take steps it believes will create power markets that are less susceptible to
such shenanigans. Chief among them is for utilities to surrender control of
their high-voltage power lines to independent operators that would give all
market participants fair access and will operate spot markets for power.

Earlier this month, the commission told three of the nation's big integrated
utilities -- American Electric Power Co., Entergy Corp. and Southern Co. --
that until they relinquish control of their power lines to an independent
operator, FERC may intervene to limit the prices they charge wholesale
customers. At least one of the three is appealing the FERC mandate.

The commission has also stepped up efforts to settle pesky but important
technical issues, such as how independent power producers can hook up new
plants to the lines of nearby utilities and how transmission services can
best be priced.

Still, even a more aggressive FERC hasn't been able to solve some lingering
problems. A good example is the continued existence of one of the nation's
worst transmission bottlenecks. Known as "Path 15,“ the line interconnects
the populous southern part of California with more abundant energy resources
in the north. The Department of Energy has pledged to help expand Path 15,
which was implicated as a key cause of the blackouts in California earlier
this year.

But actually getting the work done may require PG&E Corp.'s Pacific Gas &
Electric unit, which owns the 90-mile stretch of line, to get approval for
the expansion from the state Public Utilities Commission. But Pacific Gas,
which placed itself under the protection of the federal bankruptcy courts
amid the California power crisis, is at loggerheads with the PUC. The upshot
is that there may be significant delays in upgrading Path 15. The
implication: when the economy cranks back up, so too will the possibility of
more supply shortages and higher prices, says Terry Winter, chief executive
of California's Independent System Operator, which operates the state's
electricity grid.

01093

01200000001765


Mid-American Energy Holdings Co., "you had to pay a premium to get a
turbine." Companies with lots of turbines on order, such as San Jose,
Calif.-based Calpine, boasted that they would clean up in newly deregulated
markets such as the West, the Northeast and New York, where electricity
supplies back then were tight. "But now," Mr. Sokol says, "I know of at least
100 (turbines) that are for sale. People want you to take their place in
line."

While most energy companies are pressing ahead with projects they have
started, they have grown cautious about breaking ground on new ones. Just a
few months ago Calpine boldly claimed it would have 70,000 megawatts of
generating capacity -- the equivalent of 35 to 45 big power plants -- in
operation by 2005. Now it's backing away from that assertion. The company
currently has only a fraction of that capacity, 11,000 megawatts.

At the root of the problem is a lack of capital and earnings. While energy
companies routinely beat their own bullish quarterly profit estimates last
year, many of them have lately indicated that they will miss earnings
projections. With electricity and natural-gas prices down, energy sales tend
to be less profitable. Hence, investors haven't been willing to pay the same
price-earnings multiples for energy stocks.

Bankers, meanwhile, want convincing evidence that future power prices will be
high enough to justify new projects. That's far from guaranteed in
deregulated markets. In fact, national electricity prices, which hit a
S2-week peak of $216 per megawatt, now are being quoted at $23.45 per
megawatt, according to the Mirant National Power Index.

To give some idea of how radically the landscape has shifted, take the case
of power conglomerate UtiliCorp United Inc., of Kansas City, Mo. In April,
taking advantage of the general enthusiasm toward deregulated markets, it
spun off its Aquila Inc. trading unit at a price of $24 a share, raising $480
million. "We saw an opportunity to crystalize the value" of the trading
company, says UtiliCorp President Bob Green.

Aquila's stock soared to $35 before it began slipping at the end of May.
Since then, it has tumbled by half. Today, with a price/earnings ratio of
eight -- less than most utilities -- the "equity markets are closed" to
Aquila, Mr. Green says.

Now, UtiliCorp, which mainly owns regulated utilities, is planning to buy
back all the publicly traded Aquila shares. It hopes that by taking shelter
under UtiliCorp's umbrella, Aquila will be able to benefit enough from its
parent's strong credit rating and healthy balance sheet to keep trading and
buying more power plants.

In other words, the regulated utilities, once considered homely wallflowers,
are looking more alluring these days as trading firms, such as Aquila and
Enron, have fallen from favor. That could portend a reduction in the huge
trading volumes, and accompanying price volatility, that marked the early
stages of energy deregulation.

But that won't help consumers unless new power plants and transmission lines
come online in time for the economy's resurgence and new rules are put in
place that guarantee a more transparent market. The latter won't be an easy
task, because power trading is done on a variety of public and private
exchanges, with traders darting in and out to take advantage of price
discrepancies.

Lately, there's been growing evidence that some power companies have found
lucrative ways to exploit this system -- at consumers’ expense. Their tactics
include manipulating wholesale electricity auctions, taking juice from
transmission systems when they aren't supposed to and denying weaker
competitors access to transmission lines. Regulators believe that this
behavior has contributed to supply glitches and inflated prices.

Under its new chairman, Pat Wood, the FERC has been pressing companies to

: 01023

01200000001695


high enough to justify new projects. That's far from guaranteed in
deregulated markets. In fact, national electricity prices, which hit a
52-week peak of $216 per megawatt, now are being quoted at $23.45 per
megawatt, according to the Mirant National Power Index.

To give some idea of how radically the landscape has shifted, take the case
of power conglomerate UtiliCorp United Inc., of Kansas City, Mo. In April,
taking advantage of the general enthusiasm toward deregulated markets, it
spun off its Aquila Inc. trading unit at a price of $24 a share, raising $480
million. "We saw an opportunity to crystalize the value" of the trading
company, says UtiliCorp President Bob Green.

Aquila's stock soared to $35 before it began slipping at the end of May.
Since then, it has tumbled by half. Today, with a price/earnings ratio of
eight -- less than most utilities -- the "equity markets are closed" to

Aquila, Mr. Green says.

Now, UtiliCorp, which mainly owns regulated utilities, is planning to buy
back all the publicly traded Aquila shares. It hopes that by taking shelter
under UtiliCorp's umbrella, Aquila will be able to benefit enough from its
parent's strong credit rating and healthy balance sheet to keep trading and
buying more power plants.

In other words, the regulated utilities, once considered homely wallflowers,
are looking more alluring these days as trading firms, such as Aquila and
Enron, have fallen from favor. That could portend a reduction in the huge
trading volumes, and accompanying price volatility, that marked the early
stages of energy deregulation.

But that won't help consumers unless new power plants and transmission lines
come online in time for the economy's resurgence and new rules are put in
place that guarantee a more transparent market. The latter won't be an easy
task, because power trading is done on a variety of public and private
exchanges, with traders darting in and out to take advantage of price
discrepancies.

Lately, there's been growing evidence that some power companies have found
lucrative ways to exploit this system -- at consumers' expense. Their tactics
include manipulating wholesale electricity auctions, taking juice from
transmission systems when they aren't supposed to and denying weaker
competitors access to transmission lines. Regulators believe that this
behavior has contributed to supply glitches and inflated prices.

Under its new chairman, Pat Wood, the FERC has been pressing companies to
take steps it believes will create power markets that are less susceptible to
such shenanigans. Chief among them is for utilities to surrender control of
their high-voltage power lines to independent operators that would give all
market participants fair access and will operate spot markets for power.

Earlier this month, the commission told three of the nation's big integrated
utilities -- American Electric Power Co., Entergy Corp. and Southern Co. --
that until they relinquish control of their power lines to an independent
operator, FERC may intervene to limit the prices they charge wholesale
customers. At least one of the three is appealing the FERC mandate.

The commission has also stepped up efforts to settle pesky but important
technical issues, such as how independent power producers can hook up new
plants to the lines of nearby utilities and how transmission services can
best be priced.

Still, even a more aggressive FERC hasn't been able to solve some lingering
problems. A good example is the continued existence of one of the nation's
worst transmission bottlenecks. Known as "Path 15," the line interconnects
the populous southern part of California with more abundant enercy resources
in the north. The Department of Energy has pledged to help expand Path 15,
which was implicated as a key cause of the blackouts in California earlier
this year.

But actually getting the work done may require PG&E Corp.'s Pacific Gas &

Electric unit, which owns the 90-mile stretch of line, to get approval for
the expansion from the state Public Utilities Commission. But Pacific Gas,

01097

01 200000001769


take steps it believes will create power markets that are less susceptible to
such shenanigans. Chief among them is for utilities to surrender control of
their high-voltage power lines to independent operators that would give all
market participants fair access and will operate spot markets for power.

Earlier this month, the commission told three of the nation's big integrated
utilities -- American Electric Power Co., Entergy Corp. and Southern Co. --
that until they relinquish control of their power lines to an independent
operator, FERC may intervene to limit the prices they charge wholesale
customers. At least one of the three is appealing the FERC mandate.

The commission has also stepped up efforts to settle pesky but important

technical issues, such as how independent power producers can hook up new
plants to the lines of nearby utilities and how transmission services can
best be priced.

Still, even a more aggressive FERC hasn't been able to solve some lingering
problems. A good example is the continued existence of one of the nation's
worst transmission bottlenecks. Known as "Path 15," the line interconnects
the populous southern part of California with more abundant energy resources
in the north. The Department of Energy has pledged to help expand Path 15,
which was implicated as a key cause of the blackouts in California earlier
this year.

But actually getting the work done may require PG&E Corp.'s Pacific Gas &
Electric unit, which owns the 90-mile stretch of line, to get approval for
the expansion from the state Public Utilities Commission. But Pacific Gas,
which placed itself under the protection of the federal bankruptcy courts
amid the California power crisis, is at loggerheads with the PUC. The upshot
is that there may be significant delays in upgrading Path 15. The
implication: when the economy cranks back up, so too will the possibility of
more supply shortages and higher prices, says Terry Winter, chief executive
of California's Independent System Operator, which operates the state's
electricity grid.

, 01014

01200000001686


52-week peak of $216 per megawatt, now are being quoted at $23.45 per
megawatt, according to the Mirant National Power Index.

To give some idea of how radically the landscape has shifted, take the case
of power conglomerate UtiliCorp United Inc., of Kansas City, Mo. In April,
taking advantage of the general enthusiasm toward deregulated markets, it
spun off its Aquila Inc. trading unit at a price of $24 a share, raising $480
million. "We saw an opportunity to crystalize the value" of the trading
company, says UtiliCorp President Bob Green.

Aquila's stock soared to $35 before it began slipping at the end of May.
Since then, it has tumbled by half. Today, with a price/earnings ratio of
eight -- less than most utilities -- the "equity markets are closed" to
Aquila, Mr. Green says.

Now, UtiliCorp, which mainly owns regulated utilities, is planning to buy
back all the publicly traded Aquila shares. It hopes that by taking shelter
under UtiliCorp's umbrella, Aquila will be able to benefit enough from its
parent's strong credit rating and healthy balance sheet to keep trading and
buying more power plants.

In other words, the regulated utilities, once considered homely wallflowers,
are looking more alluring these days as trading firms, such as Aquila and
Enron, have fallen from favor. That could portend a reduction in the huge
trading volumes, and accompanying price volatility, that marked the early
stages of energy deregulation.

But that won't help consumers unless new power plants and transmission lines
come online in time for the economy's resurgence and new rules are put in
place that guarantee a more transparent market. The latter won't be an easy
task, because power trading is done on a variety of public and private
exchanges, with traders darting in and out to take advantage of price
discrepancies.

Lately, there's been growing evidence that some power companies have found
lucrative ways to exploit this system -- at consumers’ expense. Their tactics
include manipulating wholesale electricity auctions, taking juice from
transmission systems when they aren't supposed to and denying weaker
competitors access to transmission lines. Regulators believe that this
behavior has contributed to supply glitches and inflated prices.

Under its new chairman, Pat Wood, the FERC has been pressing companies to
take steps it believes will create power markets that are less susceptible to
such shenanigans. Chief among them is for utilities to surrender control of
their high-voltage power lines to independent operators that would give all
market participants fair access and will operate spot markets for power.

Earlier this month, the commission told three of the nation's big integrated
utilities -- American Electric Power Co., Entergy Corp. and Southern Co. --
that until they relinquish control of their power lines to an independent
operator, FERC may intervene to limit the prices they charge wholesale
customers. At least one of the three is appealing the FERC mandate.

The commission has also stepped up efforts to settle pesky but important
technical issues, such as how independent power producers can hook up new
plants to the lines of nearby utilitics and how transmission services can

5

01110

01200000001782


Farrell, Paula

From: James_Mietus@omb.eop.gov
Seni Friday, November 30, 2007 12:24 PM
To: Alexander_M. Brill@cea.eop.gov, gary.burner@do.treas.gov; paula.farrell@do.treas.gov;
peter.karpoff@hq.doe.gov; kevin.kelly@ferc.fed.us; dan.larcamp@ferc.fed.us; Wallace_P.
—MulinGcea 2p gov. devidrosten@o treas.gov, arthur.rypinski@hq.doe.gov; Garrett_D.
Soden@opd.eop.gov; Michael_C._Toth@omb.eop.gov
Subject: Enron, Deregulation, and TVA

Of possible interest...
- - Forwarded by James Mietus/OMB/EOP on 11/30/2001 12:23 PM

James Mietus
11/30/2001 12:17:36 PM

Record Type: Record

To: Richard A. Mertens/OMB/EOP

cc: Mark A. Weatherly/OMB/EOP@EOP, Marcus Peacock/OMB/EOP@EOP
Subject: Enron, Deregulation, and TVA

In case it has not yet come to your attention, attached below is a copy of a
feature article the Wall Street Journal published today on Enron and
deregulation that has important implications for TVA.

The article, titled "Enron's Swoon Leaves A Grand Experiment In a State of
Disarray." struck me as a "must read” item and a useful overview of the Enron
situation and its relationship to electric industry deregulation

The situation in brief, as I understand it:
Markets are like people. They take time to grow and develop. They pass
through an adolescence that can be easy or hard.
Some have an easy time of it, play varsity ball, get into a competitive
college. Telecommunications worked this way. Competition emerged quickly
and drove down prices. Innovation blossomed as planned. Cell phones are
plentiful and commonplace.
Other markets have a harder time of it and give their advocates fits, like
the high-potential kid with behavioral problems. Electricity seems to fit
in this category. California and Enron are symptomatic of the struggle
underway as the market labors to develop.
Where you stand determines what you see.
Deregulation fans will see Enron and its aftermath as regrettable but
predictable, given the fact that laws are confusing and reforms are
incomplete. ‘The obvious solution: Let PERC, states and competitors work
out the needed reforms and institutions ASAP.
Critics of deregulation of course will see this Rorschach test quite
differently -- risky business, doomed from the start, the result from
irrational adherence to ideology, a victory of theory over common sense.
TVA staff called, by the way and asked if people here had any reaction to the
Enron debacle. I asked about the reaction in Knoxville. Some TVA people were
(jokingly, I think) singing "The witch is dead." Others expressed deep
dismay at what looks like Enron malfeasance.

The Wall Street Journal article follows FYI.

November 30, 2001

Page One Feature

Enron's Swoon Imperils Grand Experiment
In Deregulation of Nation's Power Markets
By REBECCA SMITH

Staff Reporter of THE WALL STREET JOURNAL

01094

01200000001766


(jokingly, I think) singing "The witch is dead." Others expressed deep
dismay at what looks like Enron malfeasance.

The Wall Street Journal article follows FYI.

November 30, 2001

Page One Feature

Enron's Swoon Imperils Grand Experiment
In Deregulation of Nation's Power Markets
By REBECCA SMITH

Staff Reporter of THE WALL STREET JOURNAL

It was one of the great fantasies of American business: a deregulated market
that would send cheaper and more reliable supplies of electricity coursing
into homes and offices across the nation.

But look what's happened instead. Enron Corp., the vast energy trader at the
center of the new freewheeling U.S. power markets, now faces collapse amid a
blizzard of questionable financial deals. And California, the first big state
to deregulate its electricity market, has watched its experiment turn into a
disaster, with intermittent blackouts and retail power rates as much as 40%
higher than they were a year ago.

Now, with the power industry hovering uneasily between regulation and
deregulation, it faces the prospect of a market that combines the worst
features of both: a return to government restrictions, mixed with volatility
and price spikes as companies struggle to meet the nation's future energy
needs.

Investors and lenders, spooked by the twin specters of California and Enron,
have become less likely to commit capital to building new power plants,
transmission lines and natural-gas pipelines. The U.S. will require big
additions to its power production and distribution capacity when it emerges
from the current recession -- but for now, at least, the nation's capital
markets are reluctant to cough up the necessary funds.

Responding to the dramatic decline in their stock prices and the recession,
energy companies are retrenching. Calpine Corp., one of the most aggressive
Players in the deregulated market, is waffling on previously announced plans
to build billions of dollars in new power plants. Virginia-based AES Corp.,
which has missed its recent earnings targets, has scaled back its expansion
goals and is selling some of its foreign assets. Northeast Utilities is
curtailing plans to build a 30-mile undersea transmission line from
Connecticut to Long Island.

Erecting Guardrails

Meanwhile, regulators are racing to place new guardrails on the U.S. power
market. The federal government is trying to beef up its market-surveillance
activities. And it also is trying to broker deals between states that might
make interstate energy transmission faster, cheaper and easier.

The power market is in "the midst of an ugly adolescence that we cannot allow
to last much longer," says Nora Brownell, a member of the Federal Energy
Regulatory Commission in Washington.

That's because, for the consumer, energy deregulation has been anything but
good news. Unlike the deregulated telecommunications market, where fierce
competition brought down prices while guaranteeing a reasonable level of
reliability, the deregulated power market isn't likely to provide real
benefits until it stabilizes. For now, consumers are at the mercy of
wholesale forces they often can't understand and have few real options to
switch between service providers.

The theory behind deregulation was that it would lead to the emergence of
efficient companies that would specialize in providing electric power,
carrying it over long distances or delivering it to a final customer.
‘Hybrids Don't Work’

While the industry started to move in that direction, it isn't anymore. Many
big power companies in the most populous states, which are the ones that also

01100

01200000001772


marketplace that sat at the center of electricity deregulation -- providing a
place for utilities and power plants to buy energy they needed in a hurry, or
to unload their excess supplies. The company's EnronOnline trading system,
which was shut down Wednesday, accounted for a quarter of all wholesale
energy trades among U.S. utilities, independent power producers and other
market players.

The trading system's shutdown came in the wake of disclosures that Enron's
directors and top officers approved a series of partnerships that moved debts
off the company's balance sheet. In several cases, those partnerships
enriched company officers but later produced huge losses for Enron.

That kind of "balance-sheet abuse" says Goldman Sachs analyst Jonathan
Raleigh, might now "reduce overall liquidity and cause lenders to tighten
credit standards" for the entire energy-trading industry. The result could be
the kind of supply squeezes that led to six days of blackouts in California
earlier this year.

California's supply problems didn't spread beyond the Pacific Northwest --
but that's largely because of the sharp economic downturn. As spot-market
power prices in California shot up to an average of $317 per megawatt in
December 2000 from $32 per megawatt hour the preceding April, energy
companies were making enormous amounts of money. Investors drove up the price
of the companies' stocks, with Enron at one point trading at 60 times its
projected next year's earnings. New funding was flooding in from debt and
equity markets. Under pressure from regulators worried about a repeat of the
California debacle, energy companies got busy building power plants, drawing
up plans to fix the nation's antiquated electric-transmission systems and
plotting new natural-gas pipelines.

But that golden moment for the industry turned out to be short-lived. Early
this year, federal energy regulators placed caps on the wholesale price of
power sold in the western U.S. as California's two main investor-owned
utilities were pushed to the brink of insolvency. Then, in the spring,
natural-gas and electricity prices collapsed around the country as the
economy suddenly slowed to a crawl. Even before Enron got into trouble, the
big energy companies began to see their stock prices sink, and investors
began to cast a more critical eye on their expansion plans in the wake of the
California chaos and the resulting multibillion-dollar electricity payment
crisis.

One of the first signs that a sea change was under way came a few months ago
when demand for power-generation turbines began to soften. Because there are
only three domestic suppliers of such multimillion-dollar engines, the most
expensive pieces of machinery used by commercial electricity producers, the
machines must be ordered well in advance of their deployment.

A year ago, says David Sokol, chief executive of Iowa-based utility owner
Mid-American Energy Holdings Co., “you had to pay a premium to get a
turbine." Companies with lots of turbines on order, such as San Jose
Calif.-based Calpine, boasted that they would clean up in newly deregulated
markets such as the West, the Northeast and New York, where electricity
supplies back then were tight. "But now," Mr. Sokol says, "I know of at least
100 (turbines) that are for sale. People want you to take their place in
line."

While most energy companies are pressing ahead with projects they have
started, they have grown cautious about breaking ground on new ones. Just a
few months ago Calpine boldly claimed it would have 70,000 megawatts of
generating capacity -- the equivalent of 35 to 45 big power plants -- in
operation by 2005. Now it's backing away from that assertion. The company
currently has only a fraction of that capacity, 11,000 megawatts.

At the root of the problem is a lack of capital and earnings. While energy
companies routinely beat their own bullish quarterly profit estimates last
year, many of them have lately indicated that they will miss earnings
projections. With electricity and natural-gas prices down, energy sales tend
to be less profitable. Hence, investors haven't been willing to pay the same
price-earnings multiples for energy stocks.

Bankers, meanwhile, want convincing evidence that future power prices will be

; 01096

01200000001768


best be priced.

Still, even a more aggressive FERC hasn't been able to solve some lingering
problems. A good example is the continued existence of one of the nation's
worst transmission bottlenecks. Known as "Path 15," the line interconnects
the populous southern part of California with more abundant energy resources
in the north. The Department of Energy has pledged to help expand Path 15,
which was implicated as a key cause of the blackouts in California earlier

this year.

But actually getting the work done may require PG&E Corp.'s Pacific Gas &
Electric unit, which owns the 90-mile stretch of line, to get approval for

the expansion from the state Public Utilities Commission. But Pacific Gas,
which placed itself under the protection of the federal bankruptcy courts
amid the California power crisis, is at loggerheads with the PUC. The upshot
is that there may be significant delays in upgrading Path 15. The
implication: when the economy cranks back up, so too will the possibility of
more supply shortages and higher prices, says Terry Winter, chief executive
of California's Independent System Operator, which operates the state's
electricity grid.

01111

01200000001783


The theory behind deregulation was that it would lead to the emergence of
efficient companies that would specialize in providing electric power
carrying it over long distances or delivering it to a final customer.

‘Hybrids Don't Work’

While the industry started to move in that direction, it isn't anymore. Many
big power companies in the most populous states, which are the ones that also
happen to be deregulated, still do a little of everything and are
increasingly confused about where to place their business bets.

When it comes to electricity markets, says Frank Wolak, a Stanford University
economics professor, these kinds of "hybrids don't work." But, he fears that
they will be around for some time to come, especially since regulators, who
once thought the markets themselves would bring about deregulation's goals,
are only belatedly assuming responsibility for making sure things run
smoothly.

Enron's sudden meltdown will deal a heavy blow to the broader energy
marketplace that sat at the center of electricity deregulation -- providing a
place for utilities and power plants to buy energy they needed in a hurry, or
to unload their excess supplies. The company's EnronOnline trading system,
which was shut down Wednesday, accounted for a quarter of all wholesale
energy trades among U.S. utilities, independent power producers and other
market players.

The trading system's shutdown came in the wake of disclosures that Enron's
directors and top officers approved a series of partnerships that moved debts
off the company's balance sheet. In several cases, those partnerships
enriched company officers but later produced huge losses for Enron.

That kind of "balance-sheet abuse" says Goldman Sachs analyst Jonathan
Raleigh, might now "reduce overall liquidity and cause lenders to tighten
credit standards" for the entire energy-trading industry. The result could be
the kind of supply squeezes that led to six days of blackouts in California
earlier this year.

California's supply problems didn't spread beyond the Pacific Northwest --
but that's largely because of the sharp economic downturn. As spot-market
power prices in California shot up to an average of $317 per megawatt in
December 2000 from $32 per megawatt hour the preceding April, energy
companies were making enormous amounts of money. Investors drove up the price
of the companies' stocks, with Enron at one point trading at 60 times its
projected next year's earnings. New funding was flooding in from debt and
equity markets. Under pressure from regulators worried about a repeat of the
California debacle, energy companies got busy building power plants, drawing
up plans to fix the nation's antiquated electric-transmission systems and
plotting new natural-gas pipelines.

But that golden moment for the industry turned out to be short-lived. Early
this year, federal energy regulators placed caps on the wholesale price of
power sold in the western U.S. as California's two main investor-owned
utilities were pushed to the brink of insolvency. Then, in the spring,
natural-gas and electricity prices collapsed around the country as the
economy suddenly slowed to a crawl. Even before Enron got into trouble, the
big energy companies began to see their stock prices sink, and investors
began to cast a more critical eye on their expansion plans in the wake of the
California chaos and the resulting multibillion-dollar electricity payment
crisis.

One of the first signs that a sea change was under way came a few months ago
when demand for power-generation turbines began to soften. Because there are
only three domestic suppliers of such multimillion-dollar engines, the most
expensive pieces of machinery used by commercial electricity producers, the
machines must be ordered well in advance of their deployment.

A year ago, says David Sokol, chief executive of Iowa-based utility owner

01091

01200000001763


The commission has also stepped up efforts to settle pesky but important
technical issues, such as how independent power producers can hook up new
plants to the lines of nearby utilities and how transmission services can
best be priced.

Still, even a more aggressive FERC hasn't been able to solve some lingering
problems. A good example is the continued existence of one of the nation's
worst transmission bottlenecks. Known as "Path 15," the line interconnects
the populous southern part of California with more abundant energy resources
in the north. The Department of Energy has pledged to help expand Path 15,
which was implicated as a key cause of the blackouts in California earlier
this year.

But actually getting the work done may require PG&E Corp.'s Pacific Gas &
Electric unit, which owns the 90-mile stretch of line, to get approval for
the expansion from the state Public Utilities Commission. But Pacific Gas,
which placed itself under the protection of the federal bankruptcy courts
amid the California power crisis, is at loggerheads with the PUC. The upshot
is that there may be significant delays in upgrading Path 15. The
implication: when the economy cranks back up, so too will the possibility of
more supply shortages and higher prices, says Terry Winter, chief executive
of California's Independent System Operator, which operates the state's
electricity grid.

e 01019

01200000001691


Connecticut to Long Island.

Erecting Guardrails

Meanwhile, regulators are racing to place new guardrails on the U.S. power
market. The federal government is trying to beef up its market-surveillance
activities. And it also is trying to broker deals between states that might

make interstate energy transmission faster, cheaper and easier.

The power market is in "the midst of an ugly adolescence that we cannot allow
to last much longer," says Nora Brownell, a member of the Federal Energy
Regulatory Commission in Washington.

That's because, for the consumer, energy deregulation has been anything but
good news. Unlike the deregulated telecommunications market, where fierce
competition brought down prices while guaranteeing a reasonable level of
reliability, the deregulated power market isn't likely to provide real

benefits until it stabilizes. For now, consumers are at the mercy of
wholesale forces they often can't understand and have few real options to
switch between service providers.

The theory behind deregulation was that it would lead to the emergence of
efficient companies that would specialize in providing electric power,
carrying it over long distances or delivering it to a final customer.

"Hybrids Don't Work’

While the industry started to move in that direction, it isn't anymore. Many
big power companies in the most populous states, which are the ones that also
happen to be deregulated, still do a little of everything and are

increasingly confused about where to place their business bets.

When it comes to clectricity markets, says Frank Wolak, a Stanford University
economics professor, these kinds of "hybrids don't work." But, he fears that
they will be around for some time to come, especially since regulators, who
once thought the markets themselves would bring about deregulation's goals,
are only belatedly assuming responsibility for making sure things run
smoothly.

Enron's sudden meltdown will deal a heavy blow to the broader energy
marketplace that sat at the center of electricity deregulation -- providing a
place for utilities and power plants to buy energy they needed in a hurry, or
to unload their excess supplies. The company's EnronOnline trading system,
which was shut down Wednesday, accounted for a quarter of all wholesale
energy trades among U.S. utilities, independent power producers and other
market players.

The trading system's shutdown came in the wake of disclosures that Enron's
directors and top officers approved a series of partnerships that moved debts
off the company's balance sheet. In several cases, those partnerships
enriched company officers but later produced huge losses for Enron.

That kind of “balance-sheet abuse” says Goldman Sachs analyst Jonathan
Raleigh, might now "reduce overall liquidity and cause lenders to tighten
credit standards" for the entire energy-trading industry. The result could be
the kind of supply squeezes that led to six days of blackouts in California
earlier this year.

01108

01200000001780


Still, even a more aggressive FERC hasn't been able to solve some lingering
problems. A good example is the continued existence of one of the nation's
worst transmission bottlenecks. Known as "Path 15," the line interconnects
the populous southern part of California with more abundant energy resources
in the north. The Department of Energy has pledged to help expand Path 15,
which was implicated as a key cause of the blackouts in California earlier
this year.

But actually getting the work done may require PG&E Corp.'s Pacific Gas &
Electric unit, which owns the 90-mile stretch of line, to get approval for
the expansion from the state Public Utilities Commission. But Pacific Gas,
which placed itself under the protection of the federal bankruptcy courts
amid the California power crisis, is at loggerheads with the PUC. The upshot
is that there may be significant delays in upgrading Path 15. The
implication: when the economy cranks back up, so too will the possibility of
more supply shortages and higher prices, says Terry Winter, chief executive
of California's Independent System Operator, which operates the state's
electricity grid.

; 01103

01200000001775


Enron's Swoon Imperils Grand Experiment
In Deregulation of Nation's Power Markets
By REBECCA SMITH

Staff Reporter of THE WALL STREET JOURNAL

It was one of the great fantasies of American business: a deregulated market
that would send cheaper and more reliable supplies of electricity coursing
into homes and offices across the nation.

But look what's happened instead. Enron Corp., the vast energy trader at the
center of the new freewheeling U.S. power markets, now faces collapse amid a
blizzard of questionable financial deals. And California, the first big state
to deregulate its electricity market, has watched its experiment turn into a
disaster, with intermittent blackouts and retail power rates as much as 40%
higher than they were a year ago.

Now, with the power industry hovering uneasily between regulation and
deregulation, it faces the prospect of a market that combines the worst
features of both: a return to government restrictions, mixed with volatility
and price spikes as companies struggle to meet the nation's future energy
needs.

Investors and lenders, spooked by the twin specters of California and Enron,
have become less likely to commit capital to building new power plants,
transmission lines and natural-gas pipelines. The U.S. will require big
additions to its power production and distribution capacity when it emerges
from the current recession -- but for now, at least, the nation's capital
markets are reluctant to cough up the necessary funds.

Responding to the dramatic decline in their stock prices and the recession,
energy companies are retrenching. Calpine Corp., one of the most aggressive
players in the deregulated market, is waffling on previously announced plans
to build billions of dollars in new power plants. Virginia-based AES Corp.,
which has missed its recent earnings targets, has scaled back its expansion
goals and is selling some of its foreign assets. Northeast Utilities is
curtailing plans to build a 30-mile undersea transmission line from
Connecticut to Long Island.

Erecting Guardrails

Meanwhile, regulators are racing to place new guardrails on the U.S. power
market. The federal government is trying to beef up its market-surveillance
activities. And it also is trying to broker deals between states that might
make interstate energy transmission faster, cheaper and easier.

The power market is in "the midst of an ugly adolescence that we cannot allow
to last much longer," says Nora Brownell, a member of the Federal Energy
Regulatory Commission in Washington.

That's because, for the consumer, energy deregulation has been anything but
good news. Unlike the deregulated telecommunications market, where fierce
competition brought down prices while guaranteeing a reasonable level of
reliability, the deregulated power market isn't likely to provide real
benefits until it stabilizes. For now, consumers are at the mercy of
wholesale forces they often can't understand and have few real options to
switch between service providers.

The theory behind deregulation was that it would lead to the emergence of
efficient companies that would specialize in providing electric power,
carrying it over long distances or delivering it to a final customer.
‘Hybrids Don't Work’

While the industry started to move in that direction, it isn't anymore. Many
big power companies in the most populous states, which are the ones that also

happen to be deregulated, still do a little of everything and are
increasingly confused about where to place their business bets.

; 01016

01200000001688


Burner, Gary

From: James_Mietus@omb.eop.gov
Sent: Friday, November 30, 2001 12:24 PM
To: Alexander_M._Brill@cea.eop.gov; gary.burner@do.treas.gov; paula.farrell@do.treas.gov;

peter.karpoff@hq.doe.gov; kevin.kelly@ferc.fed.us; dan.larcamp@ferc.fed.us; Wallace_P.
_Mullin@cea.eop.gov; david.reiffen@do.treas.gov; arthur.rypinski@hq.doe.gov; Garrett_D.
“Soden@opd.eop.gov; Michael_C._Toth@omb.eop.gov

Subject: Enron, Deregulation, and TVA

Of possible interest...
werner nnee Forwarded by James Mietus/OMB/EOP on 11/30/2001 12:23 PM

James Mietus
11/30/2001 12:17:36 PM

Record Type: Record

To: Richard A. Mertens/OMB/EOP

ce: Mark A. Weatherly/OMB/EOP@EOP, Marcus Peacock/OMB/EOP@EOP
Subject: Enron, Deregulation, and TVA

In case it has not yet come to your attention, attached below is a copy of a
feature article the Wall Street Journal published today on Enron and
deregulation that has important implications for TVA.

The article, titled "Enron's Swoon Leaves A Grand Experiment In a State of
Disarray." struck me as a "must read" item and a useful overview of the Enron
situation and its relationship to electric industry deregulation

The situation in brief, as I understand it:
Markets are like people. They take time to grow and develop. They pass
through an adolescence that can be easy or hard.
Some have an easy time of it, play varsity ball, get into a competitive
college. Telecommunications worked this way. Competition emerged quickly
and drove down prices. Innovation blossomed as planned. Cell phones are
plentiful and commonplace.
Other markets have a harder time of it and give their advocates fits, like
the high-potential kid with behavioral problems. Electricity seems to fit
in this category. California and Enron are symptomatic of the struggle
underway as the market labors to develop.
Where you stand determines what you see.
Deregulation fans will see Enron and its aftermath as regrettable but
predictable, given the fact that laws are confusing and reforms are
incomplete. The obvious solution: Let FERC, states and competitors work
out the needed reforms and institutions ASAP.
Critics of deregulation of course will see this Rorschach test quite
differently -- risky business, doomed from the start, the result from
irrational adherence to ideology, a victory of theory over common sense.
TVA staff called, by the way and asked if people here had any reaction to the
Enron debacle. I asked about the reaction in Knoxville. Some TVA people were
(jokingly, I think) singing "The witch is dead." Others expressed deep
dismay at what looks like Enron malfeasance.

The Wall Street Journal article follows FYI.

November 30, 2001

rover 20,200 01015

01200000001687


Mid-American Energy Holdings Co., "you had to pay a premium to get a
turbine." Companies with lots of turbines on order, such as San Jose,
Calif.-based Calpine, boasted that they would clean up in newly deregulated
markets such as the West, the Northeast and New York, where electricity
supplies back then were tight. "But now," Mr. Sokol says, "I know of at least
100 (turbines) that are for sale. People want you to take their place in
line."

While most energy companies are pressing ahead with projects they have
started, they have grown cautious about breaking ground on new ones. Just a
few months ago Calpine boldly claimed it would have 70,000 megawatts of
generating capacity -- the equivalent of 35 to 45 big power plants -- in
operation by 2005. Now it's backing away from that assertion. The company
currently has only a fraction of that capacity, 11,000 megawatts.

At the root of the problem is a lack of capital and earnings. While energy
companies routinely beat their own bullish quarterly profit estimates last
year, many of them have lately indicated that they will miss earnings
projections. With electricity and natural-gas prices down, energy sales tend
to be less profitable. Hence, investors haven't been willing to pay the same
price-earnings multiples for energy stocks.

Bankers, meanwhile, want convincing evidence that future power prices will be
high enough to justify new projects. That's far from guaranteed in
deregulated markets. In fact, national electricity prices, which hit a
52-week peak of $216 per megawatt, now are being quoted at $23.45 per
megawatt, according to the Mirant National Power Index.

To give some idea of how radically the landscape has shifted, take the case
of power conglomerate UtiliCorp United Inc., of Kansas City, Mo. In April,
taking advantage of the general enthusiasm toward deregulated markets, it
spun off its Aquila Inc. trading unit at a price of $24 a share, raising $480
million. "We saw an opportunity to crystalize the value" of the trading
company, says UtiliCorp President Bob Green.

Aquila's stock soared to $35 before it began slipping at the end of May.
Since then, it has tumbled by half. Today, with a price/earnings ratio of
eight -- less than most utilities -- the "equity markets are closed" to

Aquila, Mr. Green says.

Now, UtiliCorp, which mainly owns regulated utilities, is planning to buy
back all the publicly traded Aquila shares. It hopes that by taking shelter
under UtiliCorp's umbrella, Aquila will be able to benefit enough from its
parent's strong credit rating and healthy balance sheet to keep trading and
buying more power plants.

In other words, the regulated utilities, once considered homely wallflowers,
are looking more alluring these days as trading firms, such as Aquila and
Enron, have fallen from favor. That could portend a reduction in the huge
trading volumes, and accompanying price volatility, that marked the early
stages of energy deregulation.

But that won't help consumers unless new power plants and transmission lines
come online in time for the economy's resurgence and new rules are put in
place that guarantee a more transparent market. The latter won't be an easy
task, because power trading is done on a variety of public and private
exchanges, with traders darting in and out to take advantage of price
discrepancies.

Lately, there's been growing evidence that some power companies have found
lucrative ways to exploit this system -- at consumers' expense. Their tactics
include manipulating wholesale electricity auctions, taking juice from
transmission systems when they aren't supposed to and denying weaker
competitors access to transmission lines. Regulators believe that this
behavior has contributed to supply glitches and inflated prices

Under its new chairman, Pat Wood, the FERC has been pressing companies to
4

01092

01200000001764


generating capacity -- the equivalent of 35 to 45 big power plants -- in
operation by 2005. Now it's backing away from that assertion. The company
currently has only a fraction of that capacity, 11,000 megawatts.

At the root of the problem is a lack of capital and earnings. While energy
companies routinely beat their own bullish quarterly profit estimates last
year, many of them have lately indicated that they will miss earnings
projections. With electricity and natural-gas prices down, energy sales tend
to be less profitable. Hence, investors haven't been willing to pay the same
price-earnings multiples for energy stocks.

Bankers, meanwhile, want convincing evidence that future power prices will be
high enough to justify new projects. That's far from guaranteed in
deregulated markets. In fact, national electricity prices, which hit a
52-week peak of $216 per megawatt, now are being quoted at $23.45 per
megawatt, according to the Mirant National Power Index.

To give some idea of how radically the landscape has shifted, take the case
of power conglomerate UtiliCorp United Inc., of Kansas City, Mo. In April,
taking advantage of the general enthusiasm toward deregulated markets, it
spun off its Aquila Inc. trading unit at a price of $24 a share, raising $480
million. "We saw an opportunity to crystalize the value" of the trading
company, says UtiliCorp President Bob Green.

Aquila's stock soared to $35 before it began slipping at the end of May.
Since then, it has tumbled by half. Today, with a price/earnings ratio of
eight -- less than most utilities -- the “equity markets are closed" to

Aquila, Mr. Green says.

Now, Utilicorp, which mainly owns regulated utilities, is planning to buy
back all the publicly traded Aquila shares. It hopes that by taking shelter
under UtiliCorp's umbrella, Aquila will be able to benefit enough from its
parent's strong credit rating and healthy balance sheet to keep trading and
buying more power plants.

In other words, the regulated utilities, once considered homely wallflowers,
are looking more alluring these days as trading firms, such as Aquila and
Enron, have fallen from favor. That could portend a reduction in the huge
trading volumes, and accompanying price volatility, that marked the early
stages of energy deregulation.

But that won't help consumers unless new power plants and transmission lines
come online in time for the economy's resurgence and new rules are put in
place that guarantee a more transparent market. The latter won't be an easy
task, because power trading is done on a variety of public and private
exchanges, with traders darting in and out to take advantage of price
discrepancies.

Lately, there's been growing evidence that some power companies have found
lucrative ways to exploit this system -- at consumers' expense. Their tactics
include manipulating wholesale electricity auctions, taking juice from
transmission systems when they aren't supposed to and denying weaker
competitors access to transmission lines. Regulators believe that this
behavior has contributed to supply glitches and inflated prices.

Under its new chairman, Pat Wood, the FERC has been pressing companies to
take steps it believes will create power markets that are less susceptible to
such shenanigans. Chief among them is for utilities to surrender control of
their high-voltage power lines to independent operators that would give all
market participants fair access and will operate spot markets for power.

Earlier this month, the commission told three of the nation's big integrated
utilities -- American Electric Power Co., Entergy Corp. and Southern Co. --
that until they relinquish control of their power lines to an independent
operator, FERC may intervene to limit the prices they charge wholesale
customers. At least one of the three is appealing the FERC mandate.

il

01018

01200000001690


which placed itself under the protection of the federal bankruptcy courts
amid the California power crisis, is at loggerheads with the PUC. The upshot
is that there may be significant delays in upgrading Path 15. The
implication: when the economy cranks back up, so too will the possibility of
more supply shortages and higher prices, says Terry Winter, chief executive
of California's Independent System Operator, which operates the state's
electricity grid.

01098

01200000001770


Burner, Gary

From: Farrell, Paula

Sent: Friday, November 30, 2001 7:22 PM

To: Bumer, Gary; Atkins, Preston Jr, Revesz, Paul; Oster, Karen; Finch, Glenda
Subject: FW: Enron, Deregulation, and TVA

-----' Original Message-----

James_Mietus@omb.eop.gov [mailto:James_Mietus@omb.eop.gov]
Sent: Friday, November 30, 2001 12:24 PM

To: Alexander_M. Brill@cea.eop.gov; gary.burner@do.treas.gov;
paula. farrell@édo.treas.gov; peter.karpoff@hq.doe.gov;

kevin. kelly@ferc.fed.us; dan.larcamp@ferc.fed.us;

Wallace _P. Mullin@cea.eop.gov; david.reiffengdo.treas.gov;
arthur.rypinski@hq.doe.gov; Garrett_D._Soden@opd.eop.gov;
Michael_C._Toth@omb.eop.gov

Subject: Enron, Deregulation, and TVA

Of possible interest

Forwarded by James Mietus/OMB/EOP on 11/30/2001 12:23 PM

James Mietus
11/30/2001 12:17:36 PM

Record Type: Record

To: Richard A. Mertens/OMB/EOP

ec: Mark A, Weatherly/OMB/EOP@EOP, Marcus Peacock/OMB/EOP@EOP
Subject: Enron, Deregulation, and TVA

In case it has not yet come to your attention, attached below is a copy of a
feature article the Wall Street Journal published today on Enron and
deregulation that has important implications for TVA.

The article, titled "Enron's Swoon Leaves A Grand Experiment In a State of
Disarray." struck me as a "must read" item and a useful overview of the Enron
situation and its relationship to electric industry deregulation

The situation in brief, as I understand it:

Markets are like people. They take time to grow and develop. They pass

through an adolescence that can be easy or hard.
Some have an easy time of it, play varsity ball, get into a competitive
college. Telecommunications worked this way. Competition emerged quickly
and drove down prices. Innovation blossomed as planned. Cell phones are
plentiful and commonplace.
Other markets have a harder time of it and give their advocates fits, like
the high-potential kid with behavioral problems. Electricity seems to fit
in this category. California and Enron are symptomatic of the struggle
underway as the market labors to develop.

Where you stand determines what you see.
Deregulation fans will see Enron and its aftermath as regrettable but
predictable, given the fact that laws are confusing and reforms are
incomplete. The obvious solution: Let FERC, states and competitors work
out the needed reforms and institutions ASAP.
Critics of deregulation of course will see this Rorschach test quite

01010

01200000001682


differently -- risky business, doomed from the start, the result from

irrational adherence to ideology, a victory of theory over common sense.
TVA staff called, by the way and asked if people here had any reaction to the
Enron debacle. I asked about the reaction in Knoxville. Some TVA people were
(jokingly, I think) singing "The witch is dead." Others expressed deep
dismay at what looks like Enron malfeasance.

The Wall Street Journal article follows FYI.

November 30, 2001

Page One Feature

Enron's Swoon Imperils Grand Experiment
In Deregulation of Nation's Power Markets
By REBECCA SMITH

Staff Reporter of THE WALL STREET JOURNAL

It was one of the great fantasies of American business: a deregulated market
that would send cheaper and more reliable supplies of electricity coursing
into homes and offices across the nation.

But look what's happened instead. Enron Corp., the vast energy trader at the
center of the new freewheeling U.S. power markets, now faces collapse amid a
blizzard of questionable financial deals. And California, the first big state
to deregulate its electricity market, has watched its experiment turn into a
disaster, with intermittent blackouts and retail power rates as much as 40%
higher than they were a year ago.

Now, with the power industry hovering uneasily between regulation and
deregulation, it faces the prospect of a market that combines the worst
features of both: a return to government restrictions, mixed with volatility
and price spikes as companies struggle to meet the nation's future energy
needs.

Investors and lenders, spooked by the twin specters of California and Enron,
have become less likely to commit capital to building new power plants,
transmission lines and natural-gas pipelines. The U.S. will require big
additions to its power production and distribution capacity when it emerges
from the current recession -- but for now, at least, the nation's capital
markets are reluctant to cough up the necessary funds.

Responding to the dramatic decline in their stock prices and the recession,
energy companies are retrenching. Calpine Corp., one of the most aggressive
players in the deregulated market, is waffling on previously announced plans
to build billions of dollars in new power plants. Virginia-based AES Corp.,
which has missed its recent earnings targets, has scaled back its expansion
goals and is selling some of its foreign assets. Northeast Utilities is
curtailing plans to build a 30-mile undersea transmission line from
Connecticut to Long Island.

Erecting Guardrails

Meanwhile, regulators are racing to place new guardrails on the U.S. power
market. The federal government is trying to beef up its market-surveillance
activities. And it also is trying to broker deals between states that might
make interstate energy transmission faster, cheaper and easier.

The power market is in “the midst of an ugly adolescence that we cannot allow
to last much longer," says Nora Brownell, a member of the Federal Energy
Regulatory Commission in Washington.

That's because, for the consumer, energy deregulation has been anything but
good news. Unlike the deregulated telecommunications market, where fierce
competition brought down prices while guaranteeing a reasonable level of
reliability, the deregulated power market isn't likely to provide real
benefits until it stabilizes. For now, consumers are at the mercy of
wholesale forces they often can't understand and have few real options to

switch between service providers.

01200000001693


Oster, Karen

ee ee EEE

From: Farrell, Paula

Sent: Friday, November 30, 2001 7:22 PM

To: Burner, Gary; Atkins, Preston Jr; Revesz, Paul; Oster, Karen; Finch, Glenda
Subject: FW: Enron, Deregulation, and TVA

wreee Original Message-----

From: James_Mietus@omb.eop.gov [mailto:James_Mietus@omb.eop.gov]
Sent: Friday, November 30, 2001 12:24 PM

To: Alexander_M._Brill@cea.eop.gov; gary.burner@do.treas.gov;
paula. farrell@do.treas.gov; peter.karpoff@hq.doe.gov;

kevin. keliy@ferc.fed.us; dan. larcamp@ferc.fed.us;

Wallace _P. Mullin@cea.eop.gov; david.reiffen@do.treas.gov;
arthur.rypinski@hq.doe.gov; Garrett_D._Soden@opd.eop.gov;
Michael_C._Toth@omb.eop.gov

Subject: Enron, Deregulation, and TVA

Of possible interest

Forwarded by James Mietus/OMB/EOP on 11/30/2001 12:23 PM

James Mietus
11/30/2001 12:17:36 PM

Record Type: Record

To: Richard A. Mertens/OMB/EOP

ce: Mark A. Weatherly/OMB/EOP@EOP, Marcus Peacock/OMB/EOP@EOP
Subject: Enron, Deregulation, and TVA

In case it has not yet come to your attention, attached below is a copy of a
feature article the Wall Street Journal published today on Enron and
deregulation that has important implications for TVA.

The article, titled "Enron's Swoon Leaves A Grand Experiment In a State of
Disarray." struck me as a "must read" item and a useful overview of the Enron
situation and its relationship to electric industry deregulation

The situation in brief, as I understand it:

Markets are like people. They take time to grow and develop. They pass

through an adolescence that can be easy or hard.
Some have an easy time of it, play varsity ball, get into a competitive
college. Telecommunications worked this way. Competition emerged quickly
and drove down prices. Innovation blossomed as planned. Cell phones are
plentiful and commonplace.
Other markets have a harder time of it and give their advocates fits, like
the high-potential kid with behavioral problems. Electricity seems to fit
in this category. California and Enron are symptomatic of the struggle
underway as the market labors to develop.

Where you stand determines what you see.
Deregulation fans will see Enron and its aftermath as regrettable but
predictable, given the fact that laws are confusing and reforms are
incomplete. The obvious solution: Let FERC, states and competitors work
out the needed reforms and institutions ASAP.
Critics of deregulation of course will see this Rorschach test quite

1

01020

01200000001692


the high-potential kid with behavioral problems. Electricity seems to fit
in this category. California and Enron are symptomatic of the struggle
underway as the market labors to develop.
Where you stand determines what you see.
Deregulation fans will see Enron and its aftermath as regrettable but
predictable, given the fact that laws are confusing and reforms are
incomplete. The obvious solution: Let FERC, states and competitors work
out the needed reforms and institutions ASAP.
Critics of deregulation of course will see this Rorschach test quite
differently -- risky business, doomed from the start, the result from
irrational adherence to ideology, a victory of theory over common sense.
TVA staff called, by the way and asked if people here had any reaction to the
Enron debacle. I asked about the reaction in Knoxville. Some TVA people were
(jokingly, I think) singing "The witch is dead." Others expressed deep
dismay at what looks like Enron malfeasance.

The Wall Street Journal article follows FYI.

November 30, 2001

Page One Feature

Enron's Swoon Imperils Grand Experiment

In Deregulation of Nation's Power Markets

By REBECCA SMITH

Staff Reporter of THE WALL STREET JOURNAL

It was one of the great fantasies of American business: a deregulated market
that would send cheaper and more reliable supplies of electricity coursing
into homes and offices across the nation.

But look what's happened instead. Enron Corp., the vast energy trader at the
center of the new freewheeling U.S. power markets, now faces collapse amid a
blizzard of questionable financial deals. And California, the first big state

to deregulate its electricity market, has watched its experiment turn into a
disaster, with intermittent blackouts and retail power rates as much as 40%
higher than they were a year ago.

Now, with the power industry hovering uneasily between regulation and
deregulation, it faces the prospect of a market that combines the worst
features of both: a return to government restrictions, mixed with volatility
and price spikes as companies struggle to meet the nation's future energy
needs.

Investors and lenders, spooked by the twin specters of California and Enron,
have become less likely to commit capital to building new power plants,
transmission lines and natural-gas pipelines. The U.S. will require big
additions to its power production and distribution capacity when it emerges
from the current recession -- but for now, at least, the nation's capital
markets are reluctant to cough up the necessary funds.

Responding to the dramatic decline in their stock prices and the recession,
energy companies are retrenching. Calpine Corp., one of the most aggressive
players in the deregulated market, is waffling on previously announced plans
to build billions of dollars in new power plants. Virginia-based AES Corp.,
which has missed its recent earnings targets, has scaled back its expansion
goals and is selling some of its foreign assets. Northeast Utilities is
curtailing plans to build a 30-mile undersea transmission line from

2

01107

01200000001779


Revesz, Paul

From: Farrell, Paula

Sent: Friday, November 30, 2001 7:22 PM

To: Burner, Gary; Atkins, Preston Jr; Revesz, Paul; Oster, Karen; Finch, Glenda
Subject: FW: Enron, Deregulation, and TVA

-----Original Message-----

From: James_Mietus@omb.cop.gov [mailto:James_Mietus@omb.cop.gov]
Sent: Friday, November 30, 2001 12:24 PM

To: Alexander_M._Brill@cea.cop.gov; gary.burner@do.treas.gov;

paula. farrell@do.treas.gov; peter.karpoff@hq.doe.gov;

kevin.kelly@ferc. fed.us; dan.larcamp@ferc.fed.us;
Wallace_P._Mullin@cea.cop.gov; david.reiffen@do.treas.gov;
arthur.rypinski@hq.doe.gov; Garrett_D,_ Soden@opd.¢cop.gov;
Michael_C._Toth@omb.cop.gov

Subject: Enron, Deregulation, and TVA

Of possible interest...
saveennsenncseseeeene Forwarded by James Mietus/OMB/EOP on 11/30/2001 12:23 PM

James Mietus
11/30/2001 12:17:36 PM

Record Type: Record

To: Richard A. Mertens/OMB/EOP

cc: Mark A. Weatherly(OMB/EOP@EOP, Marcus Peacock/OMB/EOP@EOP
Subject: Enron, Deregulation, and TVA

In case it has not yet come to your attention, attached below is a copy of a
feature article the Wall Street Journal published today on Enron and
deregulation that has important implications for TVA.

The article, titled "Enron's Swoon Leaves A Grand Experiment In a State of
Disarray." struck me as a "must read" item and a useful overview of the Enron
situation and its relationship to electric industry deregulation

The situation in brief, as I understand it:

Markets are like people. They take time to grow and develop. They pass

through an adolescence that can be easy or hard.
Some have an easy time of it, play varsity ball, get into a competitive
college. Telecommunications worked this way. Competition emerged quickly
and drove down prices. Innovation blossomed as planned. Cell phones are
plentiful and commonplace.
Other markets have a harder time of it and give their advocates fits, like

01106

01200000001778


When it comes to electricity markets, says Frank Wolak, a Stanford University
economics professor, these kinds of “hybrids don't wor! But, he fears that
they will be around for some time to come, especially since regulators, who
once thought the markets themselves would bring about deregulation's goals,
are only belatedly assuming responsibility for making sure things run
smoothly.

Enron's sudden meltdown will deal a heavy blow to the broader energy
marketplace that sat at the center of electricity deregulation -- providing a
place for utilities and power plants to buy energy they needed in a hurry, or
to unload their excess supplies. The company's EnronOnline trading system,
which was shut down Wednesday, accounted for a quarter of all wholesale
energy trades among U.S. utilities, independent power producers and other
market players.

The trading system's shutdown came in the wake of disclosures that Enron's
directors and top officers approved a series of partnerships that moved debts
off the company's balance sheet. In several cases, those partnerships
enriched company officers but later produced huge losses for Enron.

That kind of "balance-sheet abuse" says Goldman Sachs analyst Jonathan
Raleigh, might now "reduce overall liquidity and cause lenders to tighten
credit standards" for the entire energy-trading industry. The result could be
the kind of supply squeezes that led to six days of blackouts in California
earlier this year.

California's supply problems didn't spread beyond the Pacific Northwest --
but that's largely because of the sharp economic downturn. As spot-market
power prices in California shot up to an average of $317 per megawatt in
December 2000 from $32 per megawatt hour the preceding April, energy
companies were making enormous amounts of money. Investors drove up the price
of the companies' stocks, with Enron at one point trading at 60 times its
projected next year's earnings. New funding was flooding in from debt and
equity markets. Under pressure from regulators worried about a repeat of the
California debacle, energy companies got busy building power plants, drawing
up plans to fix the nation's antiquated electric-transmission systems and
plotting new natural-gas pipelines.

But that golden moment for the industry turned out to be short-lived. Early
this year, federal energy regulators placed caps on the wholesale price of
power sold in the western U.S. as California's two main investor-owned
utilities were pushed to the brink of insolvency. Then, in the spring,
natural-gas and electricity prices collapsed around the country as the
economy suddenly slowed to a crawl. Even before Enron got into trouble, the
big energy companies began to see their stock prices sink, and investors
began to cast a more critical eye on their expansion plans in the wake of the
California chaos and the resulting multibillion-dollar electricity payment
crisis.

One of the first signs that a sea change was under way came a few months ago
when demand for power-generation turbines began to soften. Because there are
only three domestic suppliers of such multimillion-dollar engines, the most
expensive pieces of machinery used by commercial electricity producers, the
machines must be ordered well in advance of their deployment.

A year ago, says David Sokol, chief executive of Iowa-based utility owner
Mid-American Energy Holdings Co., “you had to pay a premium to get a
turbine." Companies with lots of turbines on order, such as San Jose,
Calif.-based Calpine, boasted that they would clean up in newly deregulated
markets such as the West, the Northeast and New York, where electricity
supplies back then were tight. "But now," Mr. Sokol says, "I know of at least
100 (turbines) that are for sale. People want you to take their place in
line."

While most energy companies are pressing ahead with projects they have

started, they have grown cautious about breaking ground on new ones. Just a
few months ago Calpine boldly claimed it would have 70,000 megawatts of

10
01200000001689


It was one of the great fantasies of American business: a deregulated market
that would send cheaper and more reliable supplies of electricity coursing
into homes and offices across the nation.

But look what's happened instead. Enron Corp., the vast energy trader at the
center of the new freewheeling U.S. power markets, now faces collapse amid a
blizzard of questionable financial deals. And California, the first big state
to deregulate its electricity market, has watched its experiment turn into a
disaster, with intermittent blackouts and retail power rates as much as 40%
higher than they were a year ago.

Now, with the power industry hovering uneasily between regulation and
deregulation, it faces the prospect of a market that combines the worst
features of both: a return to government restrictions, mixed with volatility
and price spikes as companies struggle to meet the nation's future energy
needs.

Investors and lenders, spooked by the twin specters of California and Enron,
have become less likely to commit capital to building new power plants,
transmission lines and natural-gas pipelines. The U.S. will require big
additions to its power production and distribution capacity when it emerges
from the current recession -- but for now, at least, the nation's capital
markets are reluctant to cough up the necessary funds.

Responding to the dramatic decline in their stock prices and the recession,
energy companies are retrenching. Calpine Corp., one of the most aggressive
players in the deregulated market, is waffling on previously announced plans
to build billions of dollars in new power plants. Virginia-based AES Corp.,
which has missed its recent earnings targets, has scaled back its expansion
goals and is selling some of its foreign assets. Northeast Utilities is
curtailing plans to build a 30-mile undersea transmission line from
Connecticut to Long Island.

Erecting Guardrails

Meanwhile, regulators are racing to place new guardrails on the U.S. power
market. The federal government is trying to beef up its market-surveillance
activities. And it also is trying to broker deals between states that might
make interstate energy transmission faster, cheaper and easier.

The power market is in "the midst of an ugly adolescence that we cannot allow
to last much longer," says Nora Brownell, a member of the Federal Energy
Regulatory Commission in Washington.

That's because, for the consumer, energy deregulation has been anything but
good news. Unlike the deregulated telecommunications market, where fierce
competition brought down prices while guaranteeing a reasonable level of
reliability, the deregulated power market isn't likely to provide real
benefits until it stabilizes. For now, consumers are at the mercy of
wholesale forces they often can't understand and have few real options to
switch between service providers.

The theory behind deregulation was that it would lead to the emergence of
efficient companies that would specialize in providing electric power,
carrying it over long distances or delivering it to a final customer.

‘Hybrids Don't Work’

While the industry started to move in that direction, it isn't anymore. Many
big power companies in the most populous states, which are the ones that also
happen to be deregulated, still do a little of everything and are
increasingly confused about where to place their business bets.

When it comes to electricity markets, says Frank Wolak, a Stanford University
economics professor, these kinds of "hybrids don't work." But, he fears that
they will be around for some time to come, especially since regulators, who
once thought the markets themselves would bring about deregulation's goals,
are only belatedly assuming responsibility for making sure things run
smoothly.

Enron's sudden meltdown will deal a heavy blow to the broader energy

‘ 01095

01200000001767


happen to be deregulated, still do a little of everything and are
increusingly confused about where to place their business bets.

When it comes to electricity markets, says Frank Wolak, a Stanford University
economics professor, these kinds of “hybrids don't work." But, he fears that
they will be around for some time to come, especially since regulators, who
once thought the markets themselves would bring about deregulation's goals,
are only belatedly assuming responsibility for making sure things run
smoothly.

Enron's sudden meltdown will deal a heavy blow to the broader energy
marketplace that sat at the center of electricity deregulation -- providing a
place for utilities and power plants to buy energy they needed in a hurry, or
to unlead their excess supplies. The company's EnronOnline trading system,
which was shut down Wednesday, accounted for a quarter of all wholesale
energy trades among U.S. utilities, independent power producers and other
market players.

The trading system's shutdown came in the wake of disclosures that Enron's
directors and top officers approved a series of partnerships that moved debts
off the company's balance sheet. In several cases, those partnerships
enriched company officers but later produced huge losses for Enron.

That kind of "balance-sheet abuse" says Goldman Sachs analyst Jonathan
Raleigh, might now "reduce overall liquidity and cause lenders to tighten
credit standards" for the entire energy-trading industry. The result could be
the kind of supply squeezes that led to six days of blackouts in California
earlier this year.

California's supply problems didn't spread beyond the Pacific Northwest --
but that's largely because of the sharp economic downturn. As spot-market
power prices in California shot up to an average of $317 per megawatt in
December 2000 from $32 per megawatt hour the preceding April, energy
companies were making enormous amounts of money. Investors drove up the price
of the companies' stocks, with Enron at one point trading at 60 times its
projected next year's earnings. New funding was flooding in from debt and
equity markets. Under pressure from regulators worried about a repeat of the
California debacle, energy companies got busy building power plants, drawing
up plans to fix the nation's antiquated electric-transmission systems and
plotting new natural-gas pipelines.

But that golden moment for the industry turned out to be short-lived. Barly
this year, federal energy regulators placed caps on the wholesale price of
power sold in the western U.S. as California's two main investor-owned
utilities were pushed to the brink of insolvency. Then, in the spring,
natural-gas and electricity prices collapsed around the country as the
economy suddenly slowed to a crawl. Even before Enron got into trouble, the
big energy companies began to see their stock prices sink, and investors
began to cast a more critical eye on their expansion plans in the wake of the
California chaos and the resulting multibillion-dollar electricity payment
crisis.

One of the first signs that a sea change was under way came a few months ago
when demand for power-generation turbines began to soften. Because there are
only three domestic suppliers of such multimillion-dollar engines, the most
expensive pieces of machinery used by commercial electricity producers, the
machines must be ordered well in advance of their deployment.

A year ago, says David Sokol, chief executive of lowa-based utility owner
Mid-American Energy Holdings Co., "you had to pay a premium to get a
turbine." Companies with lots of turbines on order, such as San Jose,
Calif.-based Calpine, boasted that they would clean up in newly deregulated
markets such as the West, the Northeast and New York, where electricity
supplies back then were tight. "But now," Mr. Sokol says, "I know of at least
100 (turbines) that are for sale, People want you to take their place in
line."

While most energy companies are pressing ahead with projects they have
started, they have grown cautious about breaking ground on new ones. Just a
few months ago Calpine boldly claimed it would have 70,000 megawatts of
generating capacity -- the equivalent of 35 to 45 big power plants -- in
01200000001773

3


Mid-American Energy Holdings Co., "you had to pay a premium to get a
turbine." Companies with lots of turbines on order, such as San Jose,
Calif.-based Calpine, boasted that they would clean up in newly deregulated
markets such as the West, the Northeast and New York, where electricity
supplies back then were tight. "But now," Mr. Sokol says, "I know of at least
100 (turbines) that are for sale. People want you to take their place in
line."

While most energy companies are pressing ahead with projects they have
started, they have grown cautious about breaking ground on new ones. Just a
few months ago Calpine boldly claimed it would have 70,000 megawatts of
generating capacity -- the equivalent of 35 to 45 big power plants -- in
operation by 2005. Now it's backing away from that assertion. The company
currently has only a fraction of that capacity, 11,000 megawatts.

At the root of the problem is a lack of capital and earnings. While energy
companies routinely beat their own bullish quarterly profit estimates last
year, many of them have lately indicated that they will miss earnings
projections. with electricity and natural-gas prices down, energy sales tend
to be less profitable. Hence, investors haven't been willing to pay the same
price-earnings multiples for energy stocks.

Bankers, meanwhile, want convincing evidence that future power prices will be
high enough to justify new projects. That's far from guaranteed in
deregulated markets. In fact, national electricity prices, which hit a
52-week peak of $216 per megawatt, now are being quoted at $23.45 per
megawatt, according to the Mirant National Power Index.

To give some idea of how radically the landscape has shifted, take the case
of power conglomerate UtiliCorp United Inc., of Kansas City, Mo. In April,
taking advantage of the general enthusiasm toward deregulated markets, it
spun off its Aquila Inc. trading unit at a price of $24 a share, raising $480
million. "We saw an opportunity to crystalize the value" of the trading
company, says UtiliCorp President Bob Green.

Aquila's stock soared to $35 before it began slipping at the end of May.
Since then, it has tumbled by half. Today, with a price/earnings ratio of
eight -- less than most utilities -- the "equity markets are closed" to

Aquila, Mr. Green says.

Now, Utilicorp, which mainly owns regulated utilities, is planning to buy
back all the publicly traded Aquila shares. It hopes that by taking shelter
under UtiliCorp's umbrella, Aquila will be able to benefit enough from its
parent's strong credit rating and healthy balance sheet to keep trading and
buying more power plants.

In other words, the regulated utilities, once considered homely wallflowers,
are looking more alluring these days as trading firms, such as Aquila and
Enron, have fallen from favor. That could portend a reduction in the huge
trading volumes, and accompanying price volatility, that marked the early
stages of energy deregulation.

But that won't help consumers unless new power plants and transmission lines
come online in time for the economy's resurgence and new rules are put in
place that guarantee a more transparent market. The latter won't be an easy
task, because power trading is done on a variety of public and private
exchanges, with traders darting in and out to take advantage of price
discrepancies.

Lately, there's been growing evidence that some power companies have found
lucrative ways to exploit this system -- at consumers' expense. Their tactics
include manipulating wholesale electricity auctions, taking juice from
transmission systems when they aren't supposed to and denying weaker
competitors access to transmission lines. Regulators believe that this
behavior has contributed to supply glitches and inflated prices.

Under its new chairman, Pat Wood, the FERC has been pressing companies to

01013

01200000001685


take steps it believes will create power markets that are less susceptible to
such shenanigans. Chief among them is for utilities to surrender control of
their high-voltage power lines to independent operators that would give all
market participants fair access and will operate spot markets for power.

Earlier this month, the commission told three of the nation's big integrated
utilities -- American Electric Power Co., Entergy Corp. and Southern Co. --
that until they relinquish control of their power lines to an independent
operator, FERC may intervene to limit the prices they charge wholesale
customers. At least one of the three is appealing the FERC mandate.

The commission has also stepped up efforts to settle pesky but important
technical issues, such as how independent power producers can hook up new
plants to the lines of nearby utilities and how transmission services can
best be priced.

Still, even a more aggressive FERC hasn't been able to solve some lingering
problems. A good example is the continued existence of one of the nation's
worst transmission bottlenecks. Known as "Path 15," the line interconnects
the populous southern part of California with more abundant energy resources
in the north. The Department of Energy has pledged to help expand Path 15,
which was implicated as a key cause of the blackouts in California earlier
this year.

But actually getting the work done may require PG&E Corp.'s Pacific Gas &
Electric unit, which owns the 90-mile stretch of line, to get approval for
the expansion from the state Public Utilities Commission. But Pacific Gas,
which placed itself under the protection of the federal bankruptcy courts
amid the California power crisis, is at loggerheads with the PUC. The upshot
is that there may be significant delays in upgrading Path 15. The
implication: when the economy cranks back up, so too will the possibility of
more supply shortages and higher prices, says Terry Winter, chief executive
of California's Independent System Operator, which operates the state's
electricity grid.

01024

01200000001696


differently -- risky business, doomed from the start, the result from

irrational adherence to ideology, a victory of theory over common sense.
TVA staff called, by the way and asked if people here had any reaction to the
Enron debacle. I asked about the reaction in Knoxville. Some TVA people were
(jokingly, I think) singing "The witch is dead." Others expressed deep
dismay at what looks like Enron malfeasance.

The Wall Street Journal article follows FYI.

November 30, 2001

Page One Feature

Enron's Swoon Imperils Grand Experiment
In Deregulation of Nation's Power Markets
By REBECCA SMITH

Staff Reporter of THE WALL STREET JOURNAL

It was one of the great fantasies of American business: a deregulated market
that would send cheaper and more reliable supplies of electricity coursing
into homes and offices across the nation.

But look what's happened instead. Enron Corp., the vast energy trader at the
center of the new freewheeling U.S. power markets, now faces collapse amid a
blizzard of questionable financial deals. And California, the first big state
to deregulate its electricity market, has watched its experiment turn into a
disaster, with intermittent blackouts and retail power rates as much as 40%
higher than they were a year ago.

Now, with the power industry hovering uneasily between regulation and
deregulation, it faces the prospect of a market that combines the worst
features of both: a return to government restrictions, mixed with volatility
and price spikes as companies struggle to meet the nation's future energy
needs.

Investors and lenders, spooked by the twin specters of California and Enron,
have become less likely to commit capital to building new power plants,
transmission lines and natural-gas pipelines. The U.S. will require big
additions to its power production and distribution capacity when it emerges
from the current recession -- but for now, at least, the nation's capital
markets are reluctant to cough up the necessary funds.

Responding to the dramatic decline in their stock prices and the recession,
energy companies are retrenching. Calpine Corp., one of the most aggressive
players in the deregulated market, is waffling on previously announced plans
to build billions of dollars in new power plants. Virginia-based AES Corp.,
which has missed its recent earnings targets, has scaled back its expansion
goals and is selling some of its foreign assets. Northeast Utilities is
curtailing plans to build a 30-mile undersea transmission line from
Connecticut to Long Island.

Erecting Guardrails

Meanwhile, regulators are racing to place new guardrails on the U.S. power
market. The federal government is trying to beef up its market-surveillance
activities. And it also is trying to broker deals between states that might
make interstate energy transmission faster, cheaper and easier.

The power market is in "the midst of an ugly adolescence that we cannot allow
to last much longer," says Nora Brownell, a member of the Federal Energy
Regulatory Commission in Washington.

That's because, for the consumer, energy deregulation has been anything but
good news. Unlike the deregulated telecommunications market, where fierce
competition brought down prices while guaranteeing a reasonable level of
reliability, the deregulated power market isn't likely to provide real
benefits until it stabilizes. For now, consumers are at the mercy of
wholesale forces they often can't understand and have few real options to
switch between service providers.

01090

01200000001762


The theory behind deregulation was that it would lead to the emergence of
efficient companies that would specialize in providing electric power,
carrying it over long distances or delivering it to a final customer.

‘Hybrids Don't Work'

While the industry started to move in that direction, it isn't anymore. Many
big power companies in the most populous states, which are the ones that also
happen to be deregulated, still do a little of everything and are
increasingly confused about where to place their business bets.

When it comes to electricity markets, says Frank Wolak, a Stanford University
economics professor, these kinds of "hybrids don't work." But, he fears that
they will be around for some time to come, especially since regulators, who
once thought the markets themselves would bring about deregulation's goals,
are only belatedly assuming responsibility for making sure things run
smoothly.

Enron's sudden meltdown will deal a heavy blow to the broader energy
marketplace that sat at the center of electricity deregulation -- providing a
place for utilities and power plants to buy energy they needed in a hurry, or
to unload their excess supplies. The company's EnronOnline trading system,
which was shut down Wednesday, accounted for a quarter of all wholesale
energy trades among U.S. utilities, independent power producers and other
market players.

The trading system's shutdown came in the wake of disclosures that Enron's
directors and top officers approved a series of partnerships that moved debts
off the company's balance sheet. In several cases, those partnerships
enriched company officers but later produced huge losses for Enron.

That kind of "balance-sheet abuse" says Goldman Sachs analyst Jonathan
Raleigh, might now "reduce overall liquidity and cause lenders to tighten
credit standards" for the entire energy-trading industry. The result could be
the kind of supply squeezes that led to six days of blackouts in California
earlier this year.

California's supply problems didn't spread beyond the Pacific Northwest --
but that's largely because of the sharp economic downturn. As spot-mar
power prices in California shot up to an average of $317 per megawatt in
December 2000 from $32 per megawatt hour the preceding April, energy
companies were making enormous amounts of money. Investors drove up the price
of the companies' stocks, with Enron at one point trading at 60 times its
projected next year's earnings. New funding was flooding in from debt and
equity markets. Under pressure from regulators worried about a repeat of the
California debacle, energy companies got busy building power plants, drawing
up plans to fix the nation's antiquated electric-transmission systems and
plotting new natural-gas pipelines.

But that golden moment for the industry turned out to be short-lived. Early
this year, federal energy regulators placed caps on the wholesale price of
power sold in the western U.S. as California's two main investor-owned
utilities were pushed to the brink of insolvency. Then, in the spring,
natural-gas and electricity prices collapsed around the country as the
economy suddenly slowed to a crawl. Even before Enron got into trouble, the
big energy companies began to see their stock prices sink, and investors
began to cast a more critical eye on their expansion plans in the wake of the
California chaos and the resulting multibillion-dollar electricity payment
crisis.

One of the first signs that a sea change was under way came a few months ago
when demand for power-generation turbines began to soften. Because there are
only three domestic suppliers of such multimillion-dollar engines, the most
expensive pieces of machinery used by commercial electricity producers, the
machines must be ordered well in advance of their deployment.

A year ago, says David Sokol, chief executive of Iowa-based utility owner
5:

01012

01200000001684


Farreh, Paula

— _
From: Farrell, Paula

Sent: Friday, November 30, 2001 7:22 PM

To: Burner, ay Atkins, Preston Jr; Revesz, Paul; Oster, Karen; Finch, Glenda
Subject: FW: Enron, Deregulation, and TVA

-----' Original Message-----

From: James_Mietus@omb.eop.gov [mailto:James_MietusGomb.eop.gov]
Sent: Friday, November 30, 2001 12:24 PM

To: Alexander_M._Brill@cea.eop.gov; gary.burner@do.treas.gov;
paula.farrell@do.treas.gov; peter.karpoff@hq.doe.gov;

kevin. kelly@ferc.fed.us; dan. larcamp@ferc.fed.us;

Wallace_P. Mullin@cea.eop.gov; david.reiffenddo.treas.gov;
arthur. rypinski@hq.doe. gov; Garrett_D._Soden@opd.eop.gov;
Michael_C. Toth@omb.eop.gov

Subject; Enron, Deregulation, and TVA

Of possible interest...
- Forwarded by James Mietus/OMB/EOP on 11/30/2001 12:23 PM

James Mietus
11/30/2001 12:17:36 PM

Record Type: Record

To: Richard A. Mertens/OMB/EOP

ce: Mark A. Weatherly/OMB/EOP@EOP, Marcus Peacock/OMB/EOP@EOP
Subject: Enron, Deregulation, and TVA

In case it has not yet come to your attention, attached below is a copy of a
feature article the Wall Street Journal published today on Enron and
deregulation that has important implications for TVA.

The article, titled "Enron's Swoon Leaves A Grand Experiment In a State of
Disarray." struck me as a "must read" item and a useful overview of the Enron
situation and its relationship to electric industry deregulation

The situation in brief, as I understand it:

Markets are like people. They take time to grow and develop. They pass

through an adolescence that can be easy or hard.
Some have an easy time of it, play varsity ball, get into a competitive
college. Telecommunications worked this way. Competition emerged quickly
and drove down prices. Innovation blossomed as planned. Cell phones are
plentiful and commonplace.
Other markets have a harder time of it and give their advocates fits, like
the high-potential kid with behavioral problems. Electricity seems to fit
in this category. California and Enron are symptomatic of the struggle
underway as the market labors to develop.

Where you stand determines what you see.
Deregulation fans will see Enron and its aftermath as regrettable but
predictable, given the fact that laws are confusing and reforms are
incomplete. The obvious solution: Let FERC, states and competitors work
out the needed reforms and institutions ASAP.
Critics of deregulation of course will see this Rorschach test quite
differently -- risky business, doomed from the start, the result from
irrational adherence to ideology, a victory of theory over common sense.

TVA staff called, by the way and asked if people here had any reaction to the

Enron debacle. 1 asked about the reaction in Knoxville. Some TVA people were

01099

01200000001771


differently -- risky business, doomed from the start, the result from

irrational adherence to ideology, a victory of theory over common sense.
TVA staff called, by the way and asked if people here had any reaction to the
Enron debacle. I asked about the reaction in Knoxville. Some TVA people were
(jokingly, I think) singing "The witch is dead." Others expressed deep
dismay at what looks like Enron malfeasance.

The Wall Street Journal article follows FYI.

November 30, 2001

Page One Feature

Enron's Swoon Imperils Grand Experiment
In Deregulation of Nation's Power Markets
By REBECCA SMITH

Staff Reporter of THE WALL STREET JOURNAL

It was one of the great fantasies of American business: a deregulated market
that would send cheaper and more reliable supplies of electricity coursing
into homes and offices across the nation.

But look what's happened instead. Enron Corp., the vast energy trader at the
center of the new freewheeling U.S. power markets, now faces collapse amid a
blizzard of questionable financial deals. And California, the first big state
to deregulate its electricity market, has watched its experiment turn into a
disaster, with intermittent blackouts and retail power rates as much as 40%
higher than they were a year ago.

Now, with the power industry hovering uneasily between regulation and
deregulation, it faces the prospect of a market that combines the worst
features of both: a return to government restrictions, mixed with volatility
and price spikes as companies struggle to meet the nation's future energy
needs.

Investors and lenders, spooked by the twin specters of California and Enron,
have become less likely to commit capital to building new power plants,
transmission lines and natural-gas pipelines. The U.S. will require big
additions to its power production and distribution capacity when it emerges
from the current recession -- but for now, at least, the nation's capital
markets are reluctant to cough up the necessary funds.

Responding to the dramatic decline in their stock prices and the recession,
energy companies are retrenching. Calpine Corp., one of the most aggressive
players in the deregulated market, is waffling on previously announced plans
to build billions of dollars in new power plants. Virginia-based AES Corp.,
which has missed its recent earnings targets, has scaled back its expansion
goals and is selling some of its foreign assets. Northeast Utilities is
curtailing plans to build a 30-mile undersea transmission line from
Connecticut to Long Island.

Erecting Guardrails

Meanwhile, regulators are racing to place new guardrails on the U.S. power
market. The federal government is trying to beef up its market-surveillance
activities. And it also is trying to broker deals between states that might
make interstate energy transmission faster, cheaper and easier.

The power market is in "the midst of an ugly adolescence that we cannot allow
to last much longer," says Nora Brownell, a member of the Federal Energy
Regulatory Commission in Washington.

That's because, for the consumer, energy deregulation has been anything but
good news. Unlike the deregulated telecommunications market, where fierce
competition brought down prices while guaranteeing a reasonable level of
reliability, the deregulated power market isn't likely to provide real
benefits until it stabilizes. For now, consumers are at the mercy of
wholesale forces they often can't understand and have few real options to
switch between service providers.

01011

01200000001683


California's supply problems didn't spread beyond the Pacific Northwest --

but that's largely because of the sharp economic downturn. As spot-market
power prices in California shot up to an average of $317 per megawatt in
December 2000 from $32 per megawatt hour the preceding April, energy
companies were making enormous amounts of money. Investors drove up the price
of the companies’ stocks, with Enron at one point trading at 60 times its
projected next year's earnings. New funding was flooding in from debt and
equity markets. Under pressure from regulators worried about a repeat of the
California debacle, energy companies got busy building power plants, drawing
up plans to fix the nation's antiquated clectric-transmission systems and
plotting new natural-gas pipelines.

But that golden moment for the industry turned out to be short-lived. Early
this year, federal energy regulators placed caps on the wholesale price of
power sold in the western U.S. as California's two main investor-owned
utilities were pushed to the brink of insolvency. Then, in the spring,
natural-gas and electricity prices collapsed around the country as the
economy suddenly slowed to a crawl, Even before Enron got into trouble, the
big energy companies began to see their stock prices sink, and investors
began to cast a more critical eye on their expansion plans in the wake of the
California chaos and the resulting multibillion-dollar electricity payment
crisis.

One of the first signs that a sea change was under way came a few months ago
when demand for power-generation turbines began to soften. Because there are
only three domestic suppliers of such multimillion-dollar engines, the most
expensive pieces of machinery used by commercial electricity producers, the
machines must be ordered well in advance of their deployment.

A year ago, says David Sokol, chief executive of lowa-based utility owner
Mid-American Energy Holdings Co., “you had to pay a premium to get a
turbine." Companies with lots of turbines on order, such as San Jose,
Calif.-based Calpine, boasted that they would clean up in newly deregulated
markets such as the West, the Northeast and New York, where electricity
supplies back then were tight. "But now," Mr. Sokol says, "I know of at least
100 (turbines) that are for sale. People want you to take their place in

line."

While most energy companies are pressing ahead with projects they have
started, they have grown cautious about breaking ground on new ones. Just a
few months ago Calpine boldly claimed it would have 70,000 megawatts of
generating capacity -- the equivalent of 35 to 45 big power plants -- in
operation by 2005. Now it's backing away from that assertion. The company
currently has only a fraction of that capacity, 11,000 megawatts.

At the root of the problem is a lack of capital and earnings. While energy
companies routinely beat their own bullish quarterly profit estimates last
year, many of them have lately indicated that they will miss earnings
projections, With electricity and natural-gas prices down, energy sales tend
to be less profitable. Hence, investors haven't been willing to pay the same
price-earnings multiples for energy stocks.

Bankers, meanwhile, want convincing evidence that future power prices will be
high enough to justify new projects. That's far from guaranteed in
deregulated markets. In fact, national electricity prices, which hit a

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operation by 2005. Now it's backing away from that assertion. The company
currently has only a fraction of that capacity, 11,000 megawatts.

At the root of the problem is a lack of capital and earnings. While energy
companies routinely beat their own bullish quarterly profit estimates last
year, many of them have lately indicated that they will miss earnings
projections. With electricity and natural-gas prices down, energy sales tend
to be less profitable. Hence, investors haven't been willing to pay the same
price-earnings multiples for energy stocks.

Bankers, meanwhile, want convincing evidence that future power prices will be
high enough to justify new projects. That's far from guaranteed in
deregulated markets. In fact, national electricity prices, which hit a
52-week peak of $216 per megawatt, now are being quoted at $23.45 per
megawatt, according to the Mirant National Power Index.

To give some idea of how radically the landscape has shifted, take the case
of power conglomerate UtiliCorp United Inc., of Kansas City, Mo. In April,
taking advantage of the general enthusiasm toward deregulated markets, it
spun off its Aquila Inc. trading unit at a price of $24 a share, raising $480
million. "We saw an opportunity to crystalize the value” of the trading
company, says UtiliCorp President Bob Green.

Aquila's stock soared to $35 before it began slipping at the end of May.
Since then, it has tumbled by half. Today, with a price/earnings ratio of
eight -- less than most utilities -- the “equity markets are closed" to

Aquila, Mr. Green says.

Now, UtiliCorp, which mainly owns regulated utilities, is planning to buy
back all the publicly traded Aquila shares. It hopes that by taking shelter
under UtiliCorp's umbrella, Aquila will be able to benefit enough from its
parent's strong credit rating and healthy balance sheet to keep trading and
buying more power plants.

In other words, the regulated utilities, once considered homely wallflowers,
are looking more alluring these days as trading firms, such as Aquila and
Enron, have fallen from favor. That could portend a reduction in the huge
trading volumes, and accompanying price volatility, that marked the early
stages of energy deregulation.

But that won't help consumers unless new power plants and transmission lines
come online in time for the economy's resurgence and new rules are put in
place that guarantee a more transparent market. The latter won't be an easy
task, because power trading is done on a variety of public and private
exchanges, with traders darting in and out to take advantage of price
discrepancies.

Lately, there's been growing evidence that some power companies have found
lucrative ways to exploit this system -- at consumers‘ expense. Their tactics
include manipulating wholesale electricity auctions, taking juice from
transmission systems when they aren't supposed to and denying weaker
competitors access to transmission lines. Regulators believe that this
behavior has contributed to supply glitches and inflated prices.

Under its new chairman, Pat Wood, the FERC has been pressing companies to
take steps it believes will create power markets that are less susceptible to
such shenanigans. Chief among them is for utilities to surrender control of
their high-voltage power lines to independent operators that would give all
market participants fair access and will operate spot markets for power.

Earlier this month, the commission told three of the nation's big integrated
utilities -- American Electric Power Co., Entergy Corp. and Southern Co. --
that until they relinquish control of their power lines to an independent
operator, FERC may intervene to limit the prices they charge wholesale
customers. At least one of the three is appealing the FERC mandate.

The commission has also stepped up efforts to settle pesky but important
technical issues, such as how independent power producers can hook up new
plants to the lines of nearby utilities and how transmission services can

| ' 01102

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The theory behind deregulation was that it would lead to the emergence of
efficient companies that would specialize in providing electric power,
carrying it over long distances or delivering it to a final customer.

‘Hybrids Don't Work!

While the industry started to move in that direction, it isn't anymore. Many
big power companies in the most populous states, which are the ones that also
happen to be deregulated, still do a little of everything and are
increasingly confused about where to place their business bets.

When it comes to electricity markets, says Frank Wolak, a Stanford University
economics professor, these kinds of “hybrids don't work." But, he fears that
they will be around for some time to come, especially since regulators, who
once thought the markets themselves would bring about deregulation's goals,
are only belatedly assuming responsibility for making sure things run
smoothly.

Enron's sudden meltdown will deal a heavy blow to the broader energy
marketplace that sat at the center of electricity deregulation -- providing a
place for utilities and power plants to buy energy they needed in a hurry, or
to unload their excess supplies. The company's EnronOnline trading system,
which was shut down Wednesday, accounted for a quarter of all wholesale
energy trades among U.S. utilities, independent power producers and other
market players.

The trading system's shutdown came in the wake of disclosures that Enron's
directors and top officers approved a series of partnerships that moved debts
off the company's balance sheet. In several cases, those partnerships
enriched company officers but later produced huge losses for Enron.

That kind of "balance-sheet abuse" says Goldman Sachs analyst Jonathan
Raleigh, might now "reduce overall liquidity and cause lenders to tighten
credit standards" for the entire energy-trading industry. The result could be
the kind of supply squeezes that led to six days of blackouts in California
earlier this year.

California's supply problems didn't spread beyond the Pacific Northwest --
but that's largely because of the sharp economic downturn. As spot-market
power prices in California shot up to an average of $317 per megawatt in
December 2000 from $32 per megawatt hour the preceding April, energy
companies were making enormous amounts of money. Investors drove up the price
of the companies! stocks, with Enron at one point trading at 60 times its
projected next year's earnings. New funding was flooding in from debt and
equity markets. Under pressure from regulators worried about a repeat of the
California debacle, energy companies got busy building power plants, drawing
up plans to fix the nation's antiquated electric-transmission systems and
plotting new natural-gas pipelines.

But that golden moment for the industry turned out to be short-lived. Early
this year, federal energy regulators placed caps on the wholesale price of
power sold in the western U.S. as California's two main investor-owned
utilities were pushed to the brink of insolvency. Then, in the spring,
natural-gas and electricity prices collapsed around the country as the
economy suddenly slowed to a crawl. Even before Enron got into trouble, the
big energy companies began to see their stock prices sink, and investors
began to cast a more critical eye on their expansion plans in the wake of the
California chaos and the resulting multibillion-dollar electricity payment
crisis.

One of the first signs that a sea change was under way came a few months ago
when demand for power-generation turbines began to soften. Because there are
only three domestic suppliers of such multimillion-dollar engines, the most

expensive pieces of machinery used by commercial electricity producers, the

machines must be ordered well in advance of their deployment.

A year ago, says David Sokol, chief executive of Iowa-based utility owner
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Atkins, Preston Jr

From: Farrell, Paula

Sent: Friday, November 30, 2001 7:22 PM

To: Burner, Gary; Atkins, Preston Jr; Revesz, Paul; Oster, Karen; Finch, Glenda
Subject: FW: Enron, Deregulation, and TVA

aiatates ‘Original Message-----

From: James _Mietus@omb.eop.gov [mailto:James_Mietus@omb.eop.gov)
Sent: Friday, November 30, 2001 12:24 PM

To: Alexander_M. Brill@cea.eop.gov; gary.burner@do.treas.gov;
paula.farrell@do.treas.gov; peter.karpoff@hq.doe.gov;

kevin. kelly@ferc.fed.us; dan.larcamp@ferc.fed.us;
Wallace_P._Mullin@cea.eop.gov; david.reiffen@do.treas.gov;
arthur.rypinski@hq.doe.gov; Garrett_D._Soden@opd.eop.gov;
Michael_C._Toth@omb.eop.gov

Subject: Enron, Deregulation, and TVA

Of possible interest...
- Forwarded by James Mietus/OMB/EOP on 11/30/2001 12:23 PM

James Mietus
11/30/2001 12:17:36 PM

Record Type: Record

To: Richard A. Mertens/OMB/EOP

cc: Mark A. Weatherly/OMB/EOP@EOP, Marcus Peacock/OMB/EOP@EOP
Subject: Enron, Deregulation, and TVA

In case it has not yet come to your attention, attached below is a copy of a
feature article the Wall Street Journal published today on Enron and
deregulation that has important implications for TVA.

The article, titled "Enron's Swoon Leaves A Grand Experiment In a State of
Disarray." struck me as a "must read" item and a useful overview of the Enron
situation and its relationship to electric industry deregulation

The situation in brief, as I understand it:

Markets are like people. They take time to grow and develop. They pass

through an adolescence that can be easy or hard.
Some have an easy time of it, play varsity ball, get into a competitive
college. Telecommunications worked this way. Competition emerged quickly
and drove down prices. Innovation blossomed as planned. Cell phones are
plentiful and commonplace.
Other markets have a harder time of it and give their advocates fits, like
the high-potential kid with behavioral problems. Electricity seems to fit
in this category. California and Enron are symptomatic of the struggle
underway as the market labors to develop.

where you stand determines what you see.
Deregulation fans will see Enron and its aftermath as regrettable but
predictable, given the fact that laws are confusing and reforms are
incomplete. The obvious solution: Let FERC, states and competitors work
out the needed reforms and institutions ASAP.
Critics of deregulation of course will see this Rorschach test quite

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