Enron Mail

Subject:California Energy Crisis
Date:Tue, 13 Mar 2001 08:17:00 -0800 (PST)

California=01,s power crisis has generated heated debate over the last seve=
months. Unfortunately, this debate has generated more heat than light. We=
want you to know what the facts are and what we are doing about the crisis.=
Please spend a few minutes reading the following overview on the situation=
and our position on California energy issues.

What happened in California

The source of California=01,s current problem is as straightforward as supp=
and demand. California=01,s economy grew 29 percent since 1998. This incr=
the demand for electricity by 24 percent. At the same time, regulatory=20
restrictions prevented new generation from getting built in the state. So=
demand grew but regulations prevented supplies from being added. The resul=
predictably, is a shortage. This summer, peak capacity will be about 10=20
percent shy of peak demand, leading to further blackouts in the state.

In addition to the supply and demand imbalance, there are two other related=
factors that led to the current crisis. First, the state=01,s regulations=
forced all sales and purchases into the spot market. The spot market for=
power is extraordinarily volatile. The way firms behave in a free market=
when faced with such volatility is to construct a portfolio of purchases lo=
term, medium term and short term, to reduce exposure to this volatility. I=
California, state regulation prevented this strategy. This would be the=20
equivalent of putting the entire state on an adjustable rate mortgage in th=
most volatile interest rate environment imaginable. Everything was fine=20
while the power surplus persisted, but when shortages ensued, every megawat=
was purchased at the sky rocketing spot price.

Second, retail markets were not deregulated. Regulated retail rates remain=
in effect, and stranded cost recovery charges were structured to keep=20
competition out. This meant that utilities were forced to pay high wholesa=
prices in the spot market but were only able to recover costs at the=20
regulated retail rate. They are now nearly bankrupt.

In short, California=01,s problems were caused by regulation, not deregulat=
ion. =20
Regulations prevented competitors from entering the market, prevented new=
generation from being built, and prevented prudent hedging against volatile=
spot prices.

At the time California was developing its restructuring plan, Enron warned=
the state=01,s policy makers about these risks and proposed alternatives, w=
if adopted, would have averted the current crisis.

Enron=01,s Role

Many political leaders in the state have elected to fix blame rather than f=
the problem. Power sellers, including Enron, have been vilified by the=20
politicians and the media. Here are the facts:

? Other than a small amount of wind power, Enron is not a generator in the=
state of California. Every megawatt we sold in California we bought in the=
same market available to other California purchasers. Because we are a=20
market maker, not a generator, we are not biased toward high prices. We ar=
interested only in having a market that works so that we can package produc=
for our customers.
? As a seller to end-use markets in the state, we provided protection from=
the problems the states=01, utilities, and their customers, now face. We=
protected, and still protect, our customers from price volatility.

You may have read that EES recently elected to have the utilities supply=20
power directly to its customers in California instead of procuring power on=
the open market. Early reports mischaracterized this as a =01&turnback=018=
of our=20
customers to the utilities. Here are the facts:

? As a result of a variety of factors existing in the current California=20
market, it made more sense for EES to source power for its customers direct=
from the utilities. This decision reduced EES=01,s market price risk by=20
allowing EES to access lower utility rates.
? EES did not terminate any customer contracts, and our customers continue =
receive the financial benefits of their contract prices.
? EES is continuing to work with its California customers to provide them=
with other energy-related products and services, including assistance in=20
reducing the demand for power, particularly at peak times.

Enron is currently proposing solutions to help California work out of its=
crisis; Enron continues to sign up customers in the state; and Enron=20
continues to actively manage its risks and capture opportunities in Western=
power markets. Enron=01,s primary business is managing risk for our custom=
with solutions customized to meet their needs. There has never been more=
demand for our products and services.

The Solution

The solution to California=01,s crisis is also straightforward. In summary=
, the=20
state must increase supply, reduce demand, reduce reliance on the spot mark=
and shore up the financial stability of the state=01,s utilities.

Increasing Supply

California=01,s process for siting and permitting new generation is nothing=
short of Byzantine. Enron has built plants elsewhere in the country in les=
than a year. In California, it often takes 5 to 7 years. California simpl=
must streamline this process. Ironically, while many of the regulations=20
generators must overcome are aimed at improving environmental quality, the=
regulations are preventing new clean technology from coming online and=20
displacing current plants, which emit 40 times as much NOx. California can=
have abundant power and cleaner air by expediting the permitting of new=20

Reducing Demand

Customers in California today have no incentive to reduce or shift demand. =
They pay the same rate no matter what the market price is. An open retail=
market would trigger demand responses, which would balance supply and deman=
at lower prices than today. California should fully open its retail market=

Reducing Reliance on the Spot Market

In a truly deregulated market, customers would protect themselves from=20
volatile spot prices by purchasing some of their requirements on a longer=
term, fixed-price basis. The state has instead left procurement in the han=
of the utilities, which it has forced to buy exclusively in the spot market=
. =20
Opening the market at the retail level will give customers control over the=
price risk.

Restoring the Financial Integrity of the State=01,s Institutions

The utilities in California are not paying their bills. This has led to=20
greater uncertainty in the market, higher costs, and reduced flexibility to=
arrive at lasting solutions. California must permit its utilities to recov=
their costs so they can pay their bills and invest in the transmission and=
distribution assets necessary to get power from where it is to where it is=

Just as important as doing these things, the state must avoid policies that=
while politically attractive, do not fix the problem or even make matters=
worse. Price caps have been proposed. They don=01,t work; have never work=
and they will not work here. Price caps succeed only in creating shortages=
which then have to be allocated among competing users. Imagine how=20
ineffectively the government would be in determining, for example, whether =
is better to make its limited power supplies available to the Imperial Vall=
or Silicon Valley. Price caps are a surefire way to make the current=20
shortage worse.

The state has also proposed to take over generation and transmission in=20
California. There is no reason to believe, and every reason to doubt, that=
the state will be more effective than free markets at investing in,=20
constructing, operating and maintaining assets. This will also result in=
California tax revenues being spent on power transmission and power=20
generation -- which the private sector can do -- instead of education, road=
and other public goods -- which the private sector cannot do.

As you are approached by people outside the company or are learning about t=
crisis from the media, it=01,s important for you to know this: We at Enron=
continue to serve our customers and we will continue to propose real=20
solutions to the state.