn’t occur until

April 26.

The problem with respect to that is we have been asking for a

West-wide investigation for some time. California utilities first approached to FERC in August. It was joined by Washington in October. FERC declined to do a West-wide investigation in December.

A motion for rehearing was brought in January, supported by

Washington. We went to the D.C. Circuit to ask the D.C. Circuit

to order FERC to open up a West-wide investigation, and that was

declined.

At the end of the day, our consumers may be with no redress if

they have to turn to FERC. I think that is fundamentally wrong.

At the end of the day, our antitrust investigation may provide a

remedy, but I am not optimistic that will be done soon given the

lack of cooperation with the generators. Sometimes that takes

years to accomplish.

So if, in fact, FERC says it has no jurisdiction and we are unable

in reconsideration to convince them otherwise, I would ask this

Committee to take that issue up so that we do not find this situation occurs again in the future.

Chairman LIEBERMAN. So the current procedure is that you are

not entitled to refunds until the period covered 60 days after an

investigation——

Ms. GREGOIRE. Is opened. Correct.

Chairman LIEBERMAN. I know this should be clear to me, but it

is not. Has FERC reached a conclusion for parts of the Western

grid outside of California that the rates charged are now unjust

and unreasonable?

Ms. GREGOIRE. Correct. They did in their order on Monday.

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Chairman LIEBERMAN. On Monday.

Ms. GREGOIRE. So it only goes back the 60 days from the time

they opened that investigation, which would put refunds due to the

rest of the West to begin in July.

Chairman LIEBERMAN. Yes.

Ms. GREGOIRE. That is fundamentally unfair, since our consumers have been harmed now for a year with unjust and unreasonable rates.

Chairman LIEBERMAN. Yes, I agree with you. It is very unfair.

So you are suggesting that the Committee may want to look, assuming that you will do everything you can to try to obtain refunds

through litigation and other means, appeals to FERC, that the law

itself is flawed and we ought to, as one result of these oversight

hearings, deal with how to correct that inequity so it doesn’t happen again?

Ms. GREGOIRE. We would ask you to do so, yes.

Chairman LIEBERMAN. My light is flashing. My time is up.

Thank you. Senator Thompson.

Chairman THOMPSON. Thank you, Mr. Chairman.

Mr. Hemmingway, Governor Davis has been critical of the

amounts charged by the Bonneville Power Administration, which,

of course, is big in your State. Do you believe that Bonneville has

engaged in price gouging?

Mr. HEMMINGWAY. Senator Thompson, no, I don’t believe they

have been. They have been selling into the ISO market and been

a price taker in that market, and I think that they have been able

to resolve their issues with Governor Davis on that. I mean, we can

check with him. They have not been able to set the price of the

power that they sell into that market. They merely take whatever

the market clearing price is of that day.

Chairman THOMPSON. So you would disagree with the governor

with regard to that particular entity, anyway.

Mr. HEMMINGWAY. [Nodded head up and down.]

Chairman THOMPSON. General Gregoire, with regard to your investigation, you were talking about the generators and, of course,

you and I both know that saying, ‘‘I am from the government and

if you don’t have anything to hide, turn over your records,’’ is not

the standard, of course, that we normally use in court or anywhere

else. In fact, civil libertarians would have a hard time with that if

it were anybody else except power generators.

But having said that, you say you have issued subpoenas. How

many generators have you subpoenaed?

Ms. GREGOIRE. We have issued civil investigative demands, and

what that provides for those companies, by the way, is absolute

confidentiality, and to date, the companies that have not complied

are Duke, Mirant, and Reliant. We have had cooperation, on the

other hand, from AES and Dynergy. We have yet to issue with regard to a couple of the other companies and we are in the process

of doing so now.

Chairman THOMPSON. How many have you issued so far?

Ms. GREGOIRE. Well, we have sent ones to Mirant, Reliant,

Dynergy, Dynergy Inc., Dynergy Energy Services, Duke Energy

Corp., Duke Energy Trading and Marketing, Duke Energy Power

Services, and AES.

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Chairman THOMPSON. How many of them own generation facilities in Washington?

Ms. GREGOIRE. None of them do. They sell into Washington

State.

Chairman THOMPSON. What percentage of the wholesale market

do these generators supply to Washington?

Ms. GREGOIRE. Well, let me give you an example. In Washington

State, for example, the purchases last year to Washington companies by AES was $15 million, by Enron was over $1 billion, by

Dynergy, $195 million, Mirant, $283 million, and Reliant, $224 million.

Chairman THOMPSON. Generally, what percentage of the wholesale market would that be?

Ms. GREGOIRE. I don’t know that.

Chairman THOMPSON. Well, it seems as if it would be a very

small percentage of your overall wholesale market.

Ms. GREGOIRE. We do not rely—most of our power comes from

Bonneville.

Chairman THOMPSON. Well, that was——

Ms. GREGOIRE. We cannot rely on these generators.

Chairman THOMPSON. That was going to be my next question.

What are the largest wholesale suppliers, electricity suppliers, in

your State, Bonneville?

Ms. GREGOIRE. Correct.

Chairman THOMPSON. Who else? Powerey?

Ms. GREGOIRE. We have some coal, we have some nuclear, and

we have these generators, primarily.

Chairman THOMPSON. What about BC Hydro or Powerey?

Ms. GREGOIRE. We have some, yes.

Chairman THOMPSON. That is electricity generation, of course.

Bonneville is electricity.

Ms. GREGOIRE. Right.

Chairman THOMPSON. Have you issued subpoenas to them to investigate their role in this?

Ms. GREGOIRE. We have had full cooperation by Bonneville. We

have not yet issued anything to any of the generators in BC Hydro.

Chairman THOMPSON. So I suppose if I was a generator out

there, when you are talking about compliance, I would wonder why

you would be issuing these subpoenas or requests, whatever you

call them, for those companies that have very little—have no presence in your State, supply what seems to me to be a small percentage of the wholesale market, on the one hand, and you really

haven’t done the same thing with regard to those generators who

supply a much larger percentage of your market.

Ms. GREGOIRE. Well, Senator, it is a multi-State investigation involving all three States, and, of course, these generators are located

in California and have not cooperated with California at all, as

well. They have refused to provide documents to California and, in

fact, have brought a protective order motion in court to ensure that

whatever documents they get, they cannot be released to either

Washington or Oregon.

Chairman THOMPSON. Of course, that is normal when a governmental subpoenas documents that they are not put on the public

record unless there are further legal proceedings. Whether or not

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a company is cooperating, of course, begs the question, whether

they are properly exercising their legal rights that any company or

any citizen has in this Nation. So the fact that they are or are not

cooperating, of course, begs the question. You will have to resolve

that, as to whether or not they are not cooperating for appropriate

reasons. But again, if I were one of them, I would be wondering

why you are going after all these out-of-State folks and not going

after the ones that are supplying most of the power.

I have nothing further.

Chairman LIEBERMAN. Thanks. Very brief factual questions. Earlier, one of the Senators from Washington State said that she

thought that the increase in electricity costs in the State was a

multiple of 11 times in the last year. Is that right?

Ms. GREGOIRE. That is correct.

Chairman LIEBERMAN. And what would be a comparable figure

for Oregon?

Mr. HEMMINGWAY. Mr. Chairman, it would be a comparable figure for companies that are buying in the wholesale market. We

have a number of utilities which are largely publicly-owned utilities which have bought a percentage of their power at those prices

and they have had to raise their retail rate as a result by 20 to

40 percent.

Chairman LIEBERMAN. Is it possible to state what percentage of

that in each of your States, roughly speaking, is derivative from

the problem in California and what percentage is more home

grown, if you will? If you can answer that, fine. If you cannot, then

we will let you think about it and submit a written answer.

Mr. HEMMINGWAY. Mr. Chairman, it is one grid, and so it is very

difficult to separate out the problem as a result of the drought from

the problem in California.

Chairman LIEBERMAN. That is what I was thinking.

Mr. HEMMINGWAY. As I said before, if we were not having a

drought, even California would not be having a problem, in my

opinion, because we export so much power from the Pacific Northwest in good water years to California that it—that is the reason,

essentially, these problems started to creep up in the year 2000,

was that the first year that we did not have, in a long time, really

large exports to California.

Chairman LIEBERMAN. General, a final question. In light of your

multi-State investigation, to the best of your knowledge, is the

Antitrust Division of the Justice Department investigating this

matter at all?

Ms. GREGOIRE. No. To my understanding, the U.S. Department

of Justice is not involved. We have asked them to join with us in

the investigation and they have not joined us as yet. It is a threeState multi-State investigation.

Chairman LIEBERMAN. How about the Federal Trade Commission? Do you know of any——

Ms. GREGOIRE. No.

Chairman LIEBERMAN. No active investigation? I do not have any

other questions.

I thank you for coming out, for your patience. Your testimony

was very helpful. I appreciate it very, very much and wish you a

safe trip back home.

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1The prepared statement of Mr. He ́bert appears in the Appendix on page 430.

Ms. GREGOIRE. Thank you.

Chairman LIEBERMAN. Senator Thompson, it is my inclination

now to take a half-hour break to allow everyone who must be here

to stretch their legs and get some lunch and we will be back at 2:15

with the five members of the Federal Energy Regulatory Commission. The Committee stands in recess.

[Recess.]

Chairman LIEBERMAN. The hearing will come back to order.

I thank the five members of the Federal Energy Regulatory Commission, at times in its history little known, I would say now probably at one of its highest points of visibility with all the attendant

responsibilities thereto.

I think you know that this Committee is an oversight committee.

And the hearings we are conducting here are pursuant to that authority, to make a judgment as to how your commission has been

responding to the general subject or matter of energy deregulation

with particular regard, of course, to the electricity markets in the

West, and most especially in California. We heard testimony last

week from some leading economists. We heard testimony today— perhaps you followed it—from Governor Davis, Governor Hoeven,

Governor Martz, Attorney General Gregoire of Washington State,

the Chairman of the PUC from Oregon, Mr. Hemmingway, and

members of Congress.

I know that you have some prepared testimony. Mr. He ́bert, I

want to start with you and we will give each of the members a

chance after that. We have been running a 5-minute clock on the

witnesses. Mr. He ́bert, if you go a little longer, I do not think we

will physically eject you from the room. And then Senator Thompson and I will proceed with some questioning.

Thank you for your understanding about the time pressures

today and keeping yourselves available. I appreciate it. It is important business and you are right at the heart of it, so we thank you

for being here. Mr. He ́bert, it is all yours.

TESTIMONY OF HON. CURT L. HE ́ BERT, JR.,1 CHAIRMAN,

FEDERAL ENERGY REGULATORY COMMISSION (FERC)

Mr. HE ́ BERT. Thank you, Chairman Lieberman. Thank you for

the opportunity to appear here to discuss the Federal Energy Regulatory Commission’s role in restructuring of the electricity markets.

The Commission’s experience in regulating electric and natural

gas utilities and, indeed, the Nation’s experience in pricing and allocating vital goods and services have 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 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 conVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00135 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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sumer 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 longterm priorities.

My written testimony, which I submitted Monday morning, describes the dozens of orders the Commission has issued in recent

months addressing California and Western energy markets. The

Commission has done everything that 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.

Moreover, the Commission has been no less active in its efforts to

investigate and lower the price of natural gas in and bring additional pipeline capacity to Western markets.

In my limited time this morning, I would like to focus on action

undertaken by the Commission on Monday afternoon after the filing of my written testimony. By a unanimous 5–0 vote, the Commission expanded the scope of a market monitoring and price mitigation plan for California and the West. An earlier version of that

plan went into effect on May 29 of this year. Since that date, as

we all know, prices of electricity and natural gas in both spot and

forwards markets have plunged dramatically. Energy prices in

California and the rest of the West are lower than at any time in

the past year and are coming close to prices in the rest of the country.

Building on that success, the Commission voted unanimously to

expand its price mitigation plan for California’s spot market sales

to all hours of the day. The Commission also extended the limitations on spot prices to all 11 States in the Western System Coordinating Council. The details of the Commission’s plan are many. For

this reason, I have submitted for the record the Commission’s 60-

page order which was issued yesterday afternoon and a 7-page

press release on the order which was issued Monday afternoon.

In a nutshell, the price mitigation ordered for the West and applicable during all hours is based on the market clearing price concept adopted in the Commission’s April 26 order. The market clearing price is based on the bid of the highest cost, least-efficient unit

in California that is called upon by the California ISO to serve load

during any day in which available reserves dip below 7 percent.

Sellers other than marketers have the opportunity to justify individual prices above the market clearing prices based on their costs.

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 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 last summer, Mr. Chairman. The ISO lowered the price cap last summer from $750 per

megawatt hour to $500 per megawatt hour and then $250 per

megawatt hour. All this did was cause an increase in the average

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electricity price and a reduction in the ability of the ISO to procure

emergency power. Indeed, last December, the ISO, the California

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 electrical grid, what we knew all

along.

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 and appellate litigation over

cost structures and reasonable rates of return. This type of delay

and uncertainty is simply unacceptable at this critical juncture.

The other point that certainly needs to be made is that under

that scenario, Mr. Chairman, the most inefficient units would be

guaranteed profits probably at levels that they will not get under

our plan. Even more disturbing, regulation based on cost would

provide no incentive for the various suppliers to become efficient

and to reduce their costs and thereby lower prices for consumers.

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 least-efficient, last-dispatch unit. A generator is now able to recover its fixed costs, but the extent of its capital recovery and the

size of its profit is determined by the very efficiency of its operations, Mr. Chairman.

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. I am very proud of the green initiatives of the

Commission’s plan. The best way to clean our air, as we all know,

is to never pollute it in the first place.

And finally, through enhanced monitoring and coordination of

generator outages, along with additional tools to act against withholding and other forms of anti-competitive behavior, the Commission has removed any doubt in that we are committed to ferreting

out and remedying any form of market manipulation and behavior

no matter when it occurs, 24 hours a day, 7 days a week.

As Monday’s order makes clear, anti-competitive behavior simply

will not be tolerated by this Commission. Indeed, in Monday’s

order, the Commission directed Duke Energy to make refunds for

the period earlier this year when it charged California consumers

approximately $3,800 per megawatt hour for electricity. In other

orders this year, the Commission has directed the refund of over

$130 million for past overcharges and manipulative behavior and

has ordered an expedited hearing into allegations of affiliate market power abuses concerning the transportation of natural gas to

the California border. Other investigations are underway, as well.

There should be no doubt that this Commission is actively pursuing refunds and other appropriate remedies for past behavior.

Frankly, I believe that the best way for California consumers to be

made whole is, if possible, to have the parties themselves negotiate

a fair and comprehensive settlement of all outstanding refund

issues. The Commission is not ducking these issues. Rather, it is

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giving the parties, including the State of California, 3 weeks, which

is not a lot of time, to do what is best for the people of California.

I hope that all parties will come to the table. I hope that all parties themselves will spare consumers the pain and uncertainty of

protracted litigation over past market behavior. If, however, these

parties are unable to reach agreement, the Commission stand committed to act quickly and decisively to resolve these issues.

As for the rest of the West, the Commission’s refund authority

presently extends from July 2 of this year, the earliest refund effective date allowed under the Federal Power Act. I understand the

pleas for an earlier refund effective date, and this is a matter that

the Commission is currently considering on rehearing of its December 15 order of last year. In that order, the Commission denied a

complaint brought by Puget Sound Energy which sought an investigation into rates charged, not for the entire West, but rather one

limited to the Pacific Northwest.

I can state, however, that Western parties outside California are

not shut out of the settlement discussions scheduled to commence

next week, as of Monday. To the contrary, those discussions are

open to all entities which are parties to the proceeding that was

the subject of Monday’s order. Those parties include Puget Sound

Energy, the City of Seattle, various Pacific Northwest utilities and

industrial companies, and the Bonneville Power Administration.

In conclusion, the Commission has been doing a great deal of

work to help ease the present energy problems in California and

the West. The Commission’s efforts have contributed to the recent

decline in Western energy prices. Monday’s order, issued by a

unanimous Commission, 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 for the

West’s immediate energy problems. It represents an effort to provide 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.

There has been a lot of talk about the past and I would like you

to know, Mr. Chairman, Senator Thompson, and the Committee,

that this Commission—I can’t speak for a previous Commission, I

can’t speak for a Commission prior to January 22. I had no control

over that agenda. But I will tell you, sirs, that we have been engaged. We have issued over 60 orders for the State of California.

We have issued a price mitigation plan. We have improved upon

that plan. We have issued refunds that no other Commission has

done. We are moving forward quickly. We are trying to resolve gas

issues, asking for transparency. We are committed, and I assure

you, sirs, I assure the members of this Committee that I know in

my educated mind and I truly believM in my heart that we are

well on our way of improving this marketplace and getting them

on their feet while bringing the consumers reasonable prices, but

at the same time attracting necessary investment.

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I read in today’s issuance of the Wall Street Journal, and I

brought up websites that say, under this order, they remain bullish

and are bringing opportunities into California, and I think we have

done it right and I am committed to it. Thank you, sirs.

Chairman LIEBERMAN. Thank you, Mr. Chairman.

Just as a point of clarification, I appreciate your testimony. I

think you said some things there that are directly responsive to

questions that were raised by the witnesses this morning. I just

want to clarify what you said, and then I will go on to the other

Commissioners. You said that once the 15-day period that is called

for in the order, Monday’s order, in which parties will work together under an administrative law judge on the question of refunds, that if that does not reach a solution that is satisfactory to

the Commission, that the Commission might—or satisfactory to the

parties, that the Commission would consider reentering on those

matters.

Mr. HE ́ BERT. Let me take 15 seconds. One, I did not get to see

this morning’s hearing. As you know, we are busy.

Chairman LIEBERMAN. Right.

Mr. HE ́ BERT. But I will tell you that the process is there is 15

days for the parties to reach settlement. If not, this Commission by

a vote of 5–0 has instructed the administrative law judge to recommend to us a settlement within 5 days of that—I am sorry, 7

days of that.

Chairman LIEBERMAN. OK.

Mr. HE ́ BERT. So 22 days, and then this Commission can act.

Chairman LIEBERMAN. And just on the second point, which was

obviously of concern to people in Washington State and Oregon

who believe that their quest for refunds is not within the purview

of the administrative law judge, did I hear you correctly to say

that, as you understand it, that they are wrong, in other words,

that the judge will consider their request for refunds, as well?

Mr. HE ́ BERT. You are going to require me to be very careful here,

and let me do it.

Chairman LIEBERMAN. I am not meaning to put any words in

your mouth.

Mr. HE ́ BERT. No, you are not.

Chairman LIEBERMAN. I just wanted to make sure I understood

what you were saying.

Mr. HE ́ BERT. This is a very delicate situation because I have the

December 15 order, which speaks to that, under rehearing at this

time, so I do not want to conflict myself out on that case, so I have

to be very careful in my answer.

The beauty, I believe, as an attorney who has been involved in

settlement processes, I will tell you that there are two things that

settle issues and cases, uncertainty and deadlines. You trade certainty for uncertainty and there is a deadline that closes it out.

We did not define the parameters of the settlement process. We

left it open. That is, in fact, the beauty of the process. They are

parties to that process. They will be in the room. It will be up to

them to negotiate what they believe to be in the best interests of

them and the parties that they represent.

Chairman LIEBERMAN. Well, that is very heartening. I just saw

a copy of a letter that is on its way to you—maybe you have reVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00139 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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1The prepared statement of Ms. Breathitt with an attachment appears in the Appendix on

page 462.

ceived it already—from some of the Congressional delegation from

Washington State asking these questions, so they will be grateful

for that. I will hold my additional questions.

Commissioner Breathitt, welcome. Thank you.

TESTIMONY OF HON. LINDA K. BREATHITT,1 COMMISSIONER,

FEDERAL ENERGY REGULATORY COMMISSION (FERC)

Ms. BREATHITT. Thank you, Mr. Chairman and Members of the

Committee. I appreciate this opportunity to appear before you this

afternoon to discuss the role of the Federal Energy Regulatory

Commission regarding the restructuring of California’s electricity

market and its implications for other States and regions.

The problems that have been experienced by consumers in the

West have been the primary focus of the Commission for almost a

year now. What we have learned through our investigations and inquiries is that the causes of the present energy situation in California and other Western States are highly complex and multifaceted. I am sure you heard a lot of that this morning. I believe

the Commission has taken bold and decisive actions within our jurisdiction to remedy the extreme distortions in the California markets and to address the instances of potential market power

abuses.

Since last August, the Commission has issued over 50 orders—

I think the Chairman said 60 now—implementing important remedial measures and price mitigation mechanisms, instituting investigations into rates and market design flaws, establishing programs

to maximize electricity supply, delivery and demand reduction, directing sellers to provide refunds of excess amounts charged for

certain electric energy sales.

Our actions are starting to have a dampening effect on prices in

California and the West. Prices have decreased significantly since

our market monitoring and price mitigation plan for California

took effect on May 29. For instance, during the week of June 9,

prices for spot purchases of power at Western trading hubs fell to

less than $55 per megawatt hour from a high of about $170 per

megawatt hour earlier in the week. The low prices continued into

the next week, and equally important to me, the price for the

longer-term contracts has also come down dramatically. We have

seen forward contracts drop for 2003 to $41 per megawatt hour in

the past month.

We have long stressed—the Commission has long stressed the

importance of long-term contracts to minimize the reliance on the

volatile spot market, and I believe we are down to about 20 percent

from 100 percent when we started issuing our orders.

In my pre-filed testimony, I highlight several of the major orders

that we have issued and I hope that you will note those when you

are going through the testimony. It is important for your Committee to understand the breadth and the scope of our myriad actions in the Western energy crisis. Critics have said we have done

nothing and that is simply not true.

133

My testimony also discusses the relationship between the problems we are experiencing in Western energy markets and those in

natural gas markets and I point to numerous impediments in natural gas markets that must be addressed.

I have a deep concern about the impact of the prolonged periods

of high natural gas prices on industries and communities in the

West and particularly the impact on the electric generation costs,

since so many of the units in California use natural gas.

But this afternoon, I would like to focus on our most recent action. On Monday, the Commission instituted a market monitoring

and price mitigation plan for the entire Western United States.

These new procedures build on our April 26 order, which implemented similar orders just in California, and we initiated the investigation that has made it possible to cover the entire Western

United States back in April.

The plan that we announced is designed to reduce 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 the Western States to repair dysfunctional market mechanisms. The mitigation plan is intended to provide breathing room

for the markets to self-correct. Importantly, the plan will apply to

all sellers, including marketers and non-public utilities across California and the balance of the United States portion of the Western

States Coordinating Council.

I fully support the premise of this order, which is that all sellers

in the West should be treated similarly to remove the incentive to

sell into one area versus another, so-called megawatt laundering.

While I wholeheartedly encourage conservation and embrace demand reduction, we need to acknowledge that natural gas and electric infrastructure needs to be expanded and upgraded. I believe

this market-oriented approach that we took in Monday’s order will

provide the price mitigation needed and it is my hope that it will

not discourage necessary investment.

I would also like to note before concluding that I attached a concurrence to express my views about one aspect of the order that I

didn’t fully endorse, and that was a section that instructs the ISO

to impose a 10 percent creditworthiness surcharge to the market

clearing price. I believe that the imposition of such a surcharge virtually conceded to the ISO the issue of whether or not the ISO

must implement our creditworthiness standards, and I thought

that was premature.

And finally, I wanted to state my support for the settlement conference. You brought that up, Mr. Chairman. I am keenly aware

of the difficulties that the parties face and the compromises that

will need to be made to fashion a very comprehensive settlement.

I have long been an advocate of negotiated resolutions and I encourage all the parties, including the State—I believe I heard the

governor this morning say that his delegated officials would be parties to the settlement, and I was very pleased to hear that, and I

hope that all these parties work very hard at the daunting task of

settling past accounts and structuring new arrangements.

Mr. Chairman, I had a few final remarks, but I will stop there

by saying that I think that all of these goals work within a marketVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00141 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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1The prepared statement of Ms. Brownell appears in the Appendix on page 484.

oriented framework and that is an approach that I have endorsed.

Thank you.

Chairman LIEBERMAN. Thank you, Commissioner Breathitt.

Commissioner Brownell, welcome.

TESTIMONY OF HON. NORA MEAD BROWNELL,1 COMMISSIONER, FEDERAL ENERGY REGULATORY COMMISSION

(FERC)

Ms. BROWNELL. Thank you. Thank you, Mr. Chairman, Senator

Thompson.

Chairman LIEBERMAN. Do you think it was a friendly act to appoint you to the Commission at this point? [Laughter.]

Ms. BROWNELL. Well, it is full employment. I don’t have any boring moments in my day, or night, I might add.

Chairman LIEBERMAN. That is for sure. Welcome. Thank you.

Ms. BROWNELL. In fact, I would like to start out by saying that

I am pleased to be here and I think that my first experience in getting out this order suggests a culture at the Federal Energy Regulatory Commission that has not been largely recognized. There was

a sense of urgency, there was open and honest communication, and

there was innovation in the development of this order. All of my

colleagues and the staff worked very hard to address a number of

concerns raised by stakeholders, and I think we responded responsibly. We have created a road map to bring certainty for the next

two summers so that we can all get down to the business of creating markets that work, that work for market participants, but

most importantly that work for consumers.

I would like to talk a little bit today about what we experienced

in Pennsylvania and what we learned, lessons learned that I think

we can bring successfully to the way we do business at the FERC.

First of all, we were asked to define the differences between California and some of the States, and I think you know them well, and

I do not say that judgmentally. There are just fundamentals that

it takes for a market to work—good market design, appropriate capacity, an independent system operator, and I emphasize that, and

sufficient infrastructure.

But while we have, in fact, had great success in Pennsylvania,

there were things that didn’t work and things that we needed to

do to transform our Commission to successfully respond to market

changes. Markets are transitional. You don’t declare them open 1

day, declare victory, and walk away. They don’t happen overnight.

They are fragile and they need nurturing. And they need more

work with the regulatory process than I would have anticipated,

frankly, when we started. But they can’t use the standard regulatory responses. Markets don’t wait for answers. Markets need

certainty. They need quick responses. People are making business

decisions. Consumers are making buying decisions.

So we designed successfully in Pennsylvania several flexible approaches that I believe address the issue of transforming markets.

All of our restructuring decisions went to settlement processes that

took no longer than 30 to 45 days to resolve. What did that accomplish? All of the stakeholders knew what the rules were. The marVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00142 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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1The prepared statement of Mr. Massey appears in the Appendix on page 494.

ket participants were not exposed in the capital markets for an

undue period of time. And we did not have to wait for the standard

litigation process, to wait 1, 2, or 3 years. We were able to bring

the benefits of a retail market to Pennsylvanians, who saved in the

first 3 years almost $3 billion. That only would have happened if

we had not used these new flexible approaches.

In the early stages, we had a lot of operational issues that traditionally would have had to wind their way through a rulemaking

or some other process that would have taken 8 to 9 months. We

had an operational SWAT team that met, in some cases, every day

in the early stages. The rules were, no lawyers, no lobbyists, no

commissioners. We had a staff person who led a team of operations

experts who brought instant solutions so that there were no market

delays, billing problems, or other kinds of impediments to the market.

The second thing we learned was that market monitoring is, indeed, a critical issue in managing the transformation and in building the credibility of the market. It is something I think we are all

learning. I am suggesting to my colleagues that we bring in some

outside experts who do this kind of thing for a living. We have been

rate makers. We have not been market monitors. And I think the

staff is the first to say that they have worked very hard to design

a system that works, but they would love some advice from the

FCC, from the FTC, and from the SEC. So I would like to move

forward with that because I understand that you, your colleagues,

and all of our constituents need the confidence that we are going

to take a good look at these markets and that there will be transparency and honesty and equity.

The third thing I think we realized and is more critical today

than ever before are regional solutions. We need to reach out to the

stakeholders in the regions, the States, the creation of RTOs, listen

to what they have to say, listen to what their experiences are. Yesterday, we had a hearing on seams issues for RTOs and I think it

made a big difference in informing us on how we must move forward. Our order called for a technical conference on technology in

the introduction in demand-side management that will bring new

technology to the market, I hope, as soon as we can. We are reaching out to learn things and to listen to stakeholders to learn. I

think this can be very successful.

So I understand why there are concerns, but now that we have

moved beyond the crisis, let us move to solutions that will work for

the longer term and create the credibility and the confidence that

we all need to introduce the benefits of competition to all Americans. Thank you.

Chairman LIEBERMAN. Thanks, Commissioner Brownell.

Commissioner Massey, thank you for being here. We look forward to your testimony.

TESTIMONY OF HON. WILLIAM L. MASSEY,1 COMMISSIONER,

FEDERAL ENERGY REGULATORY COMMISSION (FERC)

Mr. MASSEY. Thank you, Mr. Chairman. Mr. Chairman, and Senator Thompson, our June 18 order brings dramatically expanded

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price controls to a broken Western 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 over the past year. Cost-based price constraints are now extended to all hours, not just those of reserve deficiency. We have long needed 24-hour-a-day, 7-day-a-week coverage, and now we finally have it. These caps will remain in place

until September 2002, giving the market two full summers to correct. I endorse these measures.

While better late than never, I wish this Commission had taken

effective action sooner. Until this order, the Commission had stubbornly refused to implement full-time price constraints despite

rather clear evidence that prices were not just and reasonable.

Businesses have closed down, putting thousands out of work and

hurting the Western economy, and all because of a broken electricity market. By acting 12 months ago, we could have prevented

much of the economic carnage in the Western interconnection that

has occurred over the past year, and I regret that we did not.

Given that the Commission adopted measures that I have long

advocated, however, I am tempted to declare victory and let it be,

but I cannot. There are some aspects of the order that I have

strong reservations about. One aspect is the addition of a 10 percent surcharge to the market clearing price to reflect credit uncertainty. I do not see the need for this. The Commission has issued

orders in the past few months instructing the ISO to abide by the

creditworthiness requirements of its tariff. I am concerned that the

adder may diminish the ISO’s enforcement of those requirements.

Moreover, it is my understanding that, recently, all sales into the

ISO markets have been backed by a creditworthy party—recently,

all sales, not until recently.

Instituting this surcharge does have a modest bright side, however, I must admit. Generators may no longer attempt to justify

bids on the basis of credit risk above what is provided for in the

cost-based clearing price methodology. This was a major flaw in the

old, ineffective $150 benchmark in our earlier mitigation program

announced in December. Eliminating that ground for high prices is

a positive development.

Second, the order should have provided guidance to the parties

that will participate in this massive settlement conference that we

order. I believe we are avoiding our responsibility under the Federal Power Act to set just and reasonable prices by requiring parties to settle a multitude of issues with a price tag of billions of dollars without at least 2 cents’ worth of guidance.

Third, I do not agree with the rhetoric in this order that characterizes cost-of-service pricing as irrelevant and perhaps even downright harmful on the theory that it would discourage new supply.

I do not understand the need nor the logic of this language. We

have made a choice in the order to strike a balance between strict

generator-by-generator cost-of-service regulation and a blind reliance on the market. The mitigation program puts in place important cost-based price caps while relying on market-based pricing.

The order sets out reasons for this balanced choice and articulating

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them is all that is needed to support our decision. Make no mistake, this is a cost-based program. The maximum price is limited

to the costs of the last generator dispatched.

I strongly disagree with the statement in the order that a costbased inquiry alone would not be sufficient to fulfill our statutory

duty under the Federal Power Act. I do not read the Federal Power

Act and the relevant court decisions so restrictively. I have aggressively supported this movement to markets, and I still do, but

there is still an important role for cost-of-service regulation where

markets melt down and prices are not just and reasonable.

What is curious about this aspect of the order is that the concern

is to avoid discouraging new supply. However, as well respected

economist Alfred Kahn recently said of our long reliance on costof-service regulation, and I believe he said it before this Committee,

‘‘If the literature agrees on anything about that experience, it is

that cost-based regulation as traditionally practiced has encouraged

the gold-plating of service and the very excess capacity that seems

to promise such enormous benefits to consumers during the past

decade if rates were deregulated.’’

Mr. Chairman, I notice the red light is on. May I have 2 more

minutes, please?

Chairman LIEBERMAN. Indeed. Go right ahead.

Mr. MASSEY. Thank you. Dr. Kahn, therefore, believes that costof-service regulation may lead to too much supply. Thus, I do not

understand the order’s logic concerning cost-based regulation discouraging supply adequacy. There may be legitimate reasons

against cost-based regulation, but discouraging new supply is not

one of them, at least according to Dr. Kahn.

These concerns notwithstanding, I supported the order and the

price protection plan it puts in place. To ensure that this price protection plan is successful, the Commission must exercise all of its

statutory powers to keep natural gas prices in the West at just and

reasonable levels. Virtually all of the formula, all of the formula except a $6 O&M adder, is tied to the cost of fuel. For the marginal

unit, that will be natural gas. Thus, the success of the plan we

adopt in lowering prices depends in large part on fluctuations in

the price of natural gas. If natural gas prices stay reasonable, our

plan will provide reasonable price mitigation.

Today’s price protection plan gives California and the West

breathing room while the markets are brought back to health. A

number of items need to be addressed in the next 15 months. There

must be substantial amounts of new generation capacity brought

on-line, a more balanced supply portfolio must be developed as

California moves away from over-reliance on the spot markets, a

robust demand response program must be implemented through

demand bidding and accurate price signals, the transmission constraints must be relieved.

Without these measures, which must be implemented over the

next 16 months, I would be concerned about whether the markets

in the West can be brought back to health. Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thank you, Commissioner Massey.

And finally, Commissioner Wood, welcome to you.

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1The prepared statement of Mr. Wood appears in the Appendix on page 504.

TESTIMONY OF HON. PATRICK H. WOOD, III,1 COMMISSIONER,

FEDERAL ENERGY REGULATORY COMMISSION (FERC)

Mr. WOOD. Thank you, Chairman Lieberman and Senator

Thompson. I would just ask that my written comments represent

my views here. I am the fifth guy of five, so I won’t belabor you

other than to say, from my own experience as a State regulator in

Texas, I share a lot of Commissioner Brownell’s perspective on

these issues and recognize that it is so important that the Federal

Commission be perceived and be in reality a co-player in regulating

these very important infrastructure industries, electricity and natural gas.

One of the important aspects of competition, the only reason that

competition works, and as we have seen the counter case in California, is that there are good market rules in place and a sufficient

infrastructure, infrastructure being a broad word, meaning supply

side and demand side, resources meaning the delivery that gets

them there, whether that be gas transportation pipelines or electric

transmission lines. It doesn’t work well—it doesn’t work at all if

the infrastructure is not in place.

I think one of the lessons learned by this Commission is that our

historic reliance on individual States or on private industry organizations to oversee that sort of reliability is, I think, a thing of the

past. I do think that is a role now that clearly ought to move to

this Commission and ought to be a constant oversight for us as we

determine that the competitive infrastructure is in place before we

move to a deregulated era.

So that is what I hope we will do. I think we probably are going

to need some resources to do that and we will be, I think, reviewing

that in the appropriate way with the Chairman and with our oversight committees, as well.

But in addition to people and financial resources, I think also one

of the things that are important for regulators to have are big

sticks, not that they ever need to be used, but when they hang

from your belt, the people who you are trying to regulate understand. Certainly, the ability to revoke a certificate, or as my colleagues here recommended, at times to go from a market-based certificate to a cost-based certificate may be perceived as a penalty of

sorts. I think administrative fines, certainly ordering refunds is one

issue, but to order refunds with an administrative penalty attached

to those would be perhaps a useful tool for the Commission to have

in its tool shed.

I think perhaps we were asked if there were treble damages,

much as exists in antitrust lawsuits. We found that we did not

have the statutory authority to do that in this order that was

issued yesterday, but that again may be an important tool for the

Commission to have. Those do not exist today, but I think if we are

going to be a vigilant market cop, we need to make sure that our

bite can match our bark.

So I look forward to working with you, Chairman Lieberman,

Senator Thompson, your Committee, Committee staff, and my colleagues on making sure that this Commission is fully equipped to

do the job that I know you want us to do well.

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Chairman LIEBERMAN. Thanks, Commissioner Wood, for that

statement, very interesting statement.

I have been thinking as I have been listening to the testimony

today. This picks up a thought that you just articulated, which is

that the market is a magnificent mechanism for stimulating, facilitating economic growth, thereby general well-being, and through

competition getting people the goods or services they want at the

best possible price.

I am paraphrasing somebody, maybe famous, maybe not. The

market, notwithstanding its great attributes, its positive attributes,

has no built-in conscience so that if there is not genuine competition, then there arises in a market without the pressure of competition, the genuine need—you just uttered the word, for what I would

say a cop on the beat, to bring back the conscience, to bring back

a sense of right and wrong, and limits. Otherwise, people will suffer.

And I do think in the environment we are in now, both in terms

of deregulation of certain elements of the energy industry and then

more broadly the grave national concern about fluctuations in energy pricing, that this is a role that various agencies and departments in the Federal Government have to play. And I appreciate

what you said. I think that there will be a way in which this Commission, I hope, has crossed a bridge to a new chapter in its history

through this period of time. So I appreciate what you have done.

As I said this morning, I think the order that was issued on Monday was a real step forward and I appreciate it. I have some questions about it, both in terms of the formula chosen and the means

chosen as well as questions about refunds which, in part, Mr.

He ́bert, you answered.

But let me go to the formula. Once you decided last December

that the rates in California were not just and reasonable, and I

gather on Monday in the order made the similar decision for the

rest of the Western grid. The question then is what relief to provide.

I am from a State Government background. I was Attorney General. My office represented the Public Utilities Commission, control

authority as we call it in my State. So the notion of a cost-of-service-plus—some reasonable profit seemed much more simple and

certain, and I suppose easier to administer to me.

As I look at the system you have chosen, I want to ask this question. It seems to, as one of you said, peg the acceptable price in

California to the last price offered during the period of time, the

highest price, and, therefore, arguably the least-efficient price, the

least-efficient company setting the price. Then they can charge up

to 85 percent of that in the off-peak hours.

So there is no question that this system will impose some constraints on pricing to the benefit of electricity consumers, energy

consumers in California and now throughout the West. But considering that the standard of law is just and reasonable rates, how

can you feel comfortable that this system will guarantee just and

reasonable rates? In other words, you have put on a ceiling here,

but because it is being set by the highest price, the last price

charged, the highest price, it can be a pretty darn high ceiling and

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there still can be a lot of latitude for unjust and unreasonable pricing underneath that ceiling.

Mr. HE ́ BERT. Let me speak to that as quickly as I can, and that

is really the crux of what we are trying to accomplish here. One,

and I know you understand this, while we were trying to put this

together, our goal was to bring prices to a reasonable level while

at the same time attracting adequate investment so we can get the

supply there, we can build the deliverability up so that we can deliver that supply, therefore keeping prices down in the long term

for consumers.

We weren’t really looking for the easiest way to get there. We

were, in fact, looking for the best way to get there. I think that is

what this plan is.

I have heard many people on this Committee, Mr. Chairman, I

have certainly heard you speak on green issues and making certain

that we have a green environment. Through driving the efficiency,

we do two things. One, we bring down prices. Two, we strive to

never make our air dirty through bringing in the cleaner units. If

the most inefficient unit that clears the market is setting the price

at which other people may take, then you are going to drive everyone’s efficiency, and the secret is this. As they enter the bid stack,

no one knows which units are going to be called and which is going

to be the last unit, so there is no way to predict or manipulate

which is the most inefficient unit and which one is going to be

called last.

There would be some people who would suggest, well, it is going

to keep the dirty units on for the long term. Well, that is not true,

because if they are what is clearing the market and if their costs

or their market inputs is what is setting that price, then their profit is much lower than anyone who has got a 7,500 heat rate system

as opposed to a 40,000 heat rate system. So what they are trying

to do is, hopefully, we will retire these dirty systems. They will go

away. We will bring in the newer 7,500, and even under compressed situations, 4,500, heat rate systems. They will be much

more efficient and they will clean the air.

Now, that is better for consumers in two aspects and it meets the

balance of bringing prices to a reasonable level while at the same

time attracting investment and providing for clean air.

Chairman LIEBERMAN. Let me ask you and any other commissioners who want to respond, why is that better than having gone

to a more traditional cost-plus-reasonable-profit system, such as

has existed traditionally at the State level?

Mr. HE ́ BERT. I will give you the brief answer and I would like

to give each of my colleagues an opportunity to answer it. One, we

have come up with a plan that I think we are going to be able to

move forward with as we move towards cost-based. We have seen

the litigious nature of that, the appellate review of it, the indecision that ever comes from it. We need something. California and

the West needed immediate results. They needed a problem solved

today. Cost-based does not do that.

And the other thing that cost-based does is it does exactly the opposite. It would guarantee a profit at maybe 10, 12, or 13 percent

return on these inefficient units and you would keep them around

a very long time and we need those units off.

141

Chairman LIEBERMAN. Do any of the other commissioners wish

to respond? Yes, Commissioner Breathitt?

Ms. BREATHITT. Mr. Chairman, I would like to make a point, that

this plan is only covering 20 percent of the electricity sales occurring in California. The number that we have gotten from State officials in California is that they have been able to secure 80 percent

of their sales in fixed price contracts. So we are only talking about

this plan mitigating prices for 20 percent of the energy purchases,

and I think that is an important factor. It is not 100 percent.

The plan also is a market-oriented plan that has incentives as

we believe that will incent new investment, but at the same time,

you can call them price caps, you can call them price controls, you

can call them a price mitigation, it does put in price controls that

have proven to be effective from our March 29 order, and if this

continues to hold forth, it is going to be effective all hours, all the

time.

Chairman LIEBERMAN. I do want to note for the record that two

of you have used the term ‘‘price control.’’ I was expecting

Groucho’s duck to come down from the ceiling. [Laughter.]

Ms. BREATHITT. I will say price cap.

Chairman LIEBERMAN. You are truly bold.

Chairman THOMPSON. I wish the governor had stayed around to

listen to this. He ought to be here.

Chairman LIEBERMAN. Commissioner Brownell, do you want to

add anything?

Ms. BROWNELL. I will try and dodge the issue of calling it anything as long as it works, frankly.

Chairman LIEBERMAN. Yes.

Ms. BROWNELL. I would add simply that I think it is pretty clear

from other markets that you do not get innovation when you have

monopolies and cost-based kinds of pricing, that the kinds of opportunities that capital flows to are created by markets where people

can make economic choices and to make choices based on other

kinds of preferences. We saw almost 20 percent of the market in

Pennsylvania choose green power. For the first time, we actually

had investment in a number of green plants, many examples of economics that work, but an example, I think, that will prove true

over time.

I also think that the commentary by the investment community

yesterday and this morning would indicate that it also satisfies

some of their concerns, so you will have stability both for the incumbents to the extent that they deal with their other issues and

the market players. I think that is important, as well.

Mr. MASSEY. Mr. Chairman, my preference was to return temporarily to a system based upon the cost of each individual generator

in the market. I think that would have been a more effective time

out and I would have exempted any new generation from that. I

hope my colleagues are right that a cost-based system tied to the

least-efficient generator will actually encourage the retirement of

those generators. A lot of economists believe that it will. Others believe that it may provide an incentive to keep some of those old

dogs around so that the market clearing price can be pegged rather

high.

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So I don’t have 100 percent confidence that this is the right approach, but it seemed to me that it was a dramatic step forward.

Chairman LIEBERMAN. Commissioner Wood, I thought I heard

you say in your opening statement that you have left the door open

to situations where the Commission might want to temporarily

order a cost-of-service-plus rating system.

Mr. WOOD. I think that is always an option, Senator. Some perspective on this. The State in 1996 put forward a plan that FERC

approved that said they wanted to move away from it as part of

their restructuring plan. The Commission, wanting to work with

the States, in fact, approved that. That moved the procurement of

almost all the power by the major investor-owned utilities to the

spot market mechanism where you take the last unit’s price.

Back in that day of surplus and prior to the drought, that incremental unit was cheaper than the average unit, and I think had

that world continued for forever, people would have continued to be

better off under the deregulated plan than the regulated plan. But

the drought, which hydroelectricity is a big part of the energy picture in California and in the Northwest, the drought and the lack

of investment in anything new caught up with the State and with

that region last summer, and in the fall, the Commission moved in

its December order to really preempt the State plan and say, this

will not work anymore. We have got to get you guys out of the spot

market and move you to a contract-based market. So that is when,

as Commissioner Breathitt pointed out, we are now down from 100

percent to 20 percent of the power plants playing in this hourly

marketplace, and so that has meant quite a bit of difference.

As I mentioned yesterday, and I am sorry I do not have my crude

drawing skills as at the Energy Committee, but in response to Senator Feinstein’s proposed legislation with Senator Smith, what we

have found is that the units that are playing in this spot market

pool are largely the older gas-fired plants, we call them the old

dogs, and they are largely about the same heat rate. They are

about the same level of inefficiency.

So because of that unique situation, it seems to me that cost-ofservice ratemaking in that spot market might actually cost the customers of California more than what the Commission adopted.

Now, that may not always be the case, and it is a tool, as your

question asked, Senator, that is a tool in the regulatory toolshed,

that if a cost-of-service rate is the best way to get to a just and reasonable rate, it certainly is in the statute and it is certainly something the Commission can do. I do think for the reasons stated that

it may be advisable to move toward ones that are more incentivizing than we have had in the past.

Chairman LIEBERMAN. Thanks. My time is more than up. I appreciate your answers. I think I understand better why you made

the decision you did on Monday.

I must say that I am left with a question about whether the system you have chosen will ultimately fulfill the statutory responsibility to maintain just and reasonable rates, but I think the answer

to that is that we are not going to know until we see for a while

how this system you have chosen works. So we will all, hopefully,

be following it with open minds and learn from the experience.

Senator Thompson.

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Chairman THOMPSON. Thank you, Mr. Chairman.

I appreciate the Commission being here and the work that they

are doing. I imagine you feel somewhat like a center on a football

team. Nobody notices much what you do until something goes

wrong. But I think people are beginning to realize more and more

the work that you have been doing, the 50 to 60 orders that you

have put out, the addressing of this issue. Just because you do not

do what people want you to do, one side or the other or both, does

not mean that you are not addressing the issue. I think, if nothing

else, you have disabused the two extremes, and these are the people who say that FERC has no role in this and the others who say

all you need to do is cap retail prices and wholesale prices and

prices will be low and everybody will be happy.

So, hopefully, we have moved away from both of those. I think

one thing that we have learned is that if we have prices that wind

up driving the demand up and the supply down, you are going to

have problems. And we can’t just look at the problem today and

what we do about it in the short run because we run the risk of

exacerbating an already troublesome situation.

It does seem to me like this is, in many cases, short-term versus

long-term consideration. Something that might be helpful in the

short term and pleasant, or more pleasant, might not be the right

thing to do in the long term, and those are the balances that you

have to make. I think the more we learn about it, the more we see

the complexities of it.

I do not think, for example, you can talk about the March order

and whether it is successful or not. Until we get a way down the

road, you may have gone not far enough, you may have gone too

far. I don’t think anybody knows. I mean, that is the nature of the

situation, and especially the nature of electricity, it seems to me.

If there was an answer—we have brilliant people here now for the

second day on both sides of the issues. If there was an answer, we

probably would have discovered it. So we have to do the best we

can and learn as we go along.

One of the things that puzzles me is what are we going to do,

and I know the tremendous pressure that this Commission has

been under, but the Department of Energy, Senator Murkowski

testified today and he pointed out that the Department of Energy

has pointed out that, as I understand it, that there will be blackouts in California. Now, you know what is going to happen. There

is going to be a hue and cry that the Commission didn’t go far

enough. That will be definite proof that the Commission didn’t go

far enough, and the pressure that you see today will be magnified

many times over.

My question is, what are you going to look at? I know you are

not going to just respond to the public opinion polls. What are the

factors that you will look at when that happens? Are you going to

look at what has happened since this order and conclude that that

can tell you what the sound policy is for the future, or will your

analysis at that point be the same analysis that you have today.

That is, you consider all of the factors that you ought to consider

and you put this down for time enough to see whether it works,

however long that might take.

144

But it seems to me that from a, I do not want to use the word ‘‘political’’ standpoint, but that is something we have to consider if

you do not, but you are buying into a tough hand here because you

are coming up with a policy in your considered judgment—some of

you have some reservations about it, but in your considered judgment is the way to, knowing that if it works as well as it can possibly work, you are going to have blackouts. How are you going to

handle that when the time comes?

Mr. HE ́ BERT. Senator Thompson, I will tell you that you are exactly right as to the politics and the pressure, there has been a lot

of pressure applied by the Senate and the House and State leaders.

The important thing is that this is an independent agency, hopefully not susceptible to pressure. I want to thank my colleagues for

taking a bold move by believing in this and saying we believe this

will work.

We cannot, ‘‘we’’ being FERC, control blackouts. It is outside the

realm of our ability to change. The reason for that is we can’t site

generation. We can’t build generation. We can’t cite intrastate gas

pipelines that supply fuel that, quite frankly, is constrained right

now in California. There are things that are outside the realm of

opportunity for us, and that means we need help and we need California to help.

We will just have to continue to believe in what we need, and

that is to call balls and strikes. Part of the beauty, I think, of this

Commission of five, Commissioner Wood brought it up about two

State Commissioners. Actually, you have four State Commissioners, previous State Commissioners, I think three of which, including myself, that were previous chairmen of State Commissions.

So we are sympathetic to the needs and plight and understand the

political pressures that are on State leaders, as well, in this regulatory environment.

There are mechanisms that we are going to continue to pay attention to. This plan stays in effect through the end of September

2002. There have been lots of questions come up, is that long

enough? How long should you go? Well, the end of September is an

educated guess based on what we are being told is going to be

brought to the marketplace in California and the West as far as

generation.

Now, there was a release in April of this year by the State of

California, perhaps it may have been the governor’s office, I can’t

recall, that there was going to be around 5,000 megawatts brought

on-line by the end of this summer, which is very important to this

Commission and certainly important to the people of Commission.

Chairman THOMPSON. By July.

Mr. HE ́ BERT. Right. The newest numbers that are out are suggesting to us that 2,309 megawatts are going to actually be what

is going to be what is on-line. That is less than half of what we

are told. If those megawatts are not brought on-line, the blackouts

will continue and they will be harsher because demand is increasing. We have no control over droughts. We have no control over

outages, although we are trying to inject ourselves there to make

sure we understand the schedules.

The short answer is, I don’t have an answer for you, Senator

Thompson. I wish I could tell you that politics are not going to play

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1The chart entitled ‘‘Average Monthly Bill By Sector,’’ appears in the Appendix on page 744.

a role in this and I wish I could tell you that I know and I am willing to bet my life on this plan. This is an evolution that we are

going through. We are learning this process. I think right now it

is the right move and I believe it will bring down prices and at the

same time bring in new supply. But I remember when I got this

job on January 22, the California crisis was right in the middle of

our face and I was asked about it by some reporter, ‘‘What are you

going to do about it?’’ and I said, ‘‘Well, we are going to work hard

and we are going to be committed. I did not start this fight, but

I am going to try to finish it.’’ And that is what we are doing.

Chairman THOMPSON. Does anyone else have a different observation or additional—Mr. Massey?

Mr. MASSEY. Senator, my view is that this order does about all

that we can do at the Federal level, this order and previous orders,

to prevent blackouts this summer. The ISO is skillful and has adequate tools to keep the system in balance if there is enough supply.

There is a ‘‘must offer’’ provision that requires all generation in the

Western interconnection that is not committed to native load or

wholesale contracts to be offered in every hour of every day. The

ISO in California will supervise maintenance schedules and outages within the State to ensure that the maximum supply is available.

We have, by imposing these price controls, I think, eliminated

any incentive to withhold generation to drive up price. That strategy is simply not available anymore because it won’t work. So that

is about all we can do.

There will still be blackouts this summer in California because

there is just not going to be enough supply in some hours, and I

am not sure what this agency can do about that at this point.

Chairman THOMPSON. Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thank you, Senator Thompson. Senator

Collins.

Senator COLLINS. Thank you, Mr. Chairman. Mr. Chairman, before I question our witnesses this afternoon, for the honor of my

State, I have to correct a wrong statement that was made this

morning by Senator Torricelli after I had left. It is my understanding that the Senator from New Jersey made comparisons

about Maine’s per capita energy use versus California and implied

that Maine was much higher. That is incorrect, which does not surprise me. And I would also note, though I am sorry he is not here

to hear this, that the residents of New Jersey use 35 percent more

electricity per household than do the residents of conservationminded Maine.

I thought it was very important for the record that I set that

straight, and I would ask unanimous consent that a table doing a

State-by-State comparison of average monthly bills be included in

the record.1

Chairman LIEBERMAN. Without objection.

Chairman THOMPSON. How does Connecticut fare? [Laughter.]

Chairman LIEBERMAN. Actually, I think we do pretty well, don’t

we? You don’t have to give me the answer now.

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Senator COLLINS. I am sure that you would be interested in

that——

Chairman LIEBERMAN. The thrifty New England Spirit.

Senator COLLINS. That is right.

Mr. Chairman, I very much appreciate the opportunity to discuss

with our FERC Commissioners this afternoon some issues that are

of great concern to the people of Maine, and since I have been in

touch with many of them on the issue I am about to raise, I am

sure it will not be a surprise to them.

I first want to congratulate the two new members, Commissioners Brownell and Wood, on their recent appointment and tell

you that I checked you out with the members of the Maine Public

Utilities Commission, on which a former counsel to me serves.

They speak very highly of you and I am confident that coming directly from State regulatory commissions that you will be especially

sensitive to how your decisions affect consumers, particularly those

who have little or no control over what they pay for electricity.

I would like to pose some questions about the charges for installed capacity, the so-called ICAP fee, which has been a very controversial issue in my State. I realize there may be some limits on

your ability to respond, and I will respect those limits.

To provide some background to my colleagues, Maine leads the

Nation in the percentage of its electric load served by competitive

providers with numbers that recently passed those for Pennsylvania and that continue to grow. Unfortunately, what appears to

be good news on the surface is the result of a less-happy development, mainly that our consumers pay very high prices for standard

offer or default service. This is because of the interest in promoting

competition. We have done more than any other State to expose

our consumers, especially our business consumers, to current market prices for power. That obviously contrasts dramatically with

the approach taken in California.

And it is a tribute to the people of Maine that they have largely

accepted these price increases with stoicism, if not silence. But it

would be unfair and unwise to abuse their patience with additional

government-imposed costs that cannot be absolutely justified. The

market is already making them pay dearly for energy, and in my

judgment, the Federal Government should not be adding to this

burden through high capacity charges.

I appreciate the importance of providing incentives for new generation, but unlike California, it is difficult to see that New England has any kind of problem on that front. More significant, we

should be very careful that in our eagerness to create incentives for

new generation, we do not want to create incentives for voters to

pull the plug on electric competition.

Against that backdrop, I have two questions. First, to what extent has FERC considered the appropriateness of using a deficiency

charge for capacity that was developed during a time of fully regulated, vertically integrated utilities in a time when power is sold

in a competitive market? To be more specific, in the prior world,

utilities sold each other energy based on their actual costs. Most

owned substantial generation, and government could ensure that

the proceeds of any capacity charges were used for new construction or otherwise benefitted consumers.

147

Now in States like Maine, energy prices are based on what the

market will allow. Companies that sell power to consumers often

have to buy all of their capacity in the market and capacity charges

are simply another cost imposed on consumers with no guarantee

that they will be used to improve reliability.

Should these dramatic changes in the nature of the industry

alter how FERC sets deficiency charges for capacity and how the

proceeds are allocated, and if so, how? Mr. He ́bert.

Mr. HE ́ BERT. You are well-educated on an issue that you should

not be required to be educated on.

Senator COLLINS. I agree with that. [Laughter.]

Mr. HE ́ BERT. I want to remind my colleagues that this is a pending matter. This is a remand back to us from the First Circuit, so,

therefore, we have jurisdiction of it at this point. I would ask the

Senator’s permission to very carefully draft you an answer in writing as opposed to giving you anything orally that may cause me to

recuse myself. That is a pending matter. Mr. Welch and I are

friends, as well, and I hear you, heard him, and we will be acting.

Ms. BREATHITT. Senator, I think that is why you saw us all sort

of shifting back and forth and talking among ourselves. We have

had this before us for a while. It went to the court. The court remanded it back and I hope we will be acting soon.

Ms. BROWNELL. Senator, I would just like to add that you asked

the right questions. The questions are not only being asked in New

England, but in PJM and throughout the country, both by the market participants and the ISOs. So it is an issue that we will be

dealing with and I think we are cognizant that a transforming

market requires new looks at everything.

I would also like to suggest it would be a great thing if you could

lead a conservation competition among all the States. It would be

the fastest way to get demand-side management to the market that

I could think of.

Mr. MASSEY. Senator, I have no idea whether we got that $8.75

charge right or not. I think our decision was reasonably well motivated. We want load-serving entities to come to the market meeting their requirements plus some measure of reserve, and if they

fail to meet that reserve capacity requirement, the question is, how

do you create incentives for them to meet that capacity reserve requirement and should they be penalized if they fail to meet that

requirement? That is really what this is all about. And if they

should be penalized, what should the level of penalty be? That is

what is before us.

The Court of Appeals said to us, you can retain the $8.75 per kilowatt month penalty if you choose to, but if you choose to, you have

to provide a much better explanation of why you made that choice,

or you can move off of that choice. We now have before us a new

proposal from New England about how to calculate that fee, and

I won’t comment on the wisdom of it because I haven’t reviewed

it, but I know it is before us.

But I do think one of the issues this Commission is struggling

with generically, and frankly, it rose out of the California debate,

there was no capacity market in California and no reserve requirement and not enough generation being built and——

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Senator COLLINS. But New England is not California, and that

is part of our—— Mr. MASSEY. That is true, but one of the reasons New England

is not California is there is this capacity requirement, and the

question is, if the load-serving entities don’t meet it, to what extent

should they be penalized? That is really the issue before us. I am

sensitive to your concerns. I am glad you raised it and we will try

to do the right thing on rehearing.

Senator COLLINS. Mr. Wood, did you want to add anything?

Mr. WOOD. I think, as kind of a general matter, because this was

really the last piece of unfinished business on the agenda when I

left the Public Utility Commission of Texas, which like New England and unlike any other place in the country both have in excess

of 20 percent excess capacity looking at this summer and next, one

would think in a market-based scenario, in a market that is slightly overbuilt, that the costs of buying social insurance for excess capacity would be relatively low, if not zero. In a market that is really tight, if you were buying social insurance for capacity, like in

California, maybe that would be a relatively expensive purchase.

So philosophically, the answer to your question is that a market

would price things different than a regulated area. How it does so

is going to be, again, subject to this proceeding that is coming up.

But I think it is a critical question to get right, because as I mentioned before, relying on external sources to make sure we have

enough capacity in future years is something that the Commission

can no longer do. We have to ensure that mechanism is something

that is ordered by this Commission, if it doesn’t already exist.

Senator COLLINS. Mr. Chairman, I am wondering if you would

indulge me with one more question—— Chairman LIEBERMAN. Go right ahead.

Senator COLLINS [continuing]. Since it involves New England.

Chairman LIEBERMAN. That was a very craven appeal to my partisan, or my regional, parochial, regional interests. There are only

three of us, so you should see the red more as a cautionary yellow

light.

Senator COLLINS. Thank you. [Laughter.]

My second question is this. The independent system operator of

New England recently submitted a proposal to FERC which provides that sellers of capacity must agree to bid their energy into

the market at a price that is capped at $1,000 a megawatt hour.

I earlier talked about a situation we had in New England last May

when there was a price spike that went to $6,000 per kilowatt

hour, more than 100 times the usual rate.

I won’t ask you to comment on the specific proposal, because I

understand the constraints you are under. But in general, should

a generator who receives capacity payments have any limits on the

prices that it charges for energy? Mr. He ́bert.

Mr. HE ́ BERT. As you know, we do have a matter pending before

us and, therefore, I am going to be precluded from answering that.

I will tell you that this Commission, I think, has been very clear

that we are conscious of rising prices, we are conscious of problems

that markets that are not fully designed and fully functioning create, and that we are willing to do what is necessary to make certain that those markets are working and on their feet.

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Senator COLLINS. Let me ask just one final question that is not

related to a matter that is pending before you. But I have to tell

you that those matters that are pending before you are of extraordinary importance to my State and have caused a great deal of consternation, and whenever I go to a manufacturing plant, it is the

first issue that comes up. In fact, you would not believe the number

of people in Maine who know what ICAP means. That is really

frightening.

Let me switch gears for a moment. It seems clear to me that

given the short-term inelasticity of electricity markets, that there

are periods when at least some sellers can know with certainty

that their output will be purchased no matter what the price. Now,

during these periods, what steps do you think we can take to constrain prices—I know the $1,000 cap has been one approach—that

will preserve public confidence and still provide sufficient incentive

for capital investment in generation?

And one particular matter I would like you to comment on, in addition to price mitigation or price caps that could be imposed, is

whether or not we should be looking to develop a real-time demand

response, and whether you have any thoughts on how such a response could be incorporated into the market structure. When we

had that $6,000 spike, consumers didn’t know that at that time

they should turn off their air conditioners or delay doing laundry

or curtail their use of electricity. They don’t have any way of knowing when we have hourly electricity markets what the prices are

for that particular time. Mr. He ́bert.

Mr. HE ́ BERT. Actually, what the Commission has done is we certainly, I believe, have a full understanding that we have to be committed to a wholesale marketplace that works. What you are talking about is fluctuations in a marketplace from time to time that

get price spikes.

I will tell you, individually myself, not speaking for the entire

Commission, I understand price spikes, but what consumers truly

feel are average prices. A price spike every now and then may give

some certainty to the investment community as to where they need

to send their dollars to invest, to build new generation, perhaps to

deal with congestion or bottlenecks.

Through our Order 2000, this Commission believes that if we set

up regional transmission organizations, which we are in the middle

of right now, we can somehow get the free flow of electrons. The

end state hopefully will be flow-based rates that will give us some

opportunity to make certain that all consumers get the benefits of

a market that works. We are not there yet. We are in the middle

of that process. It is a part of the evolution, but we are continuing

to go down that road.

We are working with State regulators. I mentioned to you Mr.

Welch. We are trying to make sure that all State regulators understand the need in us working together with the regional transmission organizations to get these grids to work. Ideally, we would

love to have one North American grid. That is not going to happen.

We have got the interconnection difficulties, but we are trying to

get it down to a lower level than we have currently got. We need

investment in infrastructure. We need investment in supply. And

the Order 2000 will bring about that, I believe.

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Senator COLLINS. Commissioner Breathitt.

Ms. BREATHITT. Senator, I would like to add that if there is sufficient supply in your area, in your State, that that expensive bid for

power may not ever be needed to be called upon by your grid operator. So one thing that can be focused on in your area is if there

is the right planning process to site new needed generation, and because of the installed capacity program in your area, there should

be the incentive in place to ensure that there always is a reserve

margin.

The other thing that is in place in the area that Commissioner

Brownell comes from, and we have seen it in ISOs to the north,

Pennsylvania, New Jersey, Maryland, is the circuit breaker concept

that you mentioned of $1,000. The few times it has been used in

the PJM control area, I think we asked recently and they have only

gotten up to $1,000 under six times. So it is rare that it gets up

there, but it is a circuit breaker if sales do reach it. So adequate

infrastructure, climates that allow for that, and a circuit breaker

approach works.

Ms. BROWNELL. Senator, I would simply add that another issue

is you have to have the rules in place that make sure you know

what is going on in that market and why that spike took place, and

you have to have appropriate things like congestion pricing that is

responsive to the market. So I think those are things that we are

working on and they are important. We do have a $1,000 cap in

PJM and I think it just sends a signal. But critically, you have to

know why that spike was there.

On demand side management, in our order on Monday, we called

for a technical conference in two phases. The first phase will actually bring in technology providers—it is really extraordinary what

is out there—and learn what is available, and then in the afternoon probably talk about implementation issues.

The reality is, I think customers are a whole lot smarter than we

think they are and I think if we can encourage the development of

technology, we can bring down costs and let everyone from large

business to small business to homeowner begin to use the tools

that are available. So we are committed to doing that and we do

understand that is a reality, an important reality, in any market.

Mr. MASSEY. Senator, I think it is a wonderful question. You

have really put your finger on an issue that I think we have grown

to believe is extraordinarily important in any electricity market.

Electricity markets aren’t like other markets where a purchaser

simply decides not to purchase if the price gets too high. In other

markets, that has a substantial price dampening effect, as you

point out. But in electricity markets, we simply don’t have that yet,

but we are working on it. It requires, I think, a strong Federal role

and an even stronger State role to make that happen. But because

of the nature of electricity, I think it is important that price volatility be minimized to the extent possible. It is simply not acceptable in electricity markets.

We need to implement demand response programs, working with

State Commissions. It will require a substantial portion of the load

actually seeing a price signal in real time, I think, having the tools

to respond to that price signal to cut back on usage. I think the

technology is available to do that. This conference that CommisVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00158 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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sioner Brownell played a leadership role in establishing, I think

could be a watershed event in this Commission moving forward to

understand the relationship between the wholesale markets and

the retail markets, particularly as they relate to the demand side,

so I very much appreciate your question.

Mr. WOOD. I guess the only thing I would add, Senator Collins,

is that unlike buying gasoline or milk or a new car, you get a bill

30 days later and it is a little hard to change your behavior because it has already happened. The big customers tend to have

real-time meters on their premises, and when, as we move to hourly markets, as you all have in the Northeast, hourly prices are then

corraborated with the usage of the plant, the manufacturing plant

that you mentioned in your question, that those folks are pretty

cognizant of what the prices are, as you know, and have the ability

to respond to them.

Actually, 30 percent of the market, which would be the commercial and industrial, the large guys, if those people have the ability

to react in real time by cutting off their power usage in whole or

in part and getting paid for it, which is what the demand side

mechanism that Nora and Bill just talked about are all about, i.e.,

if you are going to pay $6,000, I will take $3,000 to shut off. This

guy will take $2,000. This guy will take $1,000. We will get down

below that $1,000 cap pretty quick. These people will take some

money to get shut off. Interruptibility has a price. Then that really

becomes another player in the market, just as good as building a

new power plant.

So it is a critical silver bullet to solving this market-based transition that we are in and I am glad to hear you are interested in it,

too.

Senator COLLINS. Thank you. Thank you, Mr. Chairman.

Mr. HE ́ BERT. If I might add one thing on the demand side, Mr.

Chairman—— Chairman LIEBERMAN. Sure.

Mr. HE ́ BERT. Senator Collins, a couple of things. The demand

side issue is something that has certainly been in front of FERC,

that we have been engaged in. Actually, the first time I think we

supported it together was March 15. We had it in our March 15

order. We had it in our April 26 order. And now, the 5–0 vote of

the Commission the first time we have been able to get together

on it.

But I will tell you, understanding, and this is, again, where I

think it is important to have four former State Commissioners engaged in this, the demand issues are State issues and they extend

beyond our jurisdiction here at the FERC. But what this Commission, through removing obstacles and impediments, is willing to do

is complement the services of States that are willing to get into demand issues. We are willing to help them when and where possible

in looking for ideas and answers. Thank you.

Senator COLLINS. Thank you very much. Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thanks, Senator Collins.

I have a series of questions about the order on Monday, just to

clarify on some questions that have come up. The first is on the

question of refunds, which there was a lot of concern about this

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morning. I think I understand, Mr. He ́bert, what you established

and what your understanding is regarding the California—the 15

days before the administrative judge—parties will discuss the settlement, the judge has 5 days or 7 days thereafter then to recommend to the Commission, and there is some latitude there to

begin a process.

You also indicated, I was pleased, that there is some way in

which Oregon and Washington can become parties to that process.

Additionally, those two States expressed a concern, and the letter

that I mentioned before is from the four Senators from the States,

Senators Wyden, Smith, Murray, and Cantwell, to the Commission,

which undoubtedly will be waiting for you when you return.

The question is the law and the fact that they need to wait 60

days after the investigation is opened to enjoy any benefits of refund, which would not in this case, in their case, occur until early

in July of this year, and that is the law. Because that seems like

an inequitable situation to me, and my question is, is there any

way to work around that within the law?

Mr. HE ́ BERT. I like that question.

Chairman LIEBERMAN. The reason I ask that is——

Mr. HE ́ BERT. As a lawyer, I love it, but—— Chairman LIEBERMAN. The Attorney General of Washington suggested that if there is not, one of the things the Committee ought

to do, working with the Commission, is to see if we cannot find a

way to change the law, and I do not mean with regard to these

cases, but in the future.

Mr. HE ́ BERT. Well, obviously, the Federal Power Act is the law

that we go by in regard to this, and certainly Congress can amend

and change and whatever law is passed down to us, we will follow.

We have to follow the law and that is what we are doing.

Sixty days after the notice is exactly right. That is why it is July

2, and I think that is the case you are talking about. As I told you,

there is a pending matter before us in dealing with Puget Sound

and we will have to be very careful in any comments we make due

to that, because I nor anyone else wants to be recused. We all want

to sit on that case.

But I will tell you at the same time, as I shared with you a little

bit before, I think that is the beauty of the settlement process that

we set up through this order that we issued on Monday, and that

is that there are entities from the Northwest, the Pacific Northwest, that are parties to this California settlement.

Chairman LIEBERMAN. Because they are suppliers into California.

Mr. HE ́ BERT. And I will tell you that we have, I believe, one of

the best settlement judges around, our chief judge that is going to

handle this matter. Now, this Commission felt it was important to

leave the uncertainty there. What this judge ends up doing within

the confines of that hearing room, I don’t know nor can I give direction to, legally or ethically. But I will tell you, I believe that is the

beauty of the settlement process.

My guess is that through this settlement process, there are many

issues within our jurisdictional grasp—‘‘we’’ being FERC—that will

be settled. As with most settlements that I have ever seen or been

a part of, my guess is there are some issues that are outside of our

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jurisdictional grasp that will be settled, as well. What are those?

I have no idea.

Chairman LIEBERMAN. I appreciate your answer. It was artfully

done.

Mr. HE ́ BERT. Thank you.

Chairman LIEBERMAN. I am not going to push any further. I

think it does leave some hope here for the folks in Oregon and

Washington that there may be some possibility of refunds, but that

is my conclusion, not—— Mr. HE ́ BERT. I am not going to draw any conclusions, but you are

certainly welcome to, sir.

Chairman LIEBERMAN. Thank you. Let me ask this question by

way of exercising our oversight function. For the moment, let us assume that—well, we do not have to assume anything. The fact that

the ability to obtain refunds is contingent on the date on which an

investigation is opened obviously puts a premium in that way and

many other ways on a swift response to complaints.

One of the criticisms of FERC in this matter, and I will ask it

now as a question, the criticism generally is that the Commission

has acted too slowly here. Price increases began in California last

spring or summer. I guess the Commission pretty quickly opened

an investigation in July, but it was not until December that the decision was made that the rates were not just and reasonable. Then,

incidentally, no investigation was opened until the end of April regarding non-California States on the Western grid, particularly in

this case, Oregon and Washington.

So the question is, or the allegation is, that until Monday, in

some sense, until last Monday, that the Commission has been sort

of dragged along more by events and rising anxiety about economic

impacts of prices in California than it has taken control of the

events—until Monday. So I want to pose that question to you, Mr.

He ́bert. How would you respond to it? How would you defend the

Commission’s behavior? And then particularly that question about

Oregon and Washington and why did you wait until late April to

get into that?

Mr. HE ́ BERT. I will defend it by my record, Mr. Chairman. I

would tell you that I think the record of this commission since January 22 has been solid.

Chairman LIEBERMAN. In fairness—excuse me—you did not arrive until January 22.

Mr. HE ́ BERT. I did not become chairman until January 22.

Chairman LIEBERMAN. I am sorry. You didn’t become chairman

until then.

Mr. HE ́ BERT. I was a commissioner, and actually, if you talk

about proceedings and the ability to get proceedings before this

Commission, under the previous chairman, the El Paso case has

been one of the big cases that so many people have talked about

and questioned about why we moved so slowly. I actually issued a

concurrence in the El Paso case under the previous chairman that

we had made enough procedural and discovery calls and it was

time that we made decisions on the substance of the matter with

the El Paso case and moved forward. And one of the first things

we did when I became chairman of this Commission is to move forward with the El Paso case. A lot of people said, why did it take

154

you a year? Well, it was the same question I was asking, and I actually issued in a concurrence prior to being chairman.

We did study not only California and look at and try to make

good balls and strikes calls when it comes to the Northwest, as

well. I think if you look at January 22, getting through that process, getting what we had to be done at the staff level to get adequate information, to call the right balls and the right strikes, I

don’t think April is that bad, actually. I think that is actually pretty good. And if you, and I know you do, know as much about a government as anybody, that is a pretty quick call.

And at the same time, most people do not understand, we were

working with a commission of three that, quite frankly, was left

with a backlog of 2,000 cases. We have reduced that backlog by

about 25 percent now while at the same time dealing with California, issuing refunds that had never been done before.

So I feel very good about our record and I think we are going to

continue to move in a strong, fast, and furious, but reasonable and

legal, manner.

Chairman LIEBERMAN. I want to yield to my colleagues in a moment. I could ask this as a question, but I am just going to make

a statement on it. Just when you mentioned the backlog it came

to mind that under Monday’s order, FERC is taking on some very

significant responsibilities to monitor energy markets in the West

on a 24/7 basis. The question, and it is a larger question for another day, is how are you going to do it as a matter of process and

organization? Do you have the personnel that will enable you to

carry that out?

Mr. HE ́ BERT. I would like to quickly try to answer it, if that is

all right, Mr. Chairman, because I think I do have an answer for

you.

Chairman LIEBERMAN. Yes.

Mr. HE ́ BERT. Several things. One, this Commission saw that

early on, actually through our Order 2000. We believed it was important through the regional transmission organizations to give

them a monitoring role, to try to give them some shared responsibility. So that is a part of Order 2000 and that will help us monitor

those markets.

At the same time, and I don’t want to speak for my colleagues,

I want to give them an opportunity, but if I recall correctly, there

were some organizations, one including one division of FERC that

was put together, that we all disagreed with. When I became

Chairman, I reassessed our resources. I looked at those resources

and I split that division back up, which was the litigation division.

We had around 150 people. We needed at least half of those people,

the technical people, to be involved in monitoring those markets.

So we sent them to the division that properly would handle that

through those markets and we sent the others to OGC to handle

the legal situation at hand.

So I think we have taken our resources. Do we need additional

resources in the future? We will see. Again, we are in an evolution

mode, but I will tell you, we are moving forward with monitoring

efforts. We probably don’t have everything we need at this point.

What will that include in the future, I will be glad to keep you

abreast of.

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Chairman LIEBERMAN. Yes, I would appreciate that, because that

is part of our oversight role, as well.

One last final question, and a quick answer, I hope. We have

talked about the order that you issued on Monday being effective

through September of next year, 2002, which would take us, as a

few of you have said, through the two summers, give time for this

to settle out, and I think that is all good.

There is another perspective on it, not negative to what I have

just said, which is that the folks in California have projected that

supply will not be in any equilibrium with demand until about a

year later. I will ask if any of you want to comment on it, but real

quickly if you would, in deference to my colleagues, will you be

open to extending the order beyond September of 2002 if that

seems appropriate?

Mr. HE ́ BERT. I think it is important that we set a deadline, and

as I said earlier, there are things out of our control—the siting of

generation, making certain that generation comes on-line, dealing

with Path 15, dealing with the intrastate network on natural gas.

All these things are problems in California. If they get resolved,

and they should be, then yes. If not, perhaps they do not get in 7

percent reserves. Perhaps they stay within 10 or 11 percent. My

suggestion will be that, yes, the plan should change. To what extent, we can’t make that call at this point.

Chairman LIEBERMAN. Does anybody else want to add to that?

Mr. Wood.

Mr. WOOD. I think if the market rules are fixed and the infrastructure sufficient, then competition can work. Deregulation can

follow from competition. And I think it is our job to make sure that

the infrastructure is in place.

Chairman LIEBERMAN. OK. Thank you all.

Senator Carnahan, I think you were here first, if that is OK with

Senator Carper.

Senator CARNAHAN. Yes. Thank you.

I have a question for Commissioner Massey. You said previously

that you do not believe that FERC has met its responsibility to assure just and reasonable prices in the wholesale market. Given the

experience in California, how might FERC reconsider its approach

in the future to better reflect the current realities in the energy

market?

Mr. MASSEY. Senator, I have supported the movement to markets

for electricity with one caveat, and that is it must benefit consumers. And so it seems to me that we have to ensure that the

markets are structured in a way that they produce just and reasonable prices all of the time, and if they don’t, we have to intervene.

There are a number of things that we can do. First of all, we

have granted market-based pricing to over 900 sellers using a

screen that literally everyone passes. A market power screen that

every seller passes is no screen. We may as well just issue a rule

saying everyone passes. So I think we need to come up with a

screen that is sensitive enough to actually measure market power

in the marketplace and deny market-based pricing to those that

have it.

Second, we need to get very serious about market design. We

need to ensure that the rules are in place in the market so that

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the market will produce just and reasonable prices in all hours.

That is a big job in the California market right now. Perhaps the

market should be redesigned to include an installed capacity market, a reserve requirement. We need to move dramatically away

from over-reliance on the spot market. Progress has been made in

that area. We need to do a lot of work to ensure that there is a

robust demand response, in other words, consumers deciding not to

consume electricity when the price gets too high. If we can achieve

that goal, it will have a substantial price mitigating effect.

And the markets need adequate supply. Our experience in California makes me wonder whether we should have markets where

we know that the supply is inadequate. What should we do? What

protections should we build in if we know it is a capacity-short

market and that prices will soar? So those are my thoughts on it.

Senator CARNAHAN. When you think of beefing up FERC’s enforcement, I have heard from many that SEC might be able to

serve as a model. The SEC closely monitors the market and it

proactively investigates anything that seems unusual. Do you think

that is a good idea?

Mr. MASSEY. It is a good idea if Congress is willing to fund it.

It seems to me that to be the tough cop on the beat, I have come

to believe that we need more resources than we have and we probably need more people involved in effective market monitoring. We

need to attract—we have excellent economists and investigators,

but we need to attract more, it seems to me. Perhaps we should

look at the SEC model, but I think the SEC devotes about half of

its staff to investigations. It is a large percentage. I don’t know

what percentage ours is, but it is probably a small percentage of

our staff.

So I think we perhaps will need to retool, because whenever—

despite our best efforts to structure good markets, there may be

problems, there may be market power, there may be abuses, and

we have to be willing to investigate those effectively and step in.

Senator CARNAHAN. Thank you. My next question is for Mr.

He ́bert. In your prepared testimony, you listed numerous actions

taken by FERC over the past several months, and I understand

that you have taken those actions based on your best judgment of

how to help. In your view, have the prices in the wholesale market

in California been just and reasonable?

Mr. HE ́ BERT. I think the mitigation plan that we put into effect

April 26, that actually was effective as of May 29, and I believe the

plan that we put into effect on Monday that will actually take effect tomorrow, is and will bring down prices to more reasonable

levels. This Commission has spoken in its December 15 order to

say, in fact, that we have found and believe rates to be unjust and

unreasonable at certain times under certain conditions.

That was my belief then. That continues to be my belief, and

that is why we have taken the action we have taken, to bring reasonable prices to the consumers of California and the West while

at the same time attracting investment in supply and infrastructure that will continue to bring them better opportunities and,

therefore, lower prices in the future.

Senator CARNAHAN. In the future, how do you feel FERC might

play a more constructive role earlier in the process to better meet

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its statutory obligation to assure just and reasonable prices when

additional States now are undertaking deregulation, such as my

home State of Missouri?

Mr. HE ́ BERT. I have said before, and I will say again, that FERC

probably made a mistake—not probably, FERC did make a mistake

in giving too much deference to the State of California in waiting

too long to intervene and step in. We hate for government to intrude in any time that they don’t need to, but clearly, we had a

dysfunctional market. We needed to step in. We have done so now

and I think the record will speak for itself that we are doing a good

job of that.

So many people want to look in the rear-view mirror and talk

about what happened last year and the year before. I wasn’t the

umpire at that point, so I am not going to go there. But I will tell

you, I believe that we are moving in the right direction. Things are

going to be better.

In saying that, I think it is only fair to say right now, since the

Commission has been trying to move California away from its reliance on the spot market, and we are very proud of where they have

moved. They have got around 20 percent—Commissioner Breathitt

had talked about that—in the spot market at this point. Whereas

we do want to move them away from reliance on that spot market,

when we talk about forward markets and them moving towards the

forward markets, I want to be very clear that there are forward

markets that are reasonable and there are forward markets that,

quite frankly, are very risky.

It is my thought and my belief that once you start getting outside of 5 years, if you get beyond that on signing contracts, I would

tell you that those are very risky contracts, especially given the volatility of energy.

Senator CARNAHAN. Thank you very much.

Mr. HE ́ BERT. Thank you.

Chairman LIEBERMAN. Thanks, Senator Carnahan. Thanks for

your interest in this subject.

Senator Carper.

Senator CARPER. Thanks. I was here earlier today, and I don’t

know if you folks were in the audience then or not, but these hearings are broadcast on C–SPAN. Sometimes they show them at

night and people might be seeing this around the country around

3 o’clock in the morning someplace. They are waking up from a little nap and say, what is this all about, FERC? I just think, a

month or two ago, most people had probably never heard of FERC,

and now you are getting to be a household word, almost like

Lieberman. [Laughter.]

Mr. HE ́ BERT. We preferred, or at least I preferred the secrecy of

FERC.

Senator CARPER. Well, you are a secret no more.

Mr. He ́bert, you were saying that you became the chairman back

in January but you served on FERC prior. How long?

Mr. HE ́ BERT. Since 1997.

Senator CARPER. All right. And Ms. Breathitt, how long have you

been there?

Ms. BREATHITT. I joined the Commission in November 1997.

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Senator CARPER. All right. And Ms. Brownell, you are pretty

new, aren’t you?

Ms. BROWNELL. A week that seems like a thousand years, Senator. [Laughter.]

Senator CARPER. You are a brave soul to take this on.

Mr. Massey, how long have you been on this team?

Mr. MASSEY. Eight years, Senator.

Senator CARPER. Eight years, wow. Mr. Wood.

Mr. WOOD. Two weeks.

Senator CARPER. Two weeks. OK. Let me just ask, for people that

might be watching this around the country and are waking up in

the middle of the night wondering what is this all about, could you

just explain for them and for this late-arriving Member of the Committee—and I am going to ask our newest members to do this—just

explain to folks who might be tuned in, what did you all actually

agree to and announce on Monday of this week?

Mr. WOOD. What we agreed to do, Senator, was to take action,

perhaps a little delayed action, but action nonetheless, to help repair a broken market out West. There is an electricity market that

was deregulated through State initiatives in 1996, or 1995 time

frame.

That worked pretty well at the beginning, but it quit raining and

the State depends for about 30 percent of its power supply on the

hydroelectricity. There was no new investment in new gas-fired

plants or other kind of plants to keep the infrastructure in place.

That confluence of bad weather and lack of investment and a deregulated market meant that prices went up.

The step that the Commission took this week was what it could

do to help mitigate the economic impact of those events, but unfortunately, no step we could have taken or can take will make up for

the fact that there are more megawatts being demanded than will

be available to be used this summer. So we did not promise that

it would be a panacea.

I think, quite frankly, we want to make sure that we mitigate

not only the price, but mitigate the expectations that things are

going to be rosy this summer in the West Coast. They will not.

There will be blackouts. But I think what we wanted to take a step

on was to make sure that those blackouts, the insult of those

wouldn’t be accompanied by the injury of a very high and unjust

bill for the power.

Senator CARPER. Thank you. Ms. Brownell, do you want to add

or take away anything from that?

Ms. BROWNELL. I would never take away from my colleague, only

to add——

Senator CARPER. Unlike us. [Laughter.]

Ms. BROWNELL [continuing]. Just a little bit. And that is, I think

that we laid out a road map. We took a number of steps. We laid

out a road map that will give certainty to consumers, to the State

of California, to the participants in the market there about what

will happen through the next two summers so that we can begin

to deal with the broader issues of a longer-term plan of how to site

more generation, create market rules that actually work, and that

will provide for just and reasonable rates in the long term. We took

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the surprise of the day out of the market so that people now know

what is going to happen.

I think the second thing we did was respond very positively to

the stakeholders from California’s issues and reached out to the

State of California to work with them, because we all have a role

to play and it is critical that we each do our part.

So I think we could give you 25,000 details, but most importantly, we took a lot of steps and we now have a plan, a map, and

some certainty, and that is important.

Senator CARPER. All right. Ms. Breathitt and Mr. Massey, if I

could ask you two the next question, and that is how do you know

if what you have agreed on unanimously to do, how will you know

that it is working or not working?

Ms. BREATHITT. We have a several-week trial of this plan having

worked in what we call emergency conditions, when the grid operator in California says reserves have diminished to 7 percent. Our

plan kicked into effect in late May and we have evidence that that

methodology worked. What we did was extend that methodology to

all hours rather than just triggering when there was an emergency

condition called by the grid operator.

So we have some evidence that it worked the times that we were

in an emergency, and we tweaked it slightly for the 24-hour condition to actually even limit more the market clearing price for the

non-emergency hours. So we think that it will work. We have some

evidence that it is working and what we did was extended the plan

to all hours and we covered the rest of the Western States. So we

now have it in 11 States.

Senator CARPER. Mr. Massey, do you want to answer?

Mr. MASSEY. Senator, I think the answer to your question is we

don’t know for certain whether it will work or not so we have to

pay attention and——

Senator CARPER. What will tell you that it is working or not

working?

Mr. MASSEY. For me, the real question in whether it is going to

provide substantial price relief is tied to the costs of the last generator to be dispatched. It could have been tighter than that, but we

know the price won’t be higher than that in the market.

That last generator to be dispatched will probably be a natural

gas-fired generator most of the time. About 95 percent of the dollars in the formula for determining the market clearing price under

our order will depend upon the price of natural gas. That is it in

a nutshell. If the price of natural gas remains reasonable, this plan

will produce reasonable prices. If the price of natural gas skyrockets in California, the price for electricity will skyrocket. And so

I think we still have a lot of work to do to ensure that prices for

natural gas are just and reasonable, as well.

Senator CARPER. Mr. Chairman, I have one last question I would

like to ask of Mr. He ́bert, if I could do this as a follow-on. You have

explained, and I think very nicely, what you agreed on and you

have given us a pretty good notion of how you will know and

maybe we will know if it is working. Let me just ask, when Governor Davis was here today, he described the unanimous step that

you took, he described it as a step in the right direction.

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Let me just ask, and this I would ask of you, Mr. Chairman, if

the kind of success you are looking for and hoping for doesn’t occur,

what would be an appropriate next step?

Mr. HE ́ BERT. First, let me say that Governor Davis and I agree

on that. It is a step in the right direction. What do we do from

here? I think it depends on what we learn from here. My experience in government and regulation and energy markets, and I have

been involved in legislating and regulating energy since 1988, my

experience is it is important to listen and learn before you lead and

I think that is what this agency has done.

I believe we have done that wisely, responsibly, and in the best

interests of the consumers by looking at not only short-term benefit

of bringing down prices and making them reasonable, but at the

same time focusing on supply and deliverability and making certain that we have got an infrastructure that will work and will, in

the long term, bring better prices and more choices to the people

of California and the West.

What do we do beyond that? Some of it, as I have said, is outside

of our control. We can’t site one generating unit in California. The

leaders in California can, and I believe and I hope that they are

committed to that. We are going to look at this plan again on several opportunities. In the plan, we talk about looking to make certain that the generation that has been discussed and scheduled

does come on-line in California, also that there is less and continued to be less reliance on the spot market.

So we are going to continue to monitor these markets. We are

evolving through that process. We have got additional people working on that right now, as I have said. I have taken the resources

at our agency and moved them around and taken half of those 150

people who were doing nothing but litigating and got them now

monitoring these markets. We are going to have the regional transmission organizations through Order 2000 monitoring markets

along with us. I believe we will be successful. If we have learned

anything in the meantime that says we made a mistake or says

that we need to change something we did, we will, in fact, do that.

Senator CARPER. Good. Mr. Chairman, I wish I could have been

here for the whole hearing. This has been quite a hearing and we

are grateful to each of you for being here today and for your service. You come to your positions, a couple of you, in a very exciting

time, and Mr. Massey, for 8 years. For you, no purgatory, straight

to heaven. [Laughter.]

Chairman LIEBERMAN. That was not a power of the Committee

that Senator Carper was talking about. That is individual authority. [Laughter.]

Thanks, Senator Carper, for coming back, and for your thoughtful questions.

I thank the members of FERC for very good testimony. This has

been a long day, very interesting to me and an important day, and

I think ultimately an encouraging day. I mean, we have a real

problem that occurred in California. There are a lot of reasons for

it. I have the impression that everybody is now trying their best

to make it better, and by your own judgment, last December, the

rates for electricity were and are unjust and unreasonable and it

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required action by yourselves and, of course, other kinds of actions

by the State.

Though occasionally, because these are important matters and

we are all in politics, there gets to be an edge to the back and

forth. These are not ultimately partisan matters. We may have different ideological points of view. We may have different jobs to do.

We may have different authorities. But these are real problems

that cry out for solution and I appreciate the efforts you made.

The Committee is going to remain involved here. We think this

is important. We would like to work with you. As I said, we not

only are going to press you and ask you why you did this or why

you did that, but sometimes we are going to ask you, what do you

need to do th things we are asking you to do? And then, we will

try to become your advocates.

I do think, as Commissioner Wood said earlier, the fact is that

the Commission is at a new chapter in its history. The very fact

that you have two new commissioners and you are now up to full

strength says that. But also, I believe that, and you are more expert at this than I, but from what I know of FERC, that this has

been a—we tend to use the term ‘‘defining moment’’ too much in

our Senatorial lives, but it seems to me this has been one of those

defining moments in the life of this Commission and that what follows will be different. And we need you to be actively involved because of the obvious central effect that energy pricing (that you

have some authority over) has on the lives of individual Americans,

but also on the vitality of our economy.

So I thank you very much for your service, for your patience

today, for your outstanding testimony, and we look forward to seeing you again soon.

The hearing is adjourned.

[Whereupon, at 4:20 p.m., the Committee was adjourned.]

(163)

THE IMPACT OF ELECTRIC INDUSTRY

RESTRUCTURING ON SYSTEM RELIABILITY

THURSDAY, JUNE 28, 2001

U.S. SENATE,

COMMITTEE ON GOVERNMENTAL AFFAIRS,

Washington, DC.

The Committee met, pursuant to notice, in room SD–342, Dirksen Senate Office Building, Hon. Joseph I. Lieberman, Chairman

of the Committee, presiding.

Present: Senators Lieberman and Thompson.

OPENING STATEMENT OF CHAIRMAN LIEBERMAN

Chairman LIEBERMAN. Good morning, and welcome to our witnesses and our guests. We thank all of you for being here.

Two votes are going to occur in the Senate at around 9:50, so we

can probably at least go until about 10 o’clock before we have to

break for a while and then return, for which I apologize.

This morning, I am pleased to continue this Committee’s examination of the Federal Government’s response to the deregulation

of the energy industry. This is the third hearing we have held on

this issue in as many weeks.

In our first two hearings, we focused on the problems of electricity deregulation in California and the West and the need for

more vigorous oversight and intervention by the Federal Energy

Regulatory Commission.

Fortunately, last week, the Commission did step up its role in

addressing the Western power crisis. This Committee will continue

to keep watch on those efforts to determine whether they bring

adequate price relief to besieged energy consumers.

Today we turn to a related concern, and that is the reliability of

the electric grid. The grid is our energy lifeline, a vast network of

transmission lines that carry electricity from a myriad of energy

producers, large and small, to the utilities and ultimately into our

homes and businesses. It is a lifeline that we take for granted

every time we switch on the lights, sit down at a computer or open

the refrigerator.

The national electric grid is vital to our lives and to our livelihoods, and it has been greatly affected by the deregulation of electric utilities. So today, we are going to ask who is operating the

grid, and who is watching what is happening on the grid on behalf

of electricity consumers, and who is it that keeps the lights on—

or, as people in California no doubt have been asking, who is to

blame when the lights go off.

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1 Chart entitled ‘‘Bundled,’’ appears in the Appendix on page 819. 2 Chart entitled ‘‘A Fully Unbundled Electric Industry Model,’’ appears in the Appendix on

page 820.

Not long ago, that was an easy question to answer. Local electric

utilities ran the show top to bottom. They produced the power for

homes and businesses in their service areas, made sure there was

enough of it, and saw to it that the electricity ran in the proper

voltages and frequencies to be transported and used safely. Local

utilities built and ran the transmission lines to get power from

their plants to their customers, and they built interconnecting lines

to neighboring utilities that allowed for modest trading in times of

shortage.

That diagram is roughly meant to show how neat things were before deregulation.1

But the deregulation of electricity markets has scrambled this

picture.2 Utilities no longer make the power they sell to retail consumers. Instead, electricity generators compete on the market to

sell to utilities and sometimes even directly to retail customers.

Nor do local utilities anymore always control the interstate

transmission lines. In several regions of the country, independent

system operators, known as ISOs, act as electricity traffic cops,

routing power from sellers to buyers.

That means that the ISOs are responsible for keeping the system

up and running. So what was once a relatively sleepy, largely local

network has been transformed into a fast-moving and extremely

congested national electricity delivery superhighway.

While deregulation obviously offers potential economic benefits,

the new arrangements it has brought to the national electricity

grid also pose some risks to the reliability of the grid. In fact, a Department of Energy task force concluded in 1998 that the current

configuration, devised in an age of far less usage of the transmission grid and far more regulation of the utility industry, is

clearly ‘‘unsustainable in the newly decentralized and competitive

electricity industry.’’ In fact, problems have already occurred. A November 2000 Staff

Report by FERC describes a disturbing incident in July 1999 when

power was tight and prices were high. As I understand it, engineers monitoring the Midwest electricity grid noticed something

unusual and troubling. Some of the electricity that should have

been in the system just was not there. What happened? According

to a later FERC report, Cinergy, a large Midwestern utility, just

took power off the grid, which apparently it had no right to, in

order to supply its own customers rather than disconnecting them

or buying the extra power it needed, which would have been at significantly higher prices.

Another account of the incident which appeared in the Wall

Street Journal notes that the utility put power back into the system later, but only after demand and prices had dropped. The utility was never punished for this behavior because the system has

historically depended on voluntary industry standards rather than

a regime of Federal regulation and enforcement.

Grid reliability has also been an issue in California, where the

grid is managed not by the local utilities but again, by one of the

new independent system operators.

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To fulfill its responsibility to keep the lights on in the spring of

last year, the California independent system operator contracted to

buy extra power in times of shortage from what is known in the

industry as an RMR, ‘‘reliability must run’’ unit. But as an April

2001 FERC Order describes it, when the California ISO needed the

backup supply last spring, some of these power plants did not cooperate. In other words, the ‘‘reliability must run’’ units were not

reliable and did not run. According to the FERC Order, to keep the

lights on, the ISO was forced to scramble to fill demand on the spot

market, obviously at much higher prices.

FERC subsequently investigated that case and approved a settle- ment, with generators paying for the $8 million difference in price.

Although FERC has jurisdiction over the interstate transmission

system under the Federal Power Act, it has not historically regulated reliability. Instead, FERC has deferred this responsibility to

regional voluntary Electric Reliability Councils, which include all of

the electric systems in the continental United States, Canada, and

part of Mexico. Industry has relied upon the voluntary standards

set by these councils through their governing body, the North

American Electric Reliability Council, or NERC.

With the changing structure of the electric industry, however, we

now need to ask whether the Federal Government should play a

more active role in maintaining and policing the national electricity

grid. Indeed, Congress has actively considered amending the Federal Power Act to require FERC to establish reliability standards

and a system for enforcement, although no such proposal has yet

been enacted.

That is the issue that we are going to explore today. Some of the

questions that I would like to ask include: Does the shift from

heavily-regulated utility systems to deregulated competitive markets threaten reliability of the grid? If so, does FERC have adequate statutory and regulatory authority to protect the public interest in a reliable electricity transmission grid? And what is the

proper division of responsibility between Federal and State regulators concerning electricity reliability overall?

I look forward to hearing our witnesses answer these and other

questions, and I thank them very much for joining us this morning.

Senator Thompson.

OPENING STATEMENT OF SENATOR THOMPSON

Senator THOMPSON. Thank you very much, Mr. Chairman.

Our topic today is less controversial than the two energy hearings that we held previously, but this one is important. We have

seen demand for electricity grow across the country, and we are

watching as new generation is being built to try to keep pace.

What may be lagging behind, however, as you point out, is the

new transmission and proper enforcement of standards to maintain

the reliability of our grids. Prior to restructuring, integrated utilities were responsible for generating, transmitting, and delivering

electricity from the power plant to the consumer. The reliability

standards in place have been voluntary, established by the North

American Electric Reliability Council, and when there is a violation, there is no penalty, even if the violation threatens the integrity of the grid, possibly resulting in blackouts.

166

In recent years, we have seen dramatic change take place. The

electric power industry is dividing itself into different components.

As a result, there is no single entity that is responsible for overall

reliability. We have seen over the years instances, some of them serious, of individual actions that have adversely affected reliability.

So, as the electric power industry restructures, we need someone

made responsible for ensuring reliability and someone who has enforcement authority.

We should note that the problem is not simply one of enforcement but also of investment. A greater demand on long-distance

sales will require more transmission. I am pleased that the President recognizes this fact and included in his National Energy Policy Report the need to streamline the siting process to allow for

construction of more lines. While the country moves down the road

toward restructuring and competition, it is important not to leave

any key component of our electricity system behind.

The good news is that we as a Senate have addressed this issue.

The Energy Committee has held hearings on this topic, including

one last month; I believe Mr. Cook testified at that hearing. In addition, in the last Congress, the Senate passed by unanimous consent a bill to establish an organization to set reliability standards

and to take disciplinary actions when those standards are violated.

That legislation did not pass the House, but it has been reintroduced this year.

Earlier this year, Senator Lott had planned to have an energy

bill ready for the President’s signature by July 4. Unfortunately,

despite the urgency and need we have seen for some action, it does

not appear that there will be discussions about the timing of such

a bill until after the July 4th recess. Perhaps at that point we will

address the energy issues which are becoming more and more critical every day and which are the focus of your well-timed hearings,

Mr. Chairman. They of course will include the issue of the reliability of our system.

Mr. Chairman, I want to apologize in advance. As you know, we

have the patient bill of rights on the floor, and my amendment is

up as we speak, so I am going to have to break away. It has to

do with exhaustion of administrative remedies; it is very exciting,

and I am sure that you will want to be a part of that as soon as

the hearing is concluded.

Chairman LIEBERMAN. And I am going to try not to be exhausted

by it.

Thanks, Senator Thompson, for coming by. I appreciate it very

much.

Let us begin with David Cook, who is General Counsel of the

North American Electric Reliability Council, to which Senator

Thompson and I both referred.

This is one of those hearings for which preparation educated me

greatly, and I think the hearing will continue that process.

Mr. Cook, please.

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1The prepared statement of Mr. Cook with attachments appears in the Appendix on page 509.

TESTIMONY OF DAVID N. COOK,1 GENERAL COUNSEL, NORTH

AMERICAN ELECTRIC RELIABILITY COUNCIL

Mr. COOK. Thank you, Mr. Chairman and Senator Thompson.

NERC welcomes the Committee’s attention to the critically important issue of the reliability of the bulk electric system.

As you indicated, NERC is a not-for-profit organization formed

after the Northeast blackout in 1965 to promote the reliability of

the interconnected bulk electric systems. NERC comprises of 10 Regional Reliability Councils that account for virtually all of the electricity that is supplied in the United States, Canada, and a portion

of Baja California Norte, Mexico.

For more than 30 years the industry has followed a system of

voluntary reliability standards. Those standards have worked very

well, and we have had an extremely reliable electric system. As you

indicated, the reliability standards have no enforcement mechanism. Peer pressure has been the only means available for achieving that compliance.

As good as that system has been, the voluntary system will not

serve us well for the future as the electric industry restructures.

Here is why. The grid is now being used in ways for which it was

not designed. There has been a quantum leap in the number of

hourly transactions and in the complexity of those transactions on

the grid.

Transmission providers and other industry participants who formerly cooperated willingly are now competitors.

Rate mechanisms which in the past permitted utilities to recover

the costs of operating systems reliably are no longer in place or are

inadequate given the increased risks and uncertainties they face.

The single, vertically-integrated utility that formerly performed

all reliability functions for an area is being disaggregated, meaning

that reliability responsibilities are being divided among many participants. Some entities appear to be deriving economic benefit

from bending or violating the reliability rules.

Construction of additional transmission capacity has not kept

pace with either the growth in demand or the construction of new

generating capacity, meaning that the existing grid is being used

much more aggressively.

The result of all this is that the transmission grid is being increasingly stressed, and that stress shows up in two ways. NERC

is seeing more congestion on the grid for more hours of the day,

and NERC is seeing increased violations of its reliability rules.

Not changing the way we deal with the reliability side of the

business as the electric industry restructures would be like an airline switching to jet airplanes without increasing the length of the

runways. Not having everyone follow a common set of rules for how

the interconnected international system is operated would be like

allowing individual airlines to choose their own routes and altitudes at which they fly.

NERC and a broad coalition of State, consumer and industry representatives have developed and are actively pursuing consensus

legislation to convert the voluntary reliability guidelines into mandatory and enforceable rules.

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The goal of that legislation is to set mandatory and enforceable

rules for all operators and users of the international interconnected

bulk power system in North America. It would be fairly developed

and fairly applied by an independent industry self-regulatory organization with oversight in the United States by FERC and similar

oversight by governmental authorities in Canada.

It would have respect for the international character of the interconnected transmission system, and regional entities would have a

significant role in implementing and enforcing compliance with

those common reliability standards.

Because of FERC’s limited jurisdiction and authority, because of

the international character of the North American grid, and because of the technical expertise required to develop and oversee

compliance with bulk power system reliability standards, this is

not a job that can simply be given to FERC.

Nor can we simply have regional organizations set and enforce

their own rules in their own way. Having an independent international industry self-regulatory organization develop and enforce

reliability rules under government oversight recognizes the interconnected and international nature of the bulk electric systems,

takes advantage of the huge pool of technical expertise that the industry currently brings to bear on the subject.

That combination of industry technical expertise to work on the

substantive reliability rules and government oversight, FERC and

the United States, provincial regulators in Canada, to assure fairness in due process, is an effective and efficient way to address

these issues.

As you indicated, the Senate passed a version of the NERC-supported reliability legislation last year. The bill died in the House.

That legislation is before the Senate again this year, both in Senator Bingaman’s bill, S. 597, and Senator Murkowski’s bill, S. 389.

Your letter inviting NERC to testify specifically asked us to address the issues of the role of independent system operators and regional transmission organizations in maintaining reliability as well

as the role of State commissions.

In the pending legislation, ISOs and RTOs are defined as system

operators. As such, they must comply with the reliability rules established by the independent SRO. I would add that having the potential for RTO development is important. It is a positive development in being able to address reliability issues, because I think it

will enable us to deal effectively with some of the issues that we

are facing. If those RTOs develop all across the country, with the

full scope and authority that FERC has envisioned for them, it will

greatly facilitate dealing with some of the issues we face.

Nevertheless, since the actions of any one system operator can

affect the result of the interconnected transmission grid, RTOs will

still need to follow a common set of reliability rules independently

established and administered by an international self-regulatory

organization.

NERC commends the Committee for focusing on this critical

issue of assuring the continued reliability of the interconnected

bulk power system as the industry undergoes restructuring. Legislation now pending would allow for timely creation and FERC oversight in the United States of that needed industry SRO. The reliVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00176 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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1The prepared statement of Mr. Harris appears in the Appendix on page 526.

ability of North America’s interconnected transmission grid need

not be compromised by changes taking place in the industry provided that reliability legislation is enacted promptly.

Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thank you, Mr. Cook. That was very

helpful and interesting testimony about the impact of deregulation

on the grid, and I suppose I should say that it is not every day that

we have a representative from industry coming to Congress, asking

for regulation. So it is a measure of the new landscape in which

you are operating.

Thanks.

Chairman LIEBERMAN. Mr. Harris, welcome.

TESTIMONY OF PHILLIP G. HARRIS,1 PRESIDENT AND CEO,

PJM INTERCONNECTION, L.L.C

Mr. HARRIS. Thank you, Mr. Chairman.

I have prepared testimony that I would like to submit for the

record if I may.

Chairman LIEBERMAN. Without objection, your testimony will be

entered in the record. I have gone over the testimony that each of

you have submitted, and I appreciate it very much. It is very

thoughtful and very helpful to the Committee, and all testimony

will be entered into the record of this proceeding.

Mr. HARRIS. Thank you, Mr. Chairman.

As you know, the critical test of any law or economic concept is

the test of use. I come to you today from the Mid-Atlantic region

where, for 4 years, we have been operating the world’s most successful competitive wholesale energy marketplace.

We have over 200 buyers and sellers and traders in our marketplace, and we have an arrangement with five States and the District of Columbia wherein the States are active in the participation

of this market development.

We have an arrangement where the environmental groups are

active and participate in our marketplace and have meaningful

input into the rules and practice and procedures that we follow in

the Mid-Atlantic region.

We also have active participation by all of those who have an effective interest in our planning. We have a total regional planning

protocol. As a matter of fact, we are the only region in the Nation

that has a regional protocol. That has resulted in over 40,000

megawatts of generation being planned. Currently in the Mid-Atlantic region today, we have nearly 7,000 megawatts of generation

under construction. Additionally, we have over $700 million of

transmission under construction to support that generation, so that

over the next 10 years, we believe that we will not have a reliability problem.

We have many buyers and sellers and traders in our marketplace. What we have seen over 4 years of rolling up our

shirtsleeves and actually doing it is that reliability has increased

in the Mid-Atlantic region and that competition has worked.

Mr. Chairman, we have had over 70 different countries visit our

area to ask questions about why is it working here and what are

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some of the root elements that we are engaging in, what are some

of the presumptions that we made several years ago that have born

fruit today. It is from that perspective that we would like to share

some thoughts with you today.

I think the first and most important thing that this Committee

should do for the Federal Energy Regulatory Commission is ensure

that it keeps its focus.

The second thing is to ensure that the Federal Energy Regulatory Commission achieves ‘‘end’’ solutions. As the Chairman mentioned, there are many needs that are important. You must meet

the environmental needs. You must meet the State needs. You

must meet the local needs. Having ‘‘end’’ solutions that achieve reliability and competition is what it is all about, ultimately.

The third thing is to ensure that the Federal Energy Regulatory

Commission promotes a national energy marketplace.

If I may, I would like to talk about each one of these. First, ensure that the Federal Energy Regulatory Commission keeps its

focus. The Energy Policy Act which was promulgated in Federal

Energy Regulatory Commission Order 888 and FERC Order 2000

had one purpose, and that was to ensure that customers have the

benefit of competitively-priced electricity. If we lose sight of the fact

that the customers are the ones who are supposed to benefit from

this change in the energy marketplace, we lose sight of the objectives of the Energy Policy Act that this Congress established and

what it is all about.

We must ensure that we have the appropriate form over function. FERC Order 2000 delineates certain functions that are necessary to ensure that the customers will have the benefit of competitive price generation, and ensuring that the Federal Energy

Regulatory Commission is true to those functions—that they do not

‘‘dummy them down,’’ that they insist on regional planning protocols, for example, so we can coordinate among regions to ensure

that there is sufficient generation for reliability and ensure that

the differences between regions are adequately addressed is absolutely imperative, and FERC should have that authority.

Second, ensure that FERC truly achieves ‘‘end’’ solutions. As the

Chairman has mentioned, electricity touches the very fabric of our

lives. We know that price is important, and it is important that

pricing be done appropriately. Electricity is a speed-of-light ecological system. It is the only product in the world that, at the very instant someone wants to consume it, it is produced. You turn on the

light switch, and nominally, you are controlling a nuclear plant.

That process goes far beyond just the bulk system. It affects the

distribution system, which the States are responsible for; it affects

local delivery to the home, because it is an instantaneous, speedof-light product.

In truth, there really are no pure reliability/economic principles.

They all overlap and are intertwined. What we are seeing today

with the wonderful network information technologies which PJM

has employed quite successfully to enable these competitive marketplaces through technology is that these things are blending and

merging. So it is very difficult to say this is reliability, and this is

not. We would recommend that this Committee ensure that the

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1The prepared statement of Mr. Kelly appears in the Appendix on page 533.

Federal Energy Regulatory Commission assert its authority over

all the things to achieve these ‘‘end’’ solutions.

Third, we think that you have to have national energy marketplaces. We have seen competition work, but the electricity grid is

like a giant synchronous motor. The Eastern connection is 650,000

megawatts; there is not another motor like that in the world. The

West is a 125,000-megawatt motor. It needs to work well together,

and the Federal Energy Regulatory Commission should take the

lead in ensuring that we have a true national marketplace that can

meet the focus of the Energy Policy Act, and that is to ensure that

customers have the benefit of competitively priced generation.

Thank you, Mr. Chairman.

Chairman LIEBERMAN. Thanks very much, Mr. Harris. That was

excellent testimony.

We will recess briefly now so that I can go over and vote, and

then I will come back.

The Committee stands in recess.

[Recess.]

Chairman LIEBERMAN. The hearing is reconvened.

I apologize to the witnesses and others here. We ended up having

two votes on the Senate floor; hopefully, there will now be a reprieve from floor action for a while.

Mr. Harris, thank you for your testimony.

We will go on now to Kevin Kelly, who is the Director of Policy

Innovation and Communication at FERC.

Thank you, Mr. Kelly, for being here.

TESTIMONY OF KEVIN A. KELLY,1 DIRECTOR, DIVISION OF

POLICY INNOVATION AND COMMUNICATION, FEDERAL ENERGY REGULATORY COMMISSION

Mr. KELLY. Good morning, Chairman Lieberman.

My name is Kevin Kelly, and I am Director of the Division of Policy Innovation and Communication within the Federal Energy Regulatory Commission’s Office of Markets, Tariffs, and Rates.

I am appearing here today as a Commission staff witness, and

I do not speak for the Commission itself or for any individual commissioner.

Thank you for the opportunity to speak on how the reliability of

electric service is being affected by the industry’s restructuring and

the Commission’s role in ensuring the reliability of electric service.

The Commission’s fundamental role in the electric utility industry is to regulate public utilities with respect to the sale of electric

energy at wholesale in interstate commerce and the transmission

of electric energy in interstate commerce. In short, the Commission

serves as an economic regulator.

Since the electric power industry began, reliability has been primarily the responsibility of the customer’s local utility as overseen

by State and local regulators. Increasingly, electricity trading over

large regions leaves many matters affecting reliability outside the

exclusive control of the local utility. So it is more important than

ever to have reliability rules that everyone follows.

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But the Commission has no statutory authority to promulgate

and enforce mandatory reliability rules.

One approach to ensuring reliability is to enact Federal legislation. In May, the administration released its National Energy Policy Report, calling on the Secretary of Energy to work with FERC

to improve the reliability of the interstate transmission system and

to develop legislation providing for its enforcement by a reliability

organization, subject to Commission oversight.

I believe that a legislative approach is preferable to another approach that some have been trying in the absence of legislation,

that is, to ensure reliability through contractual commitments.

Congress should understand, however, that mandatory transmission reliability rules alone are not enough to ensure reliable

electric service. Senator Lieberman, you asked who is watching the

grid. We believe it should be RTOs, and partly for reliability reasons, the FERC has strongly encouraged the formation of Regional

Transmission Organizations. These RTOs would eliminate many of

the reliability problems caused by the highly Balkanized way in

which the interstate transmission grid is now operated.

In adopting its RTO rule, called FERC’s Order 2000, in December 1999, the Commission set out at length the need for an RTO

in each region to ensure reliability. The needs include coordinated

operation and maintenance of interconnected transmission systems,

improved determination of transmission system throughput capability, and unified regional planning of necessary grid additions.

The Commission required in particular that a RTO must have

the authority to ensure the short-term reliability of the regional

grid and also must be responsible for planning and arranging necessary transmission expansions and additions that will enable it to

provide efficient and reliable transmission service.

But reliability requires more. It also requires adequate generating resources. A current issue, for example, is whether those who

sell power to retail customers all over the country must maintain

a specified level of generating reserves. Reliability also requires

that generation support transmission in certain ways, and the

Commission required in its ‘‘open access rule’’ of 1996, called Order

888, that all public utility transmission owners must offer generation-related ancillary services to their transmission customers, including the provision of minimum levels of generating reserves.

Senator Thompson pointed out in his opening remarks that to

further ensure reliability, we also need to find ways to encourage

the construction of new transmission facilities.

Market and regulatory rules must be designed to elicit sufficient

investment in new transmission. For example, to provide transmission owners with an incentive to meet the needs of transmission

users, the Commission could adopt performance-based rates reflecting the reliability of a transmission owner’s system. The Commission already had authority to adopt such rates under the Federal

Power Act.

In closing, restructuring of the electric power industry makes it

necessary to consider new means of ensuring the reliability of electric service. The Commission has only limited authority to address

reliability, and the need for new approaches is clear. Federal transmission reliability legislation is one such approach but alone is not

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1The prepared statement of Mr. Popowsky appears in the Appendix on page 545.

sufficient. The Nation must also develop regional transmission organizations for reliable grid operation and must develop its transmission and generation infrastructure.

Again, thank you for inviting me to testify this morning.

Chairman LIEBERMAN. Thanks, Mr. Kelly. That was very

thoughtful and very helpful.

Mr. Popowsky—how did you get the name ‘‘Sonny’’?

TESTIMONY OF IRWIN ‘‘SONNY’’ A. POPOWSKY,1 PENNSYLVANIA CONSUMER ADVOCATE, ON BEHALF OF THE NATIONAL ASSOCIATION OF STATE UTILITY CONSUMER ADVOCATES (NASUCA)

Mr. POPOWSKY. I think it is because the first two children born

to my parents were both daughters, and my father was determined

that the next child would be a son and was determined to call me

‘‘Sonny’’ regardless.

Chairman LIEBERMAN. That is a good reason.

Mr. POPOWSKY. The other reason it stuck is because my real

name is ‘‘Irwin’’ and that speaks for itself. [Laughter.]

Chairman LIEBERMAN. Understood. Well, ‘‘Sonny’’ seems like a

good name to have for someone in your line of work.

Thanks for being here.

Mr. POPOWSKY. Thank you, Chairman Lieberman.

I am the Consumer Advocate of Pennsylvania. I am also past

President of the National Association of State Utility Consumer

Advocates, or NASUCA. From 1997 until earlier this year, I also

served as the representative of small utility consumers on the

board of trustees of the North American Electric Reliability Council. I am testifying today on behalf of NASUCA.

NASUCA is an organization comprised of offices from 40 States

and the District of Columbia, charged by our respective State laws

to represent utility consumers before Federal and State regulatory

commissions and the courts. Our members’ primary interest is the

protection of residential and other small utility consumers.

In your letter of invitation, you asked NASUCA to address ‘‘the

challenges to electric system reliability resulting from the restructuring of the electric industry and its increasing reliance on competitive markets.’’

In my opinion, there is no more important issue facing the electric industry and its consumers today. There remains great disagreement across the Nation regarding the relative costs and benefits of electric restructuring, but I believe there is little disagreement that if the road to restructuring leads us down the path of

severely deteriorated reliability, then we will have accomplished

little as a Nation and will indeed have set ourselves back, both economically and in terms of basic human welfare.

Today, I would like to discuss the role of the States, the NERC,

the FERC, and the Regional Transmission Organizations in ensuring that the American public will continue to receive reliable electric service.

In my view, each State must continue to play an important role

in ensuring reliability for its consumers. In practice, most day-toVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00181 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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day outages and reliability problems that affect retail consumers

occur on the local distribution system, which has been and remains

under State jurisdiction. States have long experience addressing

these issues, and Federal involvement here would be duplicative

and less effective than the current State efforts.

Nevertheless, it is obvious that electric reliability problems can

affect more than one State. Indeed, NERC itself was formed in response to the blackout of 1965 that cascaded across the Northeast

with no respect for State boundaries.

In my opinion, NERC and its member Regional Reliability Councils have done an outstanding job of developing standards and tools

to operate an extremely reliable electric network.

But as you have already heard, NERC is a voluntary organization that has traditionally had no ability to enforce its rules

through anything more than peer pressure. To its credit, I believe

that NERC has done almost everything that it can do, first, to open

its doors to organizations like NASUCA that are outside the traditional utility industry, and more recently, to establish a fully independent board of trustees.

NERC and some of its regional councils have also attempted to

develop contractual enforcement mechanisms to put more force behind their rules and standards.

But NASUCA agrees with NERC that more is needed, and we

fully support the legislation that would establish a self-regulatory

industry organization that would continue to develop reliability

standards but whose standards would be fully enforceable and ultimately subject to the review of the FERC. I believe this proposal

is essential in a world of increased competition. The players in this

game can no longer also serve as the referees, and the referees

must be able to do more than just issue warnings to the players

who violate the rules.

What else can FERC do? I hope that FERC will turn its attention as soon as possible to completing the task of establishing a set

of Regional Transmission Organizations across the United States.

These organizations will play a vital role in the reliable operation

and planning of the electric network. These RTOs in turn must coordinate their activities closely with their respective Regional Reliability Organizations and with any new national reliability organization.

Ultimately, every reliability standard will have effects on the economics of many transactions, and any economic transaction could

have an effect on reliability. RTOs and reliability organizations

must work together on wholesale bulk power issues, but ultimately,

they must both answer to a single entity, which I believe for interstate purposes must be FERC.

I would like to close with a personal observation if I may about

the electric restructuring experiences in California and my own experience in Pennsylvania.

Viewing the California situation from 3,000 miles away, I would

have to say that even if wholesale prices had not spiked to absurd

levels, and even if major utilities had not been thrown into financial disarray, the reliability impacts alone of the recent electricity

crisis in California were totally unacceptable.

175

I never thought I would see the day when such a large segment

of the American public could not be confident that their lights

would stay on from 1 day to the next.

A few years ago, some people questioned whether there would be

adequate generation supplies at reasonable prices in a restructured

electric industry, but they were assured that ‘‘the market would

provide.’’ Well, the market did not provide in California.

The question our Nation must face is whether the past year’s

failure of the California market was the result of a ‘‘perfect storm’’

of events in which everything that could go wrong, including the

weather, did go wrong or whether California was the ‘‘canary in the

mine shaft,’’ giving the rest of the Nation a warning that we should

turn back from this path as soon as possible.

In contrast, when I look in Pennsylvania at the current PJM

market, I generally see reliable service, supply keeping up with demand, and prices that, at least most hours of the year, are close

to what one would expect in a competitive market. The PJM market still has several flaws and is far from perfect, but at least the

staff and independent board of PJM, as well as many PJM members, recognize these flaws and are taking steps to try to remedy

them.

In closing, I am hopeful that our experience in PJM to date will

turn out to be closer to the rule and that the recent California experience will turn out to be the exception. But I think we first need

to ensure that entities such as the newly reconstituted North

American reliability organization, the FERC, and the hopefully

independent RTOs will have the tools to create enforceable reliability rules and market structures where the benefits of competition can be secured for all Americans in a reliable and economic

manner. Thank you.

Chairman LIEBERMAN. Thanks, Mr. Popowsky, for your very interesting testimony.

Let me begin my questions by following up on the questions that

you raised at the end of your testimony. They join the first two

hearings, that we held on the California crisis, to this hearing.

How do you—and you have had some experience in this—answer

the questions that you raised? In other words, how do you explain

why reliability of electricity has become in doubt for this summer;

and even though the prices are now, fortunately, moderating, there

is still concern about blackouts. How do you explain why it happened?

Mr. POPOWSKY. It is easier for me to try to explain why it has

not happened in PJM, so if I could start with that, I think that if

you have rational market rules where people can come in and build

power plants and know they can be interconnected to the system

in a rational manner and that they will participate in a market

that actually works, you do not need ridiculously high prices in

order to get people to build power plants and have the supply meet

demand.

I think again, from afar, in California, it appears that for whatever reasons, generators whom one would think should have been

flocking to California to build needed generation did not do so, and

there was a fundamental mismatch of supply and demand.

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As I said, I do not see that happening in PJM, but I think you

have to have the market structure and the rules in place, and they

have to be understood in order for the market to have any chance

of working.

Chairman LIEBERMAN. So if a big part of the problem was simply

that the industry was not building new generating facilities, looking back at it, who should have done what to avoid the crisis that

has occurred in California? That is a big question, but I am curious

whether you see that there was a role for the government here.

This part of reliability is the adequacy of supply, really, and what

is coming onto the grid, if I hear you correctly, as opposed to

whether the grid can handle it and whether it is being policed adequately.

Mr. POPOWSKY. Yes, I think that that is right, and that is why

I raised the question, which is in theory, the market should provide

the incentives to build the adequate generation.

In PJM, the theory gets a little thumb on the scale. If you would

agree, Mr. Harris—there is a requirement in PJM that the parties

which are called ‘‘load-serving entities,’’ the parties or companies

that serve load, have to have enough generation to serve their load

plus a reserve margin in terms of capacity that they must have in

addition to what they think they might need in their peak hour.

So there is actually a requirement within PJM that requires participants in the market to have additional capacity over and above

what they think they will need.

Chairman LIEBERMAN. Who sets that requirement? What is its

origin?

Mr. POPOWSKY. I believe it is set by PJM in cooperation with the

Regional Reliability Council, the Mid-Atlantic reliability council.

Chairman LIEBERMAN. Mr. Harris.

Mr. HARRIS. I have just a couple things to add to Sonny’s comments. I think we get back to some very elemental things here. In

the Mid-Atlantic region, the questions you are asking were considered so important that we insisted that we had to have a regional

planning protocol before we began commercial operations in our

competitive marketplace.

We spent the years 1994 to 1996 negotiating with five States and

the District of Columbia, consumer advocate groups—Sonny’s group

participated—and environmentalists to come up with a regional

planning protocol. So we are the only area that has a regional planning protocol in place before we begin competitive marketplaces.

This is absolutely crucial to ensure that you will have capacity to

meet demand.

Chairman LIEBERMAN. Was that one pursuant to some governmental authority or requirement, or was it just done voluntarily

within the industry?

Mr. HARRIS. No, sir. To credit the political and other leadership

in the Mid-Atlantic region, the States, they determined that this

was such a crucial point that they wanted to have this in place. It

took us 2 years to negotiate the protocol so that all five States and

the District of Columbia, consumer advocates, environmentalists

and others joined in this process. We filed that to begin operation

as an independent system operator.

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The second thing is a point which you made, that prices are important, and it is important to get prices right. So we developed a

system that would make public transparent spot prices. We publish

prices, every 5 minutes, on the electrical grid, and everyone can see

the price, and transparent spot prices enable you to have appropriate competitive behaviors and enable people to determine when

and if they want to build generation.

Chairman LIEBERMAN. Just talk a little more about that. That is

very interesting. So that every 5 minutes, you are publishing the

prices in that period of time from the various sources of electricity

coming onto the grid.

Mr. HARRIS. That is correct. And if you want it, we can give it

to you every few seconds. As a matter of fact, information transparency is so important to having a competitive energy marketplace that we have created a program which we call ‘‘E-data,’’ and

your staff and yourself can get on that program, and you can see

these prices. Any individual can see what the prices are at any

point in time, and then you can make your decisions based on that

price transparency.

Chairman LIEBERMAN. Do people actually buy—what is the

smallest unit of time that you can buy? In other words, how quickly can you change your purchases?

Mr. HARRIS. You can change with 30 minutes’ notice, actually.

We have hundreds of traders in any given hour. On hot days where

the system is getting tighter, we have actually had 400 to 500

changes an hour in the marketplace. So another thing you need to

have in your market is many buyers and sellers, which gets you

back to the importance of having regional solutions when you move

forward.

Chairman LIEBERMAN. Let me step back a little bit and go back

to what the problem is and see if you can illustrate it before we

get to some of the solutions.

As I hear you, and understand from what I have read and studied, part of the problem, or a big part of it, is the significant transition we have made to deregulated electricity markets, and the fact

that the electricity grid, which was largely local or regional in the

old model of a particular local utility building a power plant, arranging for the lines to get to its customers, creating some backup

possibility where it connected a transmission line to neighboring

utilities—now you have a very active deregulated market in which

every 5 minutes, even every couple of seconds if you want, buying

and selling is occurring over this grid, which was for the most part

not built for this kind of traffic, so there are both congestion and

reliability problems.

I cited two examples that we found as we were going over this.

One was the Cinergy case, where they basically took some power

which they were not entitled to; and the second was the California

case where the backup units did not fulfill their obligation to come

on in time of need.

I would just like to ask all four of you if there are other examples

that you have of the problems which have come with the transition

we have made to deregulated markets, just as a way of illustrating

what we are dealing with here. Mr. Cook.

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Mr. COOK. Another kind of situation—I think the congestion

issue that you mentioned, with the limits on how much power we

can transfer from one part of the country to another, is a very critical one.

Chairman LIEBERMAN. And of course, once that happens, it then

goes to the very heart of deregulation, because it limits competition.

Mr. COOK. It can limit competition. It means that power cannot

move into an area that might be less expensive, so people need to

resort to more expensive generation, and in some instances, transactions need to be curtailed, because there simply is not enough

ability to serve that load. That is one of the things that we are seeing, and it gives rise to the need that we have talked about to have

a more robust transmission system.

Chairman LIEBERMAN. Mr. Harris.

Mr. HARRIS. Thank you, Mr. Chairman.

First of all, the two problems that you elucidated could not have

happened in the Mid-Atlantic region simply because we are administered by an independent entity that has no financial interest in

the marketplace. We have 10 different transmission-owning companies and hundreds of traders, and it is independently administered

so it would not have occurred.

Chairman LIEBERMAN. Take those two cases and tell us how your

region would have prevented them from occurring, or why they

would not have happened.

Mr. HARRIS. It would not have happened because the operation

of the power grid is done by an independent entity that has no financial interest in the marketplace. We have many companies.

Cinergy was one company, vertically integrated, with everything

under its control. We operate and direct the operations of the

power grid neutrally and independently from all market participants.

Chairman LIEBERMAN. So what would happen in the case where

Cinergy took the power off the grid that it was not entitled to?

Mr. HARRIS. Well, again, it would not have happened in our area.

We saw the power change, because the frequency dropped, because

there was not enough generation to serve load, and we were asking

questions about who was not playing by the rules. That is how it

came about.

Chairman LIEBERMAN. OK.

Mr. HARRIS. Two things that I think are problematic and symptomatic that this Committee could certainly look into are, first, the

fact that electricity does get consumed the instant it is produced.

It does not say this is only wholesale. It does not say it is only retail. It does not say it is just in this State. It travels at the speed

of light. So the solutions that FERC needs to have need to be ‘‘end’’

umbrella solutions where you look at the whole thing. As Sonny

was saying, things are not pure—pure reliability or pure economics—they blend. So it is extremely important to have a holistic view

of the problem.

The second thing is in the way that institutions are getting approved. We have institutions now that have spot market authority.

There are certain RTOs that do not administer spot markets, and

that creates difficulties, as you saw. We need to come to the naVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00186 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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tional energy market with common designs so that we can solve

these problems much more quickly and robustly as we move forward.

There are other things coming out—the gas industry recently

proposed an energy industry standards board. Some of the things

that they proposed are interesting. They recognize that there is a

nexus between natural gas and electricity, and there must be ways

to resolve those issues as we move to the future.

So we are learning, and the process we have followed, we call

‘‘little steps, little feet.’’ It is very complicated. We take little steps.

We learn, pilot, take the next step, learn, and increment our way

to the future.

Chairman LIEBERMAN. Thanks.

Mr. Kelly, do you have any examples of reliability problems on

the grid that might help illustrate the problem that we are trying

to solve?

Mr. KELLY. There are many, but let me give you two—one, illustrating difficulties with incentives to build generation, and one

with difficulties in incentives to build transmission.

You were asking Mr. Popowsky about California earlier. One

thing that is rarely mentioned that I think is very important is

that the West Coast is heavily dependent on hydro power. You

have the Cascade Mountains down through Washington and Oregon, and the Sierra Nevadas through California; and starting

around the time of World War I, they started developing the hydro

resources there heavily. I think California is about 30 percent dependent on hydro. They had unusually heavy rainfalls in 1998 and

1999, that created a surplus of electric energy in the West, which

created a disincentive for people to come in and build generation

right away. And then, they had 2 years of drought.

It is my personal belief that with or without deregulation in California, the West would have been stressed over the last 2 years.

With the old world of regulation, however, there were reserve margin requirements, as Mr. Harris has talked about. The California

market design chose not to have such a requirement, at least of the

old sort. It was not built into their system as it is built into the

East Coast systems.

The FERC asked the California ISO and the California parties

last November to consider having such a requirement. It is my personal belief that a reserve requirement of some sort is needed to

incent generation construction in a market environment and to prevent the cyclical boom and bust of inadequate and surplus generation that can cause price swings.

Let me turn to a transmission story. We are seeing a lot of gasfired generation being sited along the Gulf Coast right now in Mississippi, Louisiana, and Texas, probably much more than can be

consumed in the area. Many of those generators, I am told, intend

to sell up in the Upper Midwest, Chicago, and States to the east

and west of that. There really is just not enough transmission capacity to move the power up there, and it is not being built, in part

because many of the traditional utilities that own generation and

transmission, I think, see themselves getting out of the transmission business—they would rather put their money into generaVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00187 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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tion—but in part because there are old, antiquated grid rules that

make things difficult.

Just for example, somebody who wants to move power from, say,

Louisiana up to Chicago is likely to look at a path going through

Tennessee and find that there is no capacity available. So it will

look for an alternate path and find one that exists on paper that

goes up through Arkansas and Missouri and gets into Illinois

through that route, and it will reserve that path. But unfortunately, the electrons still flow through Tennessee, tending to overload the grid in Tennessee.

You might say, well, the solution is for the utilities in and

around Tennessee, primarily TVA, to build more transmission. The

trouble is they do not have a transmission customer. The utilities

that have the customers are the utilities in the Arkansas-Missouri

area.

So those are two examples, Senator.

Chairman LIEBERMAN. Those are very interesting examples. I

don’t want to break the trend here, but it leads me to ask for the

record for those who are watching, just to help us understand—in

the normal course, who decides whether additional transmission

capacity will be built? Is that totally a market judgment where

somebody has to come along and see an opportunity and decide to

build—because that is a fascinating example. Plants are being built

in Louisiana, more generation than the region needs, big markets

up North, and how do you get the electricity there?

Mr. KELLY. In the old world, it was the individual utility that

was building transmission primarily to distribute its own power

around its own area, and it built some interconnection with its

neighbors for reliability purposes.

In the new world that I have just described, I do not think that

model will work. You need a large regional organization that encompasses all the utilities along all the flow paths from Mississippi

to Chicago to decide when and where transmission should be built

to meet the aggregate needs of the region. Hence the RTO.

Chairman LIEBERMAN. OK. So the vision that FERC has of the

RTOs is that the RTOs would play that role.

Mr. KELLY. Yes.

Chairman LIEBERMAN. And how would they do it? Would they actually do the building of the transmission lines themselves?

Mr. KELLY. They would certainly do the planning and come out

with a plan that meets the needs of a large region and have some

role in either directing or carrying out the building.

In our rules, we allowed some flexibility to how an RTO would

do that, because there are different flavors of RTOs. One, for example, might be a pure transmission company that would build and

own it itself. But in another region, you might have utilities that

are owned by government. TVA is one example, and the cooperative

utilities in Missouri, for example, who feel that they cannot turn

their transmission over, either by law or custom, to another entity.

There could be protocols where those utilities could build transmission in response to a plan by the RTO and a compensation

scheme devised by the RTO and subject to FERC approval.

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Chairman LIEBERMAN. Mr. Cook, does NERC play a role, the reliability councils, in trying to make sure that there is enough transmission capacity to handle the electricity that wants to move?

Mr. COOK. Not in actually building the systems. NERC does do

an assessment on a regular basis of the generation adequacy and

transmission adequacy so that information is available about where

the problem spots are and the kind of things that need to be taken

on.

Chairman LIEBERMAN. Mr. Harris, what about PJM; what are

you doing with regard to the need for new transmission liens?

Mr. HARRIS. As I mentioned, we do have a regional planning

process which is independently administered. We believe that the

person who is doing the planning should not own the transmission;

it should be those who are in the transmission business.

We look at things regionally and ask what is the least-cost solution to ensure that generation will meet load over all five States.

That is why we have approved and now have $700 million worth

of transmission under construction.

Chairman LIEBERMAN. Who is doing that?

Mr. HARRIS. My office is doing that.

Chairman LIEBERMAN. I mean, who is actually building the

lines?

Mr. HARRIS. Each individual utility is building the lines that go

through their particular territories.

Chairman LIEBERMAN. And how did you get to that point? In

other words, you saw the need, and you planned, but how did you

make sure they would go ahead and build the lines that were needed?

Mr. HARRIS. I think it was the maturity and the development of

our marketplace. The companies got together and said this is going

to be the reality of the future, and if we have a neutral and independently derived plan from somebody with no financial interest in

the outcome, we will obligate ourselves to build and construct in accordance with that plan. That is what they agreed to back in 1996,

and that is what we are following today.

Chairman LIEBERMAN. In the new deregulated market, are those

generating companies, or what I used to call the utilities that are

actually selling to the customers, who are building the lines?

Mr. HARRIS. They are the utilities. In our market, someone could

come in in a merchant capability if they so desired and do it if they

wanted to; they are not precluded.

The intriguing question that Mr. Kelly raised does bring up an

interesting point as to how you get the broad interregional needs.

With RTOs that have the planning functions, the key is making information available to those who have a commercial interest and

can achieve an appropriate economic solution. In many instances,

transmission is competing with generation to come up with the

same solution. The problem they all have is how do I get the information so that I can make an informed decision.

Chairman LIEBERMAN. Mr. Popowsky, let me come back to the

earlier question about whether you had in your work, either in

Pennsylvania or information from your colleagues, illustrations of

what the problem is with the grid now as a result of deregulation.

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Mr. POPOWSKY. Again, in our area, we have not seen the kind of

reliability problems arising as a result of market failure. I do think,

however, that we have seen some instances where it would have

been a lot better if we had had more and different generating companies on the system.

For example, the market for capacity—as I said, capacity is very

important in PJM to make sure we have enough available. On the

other hand, it is not a very liquid market, and if we look at the

prices this past winter, they went from zero to $177 a kilowatt-day

and stayed at $177 for 2 months. And two summers ago when we

had a heat wave, the energy price actually went up as high as

$900, which is really unprecedented and, fortunately, I do not

think has happened again.

But as I said, in PJM, we are making strides so that when things

like that happen, the PJM Market Monitoring Unit and the PJM

board can look at those things and either try to reach a resolution

itself or come to the FERC with resolutions, as they have done over

the last few months, to try to correct these remaining market

flaws.

If I could just mention one other thing about the Cinergy example, as Mr. Harris indicated, it is not a question of what PJM

would have done at that point if that happened; it is that if you

have a truly independent system operator who is operating the system, that will not happen. And my recollection is that when it did

happen, I think the NERC board and the regional council were able

to basically send a nasty letter saying ‘‘Do not do that again.’’ That

is why we need the legislation so that FERC can follow up on that

nasty letter with a little more authority.

Chairman LIEBERMAN. ‘‘Strong action to follow.’’

Mr. POPOWSKY. Yes.

Chairman LIEBERMAN. Just to summarize what you have said, as

I recall in the statements you submitted, Mr. Kelly and Mr. Cook,

you both indicated that the number of violations of reliability rules

are increasing in the deregulated market nationally, and I assume

nobody on the panel would disagree with that.

Mr. Cook, did you want to add something?

Mr. COOK. Just to reaffirm that statement, that we are seeing

more of that as the system is being stressed more; yes.

Chairman LIEBERMAN. Let us talk now about what to do about

it. As I listened to the first two witnesses, Mr. Cook and Mr. Harris, I thought that I heard a difference of approach, and please correct me if I am wrong. I thought, Mr. Cook, that you were talking

about the desirable answer here being to establish independent authority through NERC, through the North American Electric Reliability Council, with some oversight from the Federal Energy Regulatory Commission.

But I thought, Mr. Harris, that you were focusing more on having FERC do this themselves, without a separate, independent

group overseeing. Did I hear it correctly, and if so, can I invite the

two of you not to get into a crossfire here, but to elucidate your

points of view.

Mr. COOK. The first point is that the panel report that you

quoted from in your opening statement—NERC had an independent panel of experts come in about the same time to look at

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how ought we be treating reliability as we go forward. Both of

those groups came to two conclusions. One was that we needed to

have the rules be mandatory and enforceable. Then the question is

what is the best way to accomplish that? Both the Secretary of Energy’s panel that you quoted from and NERC’s own panel of experts came to the conclusion that the best way to do that was to

use an industry self-regulatory organization modeled after the

SROs that are presently in operation in the securities industry.

That is a way to have the industry expertise brought together and

have government oversight there to make sure the process is fair

and open. It is also a way to deal with the international character

of the grid.

As Mr. Harris said, the interconnection is one big machine. The

map that I attached to my testimony indicates the scope of that

machine, including the provinces in Canada as well. It is necessary

for that machine to operate under a single common set of rules. If

FERC was to set the rules for that, in effect they would be dictating what the rules would be in Canada as well. Having the

international organization set those rules, Canadians participate

now extensively in NERC activities, and that would carry forward

into this new organization. That is a way to deal with that international issue as well.

Chairman LIEBERMAN. I was going to ask you if there is a model

existing for what you propose, and from what you are saying, I

gather that it is in securities regulation.

Mr. COOK. In the securities regulation area, where you have the

stock exchange and the NASD take on the role of setting rules for

their marketplaces and how the broker-dealers are to be handled,

under oversight by the SEC. The exchanges develop their rules,

they are filed with SEC, and that gives them the legal authority

to enforce them. SEC has independent authority to carry out its

own enforcement activities if it sees a need to do that.

Those features are really built into the legislation that is before

you now. It is the same model that we have used.

Chairman LIEBERMAN. Mr. Harris, what is wrong with that?

Mr. HARRIS. What we have learned over 4 years of looking at

how do you get to competitive marketplaces and ensure you have

the reliability necessary is that it is a learning curve. I also served

on the NERC board of trustees, and I am the regional manager of

the Mid-Atlantic Council, so I am very close to these issues and the

genesis and the development of them.

But we have made over 110 changes to our rules since we started

by incrementally learning and growing. What we are seeing now in

this industry is that we really need to deal with the realities. I

think you said it very well—we have to address all the needs.

There are environmental needs, there are State needs, there are

local needs. And how we develop those is going to be extremely important to ensure that we do not have any more huge unintended

consequences and missteps.

So as we look at what is necessary to make sure those things

happen, it should definitely be this Committee’s oversight of the

Federal Energy Regulatory Commission to ensure that the total holistic solutions are met, and met reliably. FERC has to have oversight.

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We are also finding the convergence of industries. Gas is important to what happens in electricity, as you have heard today. We

were somewhat intrigued by the gas industry’s proposal to solve

this problem with an energy industry standards board where the

current NERC would have a meaningful role in that process. This

needs to have more thought, and it needs to be looked through.

So our suggestion is that it needs to have FERC oversight, and

the simplest way to do it would be to have the Federal Energy Regulatory Commission determine what is a necessary reliability organization and have the Federal Energy Regulatory Commission determine the scope and extent of that organization. Then we can get

into the details without bothering the Committee. But I think this

Committee should ensure that the Federal Energy Regulatory

Commission puts forth some organization that allows that to take

place, and we should learn from our experiences as we grow.

Chairman LIEBERMAN. Interesting. So if I am hearing you correctly, you are saying that the Federal Energy Regulatory Commission ought to make this decision, and not to presume that NERC

is going to play that role, but obviously, that would be one of the

options that FERC would consider.

Mr. HARRIS. Yes, sir, that is correct.

Chairman LIEBERMAN. Mr. Cook.

Mr. COOK. I was just going to say that under the legislation, the

Federal Energy Regulatory Commission would be making that decision. That is, FERC would make the decision on what organization

is going to carry forward once that legislation passes. The organization would submit a proposal to FERC saying ‘‘We propose to take

on that function and here is how we propose to meet it, and here

is what we would do.’’ So that feature really is built into the legislation.

Chairman LIEBERMAN. Mr. Kelly, what is your reaction on the

FERC to this question of how to best organize a legislative response?

Mr. KELLY. In terms of the differences that Messrs. Harris and

Cook have expressed, if there are real differences, I do not see

them as 180 degrees apart; to me, they are 5 or 10 degrees apart.

Mr. Harris wants to put a greater emphasis on the coming RTOs

than he perceives NERC is placing. NERC has drafted a bill that

puts emphasis on NERC and regional councils.

In my personal view, when we get right-sized RTOs and rightsized regional councils, the councils will be coincident with the

RTOs, and most of the differences that they may think they have

will disappear.

Chairman LIEBERMAN. Mr. Popowsky.

Mr. POPOWSKY. I would agree, and I think that is what the legislation is intended to do. There is a discussion of what the role of

the States is through a savings clause. There is a discussion of coordination with Regional Transmission Organizations.

I think, though, the bottom line is that both of the final decisions

should come down to FERC. But that does not mean that FERC

staff have to be sitting there, trying to develop reliability standards. That is better done by the new NERC or NAERO group, I

think. Even today, they have a tremendous staff who focus on reliability. That is their area of expertise, and they should be working

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with the RTOs, coordinating their activities, and then, ultimately,

it should be up to FERC to make those tough calls as to how much

to emphasize reliability versus economics and how to reconcile

those.

Chairman LIEBERMAN. Do any of you want to add anything about

the legislation that is before us? We have both the Murkowski and

the Bingaman proposals.

Mr. COOK. On the reliability piece, Mr. Chairman, those bills are

the same.

Chairman LIEBERMAN. Right. So that, basically, your request

would be to get one of them adopted, but certainly that part of

them adopted, and there is no real difference between them on reliability.

Mr. COOK. That is correct.

Chairman LIEBERMAN. Mr. Popowsky, the National Association

of State Utility Consumer Advocates which you represent here

today filed comments with the Department of Energy, as I believe

you know, that argue quite forcefully that FERC needs to act on

reliability whether or not Congress passes additional legislation,

and also argue that FERC has the authority to do so.

I wonder if you are in a position to talk a little bit more about

that now and if so, prior to the legislation, since we know that is

hard to predict around here, what would you like to see FERC do?

Mr. POPOWSKY. In light of what has happened over the last several months starting with the realignment—in other words, in February 2001, NERC did turn over its trusteeship to the new independent board of trustees. In addition, they began to establish contractual enforcement activities.

Our first preference is certainly to pass legislation. If legislation

is not passed, then FERC can certainly go back and try to eke out

whatever authority it does have to address reliability matters.

I personally think that is by far a second-best or much worse solution to giving FERC the actual authority to review reliability

rules that would apply to all actors in the market and not just

those who are under FERC’s jurisdiction already.

So that would still be by far the lower priority, and as I look at

it, a better use of FERC’s resources now would be to really get the

RTOs in place, because the RTOs also have a reliability role, and

to make sure that we have a national set, a complete set of RTOs

that also have reliability authority, and that, clearly, the FERC has

the ability to do. That would certainly be my preference at this

point.

Chairman LIEBERMAN. You kind of anticipated my next question.

Mr. Kelly, one of the points you made in your statement is that

FERC does not have jurisdiction over a number of the utilities that

control parts of the transmission grid, such as Federal power administrations or municipally owned utilities.

I was interested in the fact that the recent order that FERC set

regarding the Western power markets includes conditions on every

utility that sells into the federally-regulated transmission system

out West, including the Federal power administrations and the municipally owned generators. So I wonder, prior to the legislation, if

it is possible for FERC to act on reliability concerns throughout the

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system, including both the Federal and municipal parts of the system.

Mr. KELLY. I suppose it would be possible, Senator, with a great

stretch on our authority, but there are difficulties. The California

situation, I think, caused the Commission to desire to act quickly

and forcefully and to put a solution in place, by interpreting its jurisdiction just about as broadly as it could, probably more broadly

than it would going into a new area.

There is a real question, I think, if you are building reliability

for the future—such an important topic that affects all 50 States

and our neighbors in Canada and portions of Mexico—if you would

want to build such an important enterprise on what might be an

untested legal foundation.

In addition, I might add, we were imposing conditions on generators who were using the transmission system that was jurisdictional to us, and imposing those generation pricing conditions as a

condition of using the grid that was jurisdictional to us—I am not

sure we could quite use the same rationale to impose conditions on

transmission systems that were not jurisdictional to us. And onethird of the transmission in the United States is not FERC jurisdictional.

Chairman LIEBERMAN. Say the last sentence again, please.

Mr. KELLY. One-third of the transmission in the United States

is not FERC jurisdictional. When you look at TVA, Bonneville, the

Western Area Power Administration, and add in the State-owned

systems like the New York Power Authority, the whole State of Nebraska, which has publicly-owned transmission and utility systems,

and all the major municipalities, and then add in the large cooperative utilities that are financed by the rural utility service and

hence, when so financed, are not subject to FERC jurisdiction, it

is fully one-third of the transmission lines.

Chairman LIEBERMAN. That is interesting.

Does everyone on the panel agree that one of the most important

parts of legislation would be to make sure that there would be one

set of standards and one enforcement mechanism since, if there is

anything that I have learned from this hearing, it is that everything is interconnected. Do you agree?

Mr. COOK. Yes, sir. The letter that I attached to the testimony

that we sent to the members of the Senate Energy and Natural Resources Committee included a long list of folks who are supporting

the legislation, and on that list are the coops, the public power people, folks that, normally, you would not think would be suggesting

that jurisdiction be extended over their members. But for purposes

of the reliability bill, they have all signed on, if you will, and are

supporting that effort.

Chairman LIEBERMAN. Are there any other responses? Mr. Kelly.

Mr. KELLY. Well, I would agree, maybe adding a footnote that

NERC’s rules themselves do recognize there may be regional differences; for example, some of the rules as applied in a hydro-dependent region might be different from the rules in a wholly coalfired region.

So NERC has a standard rule, but the rule itself allows for variation. So with that footnote, I would agree with the statement.

Chairman LIEBERMAN. Mr. Harris.

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Mr. HARRIS. One additional footnote is that we just cannot ignore

the physics. It is consumed the instant it is produced; it is a speedof-light product; it does not know State boundaries; it is the consumer from the generating plant and the fuel behind it. So we cannot just carve out the wholesale business from the retail business.

You cannot just carve out the States. You cannot carve out the environmental. It is a separate problem.

The Federal Energy Regulatory Commission needs to have holistic authority to ensure that this thing will work together as a single, synchronized motor.

Chairman LIEBERMAN. It is really quite remarkable, and I do not

know that I fully understand it—one of you referred to it before— about the example of the Louisiana utility trying to get its power

to Chicago. But in a regulated market where utilities, conceptually,

should be able to buy from generators anywhere on the national

grid—at one point, I remember having a conversation where it was

suggested that customers actually might—that is, business customers or even residential, ideally—would be able to choose where

they wanted their power to come from based on a competitive

model. The conceptual difficulty is in visualizing how this happens.

It is one thing, as I said to my staff the other day, for me to understand that if I want to buy shirts from a particular mail order

house, I have a series of choices to make, and then I know that

they are going to find their way, either by airline or by truck, to

Federal Express or UPS or whatever, to my house. But how does

one envision how those units of electricity get instantaneously from

a generator that may be halfway around the country to my utility

in Connecticut, let alone to me?

What I have been told is that they do not—is that right? In other

words, somebody is adding to the pool, and what my utility is taking out is probably not part of that even though I am paying at a

rate based on what that generator has added to the transmission

grid.

Mr. HARRIS. I appreciate your comment. That is the beautiful

thing about moving to competitive electricity marketplaces. We

now have over 100 different companies trading on the market in

any given hour, from Florida, Texas, and Canada, all trading into

the PJM marketplace.

The Federal Energy Regulatory Commission has approved a pilot

program this summer where we have economic incentives for individual customers to buy and make choices based on the spot price

of electricity.

Chairman LIEBERMAN. Not utility companies—but customers.

Mr. HARRIS. No, sir. Individual customers to make economic decisions based on that spot price. What we are seeing is the beautiful

things about network information technology—the power and speed

of processors, the broad bandwidth capabilities that will enable

competitive enterprise to work down to the individual level. While

it may be complex in administration, one of the things that we

have found, again through these technologies, is that we can actually make the life of the customer more simple and more convenient through the use of these technologies.

It is also something, I might add, that the Committee might

want to ensure that the Federal Energy Regulatory Commission

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has, and that is the appropriate technology and tools to have oversight over this vast network of process. That can happen; they can

understand what is going on in prices to see if it is an anomaly

over a broad scope, and technology will enable that today.

Chairman LIEBERMAN. And the truth is that without technology,

you could not do it; you could not monitor it. Too much is happening too quickly.

Mr. HARRIS. That is correct. We can do things now that were impossible a year ago, and the technology keeps growing rapidly so

that we can take this speed-of-light product and really simplify the

life of the consumer and add value to the economy in these ways.

Chairman LIEBERMAN. Now that we are on this fascinating subject, just very briefly, how is the individual customer going to tap

into the information that will allow him or her to decide where

they will buy the electricity to their—are we talking about to their

house, or to their office building, or——

Mr. HARRIS. If the individual customer wanted to do that to their

house, they could. Remember that we are developing our program

‘‘little steps by little feet,’’ so we have a pilot program that we are

running that we call an ‘‘economic program.’’ It is interesting—we

filed the program, and the Federal Energy Regulatory Commission

approved it for this next season, and in that program, we negotiate

a way where individuals, customers or small businesses, can see

that spot price and then make decisions on whether they want to

isolate to the grid, i.e., buy megawatts, or where you would actually pay them to come off the grid at their choice——

Chairman LIEBERMAN. And they see it on their personal computers, for instance?

Mr. HARRIS. It is seen through some type of networking tool that

would allow that information to be there. Again, this is a pilot program, but what it shows is the promise of the future.

I think that one of the sad things about the California situation

is that it masks the wonderful opportunities that we now have in

a networked information economy, and somehow, we need to get

back to that.

Chairman LIEBERMAN. Yes. Mr. Popowsky.

Mr. POPOWSKY. In terms of residential consumers, I think most

of the participants will be larger commercial and industrial customers, at least initially.

Mr. HARRIS. Yes, we have some small commercial, but there is

nothing that precludes a residential if they wanted to play.

Mr. POPOWSKY. But there are other things that can be done. To

get back to your first example, I think one of the positive developments in Pennsylvania is that consumers who wish to do so can

buy green power, that is, power developed from renewable resources. Now, as you indicated, it is not that you can get the power

all the way from the windmill, two States away, into your toaster

oven; but by patronizing with that market or with that company,

that company will put more of the wind power onto the grid. So it

is not that you get those kilowatt hours, it is that you contribute.

Chairman LIEBERMAN. People feel good about it?

Mr. POPOWSKY. We found in Pennsylvania that people are even

willing to pay more, like they buy recycled paper goods at the supermarket. They are willing to pay more, and I believe they underVerDate 11-MAY-2000 09:27 Aug 13, 2002 Jkt 000000 PO 00000 Frm 00196 Fmt 6601 Sfmt 6601 75477.TXT SAFFAIRS PsN: SAFFAIRS
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stand that they are not literally getting those kilowatt hours, but

they are contributing to getting more of those kilowatt hours onto

the grid.

Chairman LIEBERMAN. Very interesting and very exciting. I

thank all of you.

From the testimony that you have offered, I would conclude that

dramatic changes have occurred, both in the markets, in the deregulation of electricity markets around the country, and of course

in the increasing demand generally as our economy has grown, and

as a result of the extraordinarily developments in technology, the

grid as it exists now has reliability vulnerabilities to it and that

the market and government and private groups have tried to react

to those. But the general feeling I get from listening to you is that

the current approach does not adequately fit the new reality of

competitive markets and technology. Also, there seems to be general agreement by one path or another that the buck has to stop

at FERC, that this is an area in which FERC has to receive new

authority, that the ideal is if Congress were to clarify FERC’s role

here.

There are details that still need to be resolved about how the actual organizational structure will be built and will operate, and it

is not clear, as I hear from you, in the absence of legislation, although some would argue on one side or another, what steps FERC

should take except to continue to pursue its vision of the RTOs.

So I think some things are happening here. I think we do have

a problem, and California is obviously the extreme example of it for

a lot of reasons. But it is also clear that unless we act to improve

the national electricity grid, consumers will not be able to achieve

the maximum benefit from deregulation, and at worst, the lights

will go off occasionally, or there will be unfair practices along the

grid because there is inadequate monitoring and policing.

So I think it is critically important that we act on this legislation

on which there seems to be general agreement. And Members of

this Committee will do our part to make sure that is so, and we

will continue to monitor FERC’s oversight of these matters.

For me, it has been a very informative hearing. I will continue

to be interested in it. As Senator Thompson said at the beginning,

it is not quite as controversial or dramatic as the current crisis in

California, yet this is all about prevention. This is all about taking

the steps necessary to make sure that we do not have more Californias, more blackouts, and more pricing of electricity that is higher

than it would be if we had a grid that was up to handling the generating capacity that will be coming on and to the opportunities

that technology provides.

We will leave the record of this hearing open for a week if any

of you want to submit additional testimony or if any Members of

the Committee who could not be here today want to submit questions for you. But in the meantime, I thank you all, not only for

your testimony, but for what each of you is doing to assure the reliability of the national electricity grid.

I thank you. The hearing is adjourned.

[Whereupon, at 11:40 a.m., the Committee was adjourned.]

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Æ