From Today's Electricity Daily

FYI. In bizarre times, help can sometimes come from bizarre places. Granted,
we're likely to disagree strongly with Hogan's continued obsession with
Poolco, but the discussion in his paper regarding market power may be
helpful---I've read the Joskow paper, but haven't yet had a chance to review
the Hogan piece.

Steve and I discussed the need to do a focused assessment of the Joskow/Kahn
"analysis" (remember it's Ed Kahn, not Alfred Kahn). Seems that it would be
very useful to fold into that analysis any useful stuff on market power
included in the paper done by Hogan & Co. If, in the end, there ain't
nothing useful, so be it. But seems like there's little downside to
exploring it.

Jim, my understanding is that Alan is already working with the fundamentals
folks on the Portland desk to deconstruct the Joskow paper. Might want to
include the Hogan paper in those discussions and might also be useful to pull
Seabron Adamson into the thinking, too. Ultimately, may be preferable to
have any assessment of Joskow and/or Hogan to come from economists, rather
than directly from us.

Best,
Jeff
----- Forwarded by Jeff Dasovich/NA/Enron on 11/30/2000 11:38 AM -----

"Daniel Douglass" <Douglass@ArterHadden.com<
11/30/2000 11:29 AM

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Subject: From Today's Electricity Daily

Has FERC Gone Far Enough in California?
The Federal Energy Regulatory Commission isn't going far enough in its
attempt to reform the California wholesale electric market, according to a
paper by three prominent economists done for San Diego Gas and Electric. The
paper by John D. Chandley, Scott M. Harvey, and William W. Hogan argues that
FERC should first end the artificial separation that divides the California
Power Exchange and the California Independent System Operator, rather than
worrying about the governance of the two institutions.
"The change in governance may help," says the paper - "Electricity Market
Reform in California" - "but it is not likely to be decisive in the near
term. Explicit guidance from the commission regarding the nature and
trajectory of reforms will be essential if market reform is to be
accomplished within an acceptable time frame." Hogan, of the Kennedy School
of Government, has been writing since 1995 in opposition to California's
market separation.
Also, argues the paper, freeing the California utilities to engage in forward
contracting is no panacea. "The expectation that merely allowing utilities to
participate in forward contracting necessarily would be the solution to high
prices is problematic and not supported by the commission's staff report,"
says the analysis, adding that "putting pressure on buyers to sign contracts
in the present environment may make things worse." If the underlying problem
in California is high cost and low capacity, requiring forward contracting
could harm not only California but also the entire Western U.S. electric
system.
FERC's $150 so-called "soft cap" is a wild card that has the three economists
scratching their heads. "It does not appear in the staff report and there is
little critical analysis of their implications, other than the discussion of
Commissioner [Curt] Hebert." If the intent of the soft cap is to move toward
cost justification for bids above $150/MWh, then FERC is headed into an
administrative morass "that would rival those under wellhead price controls
in the natural gas industry."
If, on the other hand, the soft cap is "truly soft" and would only require
some paper work at FERC and the possibility of a refund if the price is
eventually deemed not just and reasonable, "there might be little impact on
consumer prices (particularly if the principal sources of those high prices
are high costs and regional capacity shortages rather than the exercise of
market power). Even so, the proposal might serve to deter entry and new
investments, thus combining the worst of both worlds, high consumer prices
and little or no new investment."
FERC's proposed order in California also demonstrates confusion about just
what constitutes market power. The paper cites the proposed order's lawyerly,
obfuscatory conclusion that "while this record does not support findings of
specific exercises of market power, and while we are not able to reach
definite conclusions about the actions of individual sellers, there is clear
evidence that in California market structure and rules provide the
opportunity for sellers to exercise market power when supply is tight and can
result in unjust and unreasonable rates under the [Federal Power Act]." The
economists note, "In this regard, the debate is confused because we are
dancing around the words where the truth may be hard to face."
In the case of California, say the economists, there is no evidence of market
power. Even the practice of generators avoiding the day-ahead market in favor
of the real-time market "is a response to bad market design and pricing
incentives (including price caps), but does not demonstrate the exercise of
market power." Nor is bidding above marginal cost necessarily an exercise of
market power, they add. "The distinction between direct marginal cost and
opportunity cost is sometimes lost in the discussion. Hence, a competitive
bidder whose direct cost of generation is $40 but who could sell the same
energy outside California for $100 should bid no less than $100. This would
not be an exercise of market power."