[Senate Hearing 107-183]
[From the U.S. Government Publishing Office]
S. Hrg. 107-183
ELECTRICITY AND GAS RATES
=======================================================================
HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
on
S. 764
TO DIRECT THE FEDERAL ENERGY REGULATORY COMMISSION TO IMPOSE JUST AND
REASONABLE LOAD-DIFFERENTIATED DEMAND RATES OR COST-OF-SERVICE BASED
RATES ON SALES BY PUBLIC UTILITIES OF ELECTRIC ENERGY AT WHOLESALE IN
THE WESTERN ENERGY MARKET, AND FOR OTHER PURPOSES
S. 597
TO PROVIDE FOR A COMPREHENSIVE AND BALANCED NATIONAL ENERGY POLICY
__________
JUNE 19, 2001
Printed for the use of the
Committee on Energy and Natural Resources
______
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii FRANK H. MURKOWSKI, Alaska
BYRON L. DORGAN, North Dakota PETE V. DOMENICI, New Mexico
BOB GRAHAM, Florida DON NICKLES, Oklahoma
RON WYDEN, Oregon LARRY E. CRAIG, Idaho
TIM JOHNSON, South Dakota BEN NIGHTHORSE CAMPBELL, Colorado
MARY L. LANDRIEU, Louisiana CRAIG THOMAS, Wyoming
EVAN BAYH, Indiana GORDON SMITH, Oregon
BLANCHE L. LINCOLN, Arkansas JIM BUNNING, Kentucky
PETER G. FITZGERALD, Illinois
CONRAD BURNS, Montana
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
Brian P. Malnak, Republican Staff Director
James P. Beirne, Republican Chief Counsel
Leon Lowery, Professional Staff Member
Howard Useem, Senior Professional Staff Member
Note: Senator Bingaman assumed the Chairmanship on June 6, 2001.
C O N T E N T S
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STATEMENTS
Page
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................ 1
Boxer, Hon. Barbara, U.S. Senator from California................ 33
Breathitt, Linda Key, Commissioner, Federal Energy Regulatory
Commission..................................................... 12
Brill, Thomas R., Director of Regulatory Policy and Analysis,
Sempra Energy, San Diego, CA................................... 56
Brownell, Nora Mead, Commissioner, Federal Energy Regulatory
Commission..................................................... 15
Fetter, Steven M., Managing Director, Global Power Group, Inc.,
New York, NY................................................... 52
Hebert, Curt, Jr., Chairman, Federal Energy Regulatory Commission 4
Henning, Bruce B., Director, Regulatory and Market Analysis,
Energy and Environmental Analysis, Inc., Arlington, VA......... 59
Massey, William L., Commissioner, Federal Energy Regulatory
Commission..................................................... 14
McMahan, Ronald L., Ph.D., Managing Partner, Enercap Associates,
LLC, Boulder, CO............................................... 48
Murkowski, Hon. Frank H., U.S. Senator from Alaska............... 1
Roberts, Geoffrey D., President and CEO, Entergy Wholesale
Operations, The Woodlands, TX.................................. 43
Wood, Patrick III, Commissioner, Federal Energy Regulatory
Commission..................................................... 16
APPENDIXES
Appendix I
Responses to additional questions................................ 71
Appendix II
Additional material submitted for the record..................... 73
ELECTRICITY AND GAS RATES
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TUESDAY, JUNE 19, 2001
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 9:07 a.m., in
room SD-106, Dirksen Senate Office Building, Hon. Jeff
Bingaman, chairman, presiding.
OPENING STATEMENT OF HON. JEFF BINGAMAN,
U.S. SENATOR FROM NEW MEXICO
The Chairman. This morning the Energy Committee has a
hearing on the recent FERC order, and it is also a hearing on
Senator Feinstein and Senator Smith's bill to impose just and
reasonable prices in Western electricity markets.
I have said from the beginning of the process that I
believe that the Federal Energy Regulatory Commission is under
an obligation under the Federal Power Act to assure just and
reasonable rates in California and throughout the West. I have
also said that in my view the Commission was slow to act in
that regard, and that if action was not taken, Congress needed
to step in.
The Commission yesterday issued an order that addresses
market issues in the West. We are anxious to hear an
explanation of that order, ask questions about how it is
expected to work, how the Commissioners themselves believe it
will work.
On hearing the testimony this morning and hearing from some
other witnesses, I believe we will be better able to determine
whether Congress needs to move ahead or await further
information.
We look forward to the testimony. I want to thank the
Commissioners particularly for being here. I know that this is
a very busy morning for them. They have a technical conference
on issues at the boundaries of regional transmission groups, as
I understand it, and I am told that they really do need to
leave here by no later than 10:30. So, we will have a short
statement by Senator Murkowski and then go right to the
witnesses and hear from them. Their general counsel is able to
stay after they leave, I am informed.
Senator Murkowski, go ahead.
STATEMENT OF HON. FRANK H. MURKOWSKI, U.S. SENATOR
FROM ALASKA
Senator Murkowski. Thank you, Senator Bingaman. Let me,
first of all, congratulate you as chairman, and make my pledge
to work with you and your professional staff.
I think between us we leave somewhat of a legacy on the
issue of energy. You and I have held 24 hearings. We have had
164 witnesses with specific recommendations on how to address
the energy crisis.
As we look at the testimony that we are about to receive
from FERC, I hope that it is enlightening relative to the
action taken and the question of whether or not this action is
sufficient.
You know, California ordered its investor-owned utilities
to divest their fossil generation, but exempted the municipal
utilities. And California prohibited its investor-owned
utilities from using long-term contracts for the power market
and forced them to rely entirely on the spot market.
It was not so long ago that we saw headlines that indicated
that power deals exceed prices on the spot market. In other
words, these long-term contracts that were recently signed in
California were at a higher rate than the spot market, which
gives you some idea of the volatility of the price of
electricity.
Now, that strategy worked for a short time until demand in
California grew beyond the availability of out-of-State supply.
The reasons included increased demand in other parts of the
West, as well as unseen factors such as record droughts on the
Western hydro resources. But the reality is that supply did not
meet demand, so now we have California's situation of
blackouts, brownouts.
The California power shortages have been evident for years.
Yet, neither the State of California nor previously the FERC,
under the previous administration, did very much about it. They
simply hoped the problem would perhaps magically go away or the
responsibility would fall on someone else's watch.
In the meantime, California bankrupted its investor-owned
utilities and put the taxpayer of California on the hook for
some $40 billion. It did not pass on the true cost of power to
consumers because of retail price caps. As a consequence,
little incentive to conserve. Now some of those costs are
passed on but I think it is still in the area of about 50
percent.
I cannot help but be somewhat amused that there seems to be
in the minds of some people in California, or at least the
media, there is a significant difference between the taxpayer
and the ratepayer. I do not see that.
Are price caps the solution to California's problems? Well,
I do not think so. Price caps do not build powerplants. Price
caps do not encourage conservation. They seem to spin the web
of assumed political relief from higher prices, but not real
relief. They do not build new powerplants or increase supply.
That is the bottom line.
But if price caps are the answer, as some suggest, I ask
why has the California government not imposed price caps on the
power sold by municipally owned utilities such as the Los
Angeles Department of Water and Power.
It is interesting to look at some of these accusations.
Private power, of course, must openly report its profit. Public
power does not have to report its windfall profits to anyone.
It can keep them secret if it wishes. Private power has to
report to the Securities and Exchange Commission and is watched
like a hawk by investors who own stock. Public power has no
investors, no SEC looking over their shoulder. Private power
pays income taxes. Public power pays no taxes.
It should come as no surprise that the State of California
and specifically Governor Davis' Department of Water Resources,
who has spent billions in purchasing power for California, has
been stonewalling a California Senate committee investigation
of suspected price gouging and market manipulation, refusing to
provide relevant documents. To accuse the private power of
profiteering, but to say so little about public power in my
opinion is shameful. But for Governor Davis to fail to stop the
Los Angeles Department of Water from profiteering is also
inexcusable.
I think it is also important, as we look at the issue of
protection for those consumers in the West to recognize that
both new generation and maintaining existing generation is an
important factor that treats both the investor-owned and
municipal utilities alike. Without a firm commitment from
investors, we are not going to see one shovel turned in the
construction of new generation. California has plenty of
permits, but how many of those permits is that financing
conditional?
I refer to a letter I received by Mr. Wayne Angell, Senior
Managing Director and Chief Economist of Bear Stearns. I will
introduce the letter in the record in its entirety, but it
reads and I quote. ``When caps are imposed and prices pushed
below the market level, three things happen. One, buyers seek
to purchase more, overriding public conservation efforts. Two,
sellers supply less by diverting scarce supplies to more
rewarding markets. And three, new energy transportation and
production facilities would continue to decline as the
uncertainties created by the regulations drive investors
elsewhere.''
Finally, Mr. Chairman, I think it is fair to say that the
FERC order is working. Electric rates are declining. I have a
chart behind me that shows some idea of the volatility of the
rate structure and the fact that there has been a leveling off.
The megawatt rate is somewhere in the area of $45 to $46, but
you can clearly see the trend.
I think FERC should be commended for their April order.
That April order is working, and yesterday we saw FERC issue an
order that builds on the April 26 price mitigation order,
expanding its price mitigation to apply to all Western States,
not just California, and expanding its price mitigation order
to apply all of the time, not just when California is in a
stage 1, 2, or 3 emergency.
Since January, the current FERC has taken numerous steps to
address California's problems. Nearly 30 orders have been
issued. Under the Bush administration, FERC has been very
aggressive to try and solve the problem.
I would ask that a letter be entered in the record from
four Governors today, Jane Dee Hull, State of Arizona; John
Hoeven, State of North Dakota; Mike Leavitt, State of Utah; Jim
Geringer, State of Wyoming. The body of the letter and the
paragraph appropriate says, ``We understand FERC has acted
unanimously to further address the issue through the existing
process. This further underscores the effectiveness of the
existing regulatory process and eliminates the need for
congressional legislation in this area.''
I commend those Governors. I commend the President and Vice
President Cheney who have urged that we stay the course on this
and that we do not need legislation. That is basically why FERC
was established.
I ask what do we need before we are convinced on the issue
that what we really need is an increased supply. If there is a
milk shortage around here, you run out and get some more cows I
guess.
But I am convinced that the time for talk is behind us.
Anyway, what we have here is an operational FERC that is doing
its job. We need to move forward with the legislation that
promotes energy production and that is the energy plan that was
presented by President Bush. It extends Price Anderson. It
opens up the 1002 area of ANWR. It expedites renewal of TAPS.
It increases LIHEAP weatherization. It expands the scope of
appliance standards, hydro licensing, comprehensive
electricity, eminent domain, pipeline safety, reauthorizes
hydrogen futures, and a number of tax items. I think it is
important to reflect on this because there are accusations here
and there that the administration has not done anything in the
sense of coming up with some positive solutions to address the
energy crisis.
What I do not think we want to do is go back to 1992 where
this committee had extended hearings and did very little. I
think what we got out of it covered encouraging renewable fuel
development, conservation, and increased LIHEAP. The American
will not stand for that. In addition, I think we have got left-
hand turns on red lights, and I think we got low-flush toilets
that you had to flush twice.
[Laughter.]
Senator Murkowski. We have got to do better this time.
Conservation can help, but it cannot do the job alone. If
conservation was the answer, California would be swimming in
energy because it is the second most energy efficient State in
the Nation. Yes, we should conserve, but we must also have
adequate supplies and increase our supplies.
So, as a consequence, Mr. Chairman, I look forward to the
witnesses this morning. I want to commend them for the action
they have taken, and I would encourage my colleagues to
recognize that before we wander in and introduce legislation,
we should allow this agency, created by the Congress, to do its
job.
The Chairman. Commissioner Hebert, why do you not go ahead
and explain to us the action that FERC took yesterday? Then we
will call on each of the other Commissioners to give their
perspective on it, to the extent they want to add anything. Why
don't you go right ahead.
STATEMENT OF CURT HEBERT, JR., CHAIRMAN,
FEDERAL ENERGY REGULATORY COMMISSION
Mr. Hebert. Thank you, Mr. Chairman. I certainly have an
opening statement that will get into what the Commission has
done, has been doing, and actually what we have done as
recently as yesterday.
The Commission's experience in regulating electric and
natural gas utilities, indeed, the Nation's experience in
pricing and allocating vital goods and services, has taught us
an important lesson. Consumers are better off if supply and
pricing decisions are based on market mechanisms rather than
bureaucratic fiat. Thus, the Commission is committed to helping
move this country toward open competitive energy markets.
At the same time, we recognize we must ensure that broken
and dysfunctional wholesale markets are fixed. This poses
challenges, particularly in California and the West where there
is a substantial imbalance of supply and demand.
In response to these challenges, the Commission has been
working aggressively to reform market structures and to enhance
consumer welfare in California and the West. The Commission has
not lost sight of the point that the best way to lower
wholesale electricity prices and to keep them low is to promote
investment in badly needed supply and delivery infrastructure
and to encourage demand reduction. The Commission's task
remains to balance these goals to ensure that short-term
measures do not undermine long-term principles.
Yesterday, by a unanimous vote of 5-0, the Commission took
action that illustrates this balanced approach perfectly. It is
the approach that has been working and that will now, I
believe, even work better.
The Commission has adopted refinements to a market
monitoring and price mitigation plan that was first implemented
on May 29 of this year. The plan strikes a balance between
bringing market-oriented price relief to the California and the
Western electricity markets providing greater price certainty
to buyers and sellers of electricity, energy, promoting
conservation, and importantly encouraging investment in
efficient generation and transmission.
The original plan established price mitigation for the spot
markets--in other words, markets in which sales are arranged 24
hours or less before delivery of the power starts--run by the
California independent system operator when the ISO declares a
reserve deficiency--in other words, when generating reserves
are at or below 7 percent.
Price mitigation has been triggered twice since the
Commission's plan was first implemented on Wednesday, May 30,
and Thursday, May 31, 2001, 2 days of record high temperatures
when the ISO announced reserve deficiencies. Prices which had
been up around $300 per megawatt hour before the ISO announced
a reserve deficiency on May 30 fell to $120 and rose no higher
than $135 during the rest of the day. On May 31, prices rose to
$130 per megawatt prior to the announcement of a reserve
deficiency, but fell to $108 when mitigation began and fell
further to $64 a megawatt hour that day.
Even more significant is the fact that spot prices
continued to fall in subsequent days, even when system
emergencies were not declared and have remained low. Spot
prices which had been up over $400 per megawatt hour for much
of the month of May, prior to implementation of the
Commission's plan, now rest comfortably around $100 per
megawatt hour. Put another way, spot prices in California and
the rest of the West are lower than at any time in the past
year and are coming close to spot prices in the rest of the
country.
In addition, the drop in spot electricity prices has been
matched by related price drops in other markets. Prices for
Western forwards contracts are also down significantly. For
example, year 2002 forwards transactions have dropped from $127
per megawatt hour to $68 per megawatt hour. And 2003 forwards
transactions have dropped from $60 per megawatt hour to $41 per
megawatt hour in this past month.
On top of all this, natural gas prices have similarly
plunged and are lower and hopefully leveling off in California
and much of the West.
Building on this success, yesterday this Commission, in a
unanimous decision, voted to refine its mitigation plan to add
price mitigation measures for spot markets during all time
periods and for all other States in the Western Systems
Coordinating Council. Now wherever there is a reserve
deficiency and when there is one in California, a market
clearing price will apply not only to the ISO spot markets, but
also to all spot markets in the 11-State region covered by the
WSCC. The market clearing price will be based on the bid of the
highest cost gas-fired unit located in California that is
needed to serve the California ISO's load on any day in which a
reserve deficiency is announced. The bid will reflect a
published gas cost plus, an adder for operating and maintaining
expenses, and a credit risk. Sellers other than marketers will
have the opportunity to justify individual prices above the
market clearing price based on their cost. Therefore, not a
cap. Marketers will not be allowed to charge more than the
market clearing price. Marketers will be price takers.
When a reserve deficiency period ends, the maximum price
that can be charged for spot market sales in California and the
rest of the WSCC will be 85 percent of the highest hourly price
that was in effect during the most recent stage 1 reserve
deficiency period, absent cost justification. For example, if
the highest market clearing price during the most recent
reserve deficiency called by the California ISO is $100 per
megawatt hour, spot prices in all subsequent hours, beginning
when the reserve deficiency ends, can as a general matter be no
higher than $85 per megawatt hour. This $85 per megawatt hour
maximum price will remain in place until the next reserve
deficiency is announced and a new market clearing price is set.
Again, sellers other than marketers will have the opportunity
to justify individual prices above the market clearing price
based on their costs.
Yesterday's order also limits the ability of generators to
exercise market power by withholding capacity by requiring that
all public utilities and non-public utilities that own or
control generation in California offer power in the California
ISO spot markets. This requirement applies to any non-
hydroelectric resource to the extent its output is not
committed for use or sale in the hour or necessary to satisfy
local reserve or reliability requirements.
The same requirement will apply to sellers throughout the
rest of the WSCC, except that they may offer their power in the
spot markets of their choosing.
Also, the Commission has made clear that through enhanced
monitoring and coordination of generation or generator outages,
along with additional tools to act against withholding in other
forms of anti-competitive behavior, it is committed to
ferreting out and remedying any form of market manipulation and
misbehavior no matter when it occurs, 24 hours a day, 7 days a
week.
I am very proud of the Commission's approach toward
reforming California and Western electricity markets. The
Commission's mitigation plan manages what many said could not
be accomplished: restraining prices while encouraging
investment. The key is that price mitigation is based on market
forces. The market clearing price is designed as a cost of the
least efficient unit that is called upon to dispatch energy.
The mitigation price is not a blunt, arbitrary figure that
bears no resemblance to market conditions and is subject to
political pressures and whims. That is what was tried in
California just this past summer. The ISO lowered the price cap
last summer from $750 per megawatt hour to $500 and then even
lower to $250 per megawatt hour. All this did was cause an
increase in the average electricity price and a reduction in
the ability of the ISO to procure emergency power.
The point I would like to make there is that there are so
many discussions about price spikes, and we certainly
understand that. We certainly look for those, as does the
industry. But we are concerned with what inevitably gets to the
consumer most and that is the average prices, and that is why I
believe this plan will work best.
Indeed, last December, the ISO begged the Commission to
allow it to remove the cap, explaining that it was impairing
the ISO's ability to meet demand and undermining the
reliability of the electricity grid.
Also the mitigation price is not based on the cost of
individual generators. A return to traditional regulation would
entail months and perhaps years of administrative appellate
litigation over cost structures and reasonable rates of return.
This type of delay and uncertainty is simply unacceptable at
this critical juncture. We need to be problem solvers now.
Even more disturbing, regulation based on cost would
provide no incentive for suppliers to become efficient and
reduce their costs and thereby lower prices for consumers.
Mr. Chairman, I do see the yellow light, but I am trying to
explain the entire plan to you. It will probably take me
another 2 or 3 minutes.
The Chairman. Go right ahead.
Mr. Hebert. Thank you.
The Commission's plan, on the other hand, provides every
incentive for suppliers to reduce their costs and improve their
efficiency. Nothing is now guaranteed. A generator or a
marketer now makes money by increasing the efficiency of
production. Its profit is determined by how much of a
differential there is between its own cost of production and
the cost of the least efficient last dispatched unit. A
generator is now able to recover its fixed costs, but to the
extent of its recovery of capital and the size of its profit,
it is determined by the efficiency of its operations. In this
manner, a generator will find it profitable to retire old,
dirty, inefficient units and replace them with new, cleaner
burning, more efficient units. It is not only better for
consumers for bringing down prices and driving efficiency, it
is also better for consumers because we all understand the best
way to clean up our environment is to never dirty it in the
first place.
Yesterday's order was just the latest of dozens of orders
we have issued in recent months addressing California and
Western energy markets. On the electric side, the Commission
has done everything it can within its jurisdiction to extract
every last drop of electricity out of existing resources and to
free up additional megawatts from demand reduction initiatives.
To accomplish these results, the Commission has removed
various obstacles through waivers and other regulatory
enhancements. It has provided various incentives to the
development of new supply, including hydroelectric supply and
the reduction of existing demand.
Other Commission-led initiatives have reformed well-
intended but operationally dysfunctional market structures and
have promoted contractual certainty.
On the natural gas side, the Commission has been no less
active. First and foremost, the Commission in recent months has
significantly expedited its processing of applications to add
badly needed pipeline capacity to California. Applications of
the type that used to take many months or years for the
Commission to process were acted on in a mere 3 to 4 weeks.
On this point, the California Energy Commission recently
identified the lack of pipeline capacity, particularly capacity
inside California as the principal reason for the recent upward
spikes in the price of natural gas. The Commission recently
held a technical conference on this subject. We do not control
intrastate capacity. It is controlled by the State of
California, by their Commission, and by their people.
The Commission has sought comment on whether to reimpose
ceiling prices for capacity release transactions on pipelines
serving California. And the Commission established an expedited
hearing on alleged affiliate market power abuses by major gas
pipelines serving southern California.
In conclusion, the Commission has been doing a great deal
of work, Mr. Chairman and members of the committee. The
Commission's efforts have contributed to the recent decline in
Western energy prices. Yesterday's order issued by a unanimous
Commission, a Commission sitting as one, improves upon a plan
that is good for California, good for the Pacific Northwest,
and good for the entire West. It is a plan that respects market
forces and that attempts to restrain prices while at the same
time offering incentives for investment in supply and delivery.
That is the only real solution to the West's immediate energy
problems. It represents an effort to provide some relief now
while making sure that mitigation is short-lived. The
Commission's goals remain to fix dysfunctional markets and to
ensure that markets regain their competitive footing as quickly
as possible.
Mr. Chairman, just quickly, many of us have understood that
too much deference has been given to California in the past. We
are acting to do what we can and what we should and what we are
bound to under the law to protect the consumers in California
and the West. In doing that, I would like to mention something
that I think is important for you to know as we understand we
cannot afford to pay too much deference when consumers may be
harmed.
It is my belief--and I am not speaking for the Commission
here and what the Commission did. This is my personal belief as
Chairman of the Commission--that when I speak of forward
contracts and I speak of less reliance on the spot market,
which we know is what damaged California, it would be my
observation and my inclination that anything outside of 5 years
of forward contracts is getting purely speculative and
potentially harmful to consumers because, as we know, prices
will continue to be volatile. I do not mean to, nor will I,
endorse 10-, 15-, and 20-year contracts with the volatility
that I know is ahead.
I know there are so many questions that come up as to what
the Commission should have done a year ago. Again, I will
continue to say that I cannot answer what this Commission
should have done a year ago. I became Chairman January 22 and I
came to many of your offices. I certainly came to Senator
Feinstein's office as well about 3 weeks after I had been named
Chairman. I assured you and I assured others on this committee
that we would act responsibly, we would act expeditiously, and
we would correct the markets. I think we have done that.
We have issued over 60 orders for California specifically.
We have had a price mitigation for California in reserve
periods. We have got the RTO filed with us now, which is
important, understanding that it is not only about supply but
deliverability of that supply. We have issued orders removing
impediments, removing obstacles. We are doing things faster
than they have ever been done before to help California and the
West. We have got gas prices coming down. We are moving towards
transparency with gas prices. We are seeking comments on that.
We are seeking comments on the caps themselves, on the capacity
release. And now we have price mitigation not only for
California but also for the West in reserve and in non-reserve
periods.
I will close by saying this, Mr. Chairman and members of
the committee. I believe in my heart and I know in my educated
mind that we are on the right track and we are doing what
should be done for California and the West with the principles
that I think are endorsed by all of America.
Thank you, sir.
[The news release of the Federal Energy Regulatory
Commission follows:]
Commission Extends California Price Mitigation Plan for Spot Markets to
All Hours, All States in Entire Western Region
The Federal Energy Regulatory Commission today expanded its price
mitigation plan for the California spot market sales to 24 hours a day,
seven days a week. The curbs on prices in the spot electric markets
were also broadened to cover the entire 11-state western region. Spot
markets cover sales that are 24 hours or less and that are entered into
the day of, or day prior to, delivery.
Chairman Curt L. Hebert, Jr. said: ``The Commission's price
mitigation plan works. Today, the Commission adopts additional
measures, based on its original mitigation plan and which continue to
employ market-oriented principles, that will ensure that the plan works
even better.''
Today's order retains the use of a single price auction and must-
offer and marginal cost bidding requirements when reserves are below 7
percent in the California Independent System Operator (ISO) spot
markets, as outlined in the April 26, 2001 price mitigation and
monitoring order. The California ISO market clearing price will also
serve to constrain prices in all other spot market sales in the Western
Systems Coordinating Council (WSCC) during reserve deficiencies in
California. Sellers in other spot markets in WSCC will receive up to
the clearing price without further justification. Sellers other than
marketers will have the opportunity to justify prices above the market
clearing price during reserve deficiency hours.
The California ISO market clearing price for reserve deficiency
hours will also be adapted for use in all western spot markets when
reserves are above 7 percent. Prices during non-reserve deficiency
hours cannot, absent justification, exceed 85 percent of the highest
hourly clearing price that was in effect during the most recent Stage 1
reserve deficiency period called by the ISO.
Building on the success of its price mitigation and monitoring
plan, the Commission said that the key to bringing down prices in
California still lies with signing a portfolio of longer term contracts
and relying less on the more volatile spot markets, and attracting
additional investment in badly needed supply and delivery
infrastructure.
Today's actions will ensure that wholesale rates in spot markets in
California and the rest of the WSCC will fall within a zone of
reasonableness. In rejecting a return to cost-of-service rates, the
Commission said that cost-based ratemaking may penalize more efficient
generators and does not provide proper incentives for generators to
become more efficient. The Commission, in this order, as it has done in
all its previous orders related to the California markets, has put
procedures in place to prevent possible abuses that could lead to
unjust and unreasonable rates.
The Commission made clear that the abuse of market power will not
be tolerated and sellers may lose their market-based rates if they
engage in anti-competitive behavior.
In adopting market-based rates for the Western energy markets, the
Commission's use of a monitoring program is key to ensuring that rates
are just and reasonable. The revisions made in this order are designed
to provide a structure that will minimize potential abuses, ensuring
reasonable rates for consumers, while also encouraging adequate supply
in the market.
Other elements of today's order are:
all public utilities and non-public utilities selling into
the markets run by the California ISO or using Commission-
jurisdictional transmission facilities, who own or control
generation in California, must offer power in the California
ISO's spot markets. This applies to any non-hydroelectric
resource to the extent its output is not committed for use
(energy or minimum operating reserves) or sale in the hour.
the same requirement will apply to sellers throughout the
rest of the WSCC, except that they may offer their power in the
spot market of their choosing.
power marketers will not be permitted to sell above the
mitigated prices.
generators' bids during reserve deficiencies must reflect
the marginal cost to replace gas used for generation,
determined by the average of the mid-point of the monthly bid
week prices as reported in Gas Daily for all three spot market
prices reported for California.
bidders will be allowed to invoice the California ISO for
the costs of complying with NOX and other emissions
standards and for fuel used for start-up. The ISO is required
to file a rate mechanism to bill those costs over the entire
load on the ISO system.
the price mitigation will end September 30, 2002.
Chairman Hebert commented: ``This is a plan that is good for
California, good for the Pacific Northwest, and good for the entire
West. It is a balanced plan that respects market forces and that
attempts to restrain prices, while at the same time offering incentives
for investment in supply and delivery that is the only real solution to
the West's immediate energy problems. It represents an effort to
provide some relief now, while making sure that mitigation is short-
lived. The Commission's goal remains to fix dysfunctional markets and
to ensure that markets regain their competitive footing as quickly as
possible.''
Commissioner Linda K. Breathitt said: ``I support the mitigation
approach adopted through this order because it contains the market
features that I believe are critical to helping remedy the market
design flaws while still encouraging new investment in infrastructure
and protecting consumers.''
Commissioner Nora Mead Brownell commented: ``It is my hope that
this order lays out a road map which will bring certainty and stability
to the citizens in the West and encourage the desperately needed
investment in infrastructure.''
Commissioner William L. Massey said: ``This order provides price
protection in the entire Western interconnection 24 hours a day, seven
days a week, it absolutely prohibits gaming and so-called megawatt
laundering, and will last 2 summers. I have been advocating this
comprehensive approach for quite some time, and am generally pleased
with this order.''
Commissioner Pat Wood, III commented: ``What we do today is about
more than California. It is about the future of competition and about
our resolve to make it a better world for energy customers in our
country.''
In a comprehensive December 15, 2000 order addressing problems in
the California wholesale markets, the Commission found that the market
structure and rules for wholesale sale of electric power in California
were flawed and that, in combination with an imbalance of supply and
demand, led to unjust and unreasonable rates for short-term energy
during certain periods and under certain conditions. The December order
provided a number of remedies for the California markets including
elimination of the Power Exchange's (PX) mandatory buy-sell requirement
price and establishment of penalties for under scheduling load.
Following the December order and a series of related refund and
investigation orders issued earlier this year, the Commission announced
its prospective price mitigation and monitoring plan for California in
an April 26 order. The Commission noted that the plan, which took
effect May 29, has already produced results with western power prices
dropping in both the spot and long term markets. California's reliance
on the spot market has dropped from near 100 percent to about 20
percent during peak hours since the Commission's December order.
The Commission also announced today that it will hold a settlement
conference before a FERC administrative law judge later this month. All
parties in the California ISO investigation proceeding are directed to
participate in the settlement discussions in order to resolve refund
issues for past periods and help structure new arrangements for
California's energy future.
KEY QUESTIONS AND ANSWERS ABOUT THE FEDERAL ENERGY REGULATORY
COMMISSION'S JUNE 18, 2001 ORDER ADDRESSING PRICE MITIGATION IN
CALIFORNIA AND THE WESTERN UNITED STATES
Question 1. Does the Commission's order put price caps on all
California wholesale electricity prices?
Answer. No. The Commission's order does not impose cost-based caps
in any markets or on any prices. Rather, it establishes price
mitigation, based on market-oriented principles, that will apply to all
wholesale sales of energy in spot markets in the United States portion
of the Western Systems Coordinating Council (WSCC). Spot market sales
are wholesale sales that last no longer than 24 hours and that are
entered into the day of, or the day prior to, the power being
delivered.
Question 2. What is the ``price mitigation'' that is being adopted?
Answer. There are two types of price mitigation being put in place
for spot market sales, depending upon how low generation operating
reserves are at any particular time:
(1) When generation operating reserves fall below 7% in California
(called a reserve deficiency), a market clearing price will apply to
all spot market sales in California and in the rest of the WSCC. All
bidders in the ISO spot markets will receive the market clearing price
without further price justification. All sellers in other spot markets
in the WSCC will receive up to the clearing price without further price
justification. The market clearing price will be based on the bid of
the highest cost gas-fired unit located in California that is needed to
serve the California Independent System Operator's load on any day in
which a reserve deficiency is called. The bid will reflect a published
gas cost plus an adder for operating and maintenance expenses. Sellers
other than marketers will have the opportunity to individually cost
justify prices above the market clearing price. Marketers must be price
takers, i.e., they cannot charge more than the market clearing price.
(2) When a reserve deficiency period ends and generation operating
reserves rise to 7% (a non-reserve deficiency period), the maximum
price that can be charged for spot market sales in California and the
rest of the WSCC during the non-reserve deficiency period, absent cost
justification, will be 85% of the highest hourly price that was in
effect during the most recent Stage 1 reserve deficiency period called
by the California ISO. An uplift charge for fuel used for start up of
generators will not be included in the market clearing price, but
instead, will be recovered through ISO charges to all California load
on the ISO's transmission system.
Question 3. How does the above price mitigation differ from that in
the Commission's April 26, 2001 order?
Answer. It differs in three major ways:
(1) The market clearing price formula is changed in three ways: it
adjusts the gas component to reflect replacement gas prices in the
North or South of California, depending upon where the generating unit
that sets the market clearing price is located; it adjusts the O&M
expense from $2 to $6; and it eliminates emission costs from the
formula. Emission costs will be recovered separately from the ISO and,
ultimately, the ISO's customers.
(2) The prior order did not provide for mitigation of spot sales
prices in non-reserve deficiency periods. As described in the answer to
Question 2, today's order does provide for such mitigation.
(3) The prior order did not provide for mitigation of spot prices
in the WSCC, other than the spot prices in the ISO's centralized
markets, but sought comment on whether and what mitigation to adopt
outside the ISO markets. Today's order applies price mitigation rules
in California and all of the WSCC's spot markets, including to
individual bilateral contract spot market sales in California and the
remainder of the WSCC.
Question 4. Do the above price mitigation rules apply to all
sellers in the West?
Answer. Yes. The same rules that apply to FERC-regulated public
utilities (such as traditional investor-owned utilities, individual
power generators and power marketers) that make spot market sales in
the WSCC also apply to any non-public utility (such as Federal power
marketing agencies, municipal utilities and electric power cooperative
utilities) that chooses to sell in FERC-regulated power markets or that
use FERC-regulated interstate transmission facilities.
Question 5. How does the Commission's order apply to power
marketers and potential market power abuse such as ``megawatt
laundering''?
Answer. ``Megawatt laundering'' refers to selling from California
to other states, and later reselling into California in order to avoid
price mitigation that may be in effect. Incentives for this will now be
eliminated because uniform price mitigation rules will apply in
California and in the remainder of the WSCC for both reserve deficiency
periods and non-reserve deficiency periods. Further, power marketers
(unlike other suppliers) will not be permitted to justify prices above
the prescribed mitigated prices. Finally, all public utility sellers'
market-based rate authorizations are conditioned on sellers agreeing to
refund overcharges resulting from anti-competitive conduct and to
potential revocation of their market rate authority.
Question 6. Does the new mitigation adopted in the order apply
retroactively? What about refunds for past periods?
Answer. The mitigation in today's order takes effect the day after
issuance of the order. The Commission will address refunds for past
periods, if not resolved by settlement, in future orders. The
Commission has directed public utility sellers and buyers in the
California ISO markets to participate in settlement efforts before a
Commission administrative law judge, with such efforts to begin by June
22 and to be completed within 15 days thereafter. Among the many issues
presented by these proceedings, the parties may address refund issues
during the settlement proceedings.
Question 7. Why hasn't the Commission imposed cost-based caps?
Isn't the Commission required by the Federal Power Act to impose cost-
based rates if competitive markets aren't working the way they are
supposed to?
Answer. The Commission has broad discretion in setting rates, and
is not required to use cost-based rates or any other specific method so
long as the end result is within a zone of reasonableness. The
Commission must balance two statutory goals: protecting customers
against unreasonable rates and encouraging adequate supplies to meet
those customers' power supply needs. Cost-based rates would squelch
development of new supplies in the West and thus perpetuate the
problems we are trying to solve. Thus, the price mitigation adopted by
the Commission ensures that rates are not unreasonable for customers
but also encourages new supplies needed in the West.
The Chairman. Thank you very much.
Let me just ask each of the other Commissioners to take two
or three minutes and add anything they would like or give their
perspective on this order. Commissioner Breathitt, why don't
you start?
STATEMENT OF LINDA KEY BREATHITT, COMMISSIONER,
FEDERAL ENERGY REGULATORY COMMISSION
Ms. Breathitt. Mr. Chairman, I have a very short statement
that complements what we have done yesterday, and I would like
to read that and ask that it be entered into record.
The Chairman. Go right ahead.
Ms. Breathitt. Mr. Chairman and members of the committee,
yesterday the Commission instituted market monitoring and price
mitigation procedures for the entire Western United States.
These new procedures build on our April 26 order which
implemented similar procedures for California and initiated a
section 206 investigation of bulk power markets throughout the
West.
The plan we announced yesterday is designed to produce
prices in all hours that are just and reasonable and to emulate
prices that would be present in a competitive market.
The purpose of the plan is to stabilize the market in the
short term and permit California and other Western States to
repair dysfunctional market mechanisms. The mitigation plan is
intended to provide breathing room for the markets to self-
correct.
Importantly, the mitigation plan will apply to all sellers,
including marketers and non-public utilities across California
and the balance of the U.S. portion of the Western States
Coordinating Council.
I fully support the premise of the order, which is that all
sellers should be treated alike to remove the incentive to sell
in one area versus another when an emergency is called by the
ISO, so-called megawatt laundering.
While I wholeheartedly encourage conservation and embrace
demand reduction mechanisms, we need to acknowledge that the
natural gas and electric infrastructure in the West must be
expanded and upgraded.
I believe the market-oriented approach we have taken
through yesterday's order will provide the price mitigation
needed. It is also my hope it will not discourage necessary
investment in supply.
I would like to note that I attached a concurrence to the
order to express my views about one aspect that I did not fully
endorse. The order instructs the ISO to impose a 10 percent
credit worthiness surcharge to the market clearing price. The
imposition of such a surcharge virtually concedes to the ISO
the issue of whether or not the ISO must implement our
Commission's credit worthiness standards, an action that I
believe may be premature.
Finally, I would like to state my support for a settlement
conference that will be established through the order. I am
keenly aware of the difficulties that the parties face and that
compromises will need to be made to fashion a comprehensive
settlement. However, I have long been an advocate of negotiated
resolutions and I encourage all the parties involved, including
the State of California, to work together at the daunting task
of settling past accounts and structuring new arrangements.
In conclusion, I am confident that the Commission has taken
the appropriate actions to address the market distortions in
California, and I am pleased that our mitigation plan will now
be extended to the other States in the WSCC. Our remedies have
been designed to help alleviate the high prices borne by
California citizens and others in the West, but they have also
been designed to ensure that sellers have incentives to sell
into those States and build sorely needed new generation and
transmission necessary to provide reliable service in the
future. Meeting these goals within a market-oriented framework
is an approach that I endorse.
The Chairman. Thank you very much.
Commissioner Massey, why don't you go ahead with any
comments you have.
STATEMENT OF WILLIAM L. MASSEY, COMMISSIONER,
FEDERAL ENERGY REGULATORY COMMISSION
Mr. Massey. Thank you, Mr. Chairman.
Yesterday's order brings substantial price relief to a
broken market. I supported the order because it adopts measures
that I have been championing for the past 8 months. Price
controls are now extended to the entire Western
interconnection, thereby eliminating the megawatt laundering
problem that has vexed the mitigation programs adopted by the
Commission and the ISO. All sellers, both jurisdictional and
non-jurisdictional, are covered. Cost-based price controls
based upon the production costs of the last increment of
generation dispatched are now extended to all hours, not just
those of reserve deficiencies. We have long needed 24/7
coverage and we finally have it. Price relief will remain in
place for two summers, until September 2002, giving the market
16 months to correct. I endorse these measures.
Given that the Commission has now adopted measures that I
have long advocated, I am tempted to declare victory and let it
be. But I cannot. I have some concerns.
First of all, why did we not implement this plan 8 months
ago? Until yesterday, the Commission had stubbornly refused to
implement full-time price constraints, despite rather clear
evidence that prices were not just and reasonable. We could
have avoided much of the economic carnage out West, the closing
of manufacturing facilities, putting people out of work that
has occurred over the past year. Of all of this, this committee
is very much aware.
No. 2, the 10 percent credit worthiness surcharge. I object
to this. I do not see the need for it. The Commission has
issued orders in the past few months instructing the ISO to
abide by the credit worthiness requirements of its tariff. I am
concerned that this 10 percent adder may diminish the ISO's
enforcement of those requirements. Moreover, it is my
understanding that recently all sales into the ISO's markets
have been backed by a credit worthy party.
Instituting this surcharge does have a modest bright side,
however. Generators may no longer attempt to justify bids on
the basis of credit risk above what is provided in the cost-
based clearing price methodology. This was a major flaw in the
old, ineffective $150 benchmark in our earlier mitigation
program. Eliminating that ground for high prices is perhaps a
positive development.
Third, we should have provided guidance, in my judgment, on
the issue of refunds. We send all the parties to a settlement
conference with absolutely no guidance whatsoever on this
question. And it seems to me that it is up to this agency to
make a determination of what just and reasonable prices should
have been, extending back to last October 2. Instead, we punt
that to a settlement. I certainly hope it works. I hope the
parties can settle the matter, but I would have preferred some
guidance on this question.
Point four, the issue of the least efficient generation
unit. Will it, as Chairman Hebert says, encourage the
retirement of inefficient generators? Or will it, on the other
hand, encourage the continued use of inefficient generators so
that the market clearing price will be high? I do not know the
answer to this question.
Point five, whether this is successful depends in
substantial part on whether spot gas prices are reasonable. The
last increment of generation will often be an inefficient gas-
fired generator, and it may very well be that 80 percent of the
cost of that generator will be natural gas. If gas prices are
high, then the last increment of generation will be high. If
gas prices are reasonable, the last increment of generation
dispatched may be reasonably priced.
Finally, Mr. Chairman, just one more minute please. Over
the next 16 months during this time out, can this broken market
be repaired, repaired by substantial new generation, repaired
by eliminating over-reliance on the spot markets, repaired by
the implementation of a robust demand response program
implemented through demand bidding that can take a bite out of
the crisis, repaired by dealing appropriately with transmission
constraints?
We must work with the State of California. We must reach
out a helping hand and approach them in a spirit of good will
to solve these problems. We now have 16 months.
Thank you, Mr. Chairman.
The Chairman. Thank you very much.
Commissioner Brownell, why don't you go ahead.
STATEMENT OF NORA MEAD BROWNELL, COMMISSIONER,
FEDERAL ENERGY REGULATORY COMMISSION
Ms. Brownell. Mr. Chairman, thank you. Senators, I am
pleased to be here today to talk about an order that I think
represents an enormous step forward.
I would like to share with you, since I have been here
last, what I found when I came to the Commission, particularly
working on this order. I found a shared sense of urgency, both
in my colleagues and by the staff. I found enormous flexibility
as we worked through the complex issues that are outlined in
this order. I found honest and open communication, and I
believe those are the elements that will allow us to
effectively respond and continue to open markets. I think you
could fairly say that this order represents the fact that
everybody gave at the office, and I think that is why it works.
What else does it represent? I think what we have done is
to provide a comprehensive road map, a plan to get through the
next two summers, a road map that will create stability and
certainty and allow all of us to address market monitoring,
structure, and policy issues to create a fully functional
market.
It is important to note also that this order responds
affirmatively to the significant and helpful input from all of
the affected parties. The stakeholders' interests are well
represented.
My colleagues have, I think, articulated the main issues
that have been handled in this order, and of course, I know you
have a lot of questions, so I am going to be brief. But I want
to talk about a couple of elements that I think are critical.
We have, in fact, established a call to action for all of
the parties to join in joint settlement discussions to bring to
closure some outstanding issues. And Commissioner Massey is
correct. Perhaps we need to give more guidance. But in
Pennsylvania, we found the settlement talks to be successful
because we believe business people can manage their own
business more effectively than we can. I urge the parties and I
urge you to urge the parties to be serious and to be quick
about addressing these issues. We will certainly do it for them
and we will certainly do it quickly. But we hope to give them
the opportunity to respond in ways that are most appropriate.
We have also begun the process to ensure that the
opportunities created by new technologies for demand response
mechanisms are fully examined and brought to the market in a
rapid fashion. Customers are smarter than we give them credit
for. Customers will use tools to manage their buying habits if
we give them those tools. We need to find more effective ways
than shutting down businesses to manage demand response. I
believe the technologies are there. I think with encouragement
from policy leaders like you and us we can bring them to
market.
I think the most critical piece of this order is that it
represents a real opportunity for the State and the Federal
Government policies and the stakeholders to work together. No
one of us can solve this problem. I wish it were that simple. I
believe we have made an effort at outreach and we will continue
to do so because I think together we can provide the leadership
that is required and, indeed, demanded and owed to the
consumers of the West and, frankly, the consumers of this
country.
I thank you and I look forward to your questions.
The Chairman. Thank you very much.
Commissioner Wood, why don't you go right ahead.
STATEMENT OF PATRICK WOOD III, COMMISSIONER,
FEDERAL ENERGY REGULATORY COMMISSION
Mr. Wood. Coming last, there is a cleanup job. There is not
much to clean up after this. We did a lot yesterday.
One of the things that we did not do that I think is
relevant to the discussions that I know were scheduled for the
committee today is move to a cost-of-service rate regulation
regime. We have contemplated it. I am just personally not
allergic to that sort of remedy, but I wanted to look to the
facts and have had the staff at the Commission, who I have
found to be very capable and helpful on this issue, research
for me some of the relevant facts here so I could share those
with you all today. So, if I could just step over for my 2
minutes to this chart.
The Chairman. Go right ahead.
Mr. Wood. The spot market in California encompasses the
last 20 percent of the total market. Due to the efforts of the
California government to get into longer-term contracts since
last December, a lot of the generation has been taken off of
the spot market and moved, as we think appropriate and support
certainly from the Commission's point of view, into longer-term
contracts that are not dealt with by yesterday's order.
Yesterday's order deals with in predominant part--and this
is what the facts show--with the older units that have what we
call the higher heat rates, the less efficient units. I know,
Senator Feinstein, you have been concerned about the use of the
least efficient units, but quite frankly what is in the
leftover part of the spot market are very many inefficient
units. So, one is not markedly more inefficient than the other.
There is some spread.
And this curve is representative--I will get some
additional facts as we work the ISO to get those. The curve
largely is a relatively flat curve that drops a little lower as
you have some of the newer more efficient units participating
in the spot market, and then the very old units that are
dispatched at the very, very end and very high units which we
could see this summer certainly setting the price.
Unlike cost-of-service ratemaking, the Commission's market
mitigation order does not add a profit. We do add this credit
worthiness that we have talked about, but we do not add a
normal profit that we would add to the cost-of-service. If we
were to take the prices of these units and add some sort of
cost-of-service, I know even the Governor of California has
said perhaps even a 50 percent return would be better, but in
general regulation is a 12 percent return after tax, or the 16
percent once you factor in the taxes. If you were to add that
on to the curve right here, you would set up a rate here
(gestering). So, that is kind of what cost-of-service would do,
taking these costs and add a profit like that.
What the Commission's order yesterday does is on a normal
first contingency emergency, which is when you have got less
than 7 percent excess capacity available in the market, we
would set the price at that level. Yes, that is the least
efficient unit in that time frame, but this (gestering) is what
you call the producer surplus. These producers have costs at
that lower level. They receive a price at that higher level. If
you have got a more extreme day, you would have the clearing
price being set at a higher level, and again we will see that
this summer undoubtedly.
But I think it is important to compare just under cost-of-
service there is still some money out there that might be more.
So, I think it is a close call as to which one is more money
out of California ratepayers' pockets, but I just want to
assure the committee that I was cognizant of that. We certainly
looked at that, at the Commission's point of view as to which
is better, and I do not think there is a dramatically different
outcome as far as the bottom line, how many dollars are going
out of customers' pockets under cost-of-service versus the
Commission's order.
So, I hope that is helpful, and we will continue to work on
the refining that kind of data because I think it is important
for you as policy makers to understand the difference between
the impact of the Commission's order yesterday and how it
treats the spot market and how those spot market prices would
work were it to be a cost-of-service based regime, which quite
frankly we have been good at for 80 years and we are trying to
move away from. But we can still do it.
The Chairman. Thank you very much.
Since the Commission has indicated they need to leave by
about 10:30, I am going to limit everyone to 5 minutes and try
to get all Senators to have a chance to ask questions. Let me
start.
Commissioner Hebert, let me ask you what your thought is.
You stated, in very eloquent terms, the pride you have in the
order that you have entered and the fact that you believe that
now this order is the right thing to be doing. There is a long
period here of many months during which Commissioner Massey and
others have thought that something similar to this should have
been in place. For that period of time, is it your thought that
the parties themselves should negotiate what they believe would
have been just and reasonable rates had this order been in
effect and settle out at that basis? Is that what your intent
is at this point, rather than having the Commission act on that
back period?
Mr. Hebert. I really get two questions out of what you are
asking me. One is why has this not been done sooner, and the
second would be the settlement and how do we do the settlement.
As far as why this has not been done sooner, I have said
many times, Mr. Chairman, I cannot answer that. We can blame
the previous chairman. We can blame the Governor. We can blame
the previous administration.
The Chairman. I am not trying to get into that blame game.
I am just trying to figure out where do they go now. Should
they try to figure out, had this been in effect from the day
that the high prices started, what would be owed in refund? Is
that what you are directing them to do in the settlement
conference?
Mr. Hebert. What we have done is the Commission has acted.
As you know, we acted to issue refunds, close to $130 million
worth of refunds. We also had a refund separate of that for
about $8 million. The Commission has taken action and has moved
forward on that. We have got those subject to rehearing at this
point, and that is from the time periods of January actually
through April. And the May numbers have just come in. We were
delayed in getting the numbers from October to December because
we did not have the filing requirement in at that point. So, we
got the new information.
It is certainly my belief, Mr. Chairman, that if we can
throw all of that into one settlement conference, we can get
the State of California to the table, we can get the generators
to the table, the utilities to the table, we can all come up
with some type of agreement.
Now, as to the direction of the agreement, there are always
those that would second guess what you do in a settlement. As
an attorney, my experience is that there are only two things
that settle settlements, and that is deadlines--and we have a
deadline here, and the deadline is the administrative law
judge, our chief judge, has 15 days. They have 15 days to
settle this case. And if they do not settle these issues, then
the ALJ, the chief judge, will make a recommendation to us
within 7 days. Now, that is fast, but our belief is that the
issues are known, the numbers are known, and they need to come
to some type of agreement.
Now, the other thing that makes a settlement come to a
close is uncertainty. If you define the parameters of the
settlement, then you cut off some opportunity to settle other
matters. It is my belief that we should not do that.
Due to the uncertainty, due to the deadline, I believe this
will be settled, and at the end of the day, if it is not done
so in 22 days, this Commission will see it again and we can
make that call then. It will be much quicker than going through
these rehearings.
The Chairman. Well, I am not disagreeing with your decision
to try to get the companies to settle. It strikes me, though,
that in some cases uncertainty detracts from the pressure to
settle because each side may have a very different idea about
what the Commission's action might be if they fail to settle.
Can you give this committee or anyone involved some
indication of what the Commission is willing to do by way of
orders for these back periods if settlement is not agreed to?
Mr. Hebert. Well, I think this Commission--and I am
speaking about the Commission I have been involved in as
chairman--has been the only Commission that has acted in the
form of refunds, has been the only Commission that has acted in
the form of mitigation of prices twice and now to the West, as
well as California. So, I think the record is clear that if
this Commission does see those issues again, that it will make
a call that I think in the end justice will be served looking
after, for the most part, the consumers of California.
The Chairman. Does anybody else have a comment?
Ms. Breathitt. Yes. Mr. Chairman, we still have an
obligation, upon rehearing, to resolve on rehearing the refund
orders that we issued for January, February, March, April, and
May, and we have got to do October, November, and December of
2000. So, this almost omnibus settlement conference would seek
to resolve those matters in that context. If it does not, I am
presuming that we would, on rehearing, resolve those dollar
amounts.
The Chairman. Since we are short on time, I will just stop
with that and defer to Senator Murkowski for his 5 minutes.
Senator Murkowski. Thank you very much, Senator.
We hear so much about price gouging, who is to blame, and
so forth. But I am looking at some figures, relative to
allegations on specific organizations that appear to have been
able to take advantage of the shortage in California and the
excess capacity that they had, particularly British Columbia
Power Exchange. I am referring to a reference that indicates
that in recent studies, it shows that the Canadian trading of
BC Hydro reaped about $176 million in alleged excess profits,
several times the amount collected by all but one of the
private generators. BC Hydro officials acknowledged they did
anticipate periods of severe power shortage and planned for
them by letting the reservoirs rise overnight and then
operating them to create hydroelectricity which could be
produced inexpensively but sold at a premium, and BC Hydro had
stashed hundreds of millions of dollars in so-called rainy day
accounts to ensure that it had among the lowest rates in North
America.
Now, it would seem to me that if we are dependent by about
one-third of the total estimated costs by the California
independent systems operator, which was estimated at $5.5
million in excess profits, and BC Hydro was a third of that and
you folks have no control over BC Hydro, they simply have
excess power and they can sell it to the highest bidder. But
that is a significant factor in the allegations associated with
pricing, and whatever they could get is whatever those that had
to have the power were willing to pay.
Since you have no control over them, I assume this is just
out there and you would like to not have to depend upon that
source. But if they have excess energy and are willing to sell
it, you have to pay the price regardless of your regulatory
authority.
Mr. Hebert.
Mr. Hebert. Well, as to the past, that may be true, but as
to the future, because of what we have done through the price
mitigation measure here, it would extend to them, and in the
sense that they would be mitigated, it would apply to them as
well.
Senator Murkowski. Their alternative is simply not to sell
into you now. Is that correct?
Mr. Hebert. Well, if they have got anything available, if
there is anything available trading through the ISO or trading
on our tariffs throughout transmission systems that we have
jurisdiction over, within that 24-hour period, the real-time
spot market, they have to make it available. They cannot
withhold.
Senator Murkowski. Within that 24-hour period.
Mr. Hebert. Correct.
Senator Murkowski. Yes, but if they do not want to
basically participate in this agreement, they are not bound, as
others are where you have some control, because BC Hydro is a
significant developer of power and they could simply contract
in if it is outside the 24-hour limitation.
The point I am getting at here--and I hope that members
pick up on it--is it is a supply and demand problem. We do not
have the supply. We are dependent on outsiders. As far as BC
Hydro is concerned, they are a significant contributor
particularly to the Pacific Northwest and ultimately
California. You have to have it. And they are going to charge
whatever they can get beyond the 24-hour period. Right?
Mr. Hebert. Right. BC Hydro itself is----
Senator Murkowski. And until you develop more power in this
country, you are going to have to depend on those sources which
are going to keep the rates high.
Mr. Hebert. Right, and BC itself is non-jurisdictional. We
do have jurisdiction over some of its affiliates, but you are
correct.
Senator Murkowski. And BC Hydro has clearly made some
extraordinary returns on its operation of the Columbia River.
Mr. Massey.
Mr. Massey. May I make a point please?
Senator Murkowski. Sure.
Mr. Massey. If they want to sell in the Western
interconnection, they have got to sell under this program that
is set out in this order. They will receive the price of the
least efficient generator that is dispatched in the California
ISO, probably a gas-fired unit, which would have costs well in
excess of their costs. They will still make a handsome profit.
Senator Murkowski. Right. Thank you.
The other point I want to ask is, Mr. Wood, you talk about
cost-of-service. To me that is cost plus a profit. Tell me how
that concept encourages efficiency in the utility industry. It
seems to me it gives them assurance of a rate of return, but no
assurance that they are necessarily going to be as efficient as
they could be otherwise.
Mr. Wood. I would agree with that, and I think that is why
I think as a general philosophical matter, on really all ends
of the spectrum, there has been a move away from that across
the Nation.
Senator Murkowski. My last question, since we are running
short of time, is to all of you, and you can answer it yes or
no. It is simply, should Congress legislate wholesale price
caps?
Mr. Hebert.
Mr. Hebert. No, sir.
Ms. Brownell. No, sir.
Mr. Massey. I would let this plan work.
Senator Murkowski. That means yes or no?
Mr. Massey. That means no.
Ms. Breathitt. No.
Mr. Wood. No.
Senator Murkowski. Well, we have somewhat of a consensus
based on the fact that all five voted for what they believed
was a workable plan. Thank you, ladies and gentlemen.
The Chairman. Senator Wyden.
Senator Wyden. Thank you, Mr. Chairman.
Mr. Hebert, to follow up on Chairman Bingaman's question
about a settlement agreement, how do you get a settlement
agreement when one key party, California's largest utility,
PG&E, is shielded from having to pay its creditors by
bankruptcy protection? As I look at it, PG&E basically has got
a one-way street going. They are going to get refunds from
those who overcharged them, but do not have to pay back those
who charged a fair price. So, I am curious about how you are
going to go about getting a settlement agreement.
Mr. Hebert. Senator Wyden, the issue is not so much that, I
do not think. I think the issue is does it position PG&E
differently than they would otherwise be positioned. In other
words, is there anything that changes through the settlement
process that would not apply to the Commission, FERC, itself.
They are in bankruptcy whether FERC is handling it through a
settlement process with its chief judge or whether we are
handling it.
But I think the proof will be in the pudding. It is my hope
within 22 days of Monday, because Monday is when the settlement
conference will start, that we will have a settlement if I hold
true to the course that I have been trying to move in. If not,
this Commission will move expeditiously on it.
Senator Wyden. I hope you are right, but I am skeptical. It
looks to me like they have got a very, very advantageous
position going into this settlement discussion. That is why I
have been concerned about it for many months.
Let me ask all of you why you chose 15 months for the
order. From the seat of my pants, maybe this is too long, maybe
it is too short.
But I guess the question illustrates why we cannot come up
with a third path between the two we have got now. We have sort
of got this one path that says caps are the answer and another
path that says caps are going to be a disaster. I guess the
question is why can we not come up with an approach that
creates some marketplace incentives as part of this.
So, my question for all of you is, why not look at caps,
even in this emergency period, only until a certain number of
megawatts come on line that are needed to meet demand? That way
you could send a message to all concerned that we want to get
generation out there as quickly as possible, and the sooner the
new generation becomes available, the sooner everybody wins.
Would that not be something that you could do now to modify
your order and actually create some incentives that would be
consistent with an approach that would allow for caps?
You are shaking your head yes, Mr. Massey, and I probably
ought to quit while I am ahead.
Mr. Massey. Senator, I think that is a very good idea to
create a generation reserve benchmark and keep these price
controls in effect until that benchmark is met. That would
certainly be another way to skin this cat.
I think the 15 months is intended to be a proxy for that,
but it is a blunt proxy because we have no assurance that there
will be sufficient generation 15 months from now. We have a
hope and a prayer, and we need to work with the State of
California to ensure that that is done.
Senator Wyden. Mr. Wood.
Mr. Wood. That 15 months--and in the order we referenced
that that was based upon what the State of California has
indicated were new plants that were expected to be on line and
by which dates. The Commission has put in a quarterly reporting
requirement to ensure that we are meeting that benchmark. So,
the 15 months, as Bill pointed out, was a blunt tool, but it
was built upon just the data you are suggesting ought to be the
trigger and with which I agree.
Senator Wyden. I hope you will look at this again because
it seems to me that there is a better way to go about doing
this. I see my colleague, Senator Smith, is here, and I am
going to discuss this with him as well. I am concerned about
the gaming prospects of caps, always have been. Suffice it to
say, I do think that there is a way, even during this emergency
period, to say that we are going to structure these caps so
that they stay in effect only until we have got those megawatts
on line that are needed to meet demand and create incentives
for powerplant developers to go out and do it as quickly as
possible. So, I hope that you will look at it. I see Senator
Smith is here and I am going to discuss this with him further.
I thank you, Mr. Chairman.
The Chairman. Thank you very much.
Senator Domenici.
Senator Domenici. Mr. Chairman, I wonder if I could let
Senator Smith go and I will wait another turn.
The Chairman. Well, yes, I guess that is according to our
rules here. Go ahead.
Senator Domenici. I do not want to do it if it is
violating--are you concerned about it?
The Chairman. Well, we just have other people in line after
you.
Senator Domenici. So, I will just do mine.
The Chairman. Why do you not go ahead?
Senator Domenici. Thank you very much.
Let me say to Mr. Massey, you just answered a while ago
that we should not pass a new Federal law, that we should let
this order of yesterday take hold and see if it works.
Thereafter, in some responses to Senator Wyden, you seemed to
indicate that you were not sure it would work.
Mr. Massey. I am not sure it will work.
Senator Domenici. Nonetheless, you say we should do it.
Mr. Massey. I am not sure it will work. I have hope that it
will work. I think it is dependent on, frankly, whether gas
prices stay reasonable.
Senator Domenici. So we will all know that you are the
Commissioners that would be getting some help if we thought we
knew how to give you help through some Federal law and you were
suggesting, this particular day versus yesterday's order, that
you do not think it is the time to pass additional Federal law
on the subject.
Mr. Massey. I think it is always better for the regulators
who have the responsibility to ensure just and reasonable
prices to use that authority effectively. It is my hope that
yesterday's order is an effective 24-hour-a-day/7-day response.
My advice is to give it some time to see if it works.
Senator Domenici. Could I ask the Chairman and any of you
to, in a simple way, tell this Senator what is your goal with
reference to the activities you are pursuing with reference to
California prices and of the West. What do you hope your legacy
will be in the next 18 months to 2 years?
Mr. Hebert. I would hope that we improve upon a
dysfunctional market in California and bring it to its feet,
deliver reasonable prices to consumers, while at the same time
making certain that we are attracting necessary supply, because
we understand that there is an imbalance between supply and
demand, but at the same time, it is not only about supply. That
is why I think if you ask me about the legacy, it would be my
thought that the legacy should be to straighten out California
and the West--and I think this plan will do that--at the same
time, understand delivery and deliverability of supply is
essential to the Regional Transmission Organizations Order No.
2000. Let us move forward with those processes so we can not
only be concerned with California and the West in the next 18
months, but we can be concerned with California, the West, and
the rest of America for the next years and decades.
Senator Domenici. Mr. Wood, what do you think your goal is?
Mr. Wood. Similar to what Curt just said, Senator. I think
we have got to put a cooling off period there while California
gets its infrastructure to sufficient levels, while the market
rules that were inadequate to stimulate long-term investment
and customer benefits in the California market get revised and
get implemented. Once that is done, then competition can come
back, but they are not done yet. So, the cooling off period is
necessary.
Ms. Brownell. Senator, I would simply like to add that
whatever actions we take need to communicate to the consumer
that they can have confidence that the public policy makers are
working together to ensure that the answers will be there and
that investment will be there. And if we do nothing else in the
next couple of weeks, I think that is a critical message.
Mr. Massey. Senator, I think there is a fair degree of
consensus about the long-term strategy, a Western
interconnection-wide RTO, because this is one big machine in
the Western interconnection, and it ought to have a single RTO
operating it.
The debate has really been about what to do in the short
term, and I hope that we have a plan in effect that will
protect consumers in the short term while we move to the long-
term implementation of RTO rules, demand side responses to a
high price, effective congestion management, and so forth.
Senator Domenici. Commissioner?
Ms. Breathitt. Senator, I would add that my goal is to
stabilize the market in the short term and permit California
and other Western States to repair dysfunctional market
mechanisms. In other words, the mitigation plan is intended to
provide breathing room for the markets to self-correct, while
protecting consumers.
Senator Domenici. Could I just ask the Chairman or anyone
to tell me what these four words mean? I have read your order
and I thought I would take the opportunity to ask you what some
of these mean. I would have to take an awful lot of time to
understand your order.
What is requiring all sellers to bid into the spot market?
What does that mean?
Mr. Hebert. Well, that means, Senator, that if they have
available capacity--there was a huge question about withholding
energy, letting prices run up, and then releasing the
electricity to get the high prices. If they have anything
available in that spot market 24 hours, they have to release
it, put it into the market so buyers can buy.
Senator Domenici. What about proxy price? What does that
mean?
Mr. Hebert. Proxy price is a price at which we establish
what a market that is functional would otherwise deliver to the
market during a dysfunctional period.
Senator Domenici. Do you all agree with that?
Mr. Massey. It is a cost-based price based upon the inputs
of fuel, O&M, and other production costs.
Senator Domenici. What does a single price auction mean?
Mr. Wood. To use that chart that I had, Senator Domenici,
it would be the point at which demand upon the X axis crosses
with the price on the Y axis, and then that price--say it is
$100--is paid to everybody whose generators dispatch. So,
everybody who is to the left of that point on my little curve
there gets paid that single price.
Mr. Hebert. Senator, that is the issue that drives the
efficiency that we were talking about, the single price
auction.
Mr. Massey. It is intended, Senator, if it works well, to
incentivize generators generally to bid their costs. It frankly
has not worked that way because there is very little risk of
non-dispatch in the market, but that is what it is supposed to
do.
Senator Domenici. My last observation has to do with
powerplants and the construction of powerplants in the State of
California. I assume you have no jurisdiction over the State
and the State's effort to license and/or permit and cause to be
constructed new powerplants.
Mr. Hebert. No, sir, we do not.
Senator Domenici. Do you have some way of finding out what
the State of California officially says they are going to be
doing in the next 2 or 3 years?
Mr. Hebert. We have actually got that in our order. It was
released, I believe, by the Governor's office, and we are going
to revisit that after, I think, the next quarter of next year.
That may or may not be right as far as the specific date, but
it is important that we keep them on track, that they do have
less reliance on the spot market, and at the same time, that
they add the supply they say they are going to add. It is one
thing to talk about it; it is another thing to bring it on
line.
Senator Domenici. Mr. Chairman, I raise that issue and, in
a way, give it back to you for further understanding before
this committee, maybe tomorrow with the Governor.
But many of us have heard California's story in terms of
when and how they were going to produce new powerplants. For
the most part, over the past decade to 15 years, 20, all of
which time I must admit I have been a Senator, so I was not out
there in the market understanding this, but it seems to me that
clearly California has historically over-promised what they
were going to build and they end up with powerplants that
cannot be built because of intervention, because of lawsuits,
because of regulations. I think it is really important we find
out. If we are going to be players and go along with the
Commission, it seems to me we ought to really know whether
California is going to build these powerplants or are there
going to be further delays as there have been in the past.
I thank you for giving me the time and I yield.
The Chairman. Senator Feinstein.
Senator Feinstein. Thanks very much, Mr. Chairman.
I just want to say that I view this action by FERC as a
giant step forward, and I am very grateful to you. I also view
the fact that Senator Smith and I have worked hard on this bill
and perhaps has been helpful in urging you along, but I will
not draw that conclusion. I just say perhaps.
Mr. Chairman, I believe Senator Smith and I are prepared to
ask you to withhold the markup for the time being. Let us watch
and wait and see how this order works.
I share the concerns of Mr. Massey.
And I thank you, Mr. Woods, for the diagram on how this
least efficient megawatt works. However, it still remains to be
seen, I think, whether it can be manipulated or not. I think we
should wait and see what happens.
I think the fact, though, that you have expanded your April
order to 7 days a week/24 hours a day and to the 11 Western
States until September 2002 is extraordinarily important and
just really a giant step forward. Whether you call this
mitigation or cost control, as they say, a rose is a rose by
any other name. I will leave that up to you. I am very hopeful.
I will be very frank with you. I want to see it work because I
think the problems there are extraordinary.
I want to comment on one thing. The order seems to change
the accounting standards for nitrous oxides, so that instead of
allowing generators to count these as variable costs,
generators will have to submit invoices from the ISO so that
the costs will no longer vary and should be lower. Is that
correct, Mr. Hebert?
Mr. Hebert. That is correct, Senator, and let me tell you
why. We found difficulty, when we used it in our April 26
order, because they would administratively change it all the
time, so we could never completely calculate how it would work.
So, we figured it was better just to have an uplift charge, let
them invoice it. That way there would be no playing around with
it. It will be their actual cost and it will be placed in
there.
Senator Feinstein. Thank you. We will watch that very, very
carefully.
I wanted to make a comment and then ask a question on this
15-day settlement conference. I am very concerned because, to
the best of my knowledge, very little if any money has actually
changed hands as a result of prior settlement conferences. I am
concerned because the costs out there to be discussed could be
up to $15 billion. I am concerned that there are no rules or no
protocol for this settlement conference. I would like to ask
that you watch it very carefully. From what Commissioner
Breathitt just said--and I want to corroborate this--if the
settlement conference is not successful in resolving these
issues, the FERC is willing to step in and make that
resolution. Is that correct?
Mr. Hebert. Absolutely.
Senator Feinstein. Well, I am really going to hold you to
it----
Mr. Hebert. You do not have to.
Senator Feinstein [continuing]. Because with a successful
settlement, you could have a real settlement that could move
the utilities out of bankruptcy as well and certainly be of
massive help to the consumers. So, I think these next 15 days
and then the 7-day recommendation period for you are
extraordinarily important.
I would like to ask this question. Why do you believe,
because of the size of the Western grid, that it is really
necessary to put this 10 percent gratuity, so to speak, on any
sale into California?
Mr. Hebert. The problem with California right now, when you
look at it from a business perspective, is several fold.
Senator Wyden pointed out part of it earlier. Bad business
environment. You have got a bankruptcy right there. Energy
companies that are thinking about doing business and building
new plants and moving forward certainly are skeptical. We had a
lot of issues in the past in looking at the credit issue. This
credit issue moves forward. It says we believe that there is a
difficulty when it comes to business transactions, when it
comes to energy needs in California. We are so concerned with
that that, quite frankly, what we are going to do is we are
going to put a 10 percent adder.
But here is the other magic. Here is the thing that has not
been talked about yet that I really think you will appreciate.
When it comes to justification, we do not have a cap in place.
We do have the proxy. We would rather them bring the energy in
than set a price at which we are not going to allow energy to
be delivered.
But you have some that have had conversations and made
comments and filed comments, that when they try to cost
justify, they may, in fact, even suggest that their risk factor
on credit is 10, 15, maybe even 100 percent because they have
not been paid. This takes that justification away from them.
They have an adder. Justification is not there. They cannot use
it. So, it is really good for the consumers.
Let met add one thing to it, something you said in the very
beginning that I think is important.
Senator Feinstein. Fast because I want to ask one more
question.
Mr. Hebert. You mentioned about the piece of legislation
and the influence. There is always conversation about what is
the political influence on an independent agency like FERC.
Senator Feinstein. I know. You are not impacted by any of
this.
Mr. Hebert. No, no, but I think it is important to point
this out. Whereas I will be fair and accurate with you, it does
take this Commission time and it is somewhat tedious to come
and testify before the Senate, testify before the House, deal
with legislation. I do not know about the influence, but I will
tell you what it does influence and that is good, open debate
that brings issues out that allows us to make good decisions.
Senator Feinstein. Thanks, Mr. Hebert.
As I understand it, the price of natural gas at various
delivery points in the West sets an average cost that gets
plugged into the heat rate formula for the least efficient
megawatt needed at any given time. It seems as though you have
changed the natural gas delivery points that are used. Could
you quickly explain the FERC's plan here for natural gas and
why you decided not to do anything about the transportation
cost?
Mr. Hebert. Commissioner Wood wants to do it. Let me say
one thing before he does that, and I will be glad to talk
further with you about it later. It is almost identical to what
the ISO itself asked for.
Commissioner Wood.
Mr. Wood. In fact, yes, ma'am. We built our recommendation
off of what the California ISO recommended. Rather than using
the daily spot price, which can be, as we know, pretty
volatile, they suggested using a monthly price which is done
the last week of the prior month. The last week of May,
everybody bids for their June deliveries. It is a monthly
price. It's a widely published benchmark used for financial
purposes. It is used for many contracts. It also reflects more
of a balanced portfolio. So, we agreed with them and used that
as part of the proxy.
We averaged, I believe, three delivery points. One is
northern California exclusive, one is southern California, and
one comes into both. That gives a weighted north/south average.
By using an average, it might be a little higher than what the
north experiences. It might be a little lower than what the
south experiences since that seems to be the disparity.
Anybody that does not feel like they got their costs
compensated may be allowed to come in and justify a higher
price, but we are going to look at their total portfolio of gas
purchases. I personally think that was very important to me in
this order to make sure that there is a dampening effect on
relying heavily on the gas spot market, just as we had a
problem in the last 8 months of people relying very heavily on
the electric spot market. So, pushing people back to portfolios
is kind of a recurring theme here.
Mr. Massey. Senator, if I may comment very quickly on that.
I think your question implies what I believe to be true, which
is the transportation differential issue, high transportation
differentials into California and high spot market prices, and
high gray market prices. If those continue, this plan will not
work well to dampen prices. So, I think my agency still has a
lot of work to do with respect to the natural gas market in
California.
Senator Feinstein. Thanks very much, Mr. Chairman. Thank
you, FERC.
The Chairman. It is 10:30. We have two additional Senators
who would like to ask questions, if you can stay and take
those. Then we have your general counsel who has agreed to be
available to answer any additional questions people have on
this.
Senator Smith, go ahead with yours.
Senator Smith. Thank you, Mr. Chairman.
I join my colleague, Senator Feinstein, in saying I believe
this order goes a long way, and I congratulate you for it. I
think it renders substantially moot the legislative effort that
she and I were pursuing. I do believe that that effort would
have won large majorities in the Senate and the House. So, I
think what you are doing is reflecting the will of the elected
representatives of the American people.
I know, because as a Republican who believes in markets,
that you will now be subject to the criticisms that have come
my way which are that you are interfering in the market. That
critique of your efforts, I tell you, I think you are safe to
defend for two obvious reasons.
No. 1, this market is not free. It is badly broken, and
your intervention has been needed for some time.
No. 2, the commodity of power is different than the
commodity of peas or widgets or anything else. People expect
power. They have a right to believe it is going to be there at
a cost that they can afford, and frankly, it is a matter of
public safety and a reasonable expectation of the American
people, which is a reason why this has been so highly regulated
an industry for so long.
We are in a process of deregulation. Senator Murkowski
cited the instance of BC Hydro. I suspect there are a lot of BC
Hydros out there on this side of the border. I think BC Hydro
needs our market just like we need their power. My hope is that
they will not be gaming the system any longer and that any
American generators are not gaming the system any longer. And
they cannot now because of what you have done. So, for that
reason, I thank you.
I hope the American people understand that what you have
done addresses the short-term problem of price gougers, but
long term the problem is supply and demand and bringing those
in balance. You cannot fix that, but ultimately investments
which still have plenty incentive will fix that and
conservation on the part of consumers will bring that also into
better balance.
I do have a couple of concerns, and they are this. Right
now your order goes 15 months. That gives California two
summers to get through this. That gives the Northwest one
winter. We are opposite from them, as you know, in terms of our
peaking load. I hope you be willing to look at this again if
mother nature does not turn the rain on and we are in a
situation where we just simply do not have the power.
Mr. Hebert. If I may comment on that briefly. Your comment
and question is indicative of the evolution that this
Commission is going through right now. We certainly do not know
it all. I have had conversations with all the Senators in this
room, and what I have shared with you is that we are not done
yet. We are continuing to learn. We are not done with the
Northwest yet. There is more to do. We are seeking comments on
that. We do not totally understand the northwestern market. It
is very different than California. So, we are seeking comment
on that, and there will perhaps be more work to do. We do not
know that yet.
Senator Smith. I appreciate that very much because, again,
I would say to any of the public watching this, it is one thing
to describe to people why the cost of their milk is at a
certain price. It is something very different to go to a
nursing home and say to seniors on fixed incomes or to an
aluminum plant that has laid off all of their workers why their
prices have gone up so exorbitantly. You cannot say, well, it
has because there are some really smart people out there
manipulating the market. That is not something this Government
should tolerate, and I am grateful that you all have stepped up
to the plate like this.
Lastly, does the settlement process for refunds that you
announced yesterday only apply to sales within California? The
reason I ask that is because of my concern about the status of
the rehearing on the Puget Sound energy complaint that was
denied on December 15. Does this just apply to California or
does it cover all the States in the West?
Mr. Hebert. At this point we are applying it only to
California.
Senator Smith. I would ask you to at least think of that
one more time because I think there may be cases outside of
California that need your review.
Thank you, Mr. Chairman.
The Chairman. Thank you very much.
Senator Cantwell.
Senator Cantwell. Thank you, Mr. Chairman.
I do want to thank the Commission for their hard work on
this order issued yesterday. But I do have some concerns about
how we are going to proceed and particularly the answer to that
last question, but I will get to that in a second.
I just want to remind my colleagues that even though this
will, I think, provide some guidance in the future, the
Northwest has already seen a 50 percent rate increase in some
of its pricing at the home residential and industrial level.
And because we have already had to buy very expensive power
through BPA, some of those costs are going to continue to be
passed on. So, I am not sure if we are saying to the people in
the State of Washington whether this is going to be much
relief, given the fact that some of those increases are already
going to take place again this summer and later this fall. So,
I would encourage my colleagues to continue to look at, as we
move through the legislative process, conservation and
curtailment efforts that might help in reducing some of that.
It seems to me that there might be a couple of ``I
gotchas'' here in the way that both under the deficiency of
reserves and in non-deficiency times how this mechanism would
work. So, I wonder if maybe one of the Commissioners, maybe
Commissioner Wood, could address this. But it seems to me that
when operating reserves fall below 7 percent and the bid must
reflect a published gas cost plus an adder, that there is a
basic mechanism where people can come back and justify a cost
higher than that. And the same when a deficiency period ends,
the same absent justification language.
So, first I am curious when we are going to see the exact
details of the order. I do not think that the full order has
been made available, or at least made available to the public
or via the web. At least we checked. When will we see the
details in the language?
And exactly how will this justification issue be resolved
to make sure that we have a solemn guarantee here that we are
going to be looking at a basic cost and knowing what that is
during this period?
Mr. Wood. The order should be issued today, which will make
it effective at midnight tonight and all day tomorrow, going
forward.
Senator Cantwell. So, the public will be able to get a copy
of the full order, the details.
Mr. Wood. Yes, ma'am.
Senator Cantwell. Which I am assuming is at least many
pages.
Mr. Wood. About 60.
The answer on the justification, the difference between a
hard price cap is you got no justification; soft price cap, you
do. That is the general thought.
Justification was important for us in the supply constraint
scenario to make sure we get every megawatt on the grid that we
possibly can. If there are extenuating circumstances that the
mitigation scheme cannot apply to fairly, we still want their
megawatt and are willing to pay them. We are just not going to
let them set that market clearing price that everybody else
gets paid.
There might be somebody that has a high gas cost. We have
put forward in that section that we will not only look at the
cost you paid for that Mcf of gas, but we will look at all the
gas prices, all the portfolio that you hold of gas to make sure
that you are not just sending the highest price cost to this
mechanism and keeping all the low priced gas that you have
acquired under longer-term contracts for the rest of your other
contracts.
We have taken off NOX, the emissions credits
that are more predominant in California I believe than they are
in the Northwest. We have taken that out of the mechanism so
that will not be dealt with. We have taken startup costs out of
the mechanism. So, they will not be dealt with either.
Senator Cantwell. These are detailed in your order.
Mr. Wood. Yes, ma'am. Those things tend to inflate the
market clearing price. We have taken those out, said you get
reimbursed for them, but we are not going to let that inflate
the price for the whole mitigation scheme.
Mr. Massey. Senator, if I might. I think the key point to
make here is the justification, if a generator comes in, has to
be based on costs. He cannot come in with some inflated notion
because we have taken a lot of that flexibility out. The gas
proxy formula is intended to replicate costs. For the emissions
allowances that are in an uplift charge, they have to submit an
invoice detailing their actual costs for those and so forth.
So, the formula is intended to be very tight. If they
cannot recover all their costs under the formula, they have got
to come in and show us what their costs were that they could
not recover. So, it is a cost-based control.
Mr. Hebert. Let me clear up two things that you may draw
into question. One is----
Senator Cantwell. Well, let me just point out since we have
not seen the details of all of this, I think that's what my
concern is. Obviously, there are numerous times when Federal
agencies come out with a new ruling and then you see the actual
details of that ruling and find that there are ways in which
people can maneuver around it. So, I want to make sure that we
have understanding from the Commissioner.
Mr. Hebert. Right, but there are two things. One, the
credit, because that is a California issue, does not apply to
the West. So, the 10 percent surcharge credit does not apply to
the West. The other thing that does not apply to the West is
the uplift on the NOX. So, those are two things that
would not apply in the West and are exceptions.
Let me volunteer to the committee our staff to come over
and brief the committee staff, as well as anyone from the
Senators' offices that would like to be included. If we could
do that all at one time, Mr. Chairman, that would be helpful.
But I would certainly love to do that. I think it would be good
for you and it would certainly be good for us.
Senator Cantwell. One critical question left, please, if
several of the Commissioners could address this, and that is
the issue of the settlement agreement as it relates to the
Northwest. Commissioner Massey, you have been excellent on your
review of the previous order and section 206 that was not broad
enough in its investigation. So, where are we leaving Northwest
energy consumers in this payback scheme, whether we are going
to be at the table or not be at the table, whether we are going
to be able to see any refunds from this or not?
Mr. Massey. That is an excellent point, Senator. I think we
could have done better than just sending it to a vague
settlement conference. I think it leaves too much uncertainty
and I think it leaves uncertainty about what residents in the
Northwest are going to get back, if anything.
Now, there are matters on rehearing that I do not believe
the Commission has dealt with that could provide relief, and I
appreciate that point.
Senator Cantwell. You still have your final decision on
that to be issued. Is that correct? On the review, on the 206?
Mr. Massey. I believe we do.
Senator Cantwell. The Commission has not issued your final
discovery on that?
Mr. Hebert. The July 2 refund effective date is out there
and the settlement process, as I have said, is applying to
California only at this point. That is what was discussed.
Actually we have not discussed anything outside of that realm.
Senator Cantwell. But we have, in your previous appearance
at this committee, talked about the fact that the West needed
some relief, including the Northwest on this, and you brought
up your section 206 investigation. At that point in time, I
brought up the fact that I thought it was late in coming, and
you said we are going to make a decision about the West.
Mr. Hebert. Well, the comments that we received from that
are one of the reasons that we moved forward to improve upon
our mitigation plan.
Senator Cantwell. I am not clear on that answer whether the
Northwest will be at the table, and you are saying they are
not. But yet, you are saying----
Mr. Hebert. They are not in the settlement conference, but
they are certainly a part of our price mitigation at this point
in the reserve and non-reserve hours. But we are, as I said
earlier, continuing to seek comment on what to do with the
Northwest. So, we invite those comments.
Senator Cantwell. I asked this question before and you were
gracious enough to answer. Have you found that the Northwest
prices are just and reasonable?
Mr. Hebert. You and I bantered about a bit, and we have
certainly had conversations in your office. I will tell you
that prices are high. There has been no judgment on the
reasonableness and justness of prices for the Northwest.
Senator Cantwell. I am still unclear about your final FERC
action on that.
Mr. Hebert. We have not done anything final on it.
Senator Cantwell. And when is that date?
Mr. Hebert. I do not have a date.
Senator Cantwell. Is it not a time span of like 60 days or
something?
Mr. Massey. The refund effective date set in the order for
the Northwest would be July 2 of this year. So, if the
implication of your question is that refunds could not go back
before July 2 of this year, you may be right, and perhaps that
is an issue for rehearing.
Senator Cantwell. Thank you.
Thank you, Mr. Chairman.
The Chairman. Thank you very much, and I want to thank the
Commissioners. I know that you have taken a great deal of
valuable time here describing this order. We congratulate you
on the action you have taken. We will be watching very closely
to see how it is implemented, as I am sure you will be.
Senator Boxer is here and would like to address the
committee. I will call her forward as a witness at this point
to give us her testimony on this issue. Then following that,
Mr. Kevin Madden, who is the General Counsel, will be available
to answer some additional questions that any of us on the
committee have, and I will call on him next.
Senator Boxer, welcome to the Energy Committee. We are
anxious to hear your views on the action FERC has taken or
action you believe they should take.
STATEMENT OF HON. BARBARA BOXER, U.S. SENATOR
FROM CALIFORNIA
Senator Boxer. Thank you so much, Mr. Chairman. Thank you,
Senator Murkowski. I know what a hectic schedule you have, and
I am going to try to complete my remarks in 5 to 6 minutes. I
think I have some definite opinions and I hope you will
consider them.
First, I want to say that the committee has been very
helpful. There are those who say there was some pressure put on
FERC to act. I think a nicer way to say it is we have
encouraged FERC to act. Senators Feinstein and Smith had a good
bill on the cost-plus pricing. Congressman Bob Filner and I had
a similar bill, but it included refunds. I think frankly
without help from outside California, we would not be at this
day. I think it is a very important day today. I cannot tell
you the feeling I have and the relief that I feel that we are
moving in the right direction.
I still believe we have more to do and I am going to
comment on that today.
The first point I want to make, Mr. Chairman, is really to
set the record straight. Many have said that FERC had nothing
to do with this crisis in California; that in fact, it came
from California. There have been jabs at our Governor, although
I think it is intriguing because the fact of the matter is that
this whole deregulation occurred before. He had nothing to do
with it. He is one of the few who had nothing to do with it. It
was bipartisan. It was Governor Wilson who recommended it and a
Democratic legislature and Republicans in the legislature who
embraced it. So, to blame this Governor is absolutely wrong.
I have had the opportunity to talk to Vice President
Cheney, and I appreciated the meeting that he took with the
California delegation. I wanted to correct the record because
Vice President Cheney has said, when we said we need help in
California, ``Go back and talk to whoever it is that blocked
the development of additional supplies in the past because they
are the ones who are responsible for the high prices.''
Well, I want to correct the record. Mr. Chairman, FERC does
bear some of the responsibility for stopping the supply, and I
want to make the case this was under a Democratic President.
This is not a partisan jab in any way.
In the early 1990's, the California Public Utilities
Commission ordered our utilities to build more powerplants.
Now, what did the utilities do? They appealed the order to a
State administrative law judge who ruled against the utilities
and said, you must build these 1,400 megawatts.
So, what did the utility companies do? They appealed to
FERC. Now, what was interesting was FERC sided with the
utilities in 1995. They said, you are right. You do not have to
build these 1,400 megawatts. Therefore, we do not have those
1,400 megawatts. And you can really say that those megawatts
may have well saved us from the rolling blackouts.
So, let me just say I was very pleased with yesterday's
about-face by FERC. I believe that they have a new tone. I
believe that they finally recognize that we needed action
throughout the entire Western region.
But I do have two unanswered questions, and the reason I
raise them is I think your committee could play a central role
in just following these issues.
One, will FERC enforce the cap or will they allow companies
to use loopholes to escape it? I think that is key and I hope
that your committee and Senator Lieberman's committee and my
Environment and Public Works Committee will take a look at
this.
Two, will the cap be set too high since it is pegged to the
least efficient producer rather than to the actual cost of each
company? I think we need to keep monitoring that.
Now, my big disappointment with the order, Mr. Chairman, is
along this line. I believe the Commission should be issuing
refunds to those who have been paying these outrageous prices.
I really do. I think maybe we will watch a settlement
conference. But I do believe it is FERC's responsibility. It is
in fact in their charter to protect against unjust and
unreasonable prices. I think that if they do not do it and if
the settlement conferences do not work, I believe Congress
should do it, and I am going to be introducing legislation that
would do just that.
Let me show you why this is so important, Mr. Chairman. I
think when you see this--you may already know this, but it will
reinforce my point. The chart on the generator profits that we
have seen. Mr. Chairman, profits increased on average by 508
percent between 1999 and 2000. I want to make a point here.
Demand increased only 4 to 5 percent, and profits increased an
average of 508 percent.
Now, you might say maybe the whole energy sector enjoyed
those kind of profits, but if you look at it, the energy sector
got a 16 percent increase in profits in the electric and gas
industry. 16 percent average profits compared to 508. One
company, Reliant Energy, saw its profits increase 1,600
percent.
Could I have that ad from the Roll Call? There is an ad in
the Roll Call, plus there are ads in all the newspapers, I
would say, except in California for obvious reasons, that show
Reliant as saying, ``Helping California keep the lights on.''
Yes, they did at 1,000 percent profit, at gouging prices. And
that is the problem that we are facing. I think the headlines
should say, ``Keep the lights on while gouging California
consumers.'' So, again, 1,000 percent increase in profits; 4
percent increase in demand.
Now, I used to be a stock broker and I know that profits
are crucial for every business. But there is a difference
between responsible corporate behavior and irresponsible
gouging.
I want to show you one other chart, Mr. Chairman and
Senator Murkowski, you may not have seen, which is the
maintenance schedule for these companies. In the blue, you see
last year the energy that was taken on line for maintenance.
Here in the yellow, Mr. Chairman, you see the current year.
Look at how many plants closed for maintenance. Now, it is hard
to believe that this is a coincidence if you look at last year
compared to this year. So, when you pull power off line, Mr.
Chairman, it puts the squeeze on, and I think we have seen that
occur. And all of this has happened at the consumers' expense.
If the price of a gallon of milk had increased at the same
rate as California's electricity prices, milk that now cost $3
a gallon would cost $190 per gallon. Mr. Chairman, imagine
where all of us would be if our consumers walked into the
supermarket and had to pay $190 a gallon. It is no different as
to what is happening to them.
Let me tell you what is beginning to happen. We are
beginning to get letters from small businesses, from individual
consumers. I will read you just a teeny part of a letter I
received from a constituent. The letter is from John Odermatt
of San Marcos, California. He wrote to President Bush and sent
me a copy. This is what he says and I quote. ``I'm a father and
a husband in a single income family. My wife and I very
carefully planned our family economics in order to give our
daughter the benefits of having a full-time parent at home.
We're currently spending money on electricity bills that should
be going into family investments for college and/or our
retirement planning.''
Mr. Chairman, I know you care deeply about those who need
help paying their bills. To help the 2.1 million low income
Californians who qualify for LIHEAP, we need additional funds
for this program, or only 10 percent of our people who need it
will receive assistance. Imagine 90 percent would not get
assistance. This summer, without air conditioning in certain
parts of California, people will perish. I want to make that
point. I worry so much about the elderly who are on fixed
incomes withholding air conditioning. People will perish.
Emergency funds for LIHEAP are needed, and I know you are
working on that.
Mr. Chairman, I support your position of $3.4 billion in
the budget for LIHEAP. Again, I know this is important to you.
You are our leader on this issue, and I stand ready to help you
in any way I can.
Now, there are those who say that LIHEAP does nothing to
hold down prices. As a matter of fact, they say, well, wait a
minute. If you make it possible for people to pay these high
prices, they will stay high. But, Mr. Chairman, this is an
emergency. We have to do all that we can.
I have one quick suggestion and then I will sum up on the
LIHEAP program. I think we ought to look at a special stream of
money for LIHEAP. There are those who have recommended the off-
shore oil revenues. If an electric generating company makes
significantly higher than average profits as compared to the
industry as a whole, I do not think it would be a bad thing for
that company to make a contribution into the LIHEAP fund to
help those consumers who are being hurt by the high prices they
are charging. I hope we can work together on this seed of an
idea that I have here.
In summary, the FERC's order was a step forward. My
colleague called it a giant step forward. I think she is right
on that.
Let me reiterate, just the major points I have made.
One, we need to monitor FERC's actions. If it is not
working, we need to move to cost-based pricing.
Two, we must see that refunds are provided to those who
have paid excessive profits. That is the role of FERC, to
protect against unjust and unreasonable prices. We need those
refunds for the victims of price gouging.
Three, increases in the funding of LIHEAP are in order and
consider that those companies that have reaped an unfair
windfall should pay into that program.
Thank you so much to you and Senator Murkowski. This is
really a much better day for us in California and we are most
appreciative.
The Chairman. Thank you very much, Senator Boxer. Thank you
for your strong effort on this Senate issue as it affects your
State.
We now have the General Counsel of FERC.
Senator Murkowski. I have one question.
The Chairman. Oh, go ahead, Senator Murkowski.
Senator Murkowski. I am glad to hear things are better in
California today.
Senator Boxer. Well, we feel better.
Senator Murkowski. I think we all agree that the FERC
action, if it is what it says and works as they hope, will give
you some relief. Of course, I believe in the theory that if
milk costs too much, we ought to get some more cows. If you get
more cows, why, the price goes down unless the milk sours. Now,
clearly we have had a souring within the energy market, but I
think the point is to produce more energy.
My only question to you--and I know of your interest
relative to consumer affairs and the idea that we should have
clear and full disclosure. But I wonder if you think that the
Governor of California should order the Los Angeles Department
of Water and Power to refund any of their windfall profits
specifically.
Would you recommend that the contracts between the State
Department of Resources and the sellers of power to the State
be open for public view?
Senator Boxer. Absolutely. I think anyone who has gouged--I
think that is against the law. If they are municipal, if they
are private owned, whatever, I really do believe in that.
By the way, Mr. Chairman, I agree we need more supply. We
will have about 1,200 megawatts on line this summer. We need to
do more there. The Governor projects there will be 13,000
megawatts on line in a couple of years. I think we are going to
be okay. I think we can do the supply. I think we can do it
right.
But it is a balanced program that I support. Energy
efficiency is key. Conservation is key. A responsible expansion
of the supply is key. I think if we do those things and if the
FERC order works, I think we are going to see the light at the
end of the tunnel and everyone can stand proud of that.
Senator Murkowski. I draw your attention to the report that
suggests that the top 10 in profiteering from California total
about $505 million, and as I have indicated, Los Angeles
Department of Water and Power is $17.8 million. And you would
recommend a refund from the Los Angeles Department of Water as
well.
Senator Boxer. I say that any entity, private, public, that
has gouged consumers and that FERC has made a judgment that
that there is gouging, that is the law, and they must, in fact,
make those refunds. Yes.
Senator Murkowski. The British Columbia Power Exchange,
which is BC Hydro, is about a third of the alleged price
gouging. Of course, we do not have much authority in British
Columbia, in a foreign nation. We are left simply to the
exposure of them having the power and we having the addiction
to the power. So, we have been paying the price.
Thank you, Mr. Chairman, and thank you, Senator Boxer.
Senator Boxer. Thank you so much.
Again, that is why energy efficiency is so important.
Thank you again.
The Chairman. Thank you.
Mr. Madden, why do you not come forward? Unless you had
some statement you wished to make, we would just go right into
questions, just to supplement what we had already asked to the
Commission itself. Is that agreeable with you?
Mr. Madden. That is agreeable, Mr. Chairman. I do not have
an opening statement other than to say the Commission and its
staff has worked extremely hard to get this order out, and we
did it in lightening speed. The order was issued on April 26.
We got the comments within the 30 days and we acted just
yesterday. Thank you.
The Chairman. Thank you.
There are some States that are affected by your order which
have not seen high prices for wholesale power, my State being
one of them, New Mexico. Are you confident that nothing in your
order, which takes the entire West and, in effect, puts in
place a limit on what can be charged based on the highest price
being charged out in California, is going to result in
increased prices for wholesale power in these other States
where they have not had the exorbitant prices for wholesale
power?
Mr. Madden. A couple points, Mr. Chairman. One, our order
only deals with 24 hours or less. Most sales outside California
are bilateral sales, more than 24 hours. So, in terms of your
particular State--and I do not have the numbers--I would assume
a great deal of the wholesale sales that occur are bilateral
sales which are not even covered by our program.
To the extent that it is, we have this price mitigation
which mimics what the market is supposed to look like, and any
agreements or any deals that want to occur below that price or
even up to the price should not affect prices outside
California in terms of how the market works.
Another point to make is that the order will go out for
comment and seek what other market-type approaches we should
look at outside of California, recognizing there are 11 States
in the WSCC. We are providing 60 days for comment to look at
whether or not those ramifications to our price mitigation that
is going to be in effect, if we issued the order today, 24
hours after that. We are asking comment from everyone in the
West whether or not there is a better approach outside of
California.
The Chairman. Are you confident that the order will not in
any way deter the entering into long-term firm sales contracts
for the future? One of the agreed-upon purposes or directions
that California has been trying to move into is to get more
long-term contracts in place in recent months. Do you believe
that that incentive to do that will continue to be there even
though this order is in place?
Mr. Madden. In our December 15 order, we recognized the
importance of California getting out of the spot market, and
they were essentially 100 percent in the spot market. We
recognized that they should really have only 5 percent in the
spot market. They have been successful to date in moving a
great deal of their portfolio outside the spot market.
I believe our mitigation program that is in place now and
our order, as of yesterday, will have no effect in terms of
California negotiating longer-term contracts. In fact, that is
the premise of our order. We want them to continue to enter
into longer-term contracts and get out of the spot market.
The Chairman. How does the monitoring and reporting system
work for the rest of this WSCC? As I understand it, the ISO has
gathered the cost information and reported prices in
California. Who is going to do that in the rest of the West, as
you see it?
Mr. Madden. In our order, we propose that the WSCC serve as
a clearinghouse, among others, for the prices. But I believe
that outside of California, the entities, the sellers, will
know the prices the ISO establishes for the particular hours of
the day.
The Chairman. Let me go ahead and defer to Senator
Murkowski for any questions he has.
Senator Murkowski. Thank you. I have no questions other
than to indicate to you, Mr. Madden, that I want to compliment
you and your professional associates for the manner in which
you have been responsive. I think it was a very thorough
effort. We will look forward to receiving the formal order very
soon.
The Chairman. Very good.
Senator Cantwell.
Senator Cantwell. Thank you, Mr. Chairman.
Mr. Madden, I am trying to understand if we do not have a
major flaw in this order. I am trying to understand the order
as it relates to the section 206 investigation and whether the
Northwest or, for that matter, all the other Western States are
entitled to have overcharging investigated and be eligible for
refunds. So, if you could clarify how this order applies to the
rest of Western States and whether we, in fact, will be
entitled to that or whether the Commission, just in haste,
limited maybe unnecessarily this refund issue just to
California.
Mr. Madden. Senator, I think you have to go back to the
April 26 order where we, as a companion to that order,
initiated a 206 investigation outside California for the entire
West. Under the law, under section 206 of the Federal Power
Act, we cannot have refunds occurring earlier than 60 days
after we have it published in the Federal Register. So, the
refund effective date for the West, other than California, with
respect to the rates is July 2, 2001. So, in terms of refunds
occurring prior to that period, we have no statutory authority
for that from a refunds standpoint.
We can look at, however, whether or not there have been
tariff violations. We can use our equitable remedies to see
whether or not public utility sellers have, indeed, violated
the tariff.
Our mitigation plan for the West, despite the July 2 refund
effective date, will be effective 24 hours after we issue the
order.
Senator Cantwell. What you are saying--and further explain,
if you would like, why California will be able to be included
in refund and possible investigation as this settlement process
prior to that, but the Northwest or other Western States will
not.
Mr. Madden. Senator, last August 2000, we issued a 206
investigation for California, not for the West. And we set the
refund effective date to October 2, 2000. That order only
applied to California. It did not apply to States outside of
California. So, with respect to the issue of refunds, why is
the West not entitled to the refund back to October 2, the
answer is that the order that we issued back in August only
applied to California and it established the refund effective
date, October 2 forward, for California. We are on two separate
tracks, California and the West, for refund periods.
Senator Cantwell. Which I think I brought up. I do not know
if you were at the last hearing with the FERC Commissioners.
But we brought up this issue and the fact that this
investigation of the Western States was, in fact, late. We can
see now that we will be penalized in this order for that unless
the Commission decides to take action otherwise in being able
to recoup some of those costs and overcharging that has
happened in the Northwest, unless the Commission does believe
that the rates have been reasonable and just in the Northwest.
Mr. Madden. Well, in our earlier order of April, we stated
that the rates may be unjust and unreasonable in the West, and
that is why we established the 206 investigation. And that is
why we established the earliest possible date under the Federal
Power Act, and that is July 2, 2001.
Senator Cantwell. If the Commission did want to take action
otherwise, how would they resolve this?
Mr. Madden. If the Commission wanted to have refunds
occurring prior to July 2, 2001 for outside the West? Is that
the question?
Senator Cantwell. Yes.
Mr. Madden. We have no statutory authority to require
refunds prior to July 2, 2001.
Senator Cantwell. So, the Commission could not take action
solely on its own.
Mr. Madden. We have no statutory authority to do so.
Senator Cantwell. Thank you, Mr. Chairman. This is
something I think the committee should investigate because,
obviously, we have seen this was a West-wide crisis in Western
States, not just in California. The impact for consumers, as
far as industrial users and residential users, has been real.
We have not had a retail cap in the State of Washington. We
have not had consumers who have been shielded from that, unless
their utilities have gotten creative with their own financing
and spreading that out over a longer period of time. So, we
have seen a real impact.
So, in this order, Mr. Chairman, to be left out without
that recourse, given that again we have already seen a 50
percent increase, we are likely to see another 70 percent
increase, even given this order and its forward actions,
because of the amount of power that has already had to be
purchased through this process. So, Mr. Chairman, I think it is
something that the committee should address. Thank you.
The Chairman. Yes. Thank you very much.
Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman. I want to thank
you all for holding this hearing and thank you, Mr. Madden, for
being here.
First, I want to say that I thought the actions of FERC
made a great deal of sense. You can call it what you will,
price cap, price control, proxy price, price mitigation. The
bottom line is that the market was broken and needed fixing.
I have generally opposed price caps in general. One of the
issues in my campaign was whether there should be credit card
interest rate caps. Senator D'Amato was for them; I was against
them. But there are occasions when the market is not working,
when it is broken, when there is, in a sense, a monopoly which
is what happened here. And then you have to act.
I think some of my colleagues confuse and many people in
the country confuse being pro business and being pro market.
They often coincide. Sometimes they do not. When you do not
have a market, it does not mean that you just help the company
do whatever it wants. That is what was happening here.
So, I am delighted that FERC did this action for the 10
Western States and salute you for doing it.
As we move on the road to deregulation, until you get a lot
of suppliers and a lot of buyers, you are not going to have
real competition, and that is what all of us have to be very
careful about. I believe in deregulation. I put in a major
deregulation bill with Phil Gramm, but again, it just does not
happen at the snap of a finger.
So, what I would like to ask you about is not the
California market, but its implications elsewhere. I come from
New York which, if you believe the pundits, what happened in
California could happen in New York. My question is as follows.
One, in general, what are the differences in the structures
of the New York market and the California market? I know we
have more long-term contracts in New York, but even there we do
not have all long-term contracts. So, we could have the same
kind of squeeze that California faced, should there be a lot of
warm days.
But second, why should what FERC did not become national
policy? Why, if the same thing happens in New York and there is
one supplier or two suppliers who are sort of doing price
leadership, should the same types of--again, call them caps,
call them controls, call them mitigation, call them what you
will. Why should they not apply?
So, my general question is how is New York different?
Should these caps--should this policy--let us not jaundice it
by calling it one thing or the other--be a national policy as
opposed to just a Western policy, and if not, what could deal
with a similar problem that might occur this summer in New
York?
Mr. Madden. Those are very good questions, Senator. Let me
see if I can respond to them.
The first question, how is New York different than
California? Let me give you my particular thoughts. California,
when it went through unbundling, told essentially the IOUs that
they should get rid of their portfolios but for essentially
hydro and nuclear, and that they sold those particular plants
to producers, to the Reliants, to the Mirants of the world. And
they did not have the IOUs enter into long-term contracts. They
essentially said that they should buy through the spot market.
As a result, they did not have either generation there to
support their load or they did not have the buy-back provisions
of a contract.
Now, if you look at New York, for example, New York did not
require all spot. It had a lot of the IOUs have longer-term
contracts. They, in fact, had their generation. More
importantly, New York is in the PJM region, and the reserves in
the PJM area, which covers this region of the country, New
York, Maryland, et cetera--they have reserves, 15, 20 percent
of reserves for the supply in the most part. It is a better
working situation here than it is in California.
Even as an example, when there was concern earlier this
year with New York being short on supply, there was an
immediate response by the State of New York to add a
substantial amount of generation to cover it. You also have the
New York ISO, in terms of how they operate the rules and the
market rules there.
What we have seen in New York and, for the most part, the
rest of the country is that the market really is working. The
prices are $30 to $50 a megawatt hour in the most part. There
are spikes, yes, but the volatility is nothing like it was or
is in California.
Now, why would you want to overlay, for example, a price
mitigation scheme that we implemented to take care of the
concerns, the dysfunctions of California and the West, when for
the most part, what we are seeing is a well functioning,
competitive market? Yes, there still have to be concerns, but
my personal view is that you should not overlay with additional
rules a situation where the market is operating very well.
Now, we at the FERC are very concerned about New York, and
a lot may happen to New York and other areas of the country. We
just last week started asking for outage data. So, we will
monitor that market, as we will the other markets in the
country.
Senator Schumer. Let me just follow up, if I have your
okay, Mr. Chairman. It is true the New York market is not as
bad off as California. First, the supply/demand equation is not
as out of sync in New York, as you say. Second, we do have
long-term contracts. And third, you are right, the PJM market
is better than the Western market. But let me just make two
points here.
One, not all of our contracts are long-term. By the way,
this tends to be at least immediately for the next summer or
two a down-state rather than an upstate problem. But Con
Edison, which I think supplies a third of New York power and is
the main supplier overwhelmingly in New York City and in
Westchester and in LIPA, Keyspan in Long Island--neither of
them are totally covered by long-term contracts. So, you still
have the problem at the margin you are similar to California.
Second, as I understand it, while, yes, there are excesses
of power in PJM and in New England, for that matter, in large
part you cannot get the power from here to there, that the
transmission lines are so overloaded and old that you just
cannot get from here to there. So, even if you have an excess
in those areas, they may not do the job.
So, my question is, yes, the markets are different, but
this policy is not designed to deal with the market in general.
It is designed to deal with it at those peak times when
ludicrous prices, way above what is needed to incentivize
companies to build new plants, are asked and paid for. Why
should we not have a policy that deals with that? I do not want
to bring you back here in September and you said, well, gee,
everything was fine except for 3 days in August, but now New
York is in a position where we are $2 billion out because we
are paying some wildly absurd sum. Could you answer that?
Because I did not find your first answer totally dispositive.
Mr. Madden. Well, Senator, unlike California, I think that
the neighboring States have provided a substantial amount of
supply to New York where it has been needed. I think New York
needs to build more infrastructure, clearly transmission lines
in New York City. There has to be the development of an
infrastructure.
Senator Schumer. Agreed, but that is 2, 3, 4 years away.
Mr. Madden. If we have the right incentives, it could be a
lot shorter. If we have the right incentives, we can have a
streamlined permitting. I just do not think at this stage,
based on what I know--by the way, there are pleadings before
the Commission asking for a similar result, Senator, in terms
of why not apply somewhat of a similar mitigation plan----
Senator Schumer. If I just might interrupt you, sir, I have
here the Energy Daily of June 19, today as it turns out. Con Ed
says that FERC is leaving New York City residents exposed to
unfair and unreasonable rates this summer by refusing to
consider special market power mitigation measures proposed by
the utility. So, it is not just me talking about this; it is
the main distribution agency in New York.
And your answer--we could be the quickest State in the
country. We are not going to get power lines ready for not
even--forget this summer--it is impossible--but for next
summer. I supported the building of those ten little plants. I
was one of the few elected officials who did, but that is not
sufficient.
Mr. Madden. Senator, we have the pleading by Con Ed and
others before the Commission right now, which raises the same
questions that you have asked me. We will be addressing that
pleading in the near future. I cannot talk more about the
specific merits of it because I am precluded, but I am well
aware of the pleading.
Senator Schumer. I would simply ask you to consider our
problem, and I do not think saying either most of the contracts
are long-term, surrounding markets do have some excessive
power, or that we can build more transmission lines over the
next few years, which I agree with--we have to--are sufficient
answers if, God forbid, we have a lot of hot days this summer.
Mr. Madden. I am not saying they are sufficient, but at the
same time, I have to recognize we have to deal with a
particular pleading by Con Ed. And we may have the relief you
are requesting.
Senator Schumer. I hope you will consider that. Thank you.
Thank you, Mr. Chairman.
The Chairman. Thank you very much.
Mr. Madden, thank you very much. Let me just say that I
know you and the Commission itself are very proud of the order
you have entered. We hope very much that it does all that you
intend. Based on the consensus view here on the committee,
which I am sure you heard, we will suspend any effort to
legislate in this area, at least in this committee, and watch
and hope to continue to stay in close touch with you to
determine whether you think your order is, in fact, handling
the situation.
Congratulations to you on the action you have taken, and we
appreciate very much your staying behind and answering some
additional questions.
Mr. Madden. Thank you, Mr. Chairman, and thank you, Senator
Murkowski.
The Chairman. Let us get all of our additional witnesses up
here. Our third panel is Mr. Geoffrey Roberts, who is president
and CEO of Entergy Wholesale Operations; Mr. Steven Fetter, who
is the managing director of Global Power Group; Dr. Ronald
McMahan, who is the managing partner of Enercap; and Mr. Thomas
Brill, director of regulatory policy and analysis for Sempra;
and Mr. Bruce Henning, who is the director of energy and
environmental analysis in Arlington, Virginia. If each of them
would come up, we would appreciate it.
Why don't we go ahead and hear from each of you? If you
could summarize your comments, we will be glad to put your
entire statement in the record. But why don't we start on the
left-hand side, my left? Mr. Roberts, why don't you start out,
and we will just go right across the table and hear your point
of view of any of these issues. Mr. Roberts, thank you for
being here.
STATEMENT OF GEOFFREY D. ROBERTS, PRESIDENT AND CEO, ENTERGY
WHOLESALE OPERATIONS, THE WOODLANDS, TX
Mr. Roberts. Thank you, Mr. Chairman, Senators. Thank you
for allowing me to appear before you today.
Entergy Wholesale Operations is the unregulated wholesale
power arm of Entergy Corp. We have powerplants operating or
under advanced stages of construction or development through
the Gulf South, Midwest, and east coast of the United States,
as well as in England, Spain, Italy, and Bulgaria. We currently
have no projects operating or in advanced development in
California or other parts of the Western States.
I have been president and CEO of EWO for nearly 3 years,
but I have been working in various parts of the energy industry
for the last 18 years. My most recent experience has been
trading and marketing electricity and natural gas and building
the infrastructure necessary to serve these important markets
in North America, Europe, South America, Australia, and Asia.
Since joining Entergy, our focus has been two-fold. The
first part has been putting together the development teams, all
the necessary work that you need to get customers, land, water,
permits, all the requirements necessary to build a powerplant.
But it is not enough to put a powerplant in the ground and
operate it well. There is a lot of risk, and it is not as easy
as it might seem. All aspects of the business are fraught with
risk. It is in understanding and evaluating these risks that
places this all together. The choice between the potential
powerplant project where we may choose to invest here or in
another location is going to be entirely dependent upon how we
assess those risks and the associated rewards.
To put this in perspective, we currently have three
different projects competing for each of the sets of turbines
that we have. Our choice of one location or another is entirely
dependent upon how we assess those risks.
We have no special insights in to how to solve what is
currently the enormous problem that is facing California today.
Since the addition of new generation to California has to be
part of the long-term solution, I hope to provide some insight
as to how we approach the market and how we make decisions
about where to invest. Perhaps that will help those who are
confronting this problem in helping them to make decisions.
Powerplant investment decisions come down to really two
simple questions. First, does the potential return on
investment justify taking the risks associated with the
investment? Second, are there other projects available that
provide either a greater return for the same risk or the same
return for less risk?
It is useful at this point to note some differential
definitions between risk and uncertainty. Risk in the
powerplant business comes from anything that makes earnings
streams uncertain and is amenable to both measurement and
management. Uncertainty refers to those hazards which are
amenable to neither quantification nor management. Obviously,
as a developer of power projects, we seek to measure and manage
those projects and those risks.
Uncertainties in particular projects, however, cause us to
rethink our investment plans fundamentally, for we are in the
business of taking calculated risk for the benefit of our
investors. By definition, uncertainty is an exposure that
cannot be calculated, where carefully developed skills may be
of no benefit, an environment in which investment loss may be
caused by arbitrary forces over which the investor has no
control.
There are two primary risks that we look at. One is
obviously the capital, the impact on the cost side of the risk.
Those were mentioned earlier today. Operating costs, ability to
construct on time and on budget, environmental costs, et
cetera. There are also risks affecting the revenue side:
customer default, prices for power and related ancillary
services, market supply and demand fundamentals, changes in
market rules, and changes in regulatory structure. We spend a
great deal of time trying to measure and quantify and manage
the risks associated with these revenue and cost streams, and
we keep a watchful eye on these uncertainties.
All these factors go into the development of what we call
forward curves or price forecasts. These take into account
anything that we think might be significantly impacting the
price of generation or our ability to operate. These forecasts
with appropriate sensitivities provide the basis for developing
the financial forecasts used to determine where and how we
invest. We make decisions about investment, acquisitions, and
divestment based upon these proprietary price curves. We
believe, through our philosophy, experience, and actions, that
price signals work. Price signals change behavior.
As I discussed before, when economically feasible, we
actively mitigate these risks. However, let us talk about some
of those specific uncertainties.
Significant uncertainties that cannot be anticipated in our
forward curves or mitigated through various market tools,
present very special challenges to any business, especially one
that is as capital intensive as ours. Risks that are visible
can be evaluated relative to expected returns and to other
projects.
Significant uncertainties that are unclear or unmanageable
lead us to make decisions not to invest in projects affected by
such uncertainties. One uncertainty that fits this description
is the risk of adverse governmental laws or actions. In
general, we choose to invest in markets where the regulator has
made a commitment to develop rules that are transparent,
stable, and fair. The rules do not have to be exactly what we
want, so long as we can operate within their framework. During
the past 3 years, we have exited from a number of international
markets specifically because of regulatory and governmental
uncertainties that would deny us the opportunity to apply our
competencies effectively in pursuit of an adequate return for
our investors.
As you carefully consider the steps to address California's
difficult power situation, it is important to consider not only
how your decisions may affect generators and customers today,
but also for years to come. The steps taken today will affect
whether generators decide to build in California, or whether
they perhaps choose to invest in other markets, or perhaps only
invest at a higher return, or perhaps not at all. If steps
taken today result in a perception by investors that the
California market is not merely a market with normal risks, but
one with uncertainties and market rules, taxes, and the general
investment climate are seen to be unmanageable, they will
either increase the required return on their capital that is
higher or build elsewhere. Moreover, if the actions taken today
reflect a trend for the broader generation market, it could
negatively impact powerplant development decisions across the
Nation.
As I stated before, the market rules do not have to work
perfectly. Electricity has the most complex physics of delivery
of any major commodity, and the market rules governing the
business of electricity tend to be complex as well. So, market
rules tend to be a compromise between the requirements of the
physical laws and the simplicity for market operation between
the needs of the generators, the investors, the end users, and
other market participants. As a market participant, we
understand the give and take inherent in any system of market
rules.
Regulatory volatility, however, is an uncertainty we cannot
tolerate. I will always choose a market with stable rules over
one without, and I will guide my investment program
accordingly. If I do build, it will require a much higher
hurdle rate to ensure that investors' interests are reasonably
protected. It is no different than how the capital markets
work. If the particular market is more risky, the costs of that
capital are higher to compensate investors for the increased
risk.
We are concerned with the energy situation in California.
We are empathetic with the hardships being faced by its
citizens. We hope this testimony helps those with
responsibility for public policy so that California's situation
does not become long term or affect the markets in other parts
of the country.
Thank you.
[The prepared statement of Mr. Roberts follows:]
Prepared Statement of Geoffrey D. Roberts, President and CEO,
Entergy Wholesale Operations, The Woodlands, TX
Mr. Chairman, Senators: Thank you for allowing me to appear before
you today. Entergy Wholesale Operations (EWO) is the unregulated
wholesale power arm of Entergy Corp. We have power plants operating or
under advanced stages of construction or development in the gulf South,
Midwest, and East Coast of the United States, as well as in the England
and Bulgaria. We have no projects operating or underway in California
or other parts of the Western United States.
I have been President and CEO of EWO for nearly three years. I have
been working in various parts of the energy industry for over 18 years,
with most of my recent experience being related to trading and
marketing electricity and natural gas, and building the infrastructure
necessary to serve these important markets in North America, Europe,
South America, Australia and Asia. Since joining Entergy, our focus at
EWO has been two-fold. One part was to build up our development,
marketing, construction and operating teams. These are the teams that
actively seek out, construct and operate the projects--seeking out
customers, land, water, permits--all the requirements necessary to put
a power plant into the ground, then to construct and operate it
efficiently.
It is not enough, however, to put a plant in the ground and operate
it well. To be worthy of our investors money, we must be sure a project
has a reasonable opportunity to provide at least a minimum return. This
is not as easy as it might seem. All aspects of our business are
fraught with risk. It is in understanding and evaluating these risks
that management makes the choice between potential power plant project
investments. To place this in perspective, we currently have over 3
different projects internally compete for each set of the gas turbines
that we have purchased. Some of these sites we will develop to become
generating plants;others we might permit and then either retain for
future development or sell to another developer. Yet others we will shy
away from, either because the economics are not there relative to the
risks or simply because there are better alternatives. Ultimately, we
want to choose those projects that provide the optimal risk/reward
profile. The second part of our focus at EWO has been in developing the
analytics and processes necessary to identify, evaluate and manage the
risks of our investments.
It is this second aspect of our business I would like to discuss
today. I have no special insights into how to solve what is currently
an enormous, but we hope, short-term problem in California. Since the
addition of new generation into California has to be part of the long-
term solution, I hope it will be helpful to provide insight into how
generation companies make their decisions about where to invest.
Perhaps this will help those who must confront this problem make
decisions--and keep what is currently a short-term problem from
becoming long-term.
Power plant investment decisions come down to two questions. First,
does the potential return on investment justify taking the risks
associated with the investment? Second, are there other projects
available that provide either a greater return for the same risk, or
the same return for less risk. It all comes down to relative risk and
return.
It is useful, at this point, to note some definitional differences
between ``risk'' and ``uncertainty''. Risk in the power plant business
comes from anything that makes the earnings stream uncertain, but is
amenable to both measurement and management. ``Uncertainty'' refers to
those hazards which are amenable to neither quantification nor
management. As a merchant developer, we seek to measure and manage our
exposure to risk, but certainly not to avoid it entirely, for
investment in a competitive marketplace inherently brings with it a
measure of risk. Uncertainties in particular projects, however, cause
us to rethink our investment plans fundamentally, for we're in the
business of taking calculated risk for the benefit of our investors. By
definition, uncertainty is an exposure that cannot be calculated, where
carefully developed skills may be of no benefit, an environment in
which investment loss may be caused by arbitrary and capricious forces
over which the investor has no control. Risks and Uncertainties come
from a myriad of sources, affecting both the costs of the project and
the revenue stream. I'll start with the capital, or cost side risks,
since as an industry, our capital costs are major factors in making
decisions. Examples of some cost-related risks include:
Operating and maintenance costs
Fuel supply reliability and cost
Ability to construct on time and on budget
Environmental mitigation and regulatory changes
Changes in transmission pricing and availability
Changes in taxes
Changes in financing costs
Natural disasters
Similar risks affect the revenue stream, including:
Customer default
Prices for power and related ancillary services
Over- or under-development of the market (supply) relative
to demand
Changes in demand, perhaps resulting from technology,
behavioral changes or other causes
Changes in market rules
Changes in regulatory structure
EWO spends considerable time and resources to identify, value and
manage the risks in these revenue and cost streams, and we keep a
watchful eye on the uncertainties. We track generation development and
customer load growth, regulatory and legislative changes,fuel supply
logistics, transmission construction and constraints, to name a few,
all to provide us the best possible view of the market and our
projects. All these factors go into the development of what we call
``forward curves'' or price forecasts. These take into account anything
we can think of that might significantly affect the price of generation
or our ability to operate. These forecasts, with appropriate
sensitivities, provide the basis for developing the financial forecasts
used to determine whether or not a power plant project would be a
prudent investment. A fundamental assumption of these curves is that
the market in which we compete is competitive and that economic forces
drive rational decision-making. We make decisions about investment,
acquisitions and divestment based upon these proprietary price curves.
We believe, through our philosophy, experience and actions, that price
signals work.
As I discussed before, when economically feasible, we actively
mitigate risks. For example, to mitigate the risk inherent in
construction, we entered into a joint venture with the Shaw group.
Similarly, fluctuations in fuel prices can be hedged in the derivatives
market. We buy insurance for natural disasters (which might cover the
cost of the hardware, but not the lost revenue), and we buy quality
equipment to maximize reliability and reduce the risk of not operating.
And now, even the risks of weather can be managed in the marketplace,
through innovative transactions being offered through our affiliate
Entergy-Koch.
However, significant earnings Uncertainties that cannot be
anticipated in our forward curves or mitigated through various market
tools, present special challenges to any business, especially to one as
capital intensive as ours. Risks that are visible can be evaluated
relative to expected return and to other projects.
Significant Uncertainties that are unclear or unmanageable lead us
to make decisions not to invest in projects affected by such
Uncertainties. One Uncertainty that fits this description is the risk
of adverse governmental laws or actions. In general, we choose to
invest in markets where the regulator has made a commitment to develop
rules that are transparent, stable, and fair. The rules do not have to
be exactly what we want, so long as we can operate within their
framework. Consequently, we look for markets where the rules of
competition are clear, encouraged and relatively stable. During the
past 3 years, we have exited from a number of international markets,
specifically because of regulatory and governmental uncertainties that
would deny us the opportunity to apply our competencies effectively in
pursuit of an adequate return for our investors.
As you carefully consider steps to address California's difficult
power situation, it is important to consider not only how your
decisions may affect generators and customers today, but also for years
to come. The steps taken today will affect whether generators decide to
build in California, or whether they perhaps choose to invest in other
markets, or perhaps invest only at a higher return, or perhaps not at
all. If steps taken today result in a perception by investors that the
California market is not merely a market with normal risks, but one in
which uncertainties in market rules, taxes, and the general investment
climate are seen as unmanageable, then they will either increase the
required return on their capital, or build elsewhere. Moreover, if the
actions taken today are perceived as reflecting a trend for the broader
generation market, it could impact hurdle rates and power plants
development decisions across the nation.
As I stated before, the market rules do not have to be perfect.
Electricity has the most complex physics of delivery of any major
commodity, and the market rules governing the business of electricity
tend to be complex as well. So, market rules tend to be compromises--
between the requirements of the physical laws vs. simplicity for market
operation, between the needs of generators and investors and the needs
of end-users. As a market participant, we understand the give-and-take
inherent in any system of market rules. As long as they are reasonable,
fair and predictable, we can figure out a way to work within their
structure. Regulatory volatility, however, is an uncertainty we cannot
tolerate. One cannot predict or mitigate the risk--the major outcomes
are recriminations, and dissatisfied investors. I will always choose a
market with stable rules over one without--and I will guide my
investment program accordingly. If I do build, it will require a much
higher hurdle rate to ensure that my investors' interests are
reasonably protected. This is no different from how the capital markets
view individual markets around the world. If the particular market is
more risky, the costs of that capital are higher--to compensate
investors for the increased risk.
EWO is concerned with the energy situation in California. We are
empathetic with the hardship being faced by its citizens. We hope this
testimony helps those with responsibility for public policy, so that
California's situation does not become long-term, or affect the markets
in other parts of the country.
The Chairman. Thank you very much.
Dr. McMahan, why don't you go right ahead.
STATEMENT OF RONALD L. McMAHAN, Ph.D., MANAGING PARTNER,
ENERCAP ASSOCIATES, LLC, BOULDER, CO
Dr. McMahan. Thank you. I will digress from the remarks I
submitted in light of the time squeeze and also the comments by
the FERC.
I do want to say that I have 25 years experience as an
economist, mostly with the company I founded, RDI, watching
these swings in cycles in the electricity market in particular.
I think we should understand two things from the outset. First
of all, nothing that has been done by the FERC today or
yesterday will do anything to help with the chronic electricity
shortages that are going to be faced in California and the rest
of the West. And secondly, we will still see high prices in the
West.
On a positive note, all the pieces are in place to help
mitigate these problems. There is a tremendous amount of
generating capacity either under construction or having been
announced in recent years given the opening of the market.
There is clearly public awareness that has led to considerable
conservation efforts, and clearly the regulatory authority does
exist to deal with the pricing issues that people have talked
about.
So, while it is no surprise where we stand, and rather than
sort of pound on the California issue and how we got here, let
me just give some orders of magnitude of what we are looking at
this summer and talk about the supply side.
First of all, the hydro issue that people have been talking
about. I included some numbers in my prepared remarks, but let
me just give some orders of magnitude around that. Given the
reservoir levels in the Northwest, even though we have been
seeing some decent spring runoff and some relief in prices,
given where we are now and according to a study by Henwood and
Associates in Sacramento, we are going to be looking at chronic
shortages in the middle of the summer and into August. The loss
of about 4,000 to 5,000 megawatts of average generation due to
just the hydro problem, the loss of about 8,000 to 9,000
megawatts of peaking capacity. That is the equivalent of losing
the entire PG&E system at noon on a hot summer day. It is a lot
of electricity.
Right now we are looking at deficits in August of about
8,000 megawatts; 139,000 megawatts of demand and only about
131,000 megawatts of effective capacity. Do not forget, a stage
3 emergency, which is the highest level of emergency in
California, is when they have a 1.5 percent reserve margin. We
are projecting August reserve margins of minus 5.3 percent.
There will be blackouts unless there is some relief in the
weather, and there will be a lot of voluntary curtailment of
load.
I prepared a map that shows where the electricity plants
are being constructed. I do not know if it is here. I have some
copies if the Senators would like to look at them.
The Chairman. Yes, we would like to see that. If somebody
could go grab those for us, I would appreciate it.
Dr. McMahan. Those are attached to the remarks that I
brought.*
---------------------------------------------------------------------------
* Retained in committee files.
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Essentially what this shows is all of the plants that have
either been under construction, have been announced or are
somewhere in the permitting process throughout the WSCC region.
The dots that are fully filled in are those that are under
construction. You can see, by the color, the red ones will be
coming on in 2000; the green ones in 2002; and the others in
2003. Some of the longer range ones are the bigger plants that
have more lead time.
But we see about 6,000 megawatts in the whole region that
is under construction to come on this summer. As you know, that
is still not enough to make up the kind of 8,000 megawatt
deficit that I was talking about.
Even if all of these plants that are completed, all the
ones that are under construction, over the next 3 years, we
would see about 17,700 megawatts of new capacity. That is
encouraging, but that still does not even get us up to the 15
percent reserve margins that people look for.
So, what is going on with all of those other plants that
you see on there that are not fully shaded? I think that those
plants are in jeopardy for several reasons.
First of all, now the analysts are going to all go back
home at the development companies that are developing projects,
break out their calculators, look at what they consider to be
the proxy price going forward, and will make decisions, as my
colleague has stated, about whether they should continue the
development of these projects, whether they should postpone the
development of those projects, or abandon them altogether.
The second big question that arises is how are the
financial markets going to react because, again, all of those
plants that are not fully shaded in are still somewhere in the
financing process, and how the markets and Wall Street react is
going to be very important.
The final technical point that I will make that sort of
takes a little bit of the gloss off of this nice development
picture is that natural gas is supplying 98 percent of these
plants that are being built. As you know, there are tremendous
strains on the natural gas system. If all of the plants were
built in the West and in Texas, we would see about half again
as much gas needed for that as all of the electricity that we
generated in the United States last year. So, the gas
infrastructure system and the gas replacement system is going
to be very critical. It could be we will have all these plants
and nothing to fire them.
So, just in conclusion, as far as what should be done, I
think clearly conservation, investing in renewables,
development of new powerplants and reinforcing the pipes and
wires infrastructure is very important.
I think cost-of-service pricing mechanisms would be a
disaster and would essentially wipe out most of the new
development that is planned. I think that punishing the rest of
the country for what is happening in California is kind of like
picking out one student who has been bad and punishing the
whole class for it. I think we need to be careful about what we
do as far as sweeping legislation in order to be sure that we
keep this pipeline of powerplants full.
Thank you.
[The prepared statement of Dr. McMahan follows:]
Prepared Statement of Ronald L. McMahan, Managing Partner,
Enercap Associates, LLC, Boulder, CO
Mr. Chairman and Members of the Committee:
I am pleased to be here today to summarize the findings of a study
I recently completed addressing the electricity supply situation in the
West. I will begin by saying that no matter what the Committee does
here today, and no matter what actions the Congress takes in the coming
weeks, this much is certain: electricity shortages will continue to
plague California in the months to come, and high energy prices will
persist throughout the region.
There are no quick fixes for the current situation. However, I
believe that all of the pieces are in place today to see us out of this
problem.
Enough new generating capacity is under construction and/or
planned to meet the West's projected needs by late next year.
--This assumes that legislators do not take rash actions that
will cause developers to withdraw.
Public awareness coupled with increasingly painful price
signals promise to deliver substantial conservation.
--At the same time, innovative suppliers and buyers are
devising methods to better understand electricity consumption
patterns and to more carefully tailor usage--particularly at
the industrial and commercial level.
The regulatory authority and mechanisms currently exist to
curtail price gouging and to deter suppliers from ``gaming the
system.''
ELECTRICITY SUPPLY
The situation that we face today in the West should come as no
surprise. Four years ago, in May, 1997, when I was invited to address
this same Committee on the topic of electricity deregulation and
stranded cost recovery, I pointed out that California's deregulation
scheme would most likely lead to supply shortages, and recommended
strongly that Congress not pattern a national scheme on such a model.
The California approach was flawed from the outset for a couple of
very basic reasons:
First, it attempted to address the problem of inordinately
high electricity rates in the state by ``re-mortgaging''
historic, high-cost power policies--these policies themselves
the product of short-sighted legislative and regulatory
constraints.
Second, the state assumed it could take advantage of low-
cost power then available in the rest of the Western grid from
states whose utilities had taken a more reasoned approach to
capacity development.
--However, it did nothing to address the issue of developing
new supply to meet growing demand.
--An unintended consequence of the stranded cost recovery
mechanism was the migration of capital away from new project
development, and largely out of the state.
Unfortunately, the inevitable supply squeeze has been exacerbated
by two factors--faster than anticipated economic (and, hence,
electricity demand) growth, and two consecutive seasons of extremely
low hydro availability in the region. To illustrate the severity of the
hydro problem consider the following chart:
WESTERN SNOW PACK IS WELL BELOW NORMAL
------------------------------------------------------------------------
Peak
% of normal capacity
------------------------------------------------------------------------
Pacific Northwest............................ 67% 30,600 MW
California................................... 78% 9,600 MW
Colorado River............................... 80% 8,400 MW
------------------------------------------------------------------------
The loss of 4,000-5,000 MW of average generation
--Equivalent to losing the entire PSCO and Colorado Springs systems
for a year.
The loss of 8,000-9,000 MW of sustainable peak
--Equivalent to losing the entire PG&E or Pacificorp system at noon
on a summer day.
According to a recent study by Sacramento-based Henwood Energy
Services, Inc., WSCC at the Brink: Disaster or Recovery, the West is on
a collision course with disaster later this summer as projected peak
demand is expected to exceed the region's total effective capacity of
131,000 MW by 8,000 MW--a massive shortfall. For perspective, in
California, a Stage 3 emergency occurs when reserve margins fall to
1.5%. In August, the study projects that peak hour reserve margins
could drop to minus 5.3%. Only drastic voluntary and forced cutbacks in
load will avert what could ultimately be the worst shortage the region
has seen.
Developers are racing to bring new generation on-line as quickly as
possible. In just the interconnected Western grid alone (WSCC), roughly
6,000 MW of new generation capacity is under construction and scheduled
to come on line by the end of the year--most likely too late to fully
avert this summer's chronic shortages. But the good news is that over
the next three years, significant new capacity is scheduled to come on
line, as illustrated in the table below and on the attached map of
power plant activity.
NEW POWER PLANTS IN THE WSCC REGION
[Net Capacity in MW]
----------------------------------------------------------------------------------------------------------------
Under
construction Permits Announced Total
----------------------------------------------------------------------------------------------------------------
2001............................................................. 5,983 160 699 6,842
2002............................................................. 6,850 4,066 3,148 14,064
2003............................................................. 4,909 5,148 9,469 19,526
----------------------------------------------------------------------------------------------------------------
Total........................................................ 17,742 9,374 13,316 40,432
----------------------------------------------------------------------------------------------------------------
Source: Henwood Energy Services, Inc., NextGen Database.
While this level of development activity is encouraging, we must
temper our optimism in light of recent developments and public
initiatives.
The 17.7 GW of capacity under construction is helpful, but
not enough to insure safe capacity margins--even in normal
hydro years.
The investment climate is cooling.
--Much of the 22.7 GW of capacity currently in the permitting
process or announced is in jeopardy of not being built as
developers become wary of increased regulatory control and the
possibility of price caps.
--The psychology of the market has turned around as
developers are ``demonized'' and inclined to wait this out or
invest their capital elsewhere.
Natural gas supply issues--too many eggs in one basket?
--Of the 17.7 GW of capacity under construction 17.3 GW (98%)
will be fired by natural gas.
--Of the total 40.4 GW announced, 39.6 GW (98%) will be fired
by natural gas.
--Between the WSCC and ERCOT (Texas), all of the natural gas
projects currently under construction or permitted will require
3.8 Bcf/d or 1.4 Tcf/y.
For comparison, in 1999, in the entire U.S., total gas-fired
electricity consumption consumed 3.1 Tcf/y.
--Current natural gas exploration is not even enough to
maintain supply.
We need to find 8.5 Bcf/d just to stay even--10,000 wells/
year.
An ``all out effort'' can produce 9.5 Bcf/d--net +1 Bcf/d.
--This level of development means further demands on a gas
pipeline system that is already operating at 85%-90% of
capacity with only minimal expansion under way.
WHAT SHOULD BE DONE?
In April, I presented these findings at a round table in Denver
chaired by Senator Craig with participation from FERC Chairman Hebert,
the Governor of Montana, and numerous state officials including the
chairmen of the California Energy Commission and the Texas Railroad
Commission. At that time, when asked what we should do, I responded,
``We need to do everything--we need to conserve as never before; we
need to invest aggressively in promising renewable energy technologies;
we need to encourage the development of new natural gas and clean-coal
power plants; and we need to reinforce the `pipes and wires'
infrastructure.''
Today, I will make an emphatic addition to that response--i.e.,
what we should not do. We should not move toward sweeping cost-of-
service pricing mechanisms for electricity. This would be a giant leap
backward to a time when cost-plus regulation created the very problems
that we are trying to untangle today. It discourages innovation; it
hurts productivity; it does nothing to check demand; and it sends all
the wrong signals to project developers.
In many ways the genie is already out of the bottle, and believe it
or not, the system is working as a plethora of new power plants are
coming on line to meet demand. If the market is left to work as it
should, we will soon see a period of increasing supply and lower
prices--especially on the spot market.
The FERC already has the authority to check ``unjust and
unreasonable'' prices, and in recent weeks has moved to implement
temporary rules aimed at accomplishing virtually the same results as
the proposed legislation. What is important is to be able to apply
these rules judiciously and fairly without invoking the dreaded image
of ``price caps'' that can send investors running.
There is always the fear that if the federal government doesn't
step in and provide price relief, the natural trend toward deregulation
will suffer. This may be true, and it may fall to the FERC to navigate
through the next few months until needed supply once again begins to
build and the situation cools down.
California continues to show us what can happen as a frustrated
government thrashes about trying to impose quick fixes--going into the
transmission business; signing high-priced power contracts at the peak
of the market; and demanding federal intervention. If Congress were to
react by implementing sweeping legislation at this time, it would be
like punishing the whole class for the misdeeds of one pupil.
The Chairman. Thank you very much.
Mr. Fetter, why don't you go right ahead.
STATEMENT OF STEVEN M. FETTER, MANAGING DIRECTOR, GLOBAL POWER
GROUP, FITCH, INC., NEW YORK, NY
Mr. Fetter. Thank you, Mr. Chairman. I must say I came
prepared for a brawl over price caps and ran into a love fest
regarding regulation. As a former regulator, I am honored to be
here.
The Chairman. Which side are you on on this issue? I am not
clear from your statement if you are for regulation or opposed.
Mr. Fetter. Well, I am someone who felt that regulation
served some beneficial purposes but would prefer a market
oriented setting.
The Chairman. All right. We will let you further explain
your views on what FERC did yesterday.
Mr. Fetter. On the small chance that FERC's action
yesterday does not solve all the problems within the Western
United States, and the members of this committee are accosted
at July 4th barbecues on the issue of price caps, let me say
these thoughts.
Major investments have been made in California and other
States based on the particular competitive frameworks mandated
by State legislatures and commissions. Price levels for
generation asset auctions were driven by the new market
orientation. A retrenchment on these policies back to a form of
cost-of-service regulation would likely curb investors'
enthusiasm for additional investment pending clearer signs as
to future policy direction. This is especially the case where
the change in direction might come from the Congress, which is
considering proposals for price controls that could apply to
just California, or potentially all 11 States within the
Western energy market, or in view of Senator Schumer's remarks
a few minutes ago, conceivably would apply to the entire United
States.
Industry participants, including Federal and State
regulators and elected officeholders, have called for
substantial amounts of investment both for new generation and
transmission upgrades if the Nation's utility restructuring
movement is to progress.
I believe the policies encompassed in the legislation under
consideration today would add to the uncertainty currently in
minds of investors in light of the serious financial
difficulties facing California. I draw an analogy to the well-
intentioned but flawed Federal policy enacted within the Public
Utility Regulatory Policies Act, known as PURPA. Passed in
1978, PURPA sought to encourage both cogeneration and small
power production in order to diversity electricity supply away
from traditional large utility-owned powerplants.
In that regard, the law failed miserably. It did succeed,
however, in touching off 2 decades of regulatory and judicial
disputes and creating billions of dollars in stranded costs, as
I saw firsthand has a State utility regulator.
Though PURPA issues were with me every day during my 6
years at the Michigan Public Service Commission, its aims only
became evident to me from a reading of PURPA because its goals
were never achieved in its implementation within the State of
Michigan or anywhere else in the United States.
I offer this example because I firmly believe that utility
regulation is not an area where the Congress can step in every
few years and attempt to deal with the pressing issue of the
moment. As we saw with PURPA, such a step can have long-term
negative economic consequences. If illegal behavior is
occurring within the California market or elsewhere in the
West, laws already exist to remedy those wrongs. But if this
body seeks to preempt State regulatory prerogatives, indeed
step in in place of the FERC and act as a guardian against
market movement in an upward direction, you will generate
growing concern in the minds of investors and lead them to
question whether they really do want to be part of the changing
energy landscape.
Already in California questions are arising about the long-
term contracts the State recently negotiated because wholesale
electricity prices have collapsed from the highs of a few
months ago. In view of the proposed about-face on competition
under consideration today, what investor would not fear that 5
to 7 years hence, when the rates flowing from California's
long-term supply contracts far exceed market levels, just as
happened under PURPA, that today's proponents of price caps
would fight to relieve their constituents from having to pay
the outrageous above-market rates being forced upon them?
And the situation is not necessarily confined to the West.
The Midwest electricity spike of June 1998 and its aftermath
led my company Fitch, to state, ``The electricity market
involves unusual risks that will affect the credit of all
market participants.'' Some industry observers have speculated
that the New York City region might experience price or supply
problems this summer.
Does this Congress intend to maintain an ongoing oversight
role so that price controls may be extended beyond the western
market whenever prices in other regions fluctuate upward? If
so, the efficiency gains envisioned coming from a truly
competitive energy environment will likely never be achieved.
Thank you, Mr. Chairman, Senator Murkowski.
[The prepared statement of Mr. Fetter follows:]
Prepared Statement of Steven M. Fetter, Managing Director,
Global Power Group, Fitch, Inc., New York, NY
I appreciate the opportunity to testify before the Committee on
Energy and Natural Resources to offer the views of Fitch on S. 764, a
bill to direct the Federal Energy Regulatory Commission to impose just
and reasonable load-differentiated demand rates or cost-of-service
based rates on sales by public utilities of electric energy at
wholesale in the western energy market, and sections 508-510 of S. 597,
the Comprehensive and Balanced Energy Policy Act of 2001, relating to
wholesale electricity rates in the western energy market, natural gas
rates in California, and the sale price of bundled natural gas
transactions. I will speak from the perspective of a member of the
financial community as well as former Chairman of the Michigan Public
Service Commission.
By now we are all familiar with the factors that have led to the
energy catastrophe in the Western U.S. electricity market. California's
restructuring plan encouraged utility divestiture of generation and
called for a high proportion of customer demand to be met by spot
market supply from day-ahead or hourly transactions. This exposed the
state's three investor-owned utilities, which were operating under
retail price caps, to extreme financial pressures due to wholesale
market volatility. By contrast, in more rational market structures for
electricity and other energy commodities, approximately 85-90% of
demand is normally provided through long-term contracts, with at most
only 15% subject to spot market fluctuations. The extreme volatility of
price at the wholesale level has given rise to urgent calls for a
``fix'' in the form of lower and lower price caps.
Three months ago, before this committee, I offered Fitch's views as
to whether price caps could provide a solution to the problems facing
California and the West. While I continue to believe that price caps
would negatively influence the evolution to a competitive electricity
market, I am willing to admit that federal enactment of a uniform price
cap at a high level--such as $1000 per mwh--might serve a useful
purpose. It could operate as a circuit breaker to cap wholesale prices
during the brief periods when extremely volatile circumstances result
in a market that cannot be contained by any manner of competitive
forces. It also probably would not interfere with any strategic
decision making by industry participants since builders of new
generation or transmission would not employ prices at that level (or
higher) in their financing models.
However, to go lower than such a safety valve type level would
undoubtedly slow the nation's movement toward an efficient competitive
wholesale market. We have already seen that imposition of a low price
cap, such as $250 per mwh or even $150 per mwh, can have the negative
effect of encouraging suppliers to seek alternative market outlets or
even to slow production, or could create anomalous pricing patterns
during off-peak periods. Continued tinkering with market rules,
especially if at the macro federal level, is sure to create uncertainty
among energy investors and delay implementation of their business
plans--this is even more the case in light of recent ambiguous economic
signs.
A further concern for market participants is that major investments
have been made in California and other states based on the particular
competitive frameworks mandated by state legislatures. Price levels for
generation asset auctions were driven by the new market orientation. A
retrenchment on these policies back to a form of cost-of-service
regulation would likely curb investors' enthusiasm for additional
investment pending clearer signs as to future policy direction. This is
especially true where the change in direction comes from the Congress,
which is considering proposals for price controls that could apply to
just California, or potentially all eleven states within the western
energy market, or conceivably the entire U.S.
What concerns me most about Congressional involvement in regulation
of the wholesale electricity market is the uncertainty it engenders
among investors. Industry participants, including federal and state
regulators and elected officeholders, have called for substantial
amounts of investment if the nation's utility restructuring movement is
to progress. New generation must be added across the country and
upgrades to the existing transmission grid are needed to transform the
former integrated utility structure into a complement of regional
competitive markets operating in a coordinated manner.
I believe the policies encompassed in the legislation under
consideration today would add to the uncertainty currently in the minds
of investors in light of the serious financial difficulties facing
Pacific Gas & Electric and Southern California Edison. I draw an
analogy to the well-intentioned, but flawed, federal policy enacted
within the Public Utility Regulatory Policies Act, known as PURPA.
Passed in 1978, PURPA sought to encourage both cogeneration and small
power production in order to diversify electricity supply away from
traditional large utility-owned power plants. In that regard, the law
failed miserably. It did succeed, however, in touching off two decades
of regulatory and judicial disputes and creating billions of dollars in
stranded costs--as I saw first-hand as a state utility regulator.
In 1987, I was appointed to the Michigan Public Service Commission
(MPSC). At the time, I had no idea what PURPA was, but I soon learned
of the positive objectives Congress sought in enacting the legislation.
Unfortunately, those aims only became evident to me from a reading of
PURPA, because its goals were never achieved in its implementation
within the State of Michigan or anywhere else in the U.S.
Soon after the announcement of my appointment, I began to receive
calls--both pro and con--about the largest cogeneration facility in the
world, a 50% utility-owned facility, that was to be considered by the
MPSC under PURPA. I was confronted with PURPA issues every day of the
six years I served as a state regulator. Finally, in May 1993, the MPSC
resolved the final major cogeneration matter before the Commission. I
left soon after, never having seen the congressional intent--and good
intentions--underlying PURPA being manifested.
I offer this example because I firmly believe that utility
regulation is not an area where the Congress can step in every few
years and attempt to deal with a pressing issue of the moment. As we
saw with PURPA, such a step can have long-term negative economic
consequences. If illegal behavior is occurring within the California
market, laws already exist to remedy those wrongs. But if this body
seeks to preempt state regulatory prerogatives and act as a guardian
against market movement in an upward direction, you will generate
growing concern in the minds of investors and lead them to question
whether they really do want to be part of the changing energy
landscape.
Already in California there is talk that the state may try to back
out of some of the agreements it recently negotiated because wholesale
electricity prices have collapsed from the highs of a few months ago.
And what of the contracts that remain in place for the next ten to
twenty years? In view of the proposed about-face on competition under
consideration today, what investor would not fear that five to seven
years hence--when the rates flowing from California's long-term supply
contracts far exceed market levels (just as happened under PURPA)--that
today's proponents of price caps would fight to relieve their
constituents from having to pay the ``outrageous'' above-market rates
being forced upon them.
And the situation is not necessarily confined to the West. The
Midwest electricity spike of June 1998 and its aftermath led Fitch to
state that ``the electricity market involves unusual risks that will
affect the credit of all market participants'' (See Fitch report,
``Electricity Price Spike: Lessons Learned,'' October 29, 1998, at
www.fitchratings.com). Indeed, there have been other instances of rate
aberrations in both the electric and natural gas sectors in various
regions of the country over the recent past. Some industry observers
have speculated that the New York City region might experience price or
supply problems this summer.
Does this Congress intend to maintain an ongoing oversight role so
that price controls may be extended beyond the western market whenever
prices in other regions fluctuate upward? If so, the efficiency gains
envisioned coming from a truly competitive energy environment will
likely never be achieved.
Already in the wake of California's serious difficulties,
restructuring activities have come to a dead halt across the country.
You may believe you are playing the role of the cavalry coming over the
hill to save the day, but from where investors sit, it appears more
like the waving of a white flag on electric industry competition.
The Chairman. Thank you very much.
Mr. Brill, why don't you go right ahead.
STATEMENT OF THOMAS R. BRILL, DIRECTOR OF REGULATORY POLICY AND
ANALYSIS, SEMPRA ENERGY, SAN DIEGO, CA
Mr. Brill. Thank you, Mr. Chairman. Thank you, Senator.
Today I am going to limit my remarks to the provisions of
S. 764 that would reinstate the maximum rate ceiling on short-
term capacity releases for transportation of natural gas into
California. I am going to attempt to do so in the context of
the order that FERC issued yesterday, which will be something
of a challenge in light of the fact that I have yet to see that
order. But I certainly have listened to the Commissioners'
statements.
The Chairman. This is the only place where we have
intensive, in-depth discussions of orders that have not yet
been issued.
[Laughter.]
Mr. Brill. It makes it easier to be right.
The Chairman. That is correct. That is why we do it.
[Laughter.]
Mr. Brill. What I will try to do is make reference to the
order based upon what I have heard the Commissioners say in
describing the order, and specifically I would like to refer to
some of the comments of Commissioner Massey who pointed out
that whether or not and the extent to which the order is
effective will depend upon the natural gas prices at the border
of California. Now, they have three pricing points, but in any
event, those input prices that will form such a significant
impact on the electric prices provided for under this order
will be impacted by the price of natural gas at the wellhead as
well as the imputed value of interstate transportation services
for getting that natural gas to California.
In order to save some time, I am going to cut my remarks
short, but at the end of my testimony, there is a table. I am
going to make reference in the comments I am about to make to
the table at the end of the testimony that I have provided. I
do have additional copies if that would be helpful.
The Chairman. It would be helpful. Thank you.
Mr. Brill. Essentially the table that is being provided to
you tracks natural gas prices at the California border
beginning January 1 of last year. On that table, you will see
the imputed value of interstate transportation services since
the beginning of last year as well as the FERC-approved cost-
of-service rate for interstate transportation. The line at the
bottom of the table represents the weighted average FERC-
approved cost-of-service rate, including fuel use for
transportation to California.
As you will note, the table depicts three dates: the
effective date of FERC order 637 which lifted FERC's cap on
capacity release transactions last year; second, the date that
SDG&E filed an emergency request with FERC, seeking relief
similar to that embodied in S. 764 with regard to natural gas
rates; and three, the date of a recent FERC order requesting
comments in response to SDG&E's emergency filing on whether
FERC should reimpose the maximum rate on short-term capacity
releases into California.
As you can see, shortly after the cap was lifted, the
imputed value of interstate transportation began to exceed the
FERC-approved cost-of-service rate. In fact, prices remained
well above the as-billed rate since mid-June of last year. To
understand the magnitude of the cost Californians and
generators in California have had to pay since this cap was
lifted, keep in mind that the FERC-approved cost-of-service
rate for transportation to California ranges from 31 to 67
cents, excluding fuel use. By contrast, since mid-June of last
year, excluding fuel use, the imputed value of this service has
exceeded $2 on 147 days. The imputed value of this service has
exceeded $6 on 110 days. This is for a service whose weighted
average rate is worth about 50-52 cents.
This is not all. Excluding fuel use, the imputed value of
transportation to California has exceeded $10 on 36 days. It
has exceeded $18 on 15 days and even reached a high of $49, all
for a transportation service with a FERC-approved cost-of-
service rate of less than 67 cents.
In light of these values, there should be no doubt that the
experimental lifting of the cap, at least for natural gas
transportation services to California, has failed.
As I have noted, the chart contains three dates, and you
can easily see what has happened in reaction to each of these
three dates. After FERC lifted the cap on an experimental
basis, the values began to increase. The values hit a high last
December, but possibly in response to a threat of reimposition
to the caps, the values declined significantly. After a period
of time when it appeared that there would be no action, the
values increased again, and when FERC issued an order
requesting comments on this issue, indicating potential action,
values began to decline once again. However, they remained
significantly above the as-billed rate.
The point of this presentation is that if FERC's order of
yesterday is to be effective and is to effectively drive
electric prices to a just and reasonable level, it will be
dependent upon what FERC or Congress does with regard to the
imputed value of natural gas transportation service to
California.
[The prepared statement of Mr. Brill follows:]
Prepared Statement of Thomas R. Brill, Director of Regulatory Policy
and Analysis, Sempra Energy, San Diego, CA
Good morning. I am Tom Brill, Director of Regulatory Policy &
Analysis for Sempra Energy. Sempra Energy is a Fortune 500 energy
services holding company headquartered in San Diego. Our subsidiaries
provide electricity and natural gas services. Sempra Energy's two
California regulated subsidiaries are San Diego Gas & Electric Company
(SDG&E) and Southern California Gas Company (SoCalGas). Thank you for
the opportunity to testify here today.
I would like to first commend Senator Feinstein for the leadership
she has shown on this issue. As Californians are all too aware, there
are some who would rather blame others for the energy crisis than look
for meaningful solutions. There is more than enough blame to go around,
but that won't build powerplants any faster or lower the high-energy
prices that nearly all Californians are paying for both electricity and
natural gas. Senator Feinstein has worked tirelessly to craft a
solution, found in S. 764, that is equitable to both consumers and
producers. Senator Bingaman, we also appreciate your willingness to
hold today's hearing as one of your first acts as Chairman, to address
this crisis which threatens the western United States.
Sempra Energy has testified on previous occasions before this and
other Congressional Committees, both regarding how the western energy
crisis began, and stating our support for the effort that Senators
Feinstein and Smith have undertaken in this legislation.
The western states, consumers, utilities and other interested
parties have sought a meaningful solution to the current crisis of high
energy costs, which include both wholesale electric costs and natural
gas prices. S. 764 takes a critical step toward solving the crisis by
instituting a much needed cooling off period for California's
dysfunctional energy market: first by imposing ``Cost of Service Plus''
rates and then for reinstating the Federal Energy Regulatory
Commission's price regulations on short-term interstate pipeline
capacity release transactions for transportation services to
California.
Today I will limit my remarks to the provisions of S. 764 that
reinstate the maximum rate ceiling on short-term capacity release
transactions into California.
NATURAL GAS COSTS
Before discussing the merits of reinstating the cap on prices that
can be charged for interstate pipeline capacity, I would like to
briefly address the impact of natural gas spot prices on the price of
electricity. I want to make very clear that our support for
reinstatement of the cap is not in any way intended to lend credence to
arguments that natural gas prices by themselves, or costs of production
in general, explain the explosion in electricity prices in California.
The interrelationship between the price of natural gas and the
magnitude of change in electric commodity process is terribly out of
alignment. For example, in the summer of 2000, the price of natural gas
was $3.50 per mcf, yet the electric commodity price was as high as
$2000 per MWh. These numbers provide little justification for the
skyrocketing electric prices that have been charged in the wholesale
market. In fact, some believe that the high natural gas prices are the
result of the skyrocketing electricity prices we have seen in
California, rather than the cause of those prices. Nonetheless, to the
extent they are a factor in western electricity prices they need to be
addressed. Indeed, FERC itself has made them a factor in its limited
approach to market mitigation. Beyond their linkage to the electricity
crisis, they are a cost factor for California consumers in and of
themselves. So addressing this problem may have a dual benefit to the
regional economy.
BACKGROUND
Holders of capacity on the interstate pipelines can sub-lease the
space to marketers or others in a transaction known as a ``capacity
release.'' While the pipelines can only charge FERC-approved rates,
non-pipeline sellers can charge as much as the market will bear for
released capacity if it is sold for a term of less than one year.
Often, marketers sell the commodity of natural gas and capacity
together as one product as a ``bundled sale'' for delivery at the
California border. The price of this bundled product is known as the
California Border Price. Until the spring of 2000, the FERC had imposed
a cap (the regulated rate) on the prices that could be charged for
capacity that was released to others. At that time, prices at the
California border were about 25 cents per therm. In Order 637, the FERC
lifted the cap on an experimental basis at a time when there appeared
to be excess capacity and before demand increased so dramatically
during the summer of 2000. What has happened since is telling.
The table that is attached * to this testimony depicts the imputed
value of interstate transportation services since the beginning of last
year based upon an analysis of California border prices and commodity
prices at the wellhead. The line at the bottom of the table represents
the weighted average FERC-approved cost of service rate, including fuel
use, for transportation to California. This table depicts three dates:
(1) the effective date of FERC Order 637, which lifted the cap last
year; (2) the date that SDG&E filed an emergency request with FERC,
seeking relief similar to that embodied in S. 764; and (3) the date of
a recent FERC Order Requesting Comments on whether FERC should re-
impose the maximum rate on short-term capacity releases into California
in response to SDG&E's filing.
---------------------------------------------------------------------------
* The table has been retained in committee files.
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As you can see, shortly after the cap was lifted, the imputed value
of interstate transportation began to exceed the FERC-approved cost-of-
service rate. In fact, prices have remained well above the as-billed
rate since mid-June of last year. To understand the magnitude of the
cost Californian's have had to pay since the cap was lifted, keep in
mind the fact that the FERC-approved cost-of-service rate for
transportation to the California border ranges from 31 to 67 cents,
excluding fuel use. By contrast, since mid-June of last year, excluding
fuel use, the imputed value of this service has exceeded $2.00 on 147
days and even exceeded $6.00 on 110 days. But this is not all:
excluding fuel use, the imputed value of transportation to California
has exceeded $10.00 on 36 days; exceeded $18 on 15 days; and even
reached a level as high as $49.00, all for a transportation service
with a FERC-approved cost-of-service rate of less than 67 cents! In
light of these values, there should be no doubt that the experimental
lifting of the cap, at least for natural gas transportation service to
California, has failed.
As I have noted, this chart contains three dates. What is important
to note is what happened to prices shortly after each of these dates.
Shortly after FERC lifted the cap on short-term capacity release
transactions, the imputed value of interstate transportation increased
above the FERC-approved as-billed rate, where it has remained ever
since.
By contrast, shortly after SDG&E made a filing at FERC seeking
relief similar to that proposed in S. 764 including reinstatement of
the cap, prices declined. However, after several weeks, when it
appeared that relief would not be forthcoming, at least any time soon,
prices began to increase again.
Finally, on May 22, FERC issued an Order Requesting Comments on
whether FERC should re-impose the maximum rate on short-term capacity
releases into California. As you can see, FERC's May 22 Order was
followed by another decline in prices. Clearly, even the prospect of
reinstatement of cost-of-service regulation has provided some relief to
California gas consumers, but under current market conditions, this is
not enough. Unfortunately, it is unclear that the FERC will take any
meaningful action to address this issue, which is why S. 764 is so
critical. In short, there is a clear need for congressional action.
WHAT CAN CONGRESS DO TO HELP?
S. 764 would require the re-imposition of the maximum rate ceiling
on short-term capacity release transactions into California and
reasonable reporting requirements for bundled sales at the border,
action that FERC has hesitated to take but that would significantly
affect the price of gas in California. A reduction in natural gas
prices would address one significant energy cost in the western region.
The extreme nature of wholesale electric price swings and generation
costs may be so out of alignment that we would hesitate to claim that
reducing natural gas prices would by itself reduce wholesale power
prices. However natural gas costs have been a consistent component of
the market mitigation measures that have been proposed and adopted by
FERC and are a significant factor in the costs of electric generation
that form a basis for the electric rate provisions of S. 764.
CONCLUSION
While it continues to be Sempra Energy's desire that FERC follow
the law and ensure ``just and reasonable'' energy rates, we have seen
little evidence that the Commission will take actions that are
necessary to mitigate the extreme prices that we have seen over the
past year in the western United States. The magnitude of the energy
crisis has reached the point at which consumers are entitled to action.
The energy crisis in the Western United States has already wreaked
havoc on local and state economies. Congress must direct FERC to follow
the law and enforce rates that are just and reasonable by temporarily
reinstating the cap on prices that can be charged for interstate
pipeline capacity and requiring that sellers separately disclose to
FERC the transportation and capacity components of their rates. We urge
Congress to pass S. 764.
The Chairman. Thank you very much.
Mr. Henning, why don't you go right ahead.
STATEMENT OF BRUCE B. HENNING, DIRECTOR, REGULATORY AND MARKET
ANALYSIS, ENERGY AND ENVIRONMENTAL ANALYSIS, INC., ARLINGTON,
VA
Mr. Henning. Thank you, Mr. Chairman. My name is Bruce
Henning, and I am director of regulatory and market analysis at
Energy and Environmental Analysis, Incorporated. EEA is a
privately owned consulting firm that provides analysis to
institutional, government, and private sector clients in the
areas of natural gas, electricity, transportation, and related
environmental issues.
Along with my colleagues at EEA, I have conducted a number
of analyses in the North American gas market. EEA provided the
analytical support for the National Petroleum Council study of
natural gas, published in 1999; the INGAA Foundation study of
the infrastructure requirements to meet a 20 trillion cubic
foot market; and provides the modeling services for the Gas
Research Institute's baseline. We also do numerous studies for
individual private clients looking at the infrastructure
requirements.
I am here today to discuss the natural gas market in
California and to relate the California market to the recent
behavior in the entire North American market. The views that I
express are my own and do not reflect the views and positions
of any of EEA's clients.
Over the past 2 decades, the structure of the natural gas
market has changed from a market that relied almost exclusively
upon price regulation to a market where prices are determined
by the balance of supply and demand, subject to the oversight
of the FERC. Over this period, consumers have benefitted in
terms of declining real natural gas prices. From 1983 to 1999,
the average price delivered to all consumers fell by almost 50
percent in real terms. And even with the run-up that occurred
in the year 2000, the average consumer price fell by more than
34 percent compared to 1983.
That being said, natural gas prices in the California
market experienced unprecedented increases beginning back in
April 2000. The increase reflected two distinct components. The
first component reflected the price increases that were
occurring all across the United States because of the overall
tightness in the balance of the market between supply and
demand. Producers were producing all that they could and there
virtually was no excess deliverability. Production utilization
approached 100 percent.
But in addition to that general tightness in the supply/
demand balance, California prices also were affected by a
significant increase in the transportation basis. The
transportation basis is the market value of transportation
capacity available to move gas from one location to another. As
gas throughput increases and approaches the capacity of the
pipe, the value of transportation services increases. In a
capacity constrained market, the value of transportation can
significantly exceed the maximum regulated rate. This happened
in California, but it has also happened for shorter periods of
time in other markets, such as in New York and in the Northeast
last December. But in California, however, the condition did
persist for much of the past 12 months.
The maximum regulated rate is a measure of the cost of
transportation on an annual or long-term basis. Since the
market value for transportation is often below the cost of
transportation, it must also at times be above the regulated
transportation rate. If not, the market value of transportation
is lower than its overall cost. When the market value of
transportation is below cost, no one invests in the new
infrastructure that is required.
The California market reached the point of constraint last
summer. Gas consumption for power generation increased
dramatically. The low hydro availability, which we have talked
about here today, required that gas generators run far more
hours than they ever were expected to do before. EEA estimates
that the California power generation gas consumption rose by 87
percent from 1999 to the year 2000.
Now, the growth in consumption unmasked an intrastate
capacity constraint. In short, there was more capacity
available to bring gas to the State border than there was to
take the gas and move it to the ultimate customers. The power
generation customers bid against one another for a limited
supply of natural gas, and those generation customers are
generally very price sensitive, but they were willing to pay
very dearly for their natural gas supplies and bid against one
another.
Now, the fact that the constraint occurred inside the State
is a subtle but important point. The reality was that there
just was insufficient take-away capacity to distribute the
natural gas to all of those customers, and the value reflected
the intrastate capacity constraints as well.
Now, in economic terms, a rent is when its value exceeds
its production cost. And the existence of these large basis
differentials are not proof of market manipulation. There is a
distinction between a market rent or a scarcity rent and a
monopoly rent. I am not prepared to make a conclusion regarding
that. That analysis is being done by the FERC, and I believe
that they are perfectly capable of making that analysis.
From my perspective, the natural gas market is far more
mature and competitive than the electricity market in virtually
every region of the country, including in California. As such,
I would like to throw out a couple of distinctions between
proposals for caps for the gas market and the electricity
market.
First, the electricity market in California was responsible
for pulling up the gas prices, not the other way around. High
electricity prices pushed up the entire gas demand curve.
Second, the prices in the California gas market are
actually doing what they are supposed to. They are drawing more
infrastructure into the State. In fact, if all of the proposed
capacity expansions get built, EEA believes that that market
will wind up returning to a period where substantial discounts
will be prevalent.
Finally, if price caps are imposed in the gas market, they
run the risk of delaying that infrastructure needed to serve
that market.
I would be happy to answer any questions.
[The prepared statement of Mr. Henning follows:]
Prepared Statement of Bruce B. Henning, Director, Regulatory and Market
Analysis, Energy and Environmental Analysis, Inc., Arlington, VA
INTRODUCTION
Good morning. My name is Bruce Henning. I am Director, Regulatory
and Market Analysis at Energy and Environmental Analysis, Inc. EEA is a
privately owned consulting firm that provides analysis to
institutional, governmental, and private sector clients in the area of
natural gas, electricity, and transportation and related environmental
issues and policy. For the past 24 years, I have been an analyst of
natural gas and energy markets. Along with my colleagues at EEA, I have
conducted a number of comprehensive analyses of the North American
natural gas markets and energy infrastructure requirements. EEA
provided the quantitative analytic support for the 1999 National
Petroleum Council study, Natural Gas: Meeting the Challenges of the
Nation's Growing Natural Gas Demand. EEA also authored the INGAA
Foundation study, Pipeline and Storage Infrastructure Requirements for
a 30 TCF Gas Market, and performs the forecast and market analysis for
the GTI (formerly Gas Research Institute) Baseline Projection. In
addition, we have performed a large number of natural gas market
analyses for private sector clients from all sectors of the energy
industry including local natural gas distribution companies, natural
gas producers, interstate natural gas pipeline companies, energy
marketers, regulated electric utilities and independent power
generation companies.
I am here today to discuss the natural gas market in California and
to relate the California market to the recent behavior in the entire
North American gas market. The views that I express are my own and do
not reflect the views and positions of any of EEA's clients.
BACKGROUND AND STRUCTURE OF THE NATURAL GAS MARKET
Over the past two decades, the structure of the natural gas market
has changed from a market that relied almost exclusively upon price
regulation to a market where prices are determined by the balance of
supply and demand subject to the regulatory oversight of the Federal
Energy Regulatory Commission (FERC). Over that period, U.S. consumers
benefited greatly in terms of declining real natural gas prices. From
1983 though 1999, the average price of gas delivered to all consumers
fell by almost 50 percent in real terms. Even with the run-up in prices
that occurred in 2000, the average consumer price was more than 34
percent below the average price in 1983. (see Exhibit 1).
That being said, natural gas prices in the California market
experienced an unprecedented increase beginning in April of 2000. The
increase reflected two distinct components. The first component
reflected the price increases that were occurring across the U.S.
because of an overall tightness in the market. Gas producers were
producing all that they could. There was virtually no excess
deliverability and production capacity utilization approached 100
percent. Since the gas price was already above oil product prices,
dual-fueled customers had already switched to their alternative fuel,
generally oil. As cold weather arrived in November and December, the
market required customers that did not have a readily available
alternative fuel source to reduce their gas consumption. The market was
brought into balance via this difficult load shedding. EEA estimates
that more than 6 billion cubic feet a day out of a potential gas load
of 98 billion cubic feet was shed as a result of the price increases.
In short, although it was very painful to consumers throughout the
country, gas market prices performed as economists expect, allocating a
commodity during periods of scarcity to those customers that value it
most. Moreover, the high prices also fulfilled their role by sending
the price signals to producers, resulting in a dramatic increase in gas
drilling activity that is increasing deliverability and contributing to
the recent moderation in wellhead prices.
THE CALIFORNIA GAS MARKET
But in addition to the general tightness in the supply/demand
balance, California prices were also affected by a significant increase
in the transportation basis. The transportation basis is the market
``value'' of transportation capacity available to move natural gas from
one market to another. When excess capacity is available, the market
``value'' for pipeline capacity is generally far below its maximum
regulated rate. As the gas throughput increases and approaches the
capacity of the pipe, the ``value'' of transportation increases. In a
capacity-constrained market, the ``value'' of transportation can
significantly exceed the maximum regulated rate. This happened in
California, but it has happened for shorter periods of time in other
markets, such as New York and the Northeast last December. In
California, however, the condition has persisted for much of the last
year.
The maximum regulated rate is a measure of the ``cost'' of
transportation service on an annual or long-term basis. Since the
market ``value'' of transportation is often below the ``cost'' of
transportation, it must also be above the regulated rate at times. If
it is not, the market value of the pipeline capacity is less than the
costs. When market value is less than cost, no additional expansion of
capacity is made. New capacity is proposed only when investors see or
anticipate that the market ``value'' of capacity exceeds its cost.
The California gas market reached its point of constraint last
summer. Gas consumption for power generation increased dramatically.
Low hydroelectric availability in the Pacific Northwest and high
electricity demand throughout the entire western part of the United
States required that gas-fired generators in California operate far
more hours than normally expected. EEA estimates that power generation
using natural gas in California in 2000 was 42 percent higher than the
1999 level. Moreover, the units that were running were often older and
inefficient peaking units. As a result, the amount of gas being
consumed for generation experienced even greater amounts of growth than
the overall growth in kilowatt hours of electricity generated from
natural gas. EEA estimates that California power generation gas
consumption rose by 87 percent, from 375 billion cubic feet in 1999 to
700 billion cubic feet in 2000.
I believe this growth in consumption unmasked an intrastate
capacity constraint. In short, there was more capacity available to
bring gas to the state border than there was to move gas to the
consumers in the state. The total amount of intrastate capacity
available was insufficient to satisfy the demand. Power generation
customers bid against each other for the scarce supply. Moreover,
because of the extreme conditions in the electricity market with very
high prices, generators--who are usually extremely sensitive to fuel
prices--were willing to pay dearly for any supply available. The result
was the extremely high basis value.
The fact that the capacity constraint was inside the state is a
subtle, but important point. Trade publications, which are widely used
for price discovery in the gas industry, were reporting very high gas
prices at the California border delivery points. Industry analysts
initially concluded that the constraints must have existed on the
interstate pipeline system. However, pipeline web sites that are
required by FERC to show operationally available capacity indicated
that some interstate capacity to the California border had no takers.
This raised concern that market participants were withholding capacity
and exercising market power. The reality was that there is insufficient
``takeaway'' capacity to increase the deliveries from the pipelines to
their capacity limit. The prices being reported at the border reflected
the ``value'' of the scarce intrastate capacity minus the state
regulated cost of distribution.
SCARCITY RENTS VS. MARKET POWER RENTS
In economic terms, a rent is the market value of a product in
excess of its costs. In and of themselves, rents are not a dispositive
indicator of an exercise of market power. The existence of very large
basis differentials to the California market is not proof of market
manipulation. The legal and economic analysis required to differentiate
between scarcity rents and market power rents is complex, and at this
time I am not prepared to reach a conclusion. It is this very analysis
that is being conducted by the FERC and, in my opinion, that is the
appropriate venue for the inquiry. I have confidence in the ability of
the agency to fulfill its statutory authority. As discussed earlier, in
a market where prices can often be below costs, scarcity rents are
necessary to attract capital for infrastructure expansion. Any attempt
to limit the scarcity rent runs the risk of eliminating the price
signals needed to attract the investments required to alleviate the
infrastructure constraints.
RESPONSE OF THE MARKET TO PRICE SIGNALS FROM THE CALIFORNIA MARKET
The marketplace is responding to the market signals coming from the
California market. A number of projects have been announced that will
increase the pipeline capacity to the state and--more importantly--
inside the state. In our recent monthly review, EEA identifies almost
3.6 billion cubic feet per day of FERC jurisdictional projects and both
Sempra and PG&E have announced plans to expand their systems as well.
Ironically, EEA believes that construction of all of these projects and
a return of ``normal'' rainfall to the Pacific Northwest would result
in the return of California to a market with ``excess gas
transportation capacity'' and discounted rates.
MARKET DATA COLLECTION
Part of the legislation being considered would require collection
of copious amounts of data regarding gas transactions in the California
market. FERC is already proposing to collect data similar to that
required by the legislation. In this effort, FERC is considering a
comprehensive collection effort based upon the agency's extensive
expertise in examining natural gas markets. Within this process, all
interested parties have the opportunity to comment on the proposed data
collection proposal. With this input FERC is capable of identifying any
market manipulation and has the authority to promulgate and enforce any
required remedy.
PRICE CAPS AND RESOURCE ALLOCATION
From my perspective, the natural gas market is far more mature and
competitive than the electricity market in virtually every region of
the country including California. As such, I would like to draw several
distinctions between price cap proposals for the gas market and the
electricity market. First, the electricity market in California was
responsible for pulling the California gas market prices up, not the
other way around. High electricity prices pushed the entire gas demand
curve up, as power generators could still operate profitably despite
high gas prices.
Second, prices in the California natural gas market acted to
allocate the incremental supply of natural gas in the state. If price
caps are placed on the gas market, regulators will be forced into the
position of deciding which customers will get the gas that they want
and which customers won't. There is really no getting around that
reality. Finally, if price caps are imposed in the gas market, they run
the risk of delaying the infrastructure needed to serve the gas
requirements of the state.
CONCLUSION
I'd like to thank the committee for the opportunity to express my
views and I would be happy to answer any question that I can.
The Chairman. Well, thank you very much. Let me ask just a
few questions and then defer to Senator Murkowski.
Very broadly speaking, I picked up that there is a
difference of opinion between Mr. Brill and Mr. Henning on
whether or not FERC should go ahead with this reimposition of a
maximum rate on short-term capacity releases into California.
Mr. Brill, you believe that reimposing that will get this
imputed value of transportation down where it should be, where
it traditionally has been. And Mr. Henning, I understand your
view is that unless we continue to leave that unregulated, we
will not have the incentive for the construction of the
additional capacity that is needed to bring gas into California
and disburse it around the State.
Let me ask first Mr. Brill. Is that a fair paraphrase of
the difference of opinion that exists there or not?
Mr. Brill. Well, I am not sure. I will not speak for Mr.
Henning.
But with regard to my point of view, yes, either for FERC
or Congress to reinstate the cap and require reasonable
reporting requirements for bundled sales at the border, you
have to realize that when FERC lifted the cap, it did not do so
for pipeline sellers. So, those that actually construct
capacity are not in a position of getting these revenues that
exceed the as-billed rate.
Now, I have heard arguments against caps in the past
because people are very concerned that they might discourage
additional construction. In this case, these values are not
going to those that do the construction. That argument
therefore does not apply to FERC's lifting of the cap on an
experimental basis.
The Chairman. Who is getting these payments?
Mr. Brill. Anyone from marketers to I have read about
companies that happen to have long-term contracts for
interstate capacity that have actually shut down their plants
and sold the gas at the border. But any seller of natural gas
within California or at the border is in a position to obtain
that value, and that would be anyone that has a long-term
commitment to interstate capacity for transportation to
California or a production contract with a California producer.
The Chairman. Mr. Henning, what is your view on this?
Mr. Henning. There are two points I would like to make, Mr.
Chairman. One is that very clearly the increase in market
value, as the transportation differentials that we are talking
about here, do wind up spurring additional pipeline
construction. While Mr. Brill is correct that it is not a
direct deregulation of what the pipeline company gets, the
change in those market values affects how shippers contract for
their services. A little over a year ago, no one was interested
in buying capacity into the California market. More recently,
when it was resold, people were willing to pony up for max rate
contracts for a term of 5 years. So, the effect of the value of
that transportation winds up affecting how the gas shippers
wind up contracting for the regulated natural gas pipelines.
It has brought about in EEA's estimates--we can document
more than 3.6 billion cubic feet a day of new pipeline
proposals that have been going into the market--FERC
jurisdictional proposals. In addition, Mr. Brill's company and
the other intrastate companies are involved in proposals to
expand their own infrastructure as well. So, the market signals
are being sent.
The second point I would like to make is if one winds up
imposing price caps, beyond the subject of whether or not it
attracts the capital, it puts government in the position where
government and regulators will have to decide which customers
that want the gas will get it and which customers will not
because at this point in time, it is the market prices that are
making that determination in the natural gas market. It is a
much more competitive and mature commodity market than the
electricity markets. I am very hopeful that the concerns
regarding electricity markets do not drive mistakes for the
natural gas markets.
The Chairman. Let me ask I guess Mr. Roberts about your
comments about the need for regulatory certainty. Would you not
concede that the issuance of the order that came out yesterday
adds to regulatory certainty, at least for the next 15 months,
in the sense that there is not nearly as much questioning going
on about what FERC is likely to do. We now know what they have
done, and assuming that they stick with it and assuming that it
has some of the results that they are anticipating, do you not
think that they have helped to stabilize the market and thereby
bring regulatory certainty and thereby perhaps encourage some
investment?
Mr. Roberts. Mr. Chairman, going directly to the question,
I think that in the short term, yes, there is some regulatory
certainty. However, the tonic of drinking price controls, price
caps is one that is often difficult to wean yourself of.
In addition to that, I think that the investment horizon
that a company like myself works under, where from a start of a
project conceptually, it may be anywhere from 2 to as many as 5
or 6 years before that project is actually on line. We look far
beyond that time horizon. Also, clearly we end up with an asset
that has a 40- or 50-year life, and so we are looking very much
long term on that.
So, I would agree that in the short term it does provide
some certainty, but the certainty, as one who is looking to be
active in an active and healthy marketplace, is one where it
adds a lot of regulatory uncertainty because you start at one
point and it is very easy to start down a slippery slope
imposing other additional controls, et cetera.
So, I guess in answer to the question, I see two issues.
One is the fact that we have a different type of a time frame.
The other one is a concern in general on caps and price
controls.
The Chairman. Dr. McMahan, let me just ask about the chart
that you have given us with all of the powerplant development
that is projected in the West. Is it your opinion that the
order that went out yesterday or that FERC is going to issue
tonight that they started talking about yesterday is going to
interfere with the development of these? Is that what you were
saying? Do you think that possibility exists?
Dr. McMahan. Yes, Senator, I definitely think that that
possibility exists. The projects that are under construction
are going to be built. Those are the projects essentially that
the FERC is counting on coming on line by September of 2002
that should hopefully get the market back in balance. If you
put yourself in the position of a developer of a project not
currently under construction, you are going to ask yourself if
and when you should actually break ground on that plan.
I would expect to see a lot of these companies sort of go
into a wait and see mode for certainly the next 6 months,
depending on where they are in their development process, until
they can understand whether this is going to be in fact some
short-term control or whether the entire development
environment has changed. I have just dealt with these things,
again, through boom cycles, bust cycles in the industry and I
know that this sort of thing tends to take the steam out of
some of this development drive that has been stimulated in the
last few years.
The Chairman. But let me just press you on that a little
more. The Commission, at least the way they understand what
they have done, they have entered an order which they believe
does allow for a price to be charged by generators which is
sufficient to incentivize additional investment. So, I think
they would say--I probably should have asked them--that even if
their order were extended for an additional period, it is
sufficiently flexible and it is taking into account what
potential costs will be of producing power and a reasonable
profit in the future so that there is really no reason for
anyone to suspend action on these plants as a result of what
they issued yesterday. I think that would be their view, and
you think that is just wrong.
Dr. McMahan. Well, no. Essentially what I think is that the
people that are developing these plants, to the extent that
they now will get better commitments, long-term commitments on
a contract basis for those projects, if the math works for
that, they will do that. Those people that were building plants
with, say, half of the capacity under contract and counting on
sort of recent history in the spot market, will think about
that and maybe not really move these projects forward until
they get more long-term contracts.
So, I think ultimately, yes, the result of the order will
be to see more of these projects find longer-term commitments
and come on in a more staggered manner. I do not think they
will go away.
The Chairman. Mr. Fetter, let me just ask you, do you think
there is anything positive in the order that came out yesterday
in terms of providing stability and certainty to the investor
community or to the markets in general? It seems to me that a
lot of what the Commission was saying is that they believe
their action will stabilize the situation, get it back into a
range of normalcy that it has not been in in recent months. Do
you think there is anything to that or not?
Mr. Fetter. Mr. Chairman, when I appeared before this
committee in March, I was willing to admit that perhaps a
$1,000 per megawatt hour cap might serve purposes where the
price spikes cannot be contained by any market mechanism. I
view the FERC's action yesterday should eliminate the potential
for such out-of-control price spikes. At the same time, it
maintains a connection between supply and demand within
California and the entire Western region, and to the extent
that the prices that flow from the FERC mechanisms are not
satisfactory to the consumers or the elected officials in
California, the fear of investors would be that then there
would be growing support to lock into a price cap at a lower
level that would impact on future investments.
In fact, the comments of Senator Schumer--just the thought
that once you start down that slippery slope of setting price
caps in a region, then anywhere in the country where a problem
crops up, it just becomes so easy to say let us just import
that idea to New York or New England or to the Midwest. And
that is what investors fear.
The Chairman. Senator Murkowski.
Senator Murkowski. I will try to be brief. I think we have
come to the conclusion, based on the statements from Senator
Feinstein and Senator Smith, that price caps, wholesale caps,
as we were considering them, are probably, for all practical
purposes, a thing of the past as a consequence of FERC's
action.
But FERC's action is for 15 months. Now, Mr. Fetter, you
are in the business of an investment analyst to some extent,
among your other areas of expertise. Are you satisfied with 15
months? That 15 months is a small piece of time in relationship
to an investment in a new powerplant costing several millions
of dollars. And you are looking at an unknown factor after
that. Does FERC come in? Do we have a free market? Do we have
an increase in supply so we have a free market working?
In reference to Dr. McMahan's chart here, where he paints a
very interesting picture of what is reality and what may be
myth, these plants that are under construction are one thing,
but those that are planned and those that are announced suggest
that firm commitments for financing are probably yet to be
arranged.
So, what I would like you to address is your evaluation of
what this 15-month FERC order means in relationship to the plan
and the announced capacity. If you could provide for the
record, either one of you, a determination of what you see--I
think Dr. McMahan, you indicated about an 8,000 megawatt
deficit still with those under construction. What we are trying
to get, I guess, as a bottom line is some degree of certainty
in the sense of your collective opinions on whether there is
still an unknown quantity associated with September of next
year relative to financing commitments that are going to have
to be made now to address planned and announced new facilities.
I would refer primarily to Steven Fetter and then Dr. McMahan.
Mr. Fetter. My view, Senator, is that once the order is
issued and if it appears to be what was discussed today, if
support coalesces and it appears that that is going to be the
last word on these issues, I do not think it would affect
investment either in California or elsewhere. To the extent
that yesterday's FERC's action just becomes a first step and
there are going to be other actions, either at the FERC or
within this body, then I think there is a large likelihood that
investment would be affected.
Senator Murkowski. Dr. McMahan.
Dr. McMahan. It is my opinion that the mechanisms that the
FERC has implemented are very interesting. I think the one
thing that they will do by the chart that the Commissioner drew
this morning--basically it says that I am going to get some
minimum price in the spot market. In other words, I do not have
to wait until the market gets bid up and hope that I am above
the curve, that all spot prices will come in at what is
intended to be a reasonable rate. Again, I think once all of
the developers punch this up in their computers and look at
their models, we will see how much that impacts development.
But I do commend the FERC for making such a good attempt at
keeping some market stimulus in their order.
Senator Murkowski. My last question is the cost-of-service
issue, which I think you brought up. I think we had one of the
FERC Commissioners also comment on it. I was surprised that it
was brought up. It seemed it just kind of came up in his
presentation individually as opposed to being connected to any
of the other matters. Cost-of-service is fairly uniform in
utility concepts, but in a situation like this, somebody has to
set the rate of return. What is your comment relative to the
application of cost-of-service as a standard guideline to try
and address new developing power generating facilities?
Dr. McMahan. Are you talking to me, Senator?
Senator Murkowski. Yes.
Dr. McMahan. Just as so many people characterized
yesterday's order as a giant step forward, I think a cost-of-
service regulation would clearly be a giant step backward.
Obviously, the genie is out of the bottle on deregulation. It
is moving ahead in several States, and in spite of what is
going on now and perhaps because of what is going on now, it
will move forward. I think that it would be almost impossible
to administer and talk about the slippery slope. I just think
it would be a big mistake.
Senator Murkowski. I guess we generally agree that FERC
action added stability to the market yesterday. I am curious to
know in your opinion whether California's action--there is a
grand jury investigation, legislative investigations, PUC
investigations, existing proposals that the companies that
allegedly overcharged refund the overcharge and some question
that the Governor is going to file suit for repayment. We heard
from Senator Boxer.
What does that do to the climate that we are looking at
here, on the one hand, a positive application of FERC's work
and, on the other, the political ramifications associated with
the finger pointing in California? Mr. Roberts?
Mr. Roberts. As a potential investor, clearly the overall
environment is positive I think from the steps that FERC is
taking, but certainly very negative from the additional
rhetoric that is in the environment surrounding any potential
investor. Again, that would enter into any investment decision.
Senator Murkowski. Does anybody else want to comment on
that very briefly? The chairman has been as patient as I have
had to be over the years. So, I will defer any further
questions other than to thank the panel and to thank the
chairman for arranging this very timely hearing.
The Chairman. Well, thank you, Senator Murkowski, Mr.
Chairman, at least chairman for a substantial portion of this
session of Congress.
Let me thank all the witnesses for being here and your
excellent testimony. We appreciate it. We will include it all
in the record.
The hearing will be adjourned.
[Whereupon, at 12:15 p.m., the hearing was adjourned.]
APPENDIXES
----------
Appendix I
Responses to Additional Questions
----------
Federal Energy Regulatory Commission,
Office of the Chairman,
Washington, DC, July 23, 2001.
Hon. Jeff Bingaman,
Chairman, Committee on Energy and Natural Resources, U.S. Senate,
Washington, DC.
Dear Chairman Bingaman: Thank you for your letter of June 25
enclosing questions from Senator Ben Nighthorse Campbell for the record
of your Committee's June 19 hearing on the Federal Energy Regulatory
Commission's price mitigation plan for California and the Western
region of the United States.
I have enclosed my responses to Senator Campbell's questions. If
you need additional information, please do not hesitate to let me know.
Sincerely,
Curt L. Hebert, Jr.,
Chairman.
[Enclosures]
Answers to Questions From Senator Campbell
Question 1. It appears that you have taken the unprecedented step
to put FERC jurisdiction over the municipal utilities and co-ops. Is
this true?
Answer. The Commission is not expanding its jurisdiction over non-
public utilities, such as municipal utilities and co-ops. In the market
monitoring and mitigation plan established in the Commission's June 19,
2001 order, the Commission is exercising its authority to impose
conditions with respect to matters within its jurisdiction. Thus, to
the extent a non-public utility voluntarily sells power in the
California Independent System Operator (ISO) or other spot markets
which are subject to the Commission's jurisdiction or voluntarily uses
the ISO's or Commission-jurisdictional interstate transmission
facilities elsewhere in the Western Systems Coordinating Council
(WSCC), it must comply with the must-offer requirement and the price
mitigation plan.
Question 2. It is unclear what the legal basis is for this action.
Can you please explain?
Answer. The basis for this requirement is the Commission's mandate
under Section 206 of the Federal Power Act to ensure that rates, terms
and conditions for jurisdictional service are just and reasonable. The
Commission determined that it cannot meet its statutory
responsibilities in California and the WSCC if it allows non-public
utilities to participate in relevant spot markets and use the
interstate transmission grid unless they observe the same conditions as
public utilities.
The Commission has previously exercised authority to review non
jurisdictional activities or to take actions that may impact non-public
utilities. For example, in City of Vernon, California, 93 FERC para.
61,103 (2000), rehearing denied, 94 FERC para. 161,148 (2001), the
Commission explained that it has the authority to evaluate non
jurisdictional activities to the extent they affect the Commission's
jurisdictional activities. In City of Vernon, the Commission reviewed
the transmission revenue requirement of a municipal utility that
voluntarily participated in a public utility ISO subject to the
Commission's jurisdiction to determine whether the municipal's rate
methodology would result in a just and reasonable component of the
ISO's rates. In another case, the Commission concluded that any
resellers of Firm Transmission Rights, whether public or non-public
utilities, must require that all resales are subject to the terms and
conditions approved by the Commission. California Independent System
Operator Corp., 89 FERC para. 61,153 (1999), rehearing denied, 94 FERC
para. 161,343 (2001).
Question 3. Do you think that the rates under this new order are
just and reasonable?
Answer. I am confident that the price mitigation established in the
Commission's June 19 order will yield just and reasonable rates in
California and throughout the WSCC. The Commission has expanded the
market monitoring and mitigation plan to produce spot market prices in
all hours that are just and reasonable and emulate those that would be
produced in a competitive market. These rates must fall within a zone
of reasonableness, and to achieve this mandate, the mitigation plan
brings market-oriented price relief to the California and Western
electricity markets, provides greater price certainty to buyers and
sellers of electric energy, promotes conservation, and simultaneously
encourages investment in efficient generation and transmission. The
mitigation plan adopted in the June 19 order is designed to provide a
structure that will minimize potential market power abuses, thus
lowering customer rates, and encouraging adequate supply. I have every
reason to believe it will succeed.
Appendix II
Additional Material Submitted for the Record
----------
Bear, Stearns & Co. Inc.,
New York, NY, June 14, 2001.
Senator Frank Murkowski,
Ranking Member, Committee on Energy and Natural Resources, U.S. Senate,
Washington, DC.
Dear Senator Murkowski: Price controls are a recipe for disaster.
Regulators in California have already proven this point. Their
imposition of price controls at the retail level, along with
regulations prohibiting energy suppliers from entering into long-term
contracts, have created shortages in the form of blackouts and
brownouts and forced one major supplier--Pacific Gas and Power--into
bankruptcy. Now many involved in the creation of the current chaotic
situation would like to see the federal government impose price
controls at the wholesale level. This would be a mistake of gigantic
proportions.
When caps are imposed and prices pushed below the market level,
three things happen: (1) buyers seek to purchase more overriding public
conservation efforts, (2) sellers supply less by diverting scarce
supplies to more rewarding markets, and (3) new energy transportation
and production facilities would continue to decline as the
uncertainties created by the regulations drive investors elsewhere.
Even when controls are imposed, this scenario is played over and over
again, with some appearing not to notice. Somehow, they believe that
the next episode of price controls will be different.
The ramifications of price controls imposed by President Nixon
provide valuable lessons. Even though the general controls were imposed
for a relatively short time, they retarded investment, reduced the
mobility of labor and created other dislocations that hampered the U.S.
economy throughout most of the 1970s.
When the general controls were removed in 1973, the price caps in
the energy sector were retained. Were it not for their tragic impact on
the lives of people, the results would be comical. Regulators and
suppliers ended up in court, debating on whether crude oil originated
from new wells or old wells because the caps permitted the former to be
sold at a higher price. Even as the shortages multiplied, wells
containing sizable amounts of oil were removed from the market because
the price caps made it too costly to use modern technology to remove
the remaining crude. The controls also led to long gas lines; service
stations with limited supplies were open only a couple hours each day.
These outcomes were not imposed upon us by either OPEC or greedy oil
companies. They were the result of the energy price caps. Thus, they
did not occur in Western Europe and other parts of the world where
price caps were absent.
Price caps invariably make it appear that the situation is far more
severe than is actually the case. The energy price caps illustrate this
point. When President Reagan removed the energy price controls in early
1981, the pundits told us that gas prices, which were approximately
$1.25 per gallon at the time, were sure to soar to $2 or more. Against
the chaotic situation of the 1970s, their predictions had a credible
ring. However, as market forces replaced political allocation, the
reality was much different. During the first two weeks following the
removal of the controls, prices rose by about a dime a gallon, but they
soon leveled off and began to fall. Six months after the controls were
removed, gasoline prices were well below the prior controlled level.
Propelled by market forces, they continued to decline for almost two
decades.
With regard to California's energy market, the conservationists are
absolutely right. If blackouts and brownouts are to be avoided in the
near term, conservation must be practiced and consumption reduced.
Without the appropriate price signals, however, conservation will be
weak and ineffective. Millions of people must be encouraged by high
prices to switch to lower wattage light bulbs, use fans more and air-
conditioning less, purchase more energy-efficient appliances and so on.
The California decision to shield consumers by picking up the energy
tab ensured that conservation was not going to happen. Price incentives
are absolutely essential for the practice of wise conservation.
While supply responses provide the long-term solution, price
controls create uncertainty and undermine the incentive to invest,
which is essential for the expansion of future supply. It is easy for
politicians to promise that the controls will be imposed only
temporarily and that reasonable profits would spur investment. Not so.
Investors know that when regulators interfere with market signals
today, there's no assurance that they will not do so tomorrow. Rather
than placing themselves hostage to an uncertain regulatory climate,
many potential investors will place their energies elsewhere driving up
the cost of transportation and production energy capital in California.
The confidence of the investment community has already been
severely damaged by California's regulatory policies. It will take time
to repair the damage and regain credibility with investors. The worst
thing regulators could do at this time would be to impose still more
controls.
However well intended, political manipulation is no substitute for
market forces. The Nixon price controls and the gas lines they created
provide ample evidence on this point. The sooner regulators make it
clear that they are not going to intervene, the sooner market
incentives will restore order to the California energy market and the
current crisis, like the gas lines of the 1970s, will be behind us.
Sincerely,
Wayne D. Angell,
Senior Managing Director
and Chief Economist.
______
Statement of Marcia Baker, EIR News Service
Dear Chairman Bingaman and Senators:
On the occasion of your hearing today, we wish to reiterate our
support for passage of Bills intended to restore ``just and reasonable
pricing''--the traditional, standing mandate of our energy law, and in
line with the General Welfare concept of the Constitution itself. We
are glad at the renewed prospects for action by Congress.
The EIR News Service, in two previous testimonies submitted this
year to the Senate Energy Committee, urged Congressional action to stop
runaway electricity prices, along the lines of the Feinstein/Boxer
Bills (S. 26, S. 80, and S. 287); and their House counterparts proposed
by Rep. Jay Inslee, Rep. Peter DeFazio, and others, for cost-based
pricing. We urged ``going the whole way'' to cover electricity prices
nationwide, and also to take the same kind of action to put a stop to
the energy hyperinflation and hyper-profiteering in all modes (natural
gas, propane, gasoline, heating oil, coal spot-markets, etc.).
LAROUCHE FOREWARNINGS ON DEREGULATION, HYPERINFLATION
Since the 1970s, the EIR News Service, and its founding editor
Lyndon LaRouche, in particular, have campaigned against implementing
deregulation in the first place--in health care (HMOs, ``managed
care,'' and hospital closures), agriculture (ending parity-pricing),
transportation, banking, etc.
A year ago, LaRouche warned of today's situation. On March 8, 2000
at the time of truckers' protest convoys in Washington, D.C., he said:
``There is a global hyperinflationary spiral in the process of
taking off. And whatever else is also true about it, the essential
bottom line is, that there is a global hyperinflation in real asset
prices, prices you realize, now ongoing globally. And the petroleum
price is chiefly a reflection of that, apart from whatever temporary
incidental features there are. This is simply, predominantly--it is not
some `market-this, market that'--it's a hyperinflationary process,
which has taken off, where it does take off. Hyperinflation tends to
hit--when it hits in a real form, as opposed to inflation--tends to hit
in primary values, such as food, and primary materials, and that's
what's happening.''
Since that warning, LaRouche has personally led a mass public
education drive for reregulation of energy, including the use of all
means available--Chapter 11 bankruptcy reorganization, where called
for, and other measures, to keep economic activity going, and create
the conditions in which to restore the economy.
In this testimony, we wish to bring to your attention three
interrelated points, which we document below. They are:
1) The backdrop to the U.S. energy hyperinflation and blackouts
crisis is that the entire financial and economic system worldwide, is
in crisis.
2) Bringing energy prices under control is best considered as the
first step to returning national policy in all respects, to a
regulation-based way of serving the public good. In particular, new
energy projects are needed. They must be undertaken in the traditional,
successful way that the FDR-era projects--TVA, Colorado and Columbia
River Dams, and Rural Electrification programs, etc.--were advanced.
They were launched by government, and carried out by private
enterprise. A most appropriate point of reference for the principle
involved is the February 1996 report known as the ``Bingaman-Daschle
Report,'' titled ``Scrambling To Pay the Bills: Building Allies for
America's Working Families.''
3) If the Senate acts in the national interest on energy, this will
occur in concert with certain nation-serving initiatives now taking
place in key parts of the world. Combined, these kinds of initiatives
can have far-reaching strategic effects of economic and diplomatic
benefit, to reverse the current plunge toward economic chaos and war.
`HOUSTON CARTEL' NOW WELL-DOCUMENTED
On the matter of hyper-profits of the energy cartel companies--
Enron EOG, Mobil-Exxon, Reliant, AES, Dynegy, El Paso, and the many
others--and their interconnections with the Administration and certain
Congressional offices, we do not provide further information in this
document. We think that the volume of information now coming into
public view, to the attention of the relevant investigative committees,
and the soon-to-be-formed California criminal grand jury, is sufficient
to document that the current looting system, now referred to as the
``Houston Cartel,'' should be stopped. Our News Service has provided
detailed dossiers on the scope and scandal of these operations over the
past months. We have coined the term ``Southern Strategy, Inc.,'' to
describe these political-business interconnections involved, which are
now deservedly vulnerable to being thrust from power.
CONTEXT: FINANCIAL SYSTEM BLOWOUT
The backdrop to the energy hyperinflation and hyper-profiteering
crisis now racking the U.S., and other economies, is that the financial
system itself is in breakdown. We are seeing the end phase of a period
of ``casino economy'' bubbles--stock market valuations, debt pyramids
of all kinds, futures, and derivatives speculation. Look at the
spectacular blowout of info-tech stocks, the foreign debt crises of
major nations, from Argentina to Turkey, and the sweeping collapse of
whole sectors of the economy, for example, the telecommunications
sector. The U.S. manufacturing sectors since last July has lost more
than 600,000 jobs.
The actions of Federal Reserve chairman Alan Greenspan, to lower
interest rates and pump liquidity into the system, only create the
conditions for worse breakdown ahead.
LaRouche is spearheading a collaborative effort to take nation-
serving measures--such as energy re-regulation--to implement today a
form of ``New Bretton Woods'' approach, like the steps taken in the
aftermath of World War II, to deliberate about and set up a new
financial system. On May 24, speaking in Warsaw, Poland, LaRouche
described the situation:
``The world is gripped at the present, by the worst, biggest
financial crisis in all history, in all human existence. . . .
``Let me give you a picture of how bad the situation is on the
financial side. According to best estimates, official estimates, the
Gross Domestic Product of all nations of the world combined is
estimated at $42 trillion equivalent. Of this, the United States
represents an estimated $11 trillion a year. In the past approximate 12
months, the United States' financial values have lost nearly $11
trillion. On the books, what is admitted publicly, is about $6 trillion
have been wiped out of financial assets of the United States during
this period. Actually, there is another $4 trillion or so, in hidden
losses, which will come to the surface soon. The United States has been
operating at a loss, as an economy, for a number of years. At my last
actual count, late last year, the rate of the current account deficit
of the United States was about $600 billion a year. That is, the United
States was spending $600 billion more than it was earning on the world
market.
``In addition, the United States was being supported, not only by
what it was not paying for, but the United States was receiving
trillions of dollars of influx of foreign exchange into the United
States for investment in the U.S. financial markets. So that, at
present, any collapse of this inflow of money, from Japan, from Europe,
and so forth, into the United States, means an absolute catastrophe for
the U.S. financial markets. . . .
``[So far, there is resort to liquidity-pumping in the U.S., Japan
and elsewhere]. . . . As a result of this, there is an outbreak of
significant hyperinflation in various parts of the world market. For
example, inside the United States, there is a hyperinflationary rate of
increase of prices of energy. . . .''
LaRouche described the scope of policy response required, in a
radio interview in Mexico May 28, broadcast in Leon, Guanajuato:
``What you can do, is, you can put the whole world through
bankruptcy reorganization. That's the only solution, which means
cancelling most of the debt, especially the financial derivatives and
similar debt. Most of the foreign debt of the Ibero-American nations
will have to be cancelled. And then, what this `New' Bretton Woods
means, is, going back to 1945, to the legacy of Franklin Roosevelt, to
create the kind of system we had between 1945 and 1958, and continuing
into the middle of the 1960s.
``In other words, that means fixed exchange rates, that means
capital controls, it means exchange controls, it means financial
controls within and among governments. It means a protectionist policy
on trade and tariffs. The best example is the Monnet Plan, the
relationship between the United States and Europe during the immediate,
first 15 years after World War II. There are a few differences today,
but in principle, that plan, that method will work. The difference is
that we have to apply it on a global scale, not just a transatlantic
scale. The issue is, finding the political will to do that.''
after price controls, start up national-interest infrastructure
Along with ending out-of-control energy prices, restoring sound
energy policy requires attention to actual infrastructure deficits in
high-tech generation, up-to-date transmission systems, and related
questions. Graph 1 (at the end of the document) shows the decline in
U.S. generating capacity per capita. Taking appropriate action on
energy infrastructure, will also be part of a driver for rebuilding
economic activity, now in a spiral of shutdown.
The approach to be stopped at all costs, is that embodied in the
Cheney/Bush National Energy Plan, and also in Energy Secretary Spencer
Abraham's proposal of a private electricity transmission project for
California. These plans axiomatically demand giving sovereign
government power over to the ``Houston Cartel'' to decide whether,
what, and where any aspect of energy provision would be built, and how
it would function. Thus the cartel demands the right to locate, own,
and operate, pipelines, wells, electric transmission lines, power
plants, etc. on their terms, which means disaster. The fact that the
cartel wraps itself in the mantle of promises of use of high-tech
methods (nuclear innovations, superconduction, etc.), and providing
jobs, is merely a crass case of the Big Bad Wolf, clad as Little Red
Riding Hood's grandmother, explaining its big teeth by smiling.
Appended to this text, are four illustrations, to focus on the
point of difference between public interest decisions on infrastructure
and the cartel-demands.
Figure 1 shows proposed corridors of new, advanced rail routes
worldwide, interconnecting the Americas with proposed Eurasian routes,
and overall defining certain ``corridors'' of potentially new economic
development zones--either alongside, or as intersection nodes. The
principle involved, is the same as that applied in the 19th century to
the building of the U.S. transcontinental railroads: opening up whole
new areas for towns, agriculture, industry, mining. etc. In turn, power
provision--nuclear, advanced-coal, even hydro-generation--could be
sited in an integrated way, benefiting the overall development
``process'' for generations to come.
Figure 2 shows in schematic form, how the siting of oil and gas
lines, power plants, and also electricity transmission systems (by
implication) are most rationally located in connection with towns,
agriculture, industry, and transportation.
Figures 3 shows a map, presented in September 2000 to the House
Energy Subcommittee by Robert Evans, president of Duke Energy Gas
Transmission Corp., on behalf of the Interstate Natural Gas Association
of America. The association is demanding that they have rights to gas
deposits shown. No pretense is made to explain how or why this might
contribute to any overall resources and infrastructure development of
the nation or continent.
Figure 4, for reference, shows the existing natural gas
transportation corridors in the United State. Clearly there is a lack
of adequate capacity to serve California; in a regulated energy
business environment, correcting this would be made a priority. But in
the recent era of deregulation, Houston-based El Paso Natural Gas has
acted to keep transmission infrastructure limited, and is the target of
multiple investigations for bilking California and racking up mega-
profits. El Paso, recently merged with Coastal, accounts for well over
25% of all natural gas moved in the United States.
BINGAMAN-DASCHLE 1996 REPORT: `PUBLIC BENEFIT'
A good taking-off point for understanding the concept of
infrastructure development in the public interest, is a Feb. 28, 1996
report issued jointly by Senators Bingaman and Daschle, ``Scrambling To
Pay the Bills: Building Allies for America's Working Families.'' The
study proposed to recreate a framework in law, which would once again
give substance to the ``General Welfare'' provisions of the
Constitution. Corporations should act in the public interest; their
private profits could and should be made accordingly. This
Constitutional view was a counter to the Conservative Revolution, and
to what Sen. Ted Kennedy called at the time, the threat from the
``most-favored corporations.''
In the five years since then, the networks Kennedy called ``most-
favored,'' have bulled through unprecedented asset grabs in energy (and
other vital supply lines--food, minerals, etc.), and are now conducting
speculation, extortionist profit-rates, and destruction on an
unprecedented scale. It is time to gain control over these processes,
before we find ourselves returning to the worst of the bad old days of
the 19th-century robber barons.
INTERNATIONAL MOMENTUM
At the same time as the Senate is taking up emergency action on the
domestic electricity crisis, there are several key international
diplomatic initiatives, involving rejection of the destructive ``free-
market'' practices, in favor of what will benefit national economic
interests. Energy, transport, and other infrastructure are at the core
of these new policy commitments.
On May 15, Moscow announced a new Eurasian Transport Union,
to provide the institutional basis for nations and companies to
collaborate on priority transportation and related
infrastructure projects. A map of the series of ``Main
Directions'' has been drawn up (available on www.mintrans.ru;
and in EIR magazine's June 1 issue).
On June 15, an historic six-nation summit occurred in
Shanghai, launching the ``Shanghai Cooperation Organization.''
The formal founding meeting was attended by the heads of state
of China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan, and
Uzbekistan. The new ``Shanghai Pact'' agreed to, is committed
to ``safeguarding regional security,'' with mutually beneficial
economic projects as the foundation. Russian President Vladimir
Putin called stronger economic ties the key aim: ``Cooperation
in economics, trade and culture is far more important than
military cooperation.'' Rebuilding the ``Silk Road'' (modern
rail routes) and expanding water supplies, were the particular
goals cited by Kazakh President Nursultan Nazarbayev.
Other expressions of return to national-interest economics, are the
instances of resistance to demands by the energy cartel for
privatization and takeover. For example, in April in Central Asia,
AES--the Virginia-based energy mega-firm, now operating in 20 nations--
was rejected in Armenia. AES had moved to acquire four electric
distribution systems there, and all the power plants, but was stopped.
There were protest rallies in Yerevan, and one-third of the Parliament
came out strongly against the AES privatization as a threat to national
security. There are many other instances of similar resistance.
Thus, the scope of action taken now in the U.S. Senate, will be
crucial to the immediate economic condition for millions in the United
States, and a leadership factor internationally. This is a matter of
strategic concern. As we endeavor to maintain and strengthen alliances
of long standing, and at the same time reach out to nations with which
we have not previously had friendships, the United States of America,
Americans, and American corporations can ill afford to appear like the
heartless, ruthless robber barons whose brutalities became legend.
[Illustrations cited are available in hard copy, from EIR News Service]
______
Statement by William C. Dudley, Chief U.S. Economist,
Goldman, Sachs & Co.
My name is William Dudley. I am the chief U.S. economist for
Goldman, Sachs & Co. It is my pleasure to submit this statement to the
U.S. Senate Committee on Energy and Natural Resources as part of the
hearings on S. 597 and S. 764. The views expressed in my statement are
my own and do not necessarily reflect the positions or views of Goldman
Sachs.
The constituency that favors high electricity prices is a small
one. Only the firms that earn extraordinary profits and their
shareholders benefit much. As a result, the pressure grows to come up
with a solution. In the case of the California energy crisis, the call
is to impose price caps on wholesale electricity rates. The idea is
that this would prevent the type of large price spikes that have
transferred considerably resources to a few power-generating companies.
What's wrong with that? After all, if the caps are set high enough,
the firms involved will still make healthy returns on their investment
and the cost of electricity to the State of California and, ultimately,
its citizens and its businesses will be reduced.
The answer is that the imposition of price caps would have
significant negative consequences. First, the imposition of price caps
would deter the type of investment in electric power generation and
transmission capacity that the State of California seeks to encourage.
That is because price caps would reduce the prospective rate of return
and raise the risks associated with new investment. The expected return
would fall because one tail of the probability distribution of possible
outcomes with respect to electricity rates--the tail associated with
high price spikes--would be eliminated by the imposition of the caps.
But the other tail of the distribution--the one of very low prices--
would remain. After all, no one is proposing that, if wholesale
electricity rates were to plummet, a corresponding transfer would be
made back to the power generating companies. The proposals are for rate
caps. They do not also include floors. That reduces the prospective
rate of return.
The risk would rise because the imposition of price caps is by its
nature arbitrary as to level, timing, and duration. If the caps were
imposed, this would increase investor anxiety that the caps could, in
the future, be lowered, broadened, or extended in terms of duration.
This would increase the level of uncertainty concerning the likely
future rate of return on the firms' investment. This risk would be
reflected in the cost of capital the firms would incur and in their
equity prices.
Lower expected returns, higher risk. This is not the desired
outcome if the goal is to encourage greater investment. In fact, the
imposition of caps would deter the type of investment that would, over
time, act to ameliorate the California energy crisis. Put simply, price
caps would work at cross-purposes to the goal of increased electric
power generation and transmission capacity that is part of the solution
to the California energy crisis.
Second, the caps would deflect attention away from the underlying
problems that have caused wholesale electricity prices to spike: The
lack of adequate power generation and transmission capacity and a
system of price signals that encourage demand management. The spikes in
wholesale electric power prices are a symptom of the underlying
problem--a deeply flawed regulatory regime in which wholesale prices
have been decontrolled, but customers do not see a corresponding
increase in retail prices. The price caps would do nothing to fix this
underlying problem. Moreover, they could do harm by reducing the sense
of urgency needed politically to generate a viable, long-term solution.
Finally, even if one were convinced that price caps were not a
terrible idea in general, one would still be faced with the difficulty
concerning the specifics. When a market system is overridden, then the
devil lies in the details. How high is too high? How long is too long?
How would the price caps be administered? How would they be phased in?
And out?
History has shown quite clearly that price caps distort the
allocation of resources by wiping out the price signals determined in
the marketplace. Command economies such as the late Soviet Union simply
do not work. History has shown that price caps are difficult to
administer and tough to remove. Once implemented, price caps create
their own entrenched political constituency.
In my view, the solution to the California energy crisis lies not
in price caps, but in encouraging the installation of additional
electric power generation and transmission capacity. Imposition of
price caps works against this.
In my view, the solution to the California energy crisis lies in
California businesses and consumers seeing the true economic cost of
incremental power generating capacity. In particular, a broad system of
peak load pricing should be implemented. This would allow businesses
and consumers to see the true costs of incremental power capacity. It
would also encourage demand shifting that would reduce the size of the
wholesale power rate spikes and the need for incremental power
generation and transmission capacity. Moreover, because the demand
shifting would be concentrated among those firms and individuals that
had the lowest costs to shift demand away from the power peaks, the
costs of shifting would be minimized. The goal should be to improve the
quality of the pricing signals sent to consumers and businesses, not to
subvert those signals.
______
June 18, 2001.
Hon. Frank Murkowski,
U.S. Senator, Hart Senate Building, Washington, DC.
Dear Senator Murkowski: Over the past year, we have watched with
concern as California's failure to provide adequate electricity to meet
its needs has threatened to harm the energy supply throughout the West.
In response to this concern, we have advocated policies which would
increase the supply of energy in both California and the West--the only
effective solution to the problem in our nation's largest state.
Accordingly, we are writing to reiterate our strongly held view
that price controls on electricity in the West will not encourage
conservation or the construction of the additional generation necessary
to meet the long-term energy needs of our region. The uncertainty
caused by such government intervention could very well discourage the
development of the new generation we need.
This problem did not occur overnight, in fact California's first
stage two alert was in May 2000. Thus, it is not reasonable to expect a
solution to appear overnight, it will take time for California to work
out of this difficult situation. We support the work they have
undertaken to overcome the many years during which no new generation
was constructed in their state.
We understand the Federal Energy Regulatory Commission (FERC) has
acted unanimously to further address this issue through the existing
process. This further underscores the effectiveness of the existing
regulatory process and eliminates the need for Congressional
legislation in this area. There is considerable evidence that the
combination of state efforts and the extensive assistance from the Bush
Administration is producing a positive turn in the California energy
market. The reports of an energy savings of 11 percent in California
indicate that they have the ability to achieve significant demand
reduction. At the same time, numerous other initiatives by the state
and federal governments have resulted in recent reduction in
electricity prices in California.
Further, in rare instances where there have been attempts to take
advantage of the people of California, since January the Department of
Energy and the FERC have effectively instigated investigations of
wrongdoing and obtained refunds where they are due.
Along with other Western Governors, we have previously expressed
our willingness to support and participate in measures that would
provide short-term relief for California as they move toward the
electric generation necessary to meet their needs. However, we have
also consistently stated our opposition to policies that would help
California at the expense of its Western neighbors. The Clinton
Administration order issued late last year essentially required other
Western states to subsidize California's energy costs by requiring the
sale of electricity from throughout the region into California.
We fear that were region-wide price controls adopted by Congress,
it would provide no benefit to the West but potentially impair demand
seduction, the operation of existing generation and the construction of
generation that is imperative to the energy future of California and
the West.
Thank you for your consideration of our position on this issue,
which is of critical importance to the well-being and economic
opportunity for the people in each of our states.
Sincerely,
Jane Dee Hull,
Governor of Arizona.
Michael O. Leavitt,
Governor of Utah.
John Hoeven,
Governer of North Dakota.
Jim Geringer,
Governor of Wyoming.