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----- Forwarded by Chip Schneider/NA/Enron on 02/05/2001 04:57 PM ----- =09webmaster@cera.com =0902/05/2001 04:37 PM =09=09=20 =09=09 To: insights@cera.com =09=09 cc:=20 =09=09 Subject: California's Desperate Attempts to Avoid a Rate Increase - = CERA=20 Alert Title: California's Desperate Attempts to Avoid a Rate Increase URL: http://www20.cera.com/eprofile?u=3D35&;m=3D2241 California=01,s Desperate Attempts to Avoid a Rate Increase On February 1, 2001, the California Assembly approved and the California=20 governor signed a new law intended to secure power supplies for California.= =20 The=20 legislature has been meeting since early January in a =01&special extraordi= nary=20 session=018 to address the power market crisis in the state, and the new la= w=20 represents their first significant piece of legislation. The bill, AB 1,=20 establishes a new mechanism for purchasing power for the state=01,s busines= ses=20 and=20 consumers. Whether the mechanism works will depend chiefly on whether the= =20 limited revenue source used to pay for the power=01*collected by the state= =01,s=20 investor-owned utilities (IOUs) under current retail rates=01*will cover=20 wholesale=20 power market costs incurred by the state. The law reflects the obsession by= =20 California lawmakers with avoiding a rate increase rather than focusing on= =20 the=20 underlying flaws in California=01,s market structure.=20 AB 1 ushers in several important changes to the California market structure= .=20 It=20 also contains several key provisions that capture the political mood in the= =20 state. Highlights of the bill include * Power buying authority transferred. The responsibility for purchasing pow= er=20 for the customers of California=01,s IOUs has been transferred to the Calif= ornia=20 Department of Water Resources (CDWR). The California utilities will continu= e=20 to=20 operate and schedule their remaining generating facilities and contracts. T= he=20 difference between the utilities=01, total load and the sum of their resour= ces=20 (referred to as the utilities=01, =01&net short=018 amount) will be supplie= d by CDWR,=20 an=20 amount of energy that varies between 5,000 and 25,000 megawatts (MW),=20 depending=20 on the time of year, time of day, and utility plant availability. The=20 utilities=20 most recently performed this function themselves, buying energy from the=20 California Power Exchange (PX). However, CDWR has been buying electricity o= n=20 behalf of the IOUs since mid-January, when the near-bankruptcy of Southern= =20 California Edison (SCE) and Pacific Gas & Electric (PG&E) threatened to=20 disrupt=20 supplies to their customers. CDWR is a state agency that manages water=20 reservoirs and transportation systems in the state. CDWR uses an enormous= =20 amount of electricity to transport water across California and provides=20 critical load-shedding capability to the independent system operator (ISO).= =20 In=20 addition, CDWR=01,s reservoirs generate power. The CDWR is thus well integr= ated=20 in=20 the state=01,s electric grid but in the past has not executed large, compli= cated=20 energy purchase arrangements to supply the customers of California=01,s=20 utilities.=20 * Portfolio of transactions. The intent of AB 1 is to allow CDWR to execute= a=20 portfolio of contracts to stabilize the cost of power for the utilities and= =20 their customers. CDWR has until January 2, 2003, to execute contracts. CDWR= =20 will take title to power and is thereby not just acting as a clearinghouse.= =20 It=20 has issued a request for bids and seeks a variety of terms, including=20 monthly,=20 annual, two-year, three-year, and longer. CDWR may also enter into options.= =20 Thus, although CDWR=01,s role is intended to be temporary, the contracts th= at it=20 executes could extend many years. * Power for munis. CDWR may purchase power on behalf of some California=20 municipal utilities at the municipal utilities=01, election. * New payment scheme. CDWR will be entitled to a portion of existing utilit= y=20 rates to pay for the cost of purchased power, interest on bonds, and=20 administrative expenses. This payment stream will be equal to the differenc= e=20 between the generation component currently embedded in utility retail rates= =20 (averaging about $0.07 per kilowatt-hour [kWh]) and the utilities= =01,=20 costs to run=20 their own generation plants, costs of bilateral and qualifying facility=20 contracts, and the costs of ancillary services. The CDWR share of retail=20 rates=20 is referred to as the California Purchase Adjustment (CPA). It is not clear= =20 whether the CPA will cover wholesale power market costs. Current prices for= =20 multiyear power contracts may lie above the CPA. In addition, if investors= =20 believe that the CPA is inadequate to cover costs, the entire program may b= e=20 abandoned.=20 * New bonds. Bonds will be issued to secure power. The total amount of bond= s=20 issued may not exceed four times the CPA. The state will transfer $500=20 million=20 from the general fund to jump-start the program, which begins immediately.= =20 This=20 seed money and all bond proceeds must be recovered by CDWR from the=20 California=20 utilities=01, customers (and municipal utilities if they opt in). * New residential rate freeze. The California Public Utilities Commission= =20 (CPUC) is prohibited from increasing residential customer rates until it ha= s=20 completed paying all outstanding obligations. This locks in the recent 9=20 percent residential rate increase indefinitely. Governor Gray Davis thus=20 keeps=20 his pledge not to increase rates further. * Retail competition. To help secure a stable payment stream for the new=20 bonds,=20 AB 1 enables the CPUC to prohibit the utilities=01, retail customers from= =20 choosing=20 an alternative electricity provider until CDWR=01,s obligations are paid.= =20 Although=20 the CPUC has yet to act on this, the action would effectively halt the=20 competitive retail markets in the state for the duration of the CDWR progra= m.=20 * Taxpayer protection. AB 1 directs that the new bonds clearly state =01&&#= 91; n]either=20 the faith and credit nor the taxing power of the State of California is=20 pledged=20 to the payment of the principal of or interest on this bond.=018 Thus, the = bonds=20 are secured only by the payment stream from utility rates. *No assets affected. The CDWR is granted neither ownership nor control of= =20 utility assets. Ironically, the authority now granted CDWR is what California utilities had= =20 essentially requested last summer when they sought to stabilize electricity= =20 prices by executing a portfolio of transactions. The utilities were never= =20 provided sufficient authority to execute term contracts. In addition, the= =20 utilities have more experience to perform this function than CDWR.=20 Rather than aligning retail rates with wholesale electricity prices,=20 California=20 has sidestepped the issue by simply transferring the electricity purchasing= =20 function. SCE and PG&E are still left to contend with uncollected costs fro= m=20 past energy purchases, although they will no longer incur costs associated= =20 with=20 buying power in the current wholesale market while charging frozen retail= =20 rates. The utility liquidity crisis has not been resolved.=20 It is not clear whether the law=01,s prohibition on rate increases for=20 residential=20 customers can be achieved. The law is silent on rate increases for commerci= al=20 and industrial customers, providing a potential path for recovering=20 higher-than- expected costs. Alternatively, CDWR could conceivably find contracts of=20 sufficient duration and low enough price that the rate pledge is met. These= =20 contracts would lock in today=01,s retail rates for a long period of time.= =20 AB 1 is just one of the steps that state officials hope will restore the=20 power=20 system in California to a more stable footing. Key tasks remain. * California=01,s wholesale market structure, which helped cause the supply= =20 crisis=20 by ensuring that it was not profitable or possible to build generation in= =20 California, remains unchanged. The term contracts CDWR is likely to sign wi= ll=20 provide a mechanism for mainly existing generators to lay off risk but will= =20 not=20 be sufficient to encourage the build of sufficient new facilities. In=20 addition,=20 California=01,s siting and permitting process remains largely unchanged. * The state must still address the need to expedite the development of new= =20 power plants. * AB 1 does not provide for the recovery of uncollected past wholesale ener= gy=20 costs of California=01,s utilities. The state has been negotiating a deal w= ith=20 the=20 utilities that may involve the transfer of generation or transmission asset= s=20 to=20 the state. However, the utilities have achieved recent court victories that= =20 may=20 pave the way to a court-directed recovery of these costs. Recent audits=20 indicate that SCE and PG&E recovered their stranded costs early in 2000,=20 which=20 should have triggered an end to their respective rate freezes. A legal=20 showdown=20 between the utilities and the state on this issue may be inevitable. **end** Follow above URL for full report. ********************************************************* Come Shoot the Rapids with us at CERAWeek2001, "Shooting the Rapids:=20 Strategies and Risks for the Energy Future" in Houston, February 12-16,=20 2001! =20 For more information and to register, please visit=20 http://www20.cera.com/ceraweek/ ********************************************************* E-mail Category: Alert =20 CERA Knowledge Area(s): Western Energy,=20 ********************************************************************** To make changes to your cera.com account go to: http://www20.cera.com/client/updateaccount Forgot your username and password? Go to: http://www20.cera.com/client/forgot This electronic message and attachments, if any, contain information=20 from Cambridge Energy Research Associates, Inc. (CERA) which is=20 confidential and may be privileged. Unauthorized disclosure, copying,=20 distribution or use of the contents of this message or any attachments,=20 in whole or in part, is strictly prohibited. Terms of Use: http://www20.cera.com/tos Questions/Comments: webmaster@cera.com Copyright 2001. Cambridge Energy Research Associates
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