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----- Forwarded by Sarah Novosel/Corp/Enron on 12/29/2000 08:58 AM -----
"Jackie Gallagher" <JGallagher@epsa.org< 12/21/2000 05:01 PM To: <bhawkin@enron.com<, <bmerola@enron.com<, <christi.l.nicolay@enron.com<, <donna.fulton@enron.com<, <janelle.scheuer@enron.com<, <jeff_brown@enron.com<, <jhartso@enron.com<, <Mary.Hain@enron.com<, <sarah.novosel@enron.com<, <tom.hoatson@enron.com< cc: Subject: Possible EPSA Response to FERC's December 15th Order MEMORANDUM TO: Regulatory Affairs Committee Power Marketers Working Group FROM: Don Santa, Regulatory Affairs Committee Chair Joe Hartsoe, Power Marketing Working Group Chair Julie Simon, Vice President of Policy DATE: December 21, 2000 RE: Possible EPSA Response to FERC's December 15th Order Directing Remedies for California Wholesale Electric Markets ? Conference Call Scheduled for Wednesday, January 3rd at 2:00 p.m. (EST) On December 15th, FERC issued an Order Directing Remedies for California Wholesale Electric Markets. The Order retains many features of the Commission's November 1st order outlining proposed remedies for the California markets. However, there are several aspects of this Order which vary from the earlier proposal. EPSA has previously forwarded FERC's press release outlining the major features of the Order, along with a brief memo highlighting the $74 benchmark for finding forward contracts prudent and the January 2nd filing requirement for forward contract offers. We need to consider whether EPSA should seek rehearing or clarification of any aspect of this Order. Filings would be due at FERC no later than January 15th. Based on a review of the order, there are limited issues on which EPSA might seek rehearing, included the continued finding that the rates in California were unjust and unreasonable and the removal of opportunity costs as a basis for justifying prices above the $150 benchmark. We will discuss these issues on our next weekly conference call, which is scheduled for Wednesday, January 3rd at 2:00 p.m. (EST). If you have additional issues you want EPSA to raise, please forward them to Julie Simon at 202-789-7200 or at jsimon@epsa.org before the call. To access the call, dial 1-800-937-6563 and ask for the Julie Simon/EPSA Call. December 15th Order Finding that the "electric power situation in California has worsened since the November 1 order was issued," the December 15th Order retained many of the proposals contained in its November 1st order, as well as new remedial measures. Briefly summarized, the order includes the following measures: ? Elimination of the requirement that California utilities buy and sell power through the Power Exchange (PX). This modification to the California market structure returns the 25,000 MWs of generation owned by the IOUs to the rate jurisdiction of the California PUC. FERC also urges the California PUC to release the IOUs from their obligation to purchase from the PX. The PX's current rate schedules are terminated as of April 30, 2001. This new ability of the IOUs to self-schedule is intended to be the primary mitigation measures to dampen prices in California. ? A benchmark price for wholesale bilateral contracts, set at $74/MWh for five-year, round-the-clock arrangements. The Commission hopes that establishing a level at which purchases can be deemed prudent will encourage the California PUC to do likewise. The $74 benchmark was derived from the pre-restructuring, average embedded cost of generation in California. To corroborate the benchmark, and make adjustments as necessary, the Commission directed all sellers with market-based rate authority to report, no later than January 2, 2001, on a confidential basis, round-the-clock long-term products in annual increments between two and five years which they are willing to offer in California. These informational reports should include price, terms and conditions, and amounts. This information can also be reported on a non-confidential basis. ? Addition of a penalty for scheduling imbalances of more than five percent in the real-time energy market. ? Market monitoring and price mitigation for the residual real-time market, including modifications to the single price auction that preclude bids over $150/MWh from setting the market clearing price. The November 1st Order had proposed this remedy for a two-year period, which has been shortened to four months in this Order. The Commission will convene a technical conference, no later than January 25th, to develop a "comprehensive and systematic monitoring and mitigation program which incorporates thresholds and screens and specific mitigation measures if those thresholds and screens are breached." A proposed plan is due by March 1, 2001 so that it can be in place by May 1, 2001. An important modification to the November 1st proposal, suggested by EPSA, is that the review period for sales over $150 will be limited to 60 days. ? Imposed a reporting requirement on the ISO and PX and jurisdictional sellers on sales over the $150/MWh "breakpoint." ? Elimination of the stakeholder boards of the ISO in favor of independent boards. The directive for replacing ISO board has been modified to requiring the current governing board to relinquish decision-making power and operating control to the ISO management on January 29, 2001, although the governing board can continue to function as an advisory board. The issue will be addressed and resolved in the context of the anticipated January 15th RTO filing. ? Requiring the ISO and the three IOUs to develop and file generation interconnection procedures. Much of the Order is focused on eliminating the PX mandatory buy-sell requirement and incenting more forward contracting, with the goal of shrinking the real-time market to the extent possible. The Commission stated: We cannot emphasize enough that the California Commission must act decisively and immediately to eliminate the requirement for the IOUs to buy the balance of their load from PX. This is the most serious flaw in the market design created by AB1890 and the California Commission's implementing orders. Continued delay in making this fundamental change places all other aspects of our remedial plan at risk, and prolongs the dysfunction of this market. In addition it is critical that the California Commission move quickly to provide the IOUs with approval of their forward purchases. The specter of after-the-fact disallowance for transactions other than PX purchases has certainly chilled the decision-making process and continues to subject California's ratepayers to the volatility of spot prices. California is in a state of economic emergency, and there is little chance that the IOUs will rise to the task if they are not afforded certainty. The Commission went on: Some parties to this proceeding argue that the prices in the forward markets will be affected by last summer's spiraling spot prices and should therefore be deemed unreasonable. We do not agree. Sellers will certainly be aware that supplies of power are tight and that the IOUs are now aggressively seeking to avoid the exposure of the spot markets. Under these circumstances, . . . , we will be vigilant in monitoring the possible exercise of market power. However, suppliers also benefit from the stable revenue stream of forward markets and have every bit as much incentive to avoid the volatility of spot markets as do purchasers. Moreover, suppliers will bargain knowing that the spot market's size will be greatly reduced and that next summer's spot prices will therefore not be fueled by frenzied buyers whose over-reliance on last minute purchases have forced them to bid up the prices to obtain needed supply. On the issue of the $150 "breakpoint," the Commission pointed out that it is intended to be a "safety net" for a vastly reduced spot market. The Commission emphasized that "by design and definition, spot markets must be allowed to reflect the price swings which capture their temporal nature." Since spot market prices are subject to dramatic drops in times of surplus, and increases in times of shortage, "those who remain in the spot market for buying their residual load or selling their residual supply should be there in full recognition of the effects on price of last minute sales and purchases." In discussing plans for careful market monitoring and review of sales over the breakpoint, the Commission announced plans to look at outage rates for the seller's resources, failure to bid unsold megawatts into the real-time market, and variations in bidding patterns. The order recognizes that sellers may bid above their marginal costs in times of scarcity, but does not expressly include the concept of opportunity costs, which were included in the November 1st Order. On an issue that EPSA raised, the Commission concluded that the review of as-bid transactions will close within 60 days after the report is filed with FERC. Unless notified by the Commission or its staff, transactions will be considered final and not subject to mitigation or other refund liability after the 60-day period. In response to requests to revise or clarify the finding in the November 1st order that the flawed market rules in California "have caused, and continue to have the potential to cause, unjust and unreasonable rates for short-term energy," the Commission clarified that the November 1st order "did not find that all rates, at all times, were unjust and unreasonable in these spot markets." The Commission points out that: We have been faced in this case with the difficult question of what makes a market-based rate unjust and unreasonable. There is no precise legal formulation for setting a just and reasonable rate and no precise bright line for when a rate becomes unjust and unreasonable. Under long-standing Supreme Court case law, rates must fall within a zone of reasonableness where the rates are neither so low as to be "less than compensatory" nor so high as to be "excessive" to consumers. While high prices in and of themselves do not make a rate unjust and unreasonable (because, for instance, underlying production prices may be high), if over time rates do not behave as expected in a competitive market, the Commission must step in to correct the situation. The Commission goes on to conclude that it has no evidence of specific abuses of market power. However, other circumstances, such as over reliance of spot markets and a supply and demand imbalance, can lead to rates being excessive relative to the benchmark of producer costs or competitive market prices and a finding that prices are not just and reasonable. In other words, even in the absence of market power abuses, prices are not necessarily just and reasonable. Possible Area for Comment Overall, the December 15th Order is consistent with the comments filed by EPSA in response to the November 1st Order. The Order largely strikes a reasonable balance between principles and political practicality, with the Commission bending very little in response to intense political pressure from California. Specifically, the Order does not find abuse of market power, order refunds, or impose California or regional price caps. However, there are two issues that remain troubling: 1. The Commission reiterates its earlier conclusion that rates were not just and reasonable under certain circumstances in California. While we argued strenuously against this conclusion in our November 22nd comments and the Commission "clarified" its early findings in this Order, the implications of this conclusion continue to have significant adverse political ramifications. Without merely repeating our early arguments, we should consider taking another run at this issue. 2. The November 1st Order expressly provided for opportunity cost as a justification for prices above the $150 breakpoint. The reference to opportunity costs has been deleted from this Order, apparently based on a belief that opportunity costs don't exist in real-time. If we can make a credible case that sellers can sell out of California into other Western markets in a real-time or next-hour market, we may want to ask the Commission to reconsider allowing opportunity costs as a justification for prices over the $150 breakpoint.
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