Enron Mail

Subject:Information from Ken Lay at Enron
Date:Fri, 16 Feb 2001 10:07:00 -0800 (PST)

It was a pleasure speaking with you on Wednesday. Based on our conversatio=
this email includes the following:

An Enron contact to discuss developing small-scale generation on Tribal lan=

Our views on the impediments to distributed generation and suggestions on h=
to remove those impediments.

A description of the credit issues that continue to impede DWR=01,s ability=
sign contracts with power suppliers, and options to resolve them. Two=20
possible options for addressing the credit issue are 1) a California PUC=20
order clarifying that DWR will recover its power purchase costs through=20
rates, and 2) an amendment to AB1X designed to accomplish the same goal. I=
have attached talking points regarding the California PUC order and propose=
amendments to AB1X. We believe that an amendment to AB1X is the preferable=

Our assessment of the supply/demand picture in California.

Our suggestions for a legislative package designed to solve both the near-=
and long-term electricity crisis in California. We will deliver to your=20
office today detailed legislative language. In those materials we will als=
identify existing bills that we believe can easily accommodate our proposed=

I hope that the information is useful. Please do not hesitate to contact m=
if you would like to discuss these materials further, or if there is anythi=
else that I can do to assist you.

Ken Lay

Contact Information to Discuss Interest Expressed by Native American Tribes=
in Installing Small-scale Generation on Tribal Lands

David Parquet, Vice-President
Enron North America
101 California Street, Suite 1950
San Francisco, CA 94111
Phone: 415.782.7820
Fax: 415.782.7851

2. Key Barriers to Distributed Generation

Excessive and Unnecessary Utility Stand-by Charges

Solution: The executive orders issued by the Governor on February 14th took=
step in the right direction. Utility stand-by charges have always been=20
designed by the utilities to protect their monopoly position, extract=20
monopoly prices from customers, or both. But there is no reason to limit t=
elimination of these charges to generation facilities that are less than=20
1MW. These limits will only lengthen unnecessarily the time it takes for=
California to close the significant gap between supply and demand and reduc=
the risk of black outs this summer. We would propose lifting the cap by=20
offering amendments to SB27X, which is designed to facilitate development o=
distributed generation.
Excessive delays and costs related to interconnecting facilities with=20
investor-owned and municipal utilities

Solution: The Governor=01,s executive order regarding interconnection is =
step in the right direction=01*D-D-26-01 requires utilities to complete=20
interconnection studies within 7 days. California should ensure that this=
requirement applies to all generation facilities, including distributed=20
generation. In addition, the financial conflicts the utilities face when=
interconnecting generation facilities are simply too powerful to overcome=
through executive orders or other regulations. To the greatest extent=20
possible, California should shift control over interconnection away from th=
utility and place that control with the California ISO. This could be=20
accomplished through amendments to SB 27X.

Permitting and Air Quality Issues
Developers of distributed (i.e., =01&on-site=018) generation that is 50 MWs=
greater must receive certification from the California Energy Commission an=
therefore face all of the impediments to development that large-scale=20
generation faces. =20

Solution: California should ensure that the executive orders (D-22-01 thru=
D-26-01) issued by the Governor to expedite plant siting and maximize plant=
output apply equally to smaller scale, =01&distributed generation=018 facil=
In addition, distributed generation that is less than 50 MWs continues to=
face local opposition. The State should ensure that local, parochial=20
interests cannot block otherwise beneficial distributed generation projects=
. =20
These objectives could be accomplished through amendments to SB27X.

3. Credit Concerns Regarding Authority Granted to DWR in AB1X to Purchase=
Electricity on Behalf of the Utilities=20

Enron responded to the RFP issued by DWR to enter into power contracts with=
Enron is in active discussions with DWR to establish contract terms with th=
goal of entering into a power purchase agreement as soon as possible.
However, ambiguities contained in AB1X have created significant credit risk=
concerns that need to be resolved in order to finalize contract terms.
We understand that the lion=01,s share of counterparties share Enron=01,s c=
risk concerns.
Enron has proposed several options for resolving the credit risk issues and=
is working with DWR to arrive at a solution that is mutually agreeable to=
both sides and that might serve as a template for power purchase agreements=
going forward.

Summary of the Source of the Credit Risk Issue

Ambiguous Ratemaking Authority
The language in AB1X is ambiguous as to whether DWR has any authority to=20
charge California ratepayers for the costs of purchasing power. From our=
analysis of the bill, the language in AB1X appears to leave intact the=20
California PUC=01,s exclusive jurisdiction over ratemaking in California. =
such, suppliers have no assurance that the PUC will agree to include in rat=
adequate charges to cover DWR=01,s costs of power purchases.

Ambiguous Regulatory Authority Regarding Contract =01&Prudence=018
The language in AB1X leaves open the possibility that the California Public=
Utilities Commission could determine that power purchases made by DWR are=
=01&imprudent.=018 On the basis of such a finding, the CPUC could then ref=
use to=20
allow DWR to collect from ratepayers the costs associated with its power=20
purchases. Consequently, suppliers have no assurance that the PUC will agr=
to include in rates the charges to cover the costs of power contracts that=
DWR has entered into with suppliers.
Ambiguous Language Regarding the Ratemaking Mechanism that Will Be Used to=
Recover DWR=01,s Costs of Power Purchases
In addition to the ambiguity regarding ratemaking and regulatory authority=
noted above, the language in the bill is equally ambiguous with respect to=
the specific ratemaking =01&mechanics=018 that AB1X directs the PUC to empl=
oy to=20
permit DWR to recover its power purchase costs. Based on our analysis, it i=
extremely difficult to determine how the PUC would design the rates to ensu=
DWR recovers its power purchase costs. Moreover, as currently drafted, it =
difficult to determine whether AB1X would even permit the PUC to include in=
rates all of the charges necessary to fully recover DWR=01,s power purchase=
costs. Again, this ambiguity raises significant credit risk concerns since=
suppliers have little assurance that DWR will have the ability to recover=
from ratepayers the costs of purchasing power.

Options to Resolve Concerns Regarding Credit Risk=20

We have been working diligently with DWR officials to resolve the credit ri=
issues. We have identified three options:

Amend AB1X
The amendments, which are attached to this email, would clarify that a) the=
PUC would accept as =01&prudent and reasonable=018 all purchase costs incur=
red by=20
DWR, and b) the PUC is obligated to include in rates the charges necessary =
ensure that DWR fully recovers its costs of power purchases. This is the=
preferred option, though we understand that the there may be some political=
challenges standing in the way of amending AB1X. (See attached file=20
entitled, =01&AmendAB1X.doc=018.)

Clarify the Ambiguities in AB1X through an Order Issued by the PUC, and=20
through Contract Language
This is the option that we are currently working with DWR officials to=20
implement. However, it is more complicated and could take significantly mo=
time to implement than the "legislative" fix. We have attached electronic=
copies of the talking points related to the order that the California PUC=
would need to issue under this option. (See attached file entitled,=20

Make Use of Other Instruments Designed to Address Credit Risk
As indicated in our letter responding to DWR=01,s RFP, we are willing to ac=
other forms of credit from DWR. Those options include a letter of credit,=
cash prepayment, or an acceptable form of collateral. DWR officials have=
indicated to us that DWR prefers to pursue the second options. That is, DWR=
prefers to clarify the ambiguities in AB1X through a PUC order and through=
contract amendments.

4. California=01,s Supply-demand Picture Heading into Summer 2001

Both the California Energy Commission and Cambridge Energy Research=20
Associates (CERA), a private sector energy think tank, have issued reports=
showing that California faces a severe supply-demand imbalance. They diffe=
only on how much and how soon additional supply will be made available. Al=
credible sources agree that supply will be very tight throughout the Summer=
of 2001 and that unless a solution is found immediately, blackouts are=20
likely. =20

CEC and CERA both forecast that California will be short of supply this=20
summer by approximately 5,000 MW. These numbers are in line with our=20
estimates. California=01,s supply base currently has a 6% capacity margin,=
below the average 15-20%, which is recommended for reliable system operatio=
in the West. Since the West relies more heavily upon hydroelectric power=
than other regions, reserves are particularly important, owing to the=20
unpredictability of the weather and the dry year the West has experienced t=
date. In the event of a low rain and snow period, the system must possess t=
flexibility to respond to the reduced availability of power supply. =20
California=01,s very low reserve margin makes it especially susceptible to =
requirement. =20

Other reasons for reduced supply for the Summer of 2001 include the early=
draw-down of reservoirs in the continual effort to manage California's seve=
supply-demand gap; emissions restrictions on existing plants; and a reduced=
number of customers who can be curtailed under their contracts with the=20
utilities. Cambridge Energy Research Associates asserts that at the curren=
pace of siting, permitting and construction, adequate supplies will not be=
added to correct the market imbalance until 2003 at the earliest.

CERA predicts that California is likely to face approximately 20 hours of=
rolling black outs this summer. The CEC paints a considerably more=20
optimistic scenario, betting that California will bring an additional 5,000=
MWs on line to meet peaking summer demand. It is our view that California=
should view the CEC's "rosy scenario" with considerable skepticism.

5. Suggested Package of Legislative Proposals Designed to Solve California=
Electricity Crisis

This email offers an overview of our proposed legislative solution. We wil=
deliver to your office tomorrow specific legislative language and existing=
bills that we believe can accommodate our proposals.

As we have suggested throughout the crisis, any solution to California's=20
crisis must focus on four issues:

Increase supply
Decrease demand
Establish a truly competitive retail electricity market
Return California=01,s Investor-owned utilities to solvency

Increase supply--Legislative vehicle: SB28X (Sher)
To site and construct a power plant in Texas takes approximately 2 years. =
Enron and others have completed the entire process in other states in less=
than a year. In California, it takes about six years, or longer.

The Governor=01,s executive orders and Senator Sher=01,s siting reform legi=
are steps in the right direction. Our suggested amendments can improve tho=
efforts by further addressing the difficulties that project developers face=
in securing air emission reduction credits to meet the air permit=20
requirements included in the CEC's certification requirements. Enron=01,s=
proposal seeks to streamline the process for 1) obtaining credits and 2)=20
transfering credits between air districts. In addition, it creates an=20
innovative emissions reduction bank to allow project sponsors to fund=20
emissions in advance of obtaining certification, and permits the affected a=
districts to use those funds to finance projects that will produce the=20
required reductions in pollution emissions.

Decrease demand=01*Legislative Vehicle: AB31X (Wright)
Because of the delay in getting a solution in place in California, closing=
the supply-demand gap through energy conservation and efficiency offers the=
best chance of avoiding blackouts this summer. This can be accomplished mo=
effectively and quickly in two ways:

Buy-down demand
California is tapping into an enormous amount of money from the General Fun=
to finance DWR=01,s power purchases. California could likely reduce demand=
economically by running an auction to determine the payments businesses wou=
be willing to receive to reduce their demand for a sustained period (e.g.,=
through the summer months). DWR could easily run an on-line auction to=20
determine the price it could pay for these demand reductions. To=20
participate, businesses would be required to have the metering equipment=20
necessary to monitor and verify that they are actually achieving the=20
reductions. Enron has developed an on-line auction software package, =01&D=
Bench,=018 that it would be willing to contribute to the effort.

Use Price Signals to Incent Voluntary Curtailment
To be successful, customers need access to the following key elements:

An internet based hour-ahead price posting system to track the market price=
for hour-ahead power in real time.=20
Real-time metering systems for baseline demand and voluntarily curtailment=
Settlement process that allows for market clearing prices of energy to be=
paid for load reduction (=01&Negawatts=018).

The potential benefits of an effective demand response program would includ=

=01&creation=018 of additional summer peaking capacity in California, parti=
in the short term, without requiring construction of additional generation=
reduction of peak or super-peak load on the over-stressed California=20
electric system, thus potentially reducing the overall cost of electricity =
the state.
fostering of demand elasticity without subjecting customers to the full ris=
of hourly market price volatility by passing market price signals to=20
customers and allowing them to voluntarily shed load and be compensated for=

We estimate that we could generate a summer 2001 on-peak demand response in=
excess of 400 MW during certain high cost hours, and a demand response for=
summer 2002 on-peak hours that could exceed 1000 MW. We further estimate=
that the market response to this program from all ESPs could be 2 to 3 time=
that amount. We recommend that the State of California provide rebates=20
directly to customers to fund the installation of advanced metering and=20
control systems that would support load curtailment implementation.

Establish a truly competitive retail electricity market=01*Legislative vehi=
The only customers who were protected from price volatility in San Diego we=
customers who chose Direct Access and signed fixed price deals with energy=
service providers. Ironically, AB1X takes that important option away from=
customers and businesses. It is critical that AB1X be amended to remove th=
prohibition against Direct Access.

Enron's legislative proposal would give customers freedom to enter into a=
direct access transaction, while simultaneously addressing the Department o=
Water Resources' concerns about stranded power costs that might result from=
customer migration. =20

In addition, California will only achieve a competitive retail market when=
the utility is removed completely from the procurement function. Procureme=
is not a utility core competency, as evidenced by the dire financial=20
condition in which the utilities now find themselves. California should=20
therefore begin immediately to phase the utility out of the procurement=20
function entirely, with the goal of having all customers served by a=20
non-utility provider within 36 months. To execute the transition, Californ=
should hold a series of competitive solicitations over the 36-month period =
which competing service providers would bid for the right to serve segments=
of utility load.

Return California=01,s Investor-owned utilities to solvency=01*Legislative =
Utility bankruptcy will not increase supply and it will not decrease demand=
. =20
In short, bankruptcy does nothing to solve California=01,s supply-demand=20
imbalance. In addition, bankruptcy increases the likelihood that consumers=
and businesses will bear the significant financial risks of having Californ=
State government assume the role of =01&electricity buyer=018 for an extend=
period of time. Finally, bankruptcy will undermine both investor confidenc=
in California's energy markets and the private sector's willingness to=20
participate in that market.

California can return the utilities to financial solvency by implementing a=
series of staged rate increases. California should design those rate=20
increases with the dual goal of returning the utilities to solvency without=
=01&shocking=018 the economy or household budgets For example, California c=
amortize the recovery of the utilities=01, past debt over a 5-10 year perio=
d. =20
In addition, the magnitude of the rate increase can be reduced in two ways:=
First, the utilities could absorb some portion of their existing debt in=20
recognition of the risk they accepted when they agreed to the structure of =
1890. Second, California can =01&net=018 the revenues the utilities have r=
from selling electricity into the Power Exchange against the debts they hav=
accrued due to the retail price cap.